Philipp Fink, Characteristics of Indigenous Firms in:

Philipp Fink

Late Development in Hungary and Ireland, page 171 - 177

From Rags to Riches?

1. Edition 2009, ISBN print: 978-3-8329-4173-4, ISBN online: 978-3-8452-1720-8

Series: Nomos Universitätsschriften - Politik, vol. 168

Bibliographic information
171 4.2.4 Characteristics of Indigenous Firms Sass/Szanyi (2004: 378) see the main reason for the low linkage capability of Hungarian firms in the fragmented structure of indigenous enterprise. The Hungarianowned enterprise sector is characterised by a large share of underfinanced and small firms. They are engaged in labour-intensive forms of low technology production, display low productivity and are mainly oriented towards the internal market. As a result, they are technologically and financially incapable to supply TNCs with the necessary quality and quantity of desired products. The average size of 12 employees per Hungarian manufacturing firm (HCSO 2004a) indicates the small-sized nature of Hungarian enterprise in general. Following EU definitions in employment size (Major 2003: 120), 71% of firms in Hungary were defined as small and medium-sized enterprises (SME) in 2002 (MET 2002: 86). 76% of which are indigenous firms (Major 2003: 121). A more detailed analysis of the Hungarian enterprise structure reveals a very large degree of fragmentation. As shown in the following table, firms in Hungary are predominantly micro-enterprises, who accounted for the largest proportion of employment (26%) in 2000 (MET 2002: 88). Table 5 EU-15 and Hungarian Enterprise Structures, 2000 (%) EU-15 Hungary a Firms Empl. GVA Firms Empl. GVA No Employees - - - 30 11 1 Micro-enterprises b 89 28 21 59 26 9 Small Enterprises c 9 22 20 7 14 9 Medium-sized Enterprises d 1 17 19 3 16 18 Large Enterprises e 0.3 33 40 1 33 64 Definitions based on tax receipts. EU-15 definitions are additionally defined by turnover thresholds. a total number of Hungarian firms in 2000 was 289,081 (HCSO 2004a); b < 10 Employees; c 10-49 Employees; d 50-249 Employees; e > 250 Employees Source: MET (2002: 86), Eurostat (2002: 2). The divergence of the Hungarian enterprise structure is most evident in terms of the contribution to the country’s GVA. A further striking feature of the Hungarian enterprise structure is the large proportion of enterprises without employees. These single-employee firms account for a considerable share of employment. Although micro-enterprises employ over a quarter of the workforce, they contribute to less than a tenth of Hungarian value-added. Similarly, value added contributions of small and medium sized firms are below EU-15 averages. GVA in Hungary mainly originates form large firms of which 92% were foreign-owned in 2001 (MET 2002: 90). 172 Similarly, capital endowment is highly concentrated in large firms, which accounted for 80% of registered equity in 2001 (MET 2002: ibid). This discrepancy illustrates not only the labour-intensiveness of production and the low productivity of the indigenous firms, but it also emphasises the dependency on TNCs to induce economic growth in Hungary. Socialist Legacies and Transition The reasons for the divergence of the Hungarian enterprise structure from EU-15 patterns are linked in part to socialist legacies originating from the particular nature of the former socialist market economy. The so-called “Second Economy” was officially legitimised in 1985, which allowed the establishment of private enterprises in order to overcome distribution and production bottlenecks. The majority of these firms were situated in the service sectors, specialised in export and import trade (Szanyi 2004: 195). Furthermore, the high level of fragmentation is in part the result of the transition process. The high incidences of one-man firms can be related to the perverting effects of the tax system. The state attempted to subsidise entrepreneurial investment and employment with corporate tax levels, which were lower than income taxes on wages. As a result, employees established single-employee firms to offer their services to their previous employers. Furthermore, employers encouraged this form of outsourcing in order to lower their wage and social security costs. Hence, a fair share of the large number of firms established since 1990 were in fact pseudo-firms, which were founded to evade taxes and social security contributions (Szanyi 2004: 196-197).139 As a result of theses past developments, the majority of Hungarian firms are located in those branches of the economy, which are not defined by high productivity and high technology products (Szanyi 2004: 198). They are predominately situated in retail and trade, personal services, real estate and the non-dynamic branches of the manufacturing sector (MET 2002: 89). Accordingly, 50% of the workforce employed by indigenous firms in the manufacturing sector were situated in the low technology branches in contrast only 6% were employed by indigenous firms producing high technology products in 2002 (Fazekas/Ozsvald 2004: 5). With the exception of large firms, the majority of enterprises are oriented towards the internal market. Exports in 2001 were dominated by large enterprises, which accounted for 83% of all export sales and were predominately foreign-owned. Medium-sized enterprises were responsible for 11% of exports, small and micro enterprises had an export share of 2.6% respectively (MET 2002: 99). Furthermore, successful Hungarian firms have been increasingly displaced from international markets 139 The numbers of self-employed grew by 42% and the number of enterprises increased by 84% between 1990 and 2000 (Szanyi 2004: 195). 