ifdp · April 30, 1993

Industry Restructuring and Export Performance: Evidence on the Transition in Hungary

Abstract

Robust and numerous small and medium-size enterprises (SMEs) are a hallmark of the market economy and development of these firms is an integral part of the structural transformation of the economies of East-Central Europe (ECE). Data for Hungary on changes in the size distribution of firms and their importance for output and employment indicates that industry restructuring is taking place. One measure of the success of restructuring is export performance. That is, increased exports by those industries undergoing restructuring suggests that the process is creating firms that are successfully responding to market demand and international price signals. Disaggregated industry data from Hungary support the propositions that restructured industries and industries that have historically been important for domestic and export markets have become more important exporters. Moreover, it appears that Hungarian exporters have been effectively exploiting the switch from the CMEA market and the opening up of the border with the European Community. However, perhaps because of the short time series of the investigation, it is too early to tell whether Hungarian exports will respond systematically to standard determinants of trade, such as changes in EC income and relative prices.

Board of Governors of the Federal Reserve System International Finance Discussion Papers Number 445

May 1993

INDUSTRY RESTRUCTURING AND EXPORT PERFORMANCE:

EVIDENCE ON THE TRANSITION IN HUNGARY

Valerie J. Chang and Catherine L. Mann

NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other. than an acknowledgment that the writer has had access to unpublished material) should be cleared with the author or authors.

ABSTRACT

Robust and numerous small and medium-size enterprises (SMEs) are a hallmark of the market economy and development of these firms is an integral part of the structural transformation of the economies of East-Central Europe (ECE). Data for Hungary on changes in the size distribution of firms and their importance for output: and employment indicates that industry restructuring is taking place. One measure of the success of restructuring is export performance. That is, increased exports by those industries undergoing restructuring suggests that the process is creating firms that are successfully responding to market demand and international price signals. Disaggregated industry data from Hungary support the propositions that restructured industries and industries that have historically been important for domestic and export markets have become more important exporters. Moreover, it appears that Hungarian exporters have been effectively exploiting the switch from the CMEA market and the opening up of the border with the European Community. However, perhaps because of the short time series of the investigation, it is too early to tell whether Hungarian exports will respond systematically to standard determinants of trade, such as changes

in EC income and relative prices.

Industry Restructuring and Export Performance: Evidence on the Transition in Hungary

Valerie J. Chang and Catherine L. Mann!

Robust and numerous small and medium-size enterprises (SMEs) are a hallmark of the market economy and development of these firms is an integral part of the structural transformation of the economies of East-Central Europe (ECE). In market economies, these enterprises produce the bulk of the output, employ most of the workers, and are key exporters. These enterprises, however, were incompatible with centrally planned systems because they made the price setting problem too complex.

The new SME sector in ECE will be created from new private enterprises, foreign joint ventures, and restructuring of the large state-owned enterprises. Data on changes in the size distribution of firms and their importance for output and employment indicates that industry restructuring is taking place. One measure of the success of restructuring is export performance. That is, increased exports by those industries undergoing restructuring suggests that the restructuring is creating firms that are successfully responding to market demand and international price signals.

What evidence is there that correlates export performance and industry restructuring? Using a disaggregated industry data set for Hungary, we find some support for the propositions that restructured industries and industries

that have historically been exporters have become better export performers.

‘The authors were Economist and Senior Economist in the International Finance Division at the Federal Reserve Board when the paper was written. Chang is now with the Emerging Markets Group at Salomon Bros. The paper was written for the International Seminar on International Trade, co-sponsored by NBER, CEPR, and ECARE, and held in Brussels in December 1992. This paper should not be

interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or its staff.

2 Moreover, we find some support for the proposition that Hungarian exporters have been exploiting the switch from the CMEA market and the opening up of the border with the European Community. However, perhaps because of the short time series of the investigation, it is too early to tell whether Hungarian exports will respond systematically to market determinants of trade, such as changes in EC income and relative prices.

The paper proceeds as follows: The next section discusses why SMEs are important in market economies and critical to the transition from central planning. This section also contrasts data on SMEs in selected industrial market economies with data from several countries in ECE. Section IJI presents a profile of how Hungarian industry has changed since the country made the formal commitment to the market economy in 1989 and discusses which industry sectors might be poised to become the SME engines of growth and employment. Section IV compares and contrasts the historical pattern and composition of Hungarian exports with more recent export behavior. An important aspect is the collapse of the CMEA. Section V outlines the empirical investigation of how industry characteristics, measures of industry restructuring, and standards determinants of trade have affected Hungary's exports to the European Community. Section VI reports the results of the

empirical investigation and concludes.

