![[ NATO COLLOQUIUM ]](../../../icons/bd-new/bd-serv.jpg){kind=icon}
Colloquium
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The Economy and Some Key Fields
of the Social and Human Dimension in Hungary (1)
va EhrlichResearch Director
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Hungary's Economic LegacyThe economic legacy Hungary inherited at the change of system really had two sides. Three of the grave drawbacks are:
One positive feature was that the Hungarian economy already included many elements of a market economy during the last twenty years. The legal and institutional system was suitable for developing a market economy, and transformation could begin at the historic juncture when political power was transferred. This preparedness for transformation included a positive balance for some human factors: levels of education and culture, European values and life style superior those to be expected at that level of economic development. The Economy in the First Phase of TransitionSome Facts about the EconomyHungary's GDP fell by more than 20% between 1989 and 1993, foreign trade by 23-24%, industrial output by 30%, and agricultural production by 35%. The aggregate fall in services was much less at 7.5%. The bottom appeared to arrive after four years, as GDP grew by 2% and industrial production by 9% in 1994 (see Table 2) (7).Among the worst-hit branches were textiles, metallurgy and engineering, (the last two improved in 1994, mainly for export). The food industry shrank least, while in the services, financial and business services and telecommunications were the liveliest. The decline in agricultural pro-duction and revenue was due to shrinking markets and severe droughts in recent years. Relative prices of agricultural products began to fall sharply in the early 1990s, as did subsidies. The agricultural crisis remains, however, a problem of uncertainty about ownership and usage rights due to the legislative situation and equivocal action taken by the government. The deep recession brought trading losses to many businesses, leaving some unable to function at all. This appeared initially in liquidity shortages, a build-up of reciprocal claims (settlement queuing) and bankruptcy proceedings, the incapacitation of firms, depletion and exhaustion of their assets, and proliferating insolvencies and liquidations. By late 1994, about two-fifths of large firms were affected (including large agricultural cooperatives). The structure of ownership has reflected a rapidly rising number of private firms, partly as a continuation of the "second economy". Registered business associations rose from 13,000 in 1989 to over 90,000 in 1994, the majority privately owned. Meanwhile the 320,000 self-employed entrepreneurs in late 1989 had become nearly 800,000 by the end of 1994. These figures reveal the prevalence of firms, but not the weight of private ownership in the economy. More meaningful are estimates that the 8% of the work force employed in the private sector in 1989 had risen by 1994 to about 50% (this includes private firms created by privatization of state-owned firms or the transformed cooperatives, with full or majority private ownership) (8). This expansion of the private sector and decentralization in the state and cooperative sectors caused a significant change in firms size structure. Data on firms by number of employees suggest the "reverse pyramid" (9) under the old system has been righted. (See Table 3.) Coupled with declining GDP have been powerful inflationary effects triggered by liberalization of foreign trade and prices, the gradual elimination of consumerprice subsidies, and a rising level of taxation. Consumerprice inflation peaked in 1991 at 35%, easing to 23% by 1992, to 22.5% in 1993 and to 19% in 1994. The forecast for 1995 was 28-30%. The overall contraction of the economy was matched by a dramatic fall in employment, down by about a quarter between 1989 and 1994, or by an absolute number of 1.3 mn. (10) Of these, 630,000 became registered unemployed, while the number over retiring age fell by 250,000. The number at working age receiving a pension rose by 120,000 and the number of students and trainees of working age by 110,000. The registered unemployment rate among the active population was 0.6% in early 1990, 2.1% in 1991, 8.2% in early 1992, 13.3% in early 1993 and 12.8 in early 1994 (11), dropping by December 1994 to 10.4%. As usual, unemployment falls hardest on those with poor education, presenting more of a threat to the unskilled and semi-skilled. Manual workers, (two-thirds of the active population including the 7.5% who are unskilled) provide 80% of the regis-tered unemployed (and the unskilled 23%). Regional differences show a characteristic distribution. The lowest rates are in Budapest (nearly 6%) and the counties on the western periphery (7-10%). The reason is not simply that Budapest is the centre and the western periphery the areas most directly linked to developed Europe, but also they are historically the areas whose inhabitants have the highest levels of culture, flexibility and multiple working skills. The least favoured region is near the north and northeast border of the country, where three counties have unemployment of 17-19%. Agricultural conditions there are poor, and these