173 as a result of TNC acquisitions. In 1992, five of the largest 10 Hungarian exporters were indigenous firms. By 1998, this figure dropped to only three firms (Mihályi 2001: 68). Product Market Competition However, those indigenous firms oriented towards the internal market were not able to benefit from rising personal consumption since 1996. Instead, they have been facing increased competitive pressure from imports (Szanyi 2004: 196). As a result of the country’s premature trade liberalisation (Stephan 1999: 213), Hungary’s import penetration rate has increased vastly. Imports of goods and services accounted for 22% of domestic demand in 1991. This figure had grown to almost 78% by 2002, meaning that internally produced goods and services only accounted for 22% of domestic demand (OECD 2006a). Furthermore, indigenous firms have also been experiencing increased competitive pressure from TNCs selling into the domestic market. In 1995, the share of domestic sales of TNC affiliates stood at 34%; by 2001 this figure reached almost 40% (HCSO 2004a). In the manufacturing sector, the growth of TNC shares in domestic sales was even larger. Between 1995 and 1999, foreign-owned firms increased their domestic manufacturing sales from 38% to 56% (ÉltetQ 2001: 10). The effects of competition have been negative, as econometric data suggest that market-snatching has detrimentally influenced the productivity of indigenous firms (Bosco 2001: 64; Görg et al. 2006: 14). Stricken by the transition process, indigenous firms have been unable to adjust to competition from imports and TNC domestic sales, resulting in a large level of firm destruction. In Major’s (2003: 121) sample of 756 SMEs in 1992 only 20% had survived the initial transition phase of the Hungarian economy and constituted nine percent of his sample in 2000. Furthermore, smaller enterprises are more inclined to make losses due to their smaller average size, low endowment with capital and the low level of technology utilisation (MET 2002: 102-103). Hence, they are not able to attain sufficient economies of scale (Szanyi 2004: 198-199). Factor Market Competition Indigenous firms are also faced with rising wage pressure as a result of TNC labour market demand effects, which contribute to their operational difficulties. The lack in indigenous competitiveness can be illustrated by comparing the unit labour costs for both sectors. In the manufacturing sector, unit labour costs were 40% lower for foreign-owned firms in comparison to indigenous firms in 1999 (ÉltetQ 2001: 13). Hence, subsequent wage rises since 1998 have additionally pressurised indigenous firms due to their labour sensitive cost structure (Szanyi 2004: 199-200). 174 The large inflows of FDI have led to above average remuneration levels for those employed by TNCs. Incomes for those members of workforce employed by foreign firms are, therefore, higher than the national average. Pay differences are defined by the higher productivity of the technologically superior TNCs and by profits made in the export markets and not by the firm’s performance in the host economy. Consequently, an increasing wage gap between both sectors of the economy has evolved. As shown in the following table, the average wage paid by a foreign-owned firm stood at 157% of the average salary in 2002 compared to 127% in 1995 (HCSO 2004a). Table 6 Wage Gaps in the Hungarian Economy, 1995, 2002 (€, %) a 1995 2002 TNC Average Ratio TNC Average Ratio Agriculture b 3,201 2,512 127 5,569 4,188 133 Mining 4,010 4,550 88 8,160 6,760 121 Manufacturing 3,802 3,234 118 7,795 5,850 133 Utilities 4,486 4,100 109 10,392 8,668 120 Construction 4,980 3,295 155 9,086 4,496 202 Trade and Retail 4,212 3,096 136 9,305 4,947 188 Tourism 2,716 2,548 107 6,007 3,556 169 Transport c 5,848 3,486 168 13,433 6,881 199 Real Estate d 5,261 3,947 133 11,972 5,480 220 Services e 4,993 3,934 125 7,697 4,361 177 Total Economy 4,164 3,268 127 8,639 5,496 157 a Wage gap ratios are defined as yearly average earnings in TNC employment as a percentage of total gross yearly wages; b includes fishing and forestry; c includes postal services and telecommunications; d includes business services; e includes private education, social, community and health