Ii. Small and Medium-size Enterprises

Small and medium-size enterprises play a key role in market economies. As manufacturers, SMEs produce intermediate inputs and niche-market final goods that increase the flexibility and efficiency of overall production (as in just-in-time inventory methods) and add to the diversity of goods in the marketplace. As distributors and wholesalers for domestic and international trade, SMEs link larger firms to each other and to the final consumers. As the competitive core of the economy, they channel and refine the price signals between p:oducers and consumers. Chart 1 shows a stylized representation of the manufacturing sector in a market economy with a network of small and medium-size manufacturers, wholesale distributors, and retailers linking consumers and large producers.

Because SMEs increase the complexity of linkages throughout the economy , they were fundamentally incompatible with central planning. Indeed, the dotted lines in Chart 1 broadly indicate how the state-owned enterprises (SOE) in ECE absorbed smaller manufacturers into the large SOE. Because total output, not variety, was the objective function of the central planner, there was no need for small manufacturers of diversified final goods. Moreover, vertical integration of input producers into the SOE was advantageous because it reduced the number of inter-firm interactions where prices would need to be set by the state. Wholesale and retail trade in the planned economy were particularly circumscribed because their operations, according to Marxist teachings, did not add value to the economy. In addition, incorporating the distribution function into the SOE further simplified the price setting

problem. ?

2For more on these points see Mann 1991.

However, SMEs are particularly important for the transition to a market economy. SMEs that can respond more quickly to changes in market demand will help clarify and stabilize prices. This is particularly important since relative prices were fixed and irrational under central planning and the forces of supply and demand were consistently muted. SMEs will take up labor as large SOEs try to rationalize input ratios. Moreover, SMEs will offer a new range of products and services which should increase consumer utility and producer efficiency as well as increase competition.

While it is clear that SMEs are important, both in market economies and to the transition of centrally planned economies, it is difficult to define exactly what they are. In terms of employee size, production complexity, and economic power, they lie somewhere between the "atomistic" entrepreneurship and the large corporation. Compared to an entrepreneurship, the small or medium-size manufacturer has greater fixed investment and working capital requirements, greater demand for organized labor input (as in a team or on a production line), and requires more management. Unlike a large corporation, the small or medium-size firm has little power over prices in input markets, although it may be able to exploit the elasticity of demand in the output market, depending on the product. In the context of a market economy, such an enterprise could be a subsidiary of a larger corporation if it retains independent decision-making authority.

In the context of an economy in transition, SMEs could arise from restructured state-owned enterprises, as well as from joint ventures and new private enterprises. The key ingredient is whether the unit responds to the economic forces of demand and relative prices. We expect that joint ventures

and new enterprises, because they start out privately owned, will respond to

5 these forces in order to maximize profit opportunities. But a significant fraction of the firms in economies in transition are still owned by the state. For several reasons, which will be discussed in greater detail in Section III, we expect that downsized state-owned enterprises also will respond to economic forces, and act as if they are private, even if they remain owned by the state.

Statisticians in market economies often use the number of employees ina decision-making unit as the measure of firm "size". (An alternative measure, for example, would be sales revenue.) Decision-making units with less than 50 or 100 employees are "small", between 50-100 and 500 or so are "medium", and others are "large". These delineations are only very rough indicators of responsiveness to market forces or degree of market power. Production and distribution technologies, lines of corporate financial and managerial control, extent of international competition, and size of domestic market will also affect the size distribution of firms in any country.

Table 1 measures the importance of SMEs in selected market economies in terms of manufacturing employment and the value of manufacturing output.

Small ard medium-size firms are the core of the market economy. More than 85 percent of firms are small, employing fewer than 100 people. But these small firms account for about a third of manufacturing employment and about a quarter of the value of manufacturing output. Medium-size firms (between 100 and 500 employees) account for about 10 percent of firms and an additional one-quarter to one-third of employment and output. In all, enterprises with fewer than 500 employees account for at least 95 percent of the firms and more than two-thirds of manufacturing employment, and produce between 50 and 60

percent of manufacturing output.