were areas where outsize complexes of heavy industry were sited under the state-socialist policy of forced industrialization. Levels of education and cultivation are lower than average. Naturally, stronger differences appear between smaller dis-tricts, where unemployment rates approaching 40% occur in a few cases. These districts with the worst conditions usually contain a high proportion of Gypsies. The collapse of COMECON, followed by the drift of the Soviet successor states into insolvency, wholly altered the situation in foreign trade. This can be clearly seen in the data on exports and imports in 1989-94 (Table 4). Hungary's exports to ex-COMECON countries fell by 56% between 1989 and 1992, and imports from them by 52%. The initial ability to adapt to the new situation appears in the low fall of less than 10% in the country's total exports over this period, as exports to the market economies rose by a third. Firms which had relied on eastward exports had to boost their exports to the West, even at a loss, to avoid chronic underutilization of their capacity. The sudden liberalization meant there was no obstacle to a switch in imports. However, the volume of imports from the West rose by only 21%, so that in spite of deteriorating terms of trade, the balance was slightly in surplus. Moreover, Hungary became the biggest importer of capital among the ex-socialist countries of CEE. Imported capital between 1989 and 1992 (with accumulated foreign-exchange deposits) exceeded the interest due on Hungary's debts. So the stock of debt fell substantially in the early years of transition. However, 1993 and 1994 became years of deteriorating economic equilibrium. Some firms providing the basis for the export capacity failed, and demand dropped due to recession in the West. Moreover, importers took advantage of the sudden liberalization to gain ground rapidly on the domestic market. This trend was reinforced by oligopolistic positions gained by one or two foreign firms during partial privatization of retail trading. Signs of a fall in exports and rise in imports appeared as early as autumn 1992. These were ignored, however, by economic policy-makers, who in their efforts to reduce inflation, continued slight revaluations of the forints and further loosened monetary constraints on demand. Exports in 1993 fell by almost 15%, while imports grew again, by 12%. The gap continued to widen in 1994. Trade deficits of USD 3.4 bn in 1993 and USD 3.9 bn in 1994 were only partly balanced by capital imports, so foreign debt rose by USD 4 bn over the two-year period. The disequilibrium that followed the equilibrium in the early years of transition can also be seen by comparing domestic utilization with GDP. (See Table 2.) Up to the end of 1992 there was only one percentage point difference between falls in domestic utilization and in GDP, no indication of an upset in equilibrium. The components of total domestic utilization showed customary proportions for times of crisis, with public consumption changing least, personal consumption decreasing rather more slowly than GDP, and gross capital formation falling much faster. In 1993, how-ever, personal consumption rose slightly and gross capital formation increased strongly, producing an astonishing 7% growth in domestic utilization alongside a 1% fall in GDP. In 1994, GDP grew for the first time since the change of system, by 2%, and investment also began to increase, by over 10%. But a shadow was cast over the long-awaited signs of recovery by expectations of domestic utilization in excess of GDP. Apart from the rise in foreign debt, there was a serious public-spending deficit, equivalent to 7% of GDP, and a sharp rise in domestic state debt. Factors Behind the Recession and Economic ProblemsData for the first phase of transition show a far deeper recession than in the slump of 1929-33. Although figures for 1993-4 showed initial signs of improvement, the economy's severe loss of equilibrium threatens to cause an extension of the recession. What lies behind this recession, which has no parallel in its depth or duration? (12)Recession was certainly inevitable according to the historical scenario followed, largely caused by objective circumstances. (13) This is apparent from the similarity in depth and scale of recessions in three (now four) (14) CEE countries with similar histories and populations. Four of these circumstances are fundamental and affect all four countries to varying extents:
Why was the recession slower in Hungary than in the other three ex-socialist CEE countries, even though Hungary was best prepared for transformation? Why did the 1994 economic flare in Hungary have to be cooled when growth of indebtedness became critical again, while growth clearly resumed in Poland in 1993 and in the Czechoslovak successor states in 1994? Why did Hungary's economic situation and creditworthiness ratings decline, so that Hungary, a clear first among the CEE countries in 1990-92, fell to second or third place in 1994? A precise answer to these questions appears to come from those who analyze the transformation process as a choice between shock therapy and gradualism. They argue that Hungary failed to apply shock therapy, and that is why tough measures are now belatedly necessary, compared to the other