services. Sources: Own calculations based on HCSO (2004a); Exchange rates taken from WIIW (2004). Wage gaps are even more pronounced in individual sub-sectors. Whilst the wage gaps for the foreign-dominated manufacturing branches are less distinct, differences in pay are high in those sectors and branches of the economy, which are dominated by indigenous firms (construction, other market services, retail). Furthermore, branches and sectors dominated by indigenous firms displayed a decrease in wages, 175 which is linked to lower profits as a result of increased competition and lower productivity (KöllQ 2002b: 84).140 A de-compositional analysis of the wage gaps between both sectors found that foreign firms were able to pay higher wages than indigenous firms due to their superior endowment with capital, higher profits and cutting-edge production technologies as well as higher industry rents, their higher productivity and larger size (KöllQ 2002a: 90). However, the wage gap was lower or negligible in Hungarian firms, which exhibited similar productivity levels compared to foreign firms (KöllQ 2002a: 87). However, as discussed very few indigenous firms meet these requirements. Kertesi/KöllQ (2001: 21) found that in comparison to indigenous firms highly skilled employees with a minimum of three years employment were overrepresented in foreign-owned firms. Furthermore, Czabán/Henderson (2003: 179) report of cases where TNCs take advantage of on-the-job training by indigenous firms through poaching their qualified personnel via higher wages. This poses a further impediment to indigenous innovation, as indigenous firms are forced to pay wage rates at similar levels to those in TNCs in order to recruit and to retain qualified personnel. More attractive TNC employment effectively reduces the amount of available highly skilled labour prepared to work for Hungarian-owned firms. Hence, superior TNC wages effectively resembles a barrier-to-entry to lucrative foreign markets, as it impedes Hungarian firms to develop their own competitive technologies (Szanyi 2002b: 13). Political Neglect Political neglect or the lack of state capacity to cater for indigenous development is a fourth factor, determining the state of Hungarian-owned enterprise. The low level of linkages displays the failure of successive government programmes designed to augment the level of substantive cooperation between foreign and indigenous firms. Although de jure non-discriminatory in nature, the industrial support schemes are de facto biased towards large firms. The eligibility requirements for industrial aid focus on minimum thresholds in terms of investment sum, employment and output. Industrial policy aimed at micro and small enterprise development is heavily centralised and suffers from low financial resources, transparency and accountability (Karsai 2003: 285). According to an EU study, the Hungarian SME sector suffers from inadequate access to cheap finance, technology and information on market possibilities and skill up-grading. Additionally, small firms are deterred from increasing investments due to the high level of interest rates as a result of the state’s low inflation policy, which aims to fulfil the Maastricht criteria (MET 2002: 10, 18). 140 These business sectors and branches were agriculture, light industry (textiles, leather, wood), tourism and construction (KöllQ 2002b: 84). 176 The small size of indigenous firms also explains why the main beneficiaries of the extensive investment and innovation subsidies offered by the Hungarian state were large firms and hence TNCs. In 2001, 91% of the tax benefits went towards large sized firms of which over 90% were foreign owned (MET 2002: 109). ÉltetQ (2001: 9) estimates that 96% of the tax concessions benefited TNCs in 1999. Nevertheless, despite their apparent operational difficulties, the total volume of revenues from indigenous firms was higher than the taxes paid by TNCs (ÉltetQ 2001: ibid).141 Similarly, within the context of transfers form the European Structural Funds, the state has increasingly tried to remedy the poor standards of institutionalised R&D. The government has devised a co-financing scheme. Tax incentives are awarded in order to increase the co-operation between private enterprise and state research institutions. However, it remains questionable, if indigenous firms will be able benefit from these measures. Again the majority of incentives are related to minimum eligibility requirements in terms of investment sum, workforce size and turnover, thereby excluding small sized indigenous enterprise (Beer 2003: iv, 79). Furthermore, agency rivalry and ill-defined goals produce an incongruence of aims and an overlapping of tasks (Sass/Szanyi 2004: 384; MET 2002: 131). Attempts to increase the level of linkages between TNCs and Hungarian firms repeatedly failed. As a result, the state focussed on enhancing technology spillovers via the creation of supplier clusters