Moreover, data for the Netherlands indicate that small and medium-size manufacturing establishments also account for about 50 percent of manufactured export sales.?

Data in Table 2, which shows similar statistics for selected ECE economies, confirms the lack of SMEs. The CSFR, which embraced planning and state ownership most actively, started their transition with the most centralized manufacturing structure; SMEs practically did not exist. In 1987, 70 percent of enterprises were large or mega, accounting for 91 percent of employment.

Hungary's industrial structure had some SMEs because, beginning some two decades ago, the state encouraged the development of industrial cooperatives in an effort to increase productivity. The industrial cooperatives looked like SMEs: industrial cooperatives of less than 500 employees accounted for 83 percent of employment and 86 percent of output. Moreover, it appears that they were more productive. Looking at data on productivity of large firms in market economies and in Hungary, large firms in Hungary used 83 percent of the employed to produce 40 percent of total output, while in the market economies 30 percent of the employed produce 40 to 50 percent of total output. This Suggests that the SMEs in Hungary were much more productive than the large firms, and confirms the extent to which the large enterprises will have to shed labor in the transition process,

However, while there were about equal numbers of cooperatives and enterprises as of 1988, the cooperatives were not very important for the manufacturing sector, accounting for only 15 percent of workers and 8 percent

of the value of industrial output. Therefore despite the state-directed

~-___—_——_—

°For more on the role of SMEs in the global economy, see Aharoni 1991.

Table 6

EC Imports from Hungary Ranked by Value

1989 Value 1991 Rank Category mil ECU Rank Category 1 Meat 265.8 1 Apparel 2 Apparel 236.1 2 Machinery 3 Machinery 170.8 3 Meat 4 Electric machinery 130.3 4 Electric machinery 5 Iron & steel 130.1 5 Plastics 6 Organic chemicals 119.4 6 Organic chemicals 7 Plastics 80.8 7 Footwear 8 Live animals 79.6 8 Iron & steel 9 Fuel 79.4 9 Furniture, prefab buildings 10 Footwear 76.4 10 Iron & steel articles Memo: . Total Imports fron Hungary 2587.0

Source: EC, External Trade, Series C

Value

mil ECU 331.0

310.0 263.6 232.6 157.8 142.0 131.8 115.6 114.1 113.0

3624.5

Table 5

Hungarian Exports (billions of forints)

1987

TOTAL EXPORTS 450.2 Ruble exports 214.4

of which:

machinery 100.8

raw materials & semi-finished goods 48.3 Non-ruble exports 235.8

of which:

raw materials & semi-finished goods 94.9

agriculture & food 57.8 Sources: Statistical Yearbook, various years

Hungarian Central Statistical Office

1989

571.3

215.9

100.0 50.4

355.4

157.8 95.6

1990

603.6

158.9

69.7 33.1

444.7

195.8 114.1

Table 4

Profile of Hungarian Industry, 1990

Industry employ/ share share share export/ Group plant output employ # firm sales Light 79 12 22 28 26 Engineering 84 21 33 49 39 Chemical 106 20 5 9 15 Food Process 115 20 16 8 22 Build.Matls 127 3 5 4 13 Elec. Energy 341 7 3 1 1 Metallurgy 374 10 5 2 35 Mining 379 6 6 1 4

Shares represent share of total industry figure.

Source: Hungarian Statistical Yearbook

share FDI

Table 3

Industry Restructuring as Measured by Average Employees per Plant

Industry Group 1989 1990 %change Mining 446 379 15 Electrical Energy 364 341 6 Metallurgy 703 374 47 Engineering 122 84 31 Building Materials 179 127 29 Chemical Industry 166 106 36 Light Industry 108 79 27

Source: Hungarian Statistical Yearbook.

Table &

The Small & Midsize Manufacturing Sector in East-Central Europe: Importance for Manufacturing Employment and Output

Size of Enterprise

CSFR Small &Mid Large Very Large Mega (1-500) (500-1000) (500-2500) (>2500) % of enterprises 10 20 45 25 Z_of employment 2 7 35 56 Hungary Small Medium Large Mega (1-100) (100-500) (500-2000) - (>2000)

Z of enterprises

1. state-owned 30 29 34 10

‘2. industrial 67 31 2 ) cooperatives

3. overall 50 30 16 4 manufacturing

% of employment

l. state-owned 1 9 43 47

2. industrial 23 60 17 0 cooperatives

3. overall 4 17 39 40 manufacturing

Z_of output

l. state-owned 1 9 39 52

2. industrial 29 57 13 0 cooperatives

3. overall 3 13 37 48

manufacturing

Note: Data are for 1988.