three countries. Although the explanation contains elements of truth, the authors consider it a simplification that misrepresents the substance of the problem. It is a simplification to say the choice between shock therapy and gradualism was one of political will; accepting or rejecting outside advice. Poland's only option to tackle spiralling inflation and domestic disequilibrium was a combination of a currency reform of sharp de-valuation and price and import liberalization. All honour is due to those who recognized and acted upon this with great economic intelligence, at the price of later political defeat. Czechoslovakia had to pull down a Stalinist edifice that had been carefully restored after the Prague Spring of 1968. The best solution was a sudden, decisive conversion of the appraisal system. Again, all honour goes to those who carried out this great economic and political task. The victorious political forces in Hungary were under no such compulsion because the previous system had prepared the way for transformation. (17) The process was ready to start once transfer of power took place. Thus there was no reason in Hungary for shock therapy. Conclusive and positive changes took place in Hungary with the transfer of power. Parliamentary democracy was established and proved viable. Private ownership became significant and the institutional and operative forms of a market economy were fortified. Integration of the Hungarian economy into the European and world economy made progress, as indicated by the volume of foreign direct investment. More than 40% of foreign capital entering CEE chose Hungary. The transformation would have made more progress, however, if politics had not overridden economic criteria recently on several questions, and the new authorities had managed to act swiftly and decisively at certain critical points. We believe Hungary's relative loss of ground was due to delay. Economic interests were relegated and government measures of great urgency postponed. An important component of the long-delayed measures is "reform of public finance", which was already being mooted under the previous system. This implies a substantial reduction in the state bureaucracy and state care, leading to a cut in state and social redistribution. The significance of public-finance reform goes beyond thrift. Far more important are the effects on the spread and allocation of savings, the balance of payments, the rates of inflation and interest, etc. Implementation is tricky for political stability and painful in social terms, normally entailing job losses and reducing or withdrawing benefits. Delay, on the other hand, will impede measures to ease inflation, normalize interest rates and put savings to economic use, in effect blocking financial and economic consolidation and the commencement of economic growth. The change of system placed public-finance reform on the immediate agenda, in the context of harnessing the state administration and social welfare to the market economy and its potential. Of special concern was the extraordinary degree of state redistribution: government operations extended across 56-57% of GDP in 1989 and 54% in 1990. This meant that budget redistribution exceeded the OECD average by 10-15 percent and the Polish and Czech figure by 5-10 points. (18) Programmes of public-finance reform were drafted, but two finance ministers were dismissed when they tried to implement them. The third finance minister was less concerned with balancing the budget than with gaining popularity before the 1994 elections. After that it was almost tragicomic when the first finance minister of the new coalition fell from grace early in 1995 for trying to push through a programme to reform the public finance. It fell to a new appointee to announce in March 1995 a bail-out package, with full backing from the prime minister and government. Support could no longer be withheld, as spending had reached or exceeded 60% of GDP, the deficit was at 7% of GDP and the balance-of-payments deficit was worsening. (19) The curbs repeatedly postponed for five years could not be delayed any longer. In March 1995 the government started a very successful hard stabilization program. According to preliminary data, GDP increased by 1.5-2%, exports increased by 9%, while imports decreased by 3%, so the trade deficit of USD 3.9 bn fell to USD 2.5 bn. Great progress was made in the property structure, with an accelerated process of privatization. By December 1995 the private sector share was already 60%, while foreign property's share was 10% of GDP. Income from privatization significantly increased, so the budget deficit started to decrease. The budget deficit of 7% of GDP in 1994 fell to 5.5% of GDP in 1995. FDI (Foreign Direct Investment) continued to increase, so by December 1995 the accumulated FDI value was USD 7 bn. Hungary's share of FDI in the CEE is more than 50%. The price the Hungarian population paid in the first year of stabilization was very hard: the standard of living significantly deteriorated, and real wages fell by 12%. Three Key Fields of the Social Human DimensionIn approaching the three key aspects of social and human dimension to be discussed here, attention must be drawn to the conflicts inherent in the current situation.The extent of