around large TNC exporters. Again policy makers overestimated the need for local supplies by foreign-owned firms. The programmes failed due to the lack of interest of the targeted TNCs to participate. Low participation points to the motivation of the investing TNC to restrict access to its product knowledge in order to safeguard its competitive position (Görg et al. 2006: 1; Hymer 1976: 20). The failure to win the interest of TNCs also illustrates the limited power of affiliates to choose or define co-operation with indigenous firms (Szanyi 2002b: 18). The decision-making power of an affiliate within the corporate hierarchy of the TNC was overestimated by the initiatives (Sass/Szanyi 2004: 381-382). Moreover, the programmes concentrated on developing linkages to a single integrator firm, which increased the possibility of the dependency of indigenous suppliers on a single client (Sass/Szanyi 2004: 383-385). Similarly, local content requirements were circumvented by TNCs, as they encouraged the location of their preferred suppliers. In difference to their EU counterparts, large Japanese investors in vehicle production and automobile supplies were forced by EU regulations to increase their local content of production in order to benefit from duty free exports to EU markets (Bartlett/Seleny 1998: 324).142 141 According to ÉltetQ (2001: 9), 114.4 billon HUF in corporate taxes originated from indigenous firms in 1999. In contrast, foreign-owned firms were taxed 110.4 billion HUF, of which firms with more than 50% of foreign-owned equity paid 88.5 bn HUF. 142 As illustrated by the Japanese car manufacturer Suzuki, which managed to reach the 60% local content requirement. However, only 20% of supplies were delivered by Hungarian firms whilst 20% were produced “in house” and a further 20% were sourced from the firm’s traditional suppliers, who had located to Hungary (Sass/Szanyi 2004: 370-371). 177 4.2.5 Dichotomy of Industry in Hungary The analysis of the economic results of the FDI-led development regime shows that the large levels of FDI inflows into the Hungarian economy supported the structural transformation of the previous socialist economy. The large inflows into the manufacturing sector of the country allowed the reorientation of the economy towards exports for EU markets. The success of the attraction policies is visible in the high levels of TNC penetration and illustrates the large capacity of the state to attract export-oriented FDI. However, this capacity is only partial, as the analysis of the indigenous sector shows. The industrial policy instruments are biased towards larger foreign-owned firms. State capacity is too low to either tackle the distortions to the productive structure or cater for an increased incorporation of TNCs into the Hungarian economy. Largely unable to benefit from industrial aid, Hungarian firms show distinct performance gaps in comparison to foreign-owned firms. They are concentrated in low technology sectors and their production is labourintensive. Their primary orientation towards the internal market and poor capital endowment act as a growth constraint, resulting in low profitability. They remain small in size and are, therefore, unable to develop scale economies. Under-funding also results in their inability to develop new technologies and products, which could enable them to access profitable markets. Furthermore, they are faced with product and factor market competition stemming from imports and TNCs. Their resulting underperformance contributes to their unattractiveness as potential co-operation partners to TNCs. The lack of co-operation is also the result of the quasi-oligopolistic firm-specific competitive advantages of TNC affiliates. The defence of these competitive advantages keeps local cooperation to a minimum. Consequently, the level of spillovers from investing TNCs to Hungarian firms is low. Hence, two distinctly different sectors have evolved creating a dualistic industrial structure, whereby the modern foreign-dominated export sectors vastly outperforms the indigenously dominated sector. As result, the foreign-owned sector dominates the Hungarian economy. Hence, the role of the TNC in Hungary as a harbinger of international competitiveness to the host economy and acting as a transfer agent for technological progress is questionable. Moreover, due to the export-oriented nature of the foreigndominated sector of the economy, economic growth and Hungarian development is dependent upon the impulses stemming from the TNC export markets, illustrating the continued peripheral nature of FDI-led growth in Hungary. 4.3 Hidden Inequality in Hungary Whilst not singularly responsible for the rise in income inequalities during the transition process, the inflows of capital-intensive FDI into Hungary since 1990 have been the drivers of structural change within the economy. As a result of the high

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