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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).
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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).
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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).
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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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References
Zusammenfassung
Irland und Ungarn verfolgen eine Entwicklungsstrategie, die in bewusster Abhängigkeit von Globalisierungsprozessen in Form von ausländischen Direktinvestitionen steht und sich als Paradigma in der Peripherie durchgesetzt hat. Doch dieser Entwicklungspfad hat zu einer ungleichen und abhängigen Entwicklung geführt. Dies ist laut dem Autor das Resultat des mangelnden Gestaltungswillens beider Staaten, für einen gleichgewichtigen Wachstumsprozess zu sorgen. Die historische Analyse zeigt, dass eine auf ausländische Firmen fußende Entwicklungsstrategie nicht ausreicht, um traditionelle Peripheralität zu überwinden. Der Autor fordert eine Reform des Entwicklungsparadigmas, um eine gleichgewichtige Entwicklung zu ermöglichen.