Table 1

The Small & Midsize Manufacturing Sector in Market Economies: Importance for Manufacturing Employment, Output, and Exports

Size of Establishment

Smalls Medium Large Mega” (# of employees) % of establishments 90 8 2 <1 % of employment 28 34 24 14 “2 of output 21 32 31 16 United Kingdom (1-100) (100-500) (500-1000) (>1000) % of establishments 95 5 1 <1 % of employment 34 35 13 19 Japan (4-100) (100-500) (500-1000) (>1000) % of establishments 97 3 <1 <1 % of employment 56 30 7 14 % of output 34 40 13 26 Korea 5-100 100-500 >500 % of establishments 91 8 2 % of employment 33 29 40 % of output 16 26 57 Netherlands (10-100) (100-500) (>500) % of establishments 86'° 12 2 % of employment 32 26 42 4 of output 15 26 59 % of exports 25 27 48

Note: Data are for 1982 for the United States; 1988 for the United Kingdom, 1983 for Japan; 1982 for Korea, and 1986 for Netherlands.

CHART 1

Stylized Representation of the Manufacturing Sector in a Market Economy

H —

Retailer .

23 Mann, C. "Industry Restructuring in East-Central Europe: The Challenge and the Role for Foreign Investment", American Economic Review, May 1991. Rodrik, D. "Foreign Trade in Eastern Europe's Transition: Early Results",

NBER working paper no. 4064, May 1992.

Szabo, T. Interview in

Transition, The newsletter about reformin economies, aS ee eee tter about relorming economies vol. 3, no. 7, The World Bank, July-August 1992.

CHART 1

Stylized Representation of the Manufacturing Sector in a Market Economy

H aes

—(45 :

23 Mann, C. "Industry Restructuring in East-Central Europe: The Challenge and

the Role for Foreign Investment", American Economic Review, May 1991.

Rodrik, D. "Foreign Trade in Eastern Europe's Transition: Early Results",

NBER working paper no. 4064, May 1992.

Szabo, T. Interview in

Transition, The newsletter about reforming economies, vol. 3, no. 7, The World Bank, July-August 1992,

CHART 1

Stylized Representation of the Manufacturing Sector in a Market Economy

( Retaiter )

NBER working paper no. 4064, May 1992.

Szabo, T. Interview in Transition, The newsletter about reformin economies, ————S ee te bout rerorming economies vol. 3, no. 7, The World Bank, July-August 1992.

CHART 1

Stylized Representation of the Manufacturing Sector in a Market Economy

il |

23 Mann, C. "Industry Restructuring in East-Central Europe: The Challenge and the Role for Foreign Investment", American Fconomic Review, May 1991. Rodrik, D. "Foreign Trade in Eastern Europe’s Transition: Early Results",

NBER working paper no. 4064, May 1992.

Szabo, T. Interview in

Transition, The newsletter about reformin economies, SSS RS EE Se pOout reforming economies vol. 3, no. 7, The World Bank, July-August 1992.

References

Aharoni, Y. "The Role of Small Firms in an Interdependent World", presented at the IBEAR Fourth Annual Research Conference on "The Globalization of

American Firms" Los Angeles, June 1991.

Blanchard, 0. et al. Reform in Eastern Europe, WIDER, The United Nations

University, 1991.

Csepi, L. and E. Lukacs. "Privatization in Hungary", presented at the Third CEEPN Annual Conference on Privatization in Central and Eastern Europe

Ljubljana, Slovenia, December 1992

Gatsios, K. "Privatization in Hungary: Past, Present, and Future", CEPR

Discussion paper no. 642, March 1992.

Mann, C., S. Lenway, and D. Utter, "Political and Economic Consequences of Alternative Privatization Strategies", mimeo presented at "Markets, States,

and Democracies" conference at U.C Berkeley, February 1993.

Mann, C. "Small and Midsize Enterprises in the United States and East-Central Europe: Common Challenges in the 1990s", presented at the IBEAR Fourth Annual Research Conference at USC in Los Angeles, June 1991; forthcoming in T.