state redistribution was excessive by international standards and incompatible with the claims of economic equilibrium. We mentioned in connection with the legacy that the proportion of net total income of the population consisting of state social provisions had steadily risen to almost 40% by the end of the 1980s, indeed to 42% by 1993. Proportions such as these could clearly not be reconciled with Hungary's economic performance. Another approach is to make an international comparison of social expenditure as a proportion of GDP. Hungary's figure of 25% is similar to France's and Austria's, surpassed by Sweden's and the Netherlands', and high-er than Germany's or Spain's. The proportion, incidentally, is 15% in the United States and 12% in Japan. (20) The conclusion is clear. Hungary, possessing a far lower GDP per capita than the developed European market economies and dogged by economic stagnation, cannot afford such generosity (or prodigality) in state redistribution and social care. The state and welfare provisions have to retreat. Otherwise the lot of the many unemployed (who often do not register) will become hopeless, income and wealth differentials pronounced, and poverty ever more widespread. Such developments threaten to upset social peace and require handling on a social scale. Attention also needs paying to the inherent conflicts between the three aspects. A saving in one may weigh disproportionally on another. Tightening pension entitlements may increase the number of unemployed and socially unprovided. Restricting unemployment benefit may spread poverty more widely. And what means and methods can be used to tackle the distress in the Gypsy ghettos, which are still only islands today? We cannot promise to identify the optimum solutions in the rest of this study. All we can do is suggest some possible ways to negotiate between opposing dangers - in outline (21) in the following pages (22). Inequalities of IncomeWe recognize in general the justification for society extending income-supplementing supports, as it is inevitable that some groups in society fall behind, and without help, they would lose all means of livelihood and endanger social peace. We can also cite the customary arguments of welfare economics, whereby if we assume the marginal utility of money falls, overall welfare can be raised by redistributing money from the rich to the poor: this allegedly brings less loss of utility to the rich than gain of utility to the poor. These assumptions do not apply when examining income equality. To what extent do social benefits in Hungary tend to even out incomes? In gauging the effects, which dimensions of social stratification merit special attention?With these criteria in mind, the study has examined data from a Hungarian Household Panel (Magyar Hztartsi Panel) survey which concentrated on two aspects:
Important facts established by the survey of household income differences A strong growth in income inequalities in the 1987-92-94 period included increases in proportions of the top and bottom deciles from 5.8 to 7 and of the top and bottom quintiles from 3.9 to 4.3. The size and increase, however, were certainly greater in real life than the survey showed. Declarations of income are well known to be distorted downwards, and the higher the income, the greater the distortion. The numerically verifiable differences of income show the share of the lowermost income group hardly changed, that of the uppermost group appreciably improved, and the relative position of the middle groups declined, matching the socio-economic transformation and real trends. A much bigger jump would be revealed if high-income families had been examined separately. It would be worth covering differences of wealth in future surveys.
Chronic poverty applies to 7% of households, and another 5% if families in the lowest quintile in the subsequent two years, but not the first, are added. These suffered a loss of income of more than 50%, primarily from a loss of work income. Therefore, about 12% of families deserve special attention from the social-policy point of view. Main Conclusions and Recommendations about Social-Policy Effects Neither the survey nor the project as a whole could cover the sum total of income-sup-plement supports or breakdown of sources. Nor could we judge the relative expediency of cuts in public spending, campaigns to gather contributions and taxes due on undeclared income, or combinations of these. Such a survey would require macroeconomic programming that took account of behaviour patterns in the microeconomy. The change of system and the economy's absolute and relative loss of ground must clearly bring a reduction in public spending. We assume initially that items of public expenditure reduced will remain within their existing order of magnitude, with no extreme reductions, say of 10%. Incomes of an insurance nature (e.g. pensions) are discounted as entitlement and sums are based on some kind of indicator of status. With other social benefits, our preference is for stricter application of the principle of need, for two reasons: a cut in public spending must be expected, as mentioned before; and change of system itself makes it inappropriate to continue applying the principle - right as a citizen - to these social benefits.
