Max Gebhardt: Corruption Does Undermine Democracy

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At the end of last month we watched thousands of Russians, possibly tens of thousands by some counts, take to the streets in Moscow and dozens of other cities across Russia to loudly voice their opposition to the level of corruption in Russia. Most commentators were surprised by both the number of those who turned out and especially surprised that protests occurred outside of Moscow in the heart of “Putin’s Russia” where there is little support for opposition parties.

There was a political component in the organizer, Progress Party leader Alexey Navalny, but the message of opposing systemic corruption is not inherently liberal or conservative in nature. A government free of corruption is, in many ways, the ultimate populist message – it is a statement of the will of the people to ensure that every penny of tax revenue goes to supporting them, and not to enriching politicians and their

There was a political component in the organizer, Progress Party leader Alexey Navalny, but the message of opposing systemic corruption is not inherently liberal or conservative in nature. A government free of corruption is, in many ways, the ultimate populist message – it is a statement of the will of the people to ensure that every penny of tax revenue goes to supporting them, and not to enriching politicians and their cronies, and that economic policy is set in the interests of the people, not the interest of politician’s pockets.In many ways, today’s Russia is seen as a possible future for Hungary.

Eschewing transparency in favor of increasing state involvement in the free market, preferring investment from domestic firms over foreign firms, and supporting a cadre of crony-capitalists “allies” has been an approach taken by many populist leaders like Putin, and appears to be the preferred way of doing business for Viktor Orban and others who see Russia as a model of success. While populist economic policies can help some key constituencies, it results in sub-optimal domestic economic growth in the long

In many ways, today’s Russia is seen as a possible future for Hungary. Eschewing transparency in favor of increasing state involvement in the free market, preferring investment from domestic firms over foreign firms, and supporting a cadre of crony-capitalists “allies” has been an approach taken by many populist leaders like Putin, and appears to be the preferred way of doing business for Viktor Orban and others who see Russia as a model of success. While populist economic policies can help some key constituencies, it results in sub-optimal domestic economic growth in the long run, and ultimately can deprive the people of their future. Like most populist plans, they might seem acceptable in the short term, but they fall apart over time.

Spring is the time of year for the US Embassy to update their Investment Climate Statement. Hungary’s outlook over the last three statements is pretty clear – Hungary is falling short on growth:

“FDI has lagged in recent years despite these advantages, and obstacles to investment remain. Businesses cite the lack of stability in the tax and regulatory environment, including retroactive application of taxes, the lack of consultation with stakeholders before implementing major regulatory and tax changes, as well as both corruption and favoritism in public tenders and sectors with heavy GOH influence. Multinationals identify a short supply of qualified labor, specifically technicians and engineers, as the single largest obstacle to FDI in Hungary. According to OECD and EU studies, test results of Hungarian elementary and high school students have worsened in recent years, which might impact the quality of the labor force over the medium term.

Hungary had been a leading destination for FDI in Central and Eastern Europe, reaching a peak FDI inflow of USD 7.4 billion in 2005. Following the 2008 global financial crisis, the pace of FDI slowed and Hungary’s comparative advantage over regional competitors diminished. Over the past two years, however, FDI grew in Hungary, with inflows reaching USD 3.4 billion and USD 6.5 billion in 2013 and 2014, respectively. This marked increase was largely composed of profit reinvestment by existing investors, capital transit between company headquarters and their Hungarian affiliates, and recapitalization of banks that had sustained losses. Only a few new investors entered the market.” —2016 Investment Climate Statement

These kind of documents are created through long collaborative editing processes between officials in the embassy and officials in Washington, ensuring that every sentence is something that the United States can stand behind as an official position. The message on Hungary is clear – lack of transparency is leading to poor economic growth. Tenders are not open and transparent, which leads to higher costs to the taxpayer in exchange for supporting economic “allies” such as construction firms and suppliers that are seen as supportive of the government. Rule and tax changes intended to bash evil “multis” makes foreign firms and investors less likely to expand their operations in Hungary.

Foreign firms support millions of jobs in Hungary, and while some might believe that it is sufficient for Hungary to only support export-oriented firms, it misses the point that all foreign firms have a choice of where they can operate. Uncertainty of operating environment is a key reason why many firms have chosen to expand operations elsewhere in Central Europe, while leaving their Hungarian operations unchanged. More to the point, perceptions matter more than reality when making decisions about the future, and the more that Hungary builds a reputation for opaque procurement and decision-making, the worse perception of corruption will get, and the more firms will look elsewhere when seeking to do business.

These decisions build up over time. Microsoft chose to wind down a Komarom facility that made outdated Nokia products in 2014, rather than invest money shift production to different products. That shutdown wiped out some 1,800 jobs, and the replacement –BYD’s much lauded investment in an electric bus plant — will only create 300 jobs. Those 300 new jobs are over two tranches that could take months or even years to realize. Other manufacturers are similarly not reinvesting in retooling existing plants to make newer products, eventually those decisions will lead to a similar end where the parent firm will have to choose whether to retool or shut down, and shut downs become more and more likely the longer this goes on.

Portfolio.hu has a wonderful piece that I agree with whole-heartedly, so it isn’t just me saying this. The US Embassy tasks economic reporting officers with covering “transparency” issues, not corruption issues, because transparency is the gateway to ensuring better business and government cooperation. If investors cannot clearly see Hungary’s policymaking, they have an increased risk of operation.

The protests in Russia should not just be seen as people frustrated with the level of corruption, they should be seen as people frustrated that their economic future is being stolen from them in the interest of supporting inefficient policies. If Hungary continues down this road, they will certainly encounter the same result.

Written by Maximilian Gebhardt

The author is an economic advisor who previously worked at the U.S. Embassy in Budapest

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