Agmon, The Globalization of American Firms,

21 VI. Results of the Empirical Investigation

Table 8 shows the result of this cross-section time-series regression. On balance, we find evidence that restructured industries are exporting more to the EC, although the response of exports to the standard determinants of trade is mixed.

We find support for proposition (1) that industries that are important domestic producers have superior export performance, and (2) that industries that depend more on exports for sales have increased exports more, and (3) that those industries that were less dependent on the ruble market have increased their exports more. Moreover, we find support for proposition (4) that down-sized industries have increased exports more, although (5) foreign investment does not appear to be a good indicator of export competitiveness.14 These results taken together tend to support the Proposition that industry restructuring has positively affected exports.

The lack of significance of (6) the ECU price suggests that exporters are not yet fully responsive to market forces, although the sign of this variable is as expected. The negative and significant correlation between (7) EC income and Hungarian exports should be seen in the positive light of Hungarian exporters exploiting the switch from the CMEA and the opening u their border with the negotiation of EC Association agreements. A longer time series should provide greater insight as to whether Hungarian exports will

respond to the familiar market forces of demand and relative prices.

“Alternative forms of this variable, including the share of foreign

investment in owner's equity and the level of foreign investment did not produce better results.

price index divided by the forint/ECU exchange rate. A fall in the ECU

price should be associated with an increase in real exports.

(7) EC GDP in 1989 and 1990.

We expect a positive correlation between income and exports.

Industry restructuring variables include: (4) Number of employees per plant by specific industry for 1989 and 1990.

We expect this variable to be negatively correlated with export performance. We have argued in this paper that a key part of making industry act more competitively is down-sizing, and that one measure of competitiveness is export performance. So, decreasing plant size should

be positively correlated with exports. (5) Change in foreign investment by specific industry between 1989 and 1990

We expect this variable to be positively correlated with export performance for two reasons. First, foreign investors may be more attracted to those firms that are competitive; increasing foreign investment might signal those industries. Second, if foreign market

contacts are important aids to exporting, then increasing foreign

investment would increase exports.

Standard determinants of exports include:

(6) ECU price of exports, by specific industry in 1989 and 1990.

We expect a positive correlation between the ECU price of exports and

the volume of exports. The ECU price is defined as the forint export

(2)

(3)

18 We expect this variable to be positively correlated with export performance using both Hecksher-Ohlin and intra-industry trade stories. That is, industries that are important producers in the domestic market point to those sectors where the country has internationally competitive costs of production, and therefore may be able export. Moreover, if there are economies of scale in production, the industry can exploit

them by producing for both the domestic and export markets.

Ratio of industry exports to industry sales by specific industry in

1990.

We expect this ratio to be positively correlated with exports to the EC market. Industries that have high export to sales ratios are more likely to have been exposed to international market discipline. The changes in price, exchange rate, and trade regimes under the new Hungarian policies give them greater opportunity to respond to market

forces and export more.

Percent of industry exports sent to the non-ruble market by specific

industry in 1989.

We expect this variable to be positively correlated with exports to the EG market. Exports to the ruble area are less likely to be internationally competitive, and are more likely to come from firms that

have not been responding to market forces, but only to State directives.

V. Industry Restructuring and Export Performance

Export performance, particularly new products to new markets, is an important indicator of the success of the structural transformation of the economy. Has the industry restructuring in Hungary positively affected export performance? This section of the paper uses a disaggregated industry data set covering 26 industries to examine the effect on exports to the European Community market in 1989 and 1990 of (1) certain industry characteristics, (2) certain measures of industry restructuring, and (3) standard determinants

of exports.?

1989 is the starting point because this date represents when Hungary initiated a significant break in policies toward both SMEs and the macroeconomic environment of prices, exchange rate, and trade

liberalization. ?°

(0) The dependent variable is the volume of exports of 26 industries to the European Community for 1989 and 1990. This variable is defined as the ECU value of exports translated into forint at the annual rate of exchange, and deflated by the industry-specific export price index.

For industry characteristics, we include:

(1) The share of specific industry output in total industry output in 1990.

°For another approach to the issue of the relationship between exports and restructuring, see Rodrik, 1992.

10An Appendix lists all the data.