Other surveys of chronic poverty show the effect to be greater than average on Gypsy families (not distinguished in this survey). Their economic activity is much lower, and the rate of unemployment much higher, than average. The compound disadvantage of a lower level of schooling, concentration in deprived regions, and discrimination on the labour market calls for special programmes targeted on them. Employment, Labour Market and UnemploymentMain data on employment and unemployment may give the impression that Hungary has simply adjusted to some kind of European norm.Output, which has fallen substantially, has been accompanied by a somewhat greater fall in employment. So productivity has slightly improved. The proportion of economic activity in the 15-64 age group in 1994 was 65%, 2% less than the European OECD average and 5% less than in Germany, but more than in Italy or Spain. Full employment in 1989 gave way to unemployment, which peaked in 1993, and in 1994 fell to just over 10%, by the ILO's sampling method. (24) This conforms with the average for Central and Western European OECD countries. A "European" system operates on the labour market. It includes passive measures of assistance (e.g. insurance) and active measures to improve the position of the unemployed on the labour market. These cost 2.0-2.5% of GDP, again in line with European standards. Characteristics of labour-market trends in Hungary
From 1st Q 1992 and 4th Q 1994, the average length of unemployment rose from 28 to 53 weeks, and the proportion of long-term unemployed (over one year) from 16.7% to 44.4%. In 4th Q 1994, 29% of unemployed had been so for at least 18 months. In 1992 Hungarian unemployment showed a comparatively low rate of entry (0.5%) and a low rate of exit (5.2%). In the latter group, 2.2% were finding employment and the rest withdrawing from the labour market. Comparable rates: West Germany, 0.9% and 16.3%; France, 0.9% and 11.4%; and United Kingdom, 1.0% and 13.5%. So Hungary's high rate of unemployment derives not from a high rate of redundancy, but from a very long duration of unemployment. This explains the emphasis placed on income support after entitlement to unemployment allowance ceases. In December 1994, 37% of the registered unemployed received unemployment allowance and 40% earnings-substitution benefit. The customary personal features of the unemployed include: low level of schooling, relatively advanced age, a greater likelihood of unemployment among women, etc. Regional differences in unemployment have increased concurrently with the rise in the rate. Regional differences also show up in changes in labour supply and labour demand. Comparing figures for 1991-3, regional differences in Hungary exceeded those of the European OECD countries, and were also high by comparison with other CEE countries. Research suggests that these differences can be explained by attributes apparent at the beginning of the move to a market economy, above all by proxy variables for the regional entrepreneurial capacity. According to a 1993 survey, unemployment and chronic unemployment were relatively low in places with higher than average numbers of individual entrepreneurs and private cars per capita, higher tax payments, a better water system, more phones, more educated population, and greater in-migration. Hungarian figures suggest that the dominance of large-scale state-owned industry generated high unemployment only where this dominance coincided with less than average entrepreneurial capacities. Other research shows that the position of employment-deprived regions correlates closely with the state of the Gypsy community. (25) In 1994, almost two-thirds of the Gypsy population of working age lived in communities with an unemployment rate of over 20%. Over 60% of Gypsies in these communities who had regular employment in previous decades had lost their jobs. In small rural communities of counties with a high Gypsy population, migration in recent years has speeded up the turnover of population. The deprivations deriving from the lack of inherited cultural traditions, schooling and skills accumulate, leading to seemingly irreversible processes of disintegration and decay and leaving truncated societies incapable of self-organization. (26) Hungary began to prepare modern labour-market institutions, benefit systems, active employment programmes, financing structures and arbitration mechanisms in the 1980s, based on European examples. These measures, adopted while labour was still scarce, produced a lavish system of supports and benefits, difficult to curtail later. Along with problems of assembling an apparatus and general inexperience, this caused frequent changes of regulations due to dysfunctional side-effects. The 1990 Employment Act originally set very liberal unemployment allowances, which could not be sustained and were tightened up several times as unemployment increased. Especially dysfunctional was the minimum level of benefit, initially set at the minimum wage, and rising to a level