16 headgear, and umbrellas. Categories within the chemical and metallurgical sectors also showed large gains. These areas of strong growth may provide clues to follow as more data become available to determine whether

Hungarian exporters developed new markets for their goods.

considerable downsizing, and this, combined with their traditional strengths in this market may have contributed to continued export success. Of the top 10 categories of EC imports from Hungary in 1991, only two categories, ranked ninth and tenth, were new to the list compared with 1989. This suggests that in many of its traditional important export categories, Hungary remains a competitive producer.

However, as the emergence of two new categories in the list of top 10 EC import categories also implies, Hungary is also discovering markets for other products in the EC. EC imports of furniture, furnishings, lamps, and prefabricated buildings from Hungary increased 95 percent between 1989 and 1991. This category of imports, which ranked ninth in 1991, ranked 14th in 1989. Table 7 shows other categories of Hungarian exports to the EC that have displayed growth of more than 95 percent between 1989 and 1991.

Although some categories showed substantial gains from already large bases--plastics, furniture and prefabricated buildings, and iron and steel articles--table 7 shows that most of the categories registering large percentage increases in fact grew from small bases. Although not easily characterized, the categories are largely agricultural and food products, and various light industry products. Increased EC imports of these goods may reflect new product categories in which small and medium sized enterprises have been able to adapt to demands in the EC market.

Of the 26 categories registering growth of 95 percent or more between 1991 and 1989, seven were agricultural and food products, a traditional strength. Several categories of light industry goods grew

sharply in the two-year period as well: knitted or crocheted fabrics,

14 data from the EC in order to present a consistent series of products over a specified time period for a well-defined export market. The 2-digit level chapters of EC's harmonized system of combined nomenclature are used to trace broad changes in the EC’s pattern of imports from Hungary; more detailed levels of the EC’s nomenclature are used in an attempt to match EC imports from Hungary with a profile of Hungarian industry for the regression in Section V. Nominal EC imports from Hungary grew from ECU 2.6 billion in 1989 to ECU 3.6 billion in 1991, an increase of almost 40 percent between 1989 and 1991.

Two observations can be made based on the limited information spanning three years of export performance. First, Hungary's top four export categories to the EC in terms of value in 1989 continued to be important categories in 1990 and 1991 (see Table 6). This would suggest that Hungary’s traditional exports to the EC may have reflected the country’s comparative advantage. Established marketing channels and buyers, as well as price competitiveness may have enabled these products to continue to sell well in the EC. Second, some product categories have experienced large percentage increases in growth (often from small bases), which implies that Hungarian producers are responding to market incentives and discovering new markets in the EC for products not historically exported there. Each of these cases is detailed below.

The 10 largest categories of EC imports from Hungary in 1989 and 1991 are detailed in Table 6. The top four categories of Hungarian exports in 1989--namely, meat, apparel, and two categories of machinery--remained the top four categories in 1991, albeit in somewhat different order. As

shown later in the appendix, all these industries have undergone

13 IV. Hungarian Trade in Transition

The collapse of CMEA trade beginning in 1990 forced Hungary to seek new markets for its products. Trade with Western partners, especially the European Community (EC), has grown dramatically. In 1987, according to Hungarian trade data, exports to the EC accounted for about 20 percent of Hungary's total ruble and non-ruble exports. By mid-1992, the EC's share of Hungary’s exports had risen to 47 percent. Total exports grew 80 percent between 1987 and 1991.

Even before the demise of the CMEA trading system, the composition of Hungary’s exports to CMEA trading partners was significantly different from its exports to market economies. Traditionally, Hungary’s exports to its CMEA partners were predominantly machinery, which accounted for 47 percent of ruble exports in 1987. Raw materials and semi-finished goods were a distant second, amounting to 22.5 percent of ruble exports to CMEA partners. Exports to non-CMEA partners, however, were dominated by raw materials and semi-finished goods, followed by agricultural products and food (Table 5).

By 1990, two trends are noteworthy. First, the share of ruble exports to total exports has shrunk considerably, from almost 50 percent in 1987 to about 25 percent by 1990. Non-ruble exports have grown from about 90 percent of total exports to about 75 percent in this period. Ruble exports continued to be led by machinery, although the value had fallen from that in 1987. Raw materials and semi-finished goods, and agriculture and food still led nonruble exports, with both categories doubling their

1987 levels by 1990.

In examining products by export category, we have chosen trade

14 data from the EC in order to present a consistent series of products over a specified time period for a well-defined export market. The 2-digit level chapters of EC's harmonized system of combined nomenclature are used to trace broad changes in the EC's pattern of imports from Hungary; more detailed levels of the EC's nomenclature are used in an attempt to match EC imports from Hungary with a profile of Hungarian industry for the regression in Section V. Nominal EC imports from Hungary grew from ECU 2.6 billion in 1989 to ECU 3.6 billion in 1991, an increase of almost 40 percent between 1989 and 1991.

Two observations can be made based on the limited information spanning three years of export performance. First, Hungary's top four export categories to the EC in terms of value in 1989 continued to be important categories in 1990 and 1991 (see Table 6). This would suggest that Hungary's traditional exports to the EC may have reflected the country’s comparative advantage. Established marketing channels and buyers, as well as price competitiveness may have enabled these products to continue to sell well in the EC. Second, some product categories have experienced large percentage increases in growth (often from small bases), which implies that Hungarian producers are responding to market incentives and discovering new markets in the EC for products not historically exported there. Each of these cases is detailed below.

shown later in the appendix, all these industries have undergone

13 IV. Hungarian Trade in Transition

The collapse of CMEA trade beginning in 1990 forced Hungary to seek new markets for its products. Trade with Western partners, especially the European Community (EC), has grown dramatically. In 1987, according to Hungarian trade data, exports to the EC accounted for about 20 percent of Hungary's total ruble and non-ruble exports. By mid-1992, the EC’s share of Hungary's exports had risen to 47 percent. Total exports grew 80 percent between 1987 and 1991.

Even before the demise of the CMEA trading system, the composition of Hungary's exports to CMEA trading partners was significantly different from its exports to market economies. Traditionally, Hungary's exports to its CMEA partners were predominantly machinery, which accounted for 47 percent of ruble exports in 1987. Raw materials and semi-finished goods were a distant second, amounting to 22.5 percent of ruble exports to CMEA partners. Exports to non-CMEA partners, however, were dominated by raw materials and semi-finished goods, followed by agricultural products and food (Table 5).

By 1990, two trends are noteworthy. First, the share of ruble exports to total exports has shrunk considerably, from almost 50 percent in 1987 to about 25 percent by 1990. Non-ruble exports have grown from about 50 percent of total exports to about 75 percent in this period. Ruble exports continued to be led by machinery, although the value had fallen from that in 1987. Raw materials and semi-finished goods, and agriculture and food still led nonruble exports, with both categories doubling their

1987 levels by 1990.

In examining products by export category, we have chosen trade

Two observations can be made based on the limited information spanning three years of export performance. First, Hungary's top four export categories to the EC in terms of value in 1989 continued to be important categories in 1990 and 1991 (see Table 6). This would suggest that Hungary's traditional exports to the EC may have reflected the country’s comparative advantage. Established marketing channels and buyers, as well as price competitiveness may have enabled these products to continue to sell well in the EC. Second, some product categories have experienced large percentage increases in growth (often from small bases), which implies that Hungarian producers are responding to market incentives and discovering new markets in the EC for products not historically exported there. Each of these cases is detailed below.

shown later in the appendix, all these industries have undergone

13 IV. Hungarian Trade in Transition

The collapse of CMEA trade beginning in 1990 forced Hungary to seek new markets for its products, Trade with Western partners, especially the European Community (EC), has grown dramatically. In 1987, according to Hungarian trade data, exports to the EC accounted for about 20 percent of Hungary's total ruble and non-ruble exports. By mid-1992, the EC's share of Hungary’s exports had risen to 47 percent. Total exports grew 80 percent between 1987 and 1991.

Even before the demise of the CMEA trading system, the composition of Hungary's exports to CMEA trading partners was significantly different from its exports to market economies. Traditionally, Hungary’s exports to its CMEA partners were predominantly machinery, which accounted for 47 percent of ruble exports in 1987. Raw materials and semi-finished goods were a distant second, amounting to 22.5 percent of ruble exports to CMEA partners. Exports to non-CMEA partners, however, were dominated by raw materials and semi-finished goods, followed by agricultural products and food (Table 5).

By 1990, two trends are noteworthy. First, the share of ruble exports to total exports has shrunk considerably, from almost 50 percent in 1987 to about 25 percent by 1990. Non-ruble exports have grown from about 50 percent of total exports to about 75 percent in this period. Ruble exports continued to be led by machinery, although the value had fallen from that in 1987. Raw materials and semi-finished goods, and agriculture and food still led nonruble exports, with both categories doubling their

1987 levels by 1990.