of HUF 8,600 (USD 72) a month in 1993, at which it remains. If average base earnings failed to reach this minimum level, the allowance was set at average earnings. Research showed that the benefit level in March 1992 was at 87% of claimants' previous earnings, reduced by March 1994 to 70%, or with inflation, the real ratio in 1994 was about 60%. Since the typical unemployed were able to find only low-paid jobs, even this relatively low level of benefit was a disincentive to employment. In addition, the act allowed claimants to receive wages up to the prevailing minimum rate without loss of benefit. (27) Young first-job seekers with higher or secondary education, who have failed to find a job in three months and registered as unemployed, can receive 75% of the prevailing minimum wage for up to six months. Changes in the rules have made this a higher level of benefit than the guaranteed minimum entitlement of the insured. (28) It is hardly surprising that the number of unemployed school-leavers grew rapidly, to over 70,000, or 13% of all unemployed, by mid-1994. This has similarly acted as an incentive to register as unemployed. (29) Understandably, the most popular of the active programmes for the unemployed is the training and retraining. This programme provided support for 60,000 people in 1992, 88,000 in 1993 and 92,000 in 1994. It offers the additional incentive of receiving 10% more than the unemployment allowance as "earnings-substitution benefit". Important conclusions can be drawn from the compositions of these trainees and the registered unemployed. The training focuses on the young, standing in for the school system. (30) Nor does the programme concentrate on the least skilled, going mainly on extension training of those who already have skills. (31) Conclusions and Proposals Economic and social policy have decisive importance to employment policy in a country like present-day Hungary. It is inconceivable for the qualifications, abilities and enterprise of the labour force to be fully utilized while the economy is shrinking or stagnating. Favourable conditions for normalizing employment, and steadily adjusting the labour force with changes in the economy, will not prevail until the economy has stabilized and steady growth has begun. Such adjustment is held up by an enormous problem: to reduce the discrepancy between the old structure, and the new demand structure now forming or due to form with the arrival of growth. The significant factor for this adjustment is clearly the effort made by labour, and only secondarily the assistance of the training and labour-market system. Examinations of crisis regions, and the employment tensions that have built up, show the limitations on employment and social policies. At most they can prevent a social explosion. They cannot stop or reverse socio-economic erosion. Their problems highlight the importance of comprehensive, economic and social-policy concepts of regional development and of concentrated efforts and resources on applying them. Only a fully comprehensive approach can hope to begin alleviating the problem of the impoverished Gypsy areas as well. A rational influence on the supply of labour through close collaboration between employment policy and education is important. One way is to broaden school education and vocational training to take account of likely changes in demand for labour. Various programmes to assist school-leavers in finding jobs can be built into this effectively. The marked change in the job structure justifies an expansion of part-time employment. This would also allow employees to undergo needed extension training and retraining. Cooperation and coordination between employment, education and social policy is required. The time and scale of retirement, including regulations on a new pension system, are also important. There are significant correlations (interchange) between employment, retirement and unemployment. Unless these relations and their results are weighed and the financial alternatives and consequences estimated, no economically rational, socially acceptable concept can emerge. The study (32) detailed proposals for a rational reorganization of the system of labour-market methods. They can be summed up as justifiable reductions in entitlements and benefits that decrease the system's liberality and dysfunctional effects without ending supports. The second treatment for unemployment takes the form of earnings-substitution benefit, which supplements insurance entitlements and improvement of chances on the labour market. Earnings-substitution benefit must be incorporated as soon as possible into a comprehensive system of social provisions, reflecting close cooperation and division of tasks and responsibilities at local and national levels between labour authorities and social institutions. Pension System and Pension ReformThe forebear of Hungary's present pension system is the Pensions Act of 1975, since frequently amended. It is worth underlining some aspects of this inherited system.
Main features of the current pension system Under the present system, for every 100 paid in wages, the employer pays a contribution of 44 and the employee a contribution of 10 to the social-insurance system. The combined contribution of 54 is shared between the pension and health-care systems in a ratio of 30.5:23.5. This makes the level of contributions misleading, high by European standards, as the base of calculation in most European countries is gross compensation - in this example 144. So the combined contribution is 21.2%, slightly over the mandatory rates of 14-18% applied in European OECD countries. (34) The 1994 deficit of the fund, after discounting non-pension payments, was 2%. (35) The fund's outstanding claims increased in 1994 through arrears of contributions, so it is incorrect to say the present pension system cannot be financed under present conditions. The main factor behind the growth in expenditure is eligibility. The number eligible for pensions equalled the number over retiring age in 1985, and in 1994 exceeded it by 16%. But only 91% of those over retiring age were pensioners: the difference is explained mainly by the spread of disability pensions and (after 1989-90) by redundancy-related early retirement. In 1994, 2,480,000 persons received pensions, of whom 2,247,000 were eligible in their own right and 233,000 as widows. (36) Of the former, 780,000 (31.1%) were disability pensioners, half being below retiring age. Altogether 25.7% of the country's inhabitants, or 54% of the economically active population, received pension benefit of some kind. Hungary's retiring age has been 55 for women and 60 for men, lower than the usual 60/65 or 65/65 in OECD countries. Hungary, however, has among the worst death figures in Europe: life expectancy at birth in 1992 was 73.7 years for women and 64.6 years for men. This compares with ranges of 78-81 for women and 71-74 for men in Western European countries. (37) One fundamental criterion of a pension system is the replacement rate - the relation between pensions and net earnings. This can be measured in two ways: taking the average of either newly established pensions or all pensions as a percentage of average earnings in the given year. Both rates steadily rose in Hungary, peaking in 1988 (at 80% and 70%, respectively) and then declining sharply to 54% and 65%, respectively, in 1994, in the middle range for Europe. By comparison, the "all pensions" rate in 1993 was 72% in Germany, 67% in Sweden, 60% in Denmark, and 49% in the Netherlands and the United Kingdom. The structure in 1994 showed signs of equalizing efforts and of haste and uncertainty in policy. Measures to maintain the purchasing power of pensions have accentuated equalizing tendencies in the system, as the use of minimum and maximum pension increases has favoured low pensions over higher ones. The basis for pension revaluation since 1991 has been the average nominal net rise in earnings, so the real value of pensions follows that of earnings, currently tending to fall rather than rise. The frequently changing methods of calculating new pensions and revaluing old ones strongly affect replacement rates for specific groups of pensioners and thereby the structural cross-section of pensions. In this respect, those with low pensions who retired long ago do best, while recent retirees with high pensions are relatively worst off. Pensions and pension-like expenditure made up 7.1% of GDP in 1980, 9% in 1990, 11.2% in 1992 and 11.5% in 1994. Interpreted in insurance terms, the figure in the last three years of about 10%, is not exceptional by European standards. In the last few years, the figures for Austria and Italy have been about 14% of GDP, Greece and France 12%, Germany 11% and the United Kingdom less than 10%. Need for Pension Reform The equalized nature of the present system confuses and blurs two fundamental components: the insurance principle and social cohesiveness. With a market economy, a pension system of such proportions becomes economically irrational and socially unfair, because there is little link between contributions paid over a lifetime and the age of retirement or benefit received as a pensioner. The Hungarian pension system is obsolete. Its underlying principles were laid down in a period of full employment, paltry inflation, high welfare provision and clear expectations of sustained economic growth and constantly rising living standards. So pension reform has to establish a system aligned and adjusted to the market economy, directly linking future pensions with contributions paid by future retirees. Only this can provide incentives to fulfil contribution commitments. Either linked or unlinked with this system, there has to be a separate system of social care for the elderly. The New Pension System A general, mandatory pension scheme that applies equally to every earner, is a socially accepted asset of European civilization, and the need and justification for it can hardly be questioned. International experience shows that even in a country like Hungary at a medium level of development, the majority of society consists of wage and salary earners. Under an employment-related pension scheme, mandatory savings in the form of contributions from earnings are the sole basis and source for pensions. The remarks that follow refer to a pension scheme of this kind. The first question about the future pension system is whether it should be a capital-reserve system, financed from capital accumulated from contributions of the insured, or a pay-as-you-go system (like the present one in Hungary), where payments at any time are supported by contributions being paid at that time. The latter may include a degree of capital accumulation, but this acts as little more than a buffer against swings in revenue and payments. There are numerous theoretical and practical arguments for and against the two kinds of system. In Hungary's case, however, we do not consider theoretical criteria decisive: there is an existing system covering over two million people, under which 30% of the adult population are already entitled to benefits. The decisive question, therefore, is whether there should be a capital-reserve or a pay-as-you-go system in the light of