In examining products by export category, we have chosen trade

Two observations can be made based on the limited information spanning three years of export performance. First, Hungary's top four export categories to the EC in terms of value in 1989 continued to be important categories in 1990 and 1991 (see Table 6). This would suggest that Hungary's traditional exports to the EC may have reflected the country's comparative advantage. Established marketing channels and buyers, as well as price competitiveness may have enabled these products to continue to sell well in the EC. Second, some product categories have experienced large percentage increases in growth (often from small bases), which implies that Hungarian producers are responding to market incentives and discovering new markets in the EC for products not historically exported there. Each of these cases is detailed below.

shown later in the appendix, all these industries have undergone

13 iV. Hungarian Trade in Transition

The collapse of CMEA trade beginning in 1990 forced Hungary to seek new markets for its products. Trade with Western partners, especially the European Community (EC), has grown dramatically. In 1987, according to Hungarian trade data, exports to the EC accounted for about 20 percent of Hungary's total ruble and non-ruble exports. By mid-1992, the EC’s share of Hungary’s exports had risen to 47 percent. Total exports grew 80 percent between 1987 and 1991.

By 1990, two trends are noteworthy. First, the share of ruble exports to total exports has shrunk considerably, from almost 50 percent in 1987 to about 25 percent by 1990. Non-ruble exports have grown from about 50 percent of total exports to about 75 percent in this period. Ruble exports continued to be led by machinery, although the value had fallen from that in 1987. Raw materials and semi-finished goods, and agriculture and food still led nonruble exports, with both categories doubling their

1987 levels by 1990.

In examining products by export category, we have chosen trade

12 The table indicates that the two industry groups -- engineering and light industries -- characterized by small plants (100 and fewer employees per plant) account for 76 percent of all firms, and form both the productive core of the economy, accounting for 33 percent of total industry output, as well as being key employers, accounting for 55 percent of employment. These statistics indicate that the Hungarian size distribution of firms is approaching the market economy distribution. Moreover, is appears that these smaller firms use their flexibility to access foreign markets through increased exports. Exports account for a large share of sales: 39 percent for engineering and 26 percent for light industries. Finally, these are also the two industry groups that have the attracted the most foreign investment, as a share of total foreign investment in industry. This is consistent with foreign investment being attracted to smaller firms that are easier to purchase, as well as to firms that have a export focus. Thus it appears that firms in the engineering and light industry groups would form the foundation for the SME sector.

Three other industry groups, chemicals, food processing, and building materials, have only slightly larger plants, but are less important in contributing to the SME sector: while their plant size is relatively small, the share of the industry in the total number of firms is also small, indicating that these are multi-plant firms. The food processing industry is the only one of the three that has other characteristics similar to those of the engineering and light industry groups: the importance of this industry to overall production and employment is significant (20 and 16 percent

respectively), and the share of exports in sales is also large at 22 percent.

Joint ventures are a third way to build the SME sector, and some 13,000 joint ventures have been registered in Hungary -- most of them SMEs. Joint ventures may be the best way to obtain the technology, management expertise, and Western market contacts that the ECE economies need to prosper.® In particular, the joint venture may be a key way to bolster the overall structural transformation by improving external performance. Combining the Hungarian investor's knowledge of the domestic market and the foreign investor's knowledge of the international market increases the chances that a new export to a new market will sell. Foreign direct investment into Hungary totalled nearly $5 billion, and the pace of the inflow increased from $900 million in 1990 to $1.7 billion in 1992.

How successful have these policies been in creating an SME sector in Hungary? Data present a mixed picture. Aggregate data suggest that substantial change has occurred in the overall structure and ownership of Hungarian industry after the government made the commitment to the market economy in 1989. The number of organizations more than doubled from 1989 to 1990 from 2933 to 7351, and most of the new entrants were small organizations. The size distribution of firms changed from about 78 percent SMEs to 87 percent SMEs. Consistent with the development of the service sector, about 30 percent of GNP in 1990 was generated by the private sector, although only about 20 percent of industrial production was private.

Table 4 exhibits somewhat more disaggregated data. The table shows various statistics for industry groups on the share of that industry in total

firms, output, employment, and exports, ranked by average