existing commitments. Rejection of pay-as-you-go in favour of a capital-reserve system would incur unacceptably high financial sacrifices. If it were assumed to be possible to terminate present pension claims and those due in ten or 15 years, leaving them nothing (or some minimal grace-and-favour allowance), a capital-reserve pension system might be adopted in the future. The reasons for rejecting this course hardly need explaining. If, on the other hand, the pension scheme for younger age groups of earners were diverted towards a capital-reserve system, while the pension expectations of older earners and the retired were met, the earning age groups would have to pay double. This double burden might be postponed by raising loans, but at Hungary's present level of indebtedness, no responsible government could take on such a vast additional commitment. We therefore see it as clear that Hungary's reformed pension system must be of the pay-as-you-go type. This conclusion is further supported by practice in most countries in Europe, which have a mandatory general system of pension insurance covering the whole earning population. There is hardly an example of any employing a capital-reserve system. The explanation for dominance of pay-as-you-go, apart from Eur-ope's humanitarian traditions, may be the huge capital losses suffered in both world wars by private insurance funds, which then failed, and had to write down or write off their earlier commitments. The pension study uses modelling to outline a new pension system for introduction in about the year 2000. (38) Calculations show it would be possible to finance the future pension commitments if the present system were consistent, in other words if the pension fund also received income to cover recipients of maternity benefit, university and college students, and soldiers on national service. (39) Without making the system consistent in this way and with the present reduced level of employment, the pension system under present conditions would operate at a small loss. (40) This could be covered by a slight reduction in the replacement rate, a short postponement of pension revaluation, a rise in the retirement age, or a combination of these. Assuming slight economic growth after 1996 and a concomitant slow rise in employment, the pension system under present conditions could break even in 1999. Equilibrium could then be maintained with slightly reduced rates of contribution. The model calculation for the system to be introduced in 2000 suggests a replacement rate of 60-65%. According to calculations applicable to Hungary today, the present pension contribution rate could fall from the present 30.5% to 25-27%, which in terms of the calculation formula generally applied in Europe means a reduction from 21.2% to 16-18%. The proposal counts on the self-employed and entrepreneurs making set minimum payments into the fund. It also assumes there will be an upper limit to contributions to the new pension system. The reformed system would naturally leave room for private insurance on a strictly commercial basis. This would mainly allow the more prosperous strata in society to augment their pensions or receive a lump-sum payment on retirement. State action would only be required in the form of legislation to protect the interests of policy-holders by ensuring commercial integrity in a field involving long-term financial commitments. The study of the pension system outlines new, transparent and easily applied methods of determining and registering the personal reversion under the new pension system and establishing the level of annual payments adjusted to the cyclical development of the economy. (41) The reversion would be expressed as a point score depending on the total registered contributions paid by the insured and the age on retirement. The greater the sum of the contributions, with accumulated interest, and the higher the age of retirement, the higher the score. The value of the payment in forints for one point would be set by actuarial means. The nominal size of this forint equivalent would be indexed annually to the rise in consumer prices and the performance of the economy. The score multiplied by the current forint equivalent yields the benefit entitlement in a particular year. The study appends to this solution a proposal for integrating pension reversions under the old system into the new. The benefit under the old system would be assigned a certain score in the transfer year, and this would incorporate existing pensioners into the new system without further ado. This, of course, would not alter in any way the distortions of the old pension structure or its strongly equalized structure by comparison with the new. Experts consider these distortions cannot reasonably be remedied, since it would cost an estimated 7% of the total present pension payments to make the adjustment. The outlined system of employment-related pensions would not solve the problem of old people who failed to obtain pension rights, wittingly or through no fault of their own, or whose pension was insufficient to maintain them. These are problems of social care, not pension provision. However, an outline is included of a way to solve them through a two-pillar system of compulsory pensions. One pillar would be the minimum basic pension, payable as a citizen's right to those over a certain age. The other would be the strongly differentiated, employment-related pension already described. The study specifies the cardinal points in this solution. Though integrated into the pension system, the part of the basic pension payments not backed by contribution payments would be a charge on the state budget (perhaps covered by a set proportion of income-tax revenue). So the study on pension reform finally outlines as an alternative both two and three-pillar systems. In the latter case, the first pillar would be the basic pension fulfilling a welfare function, the second the employment-related, pay-as-you-go pension, and the third the auxiliary, expressly commercial, capital-reserve pension. As mentioned before, the study includes extensive model calculations and measures out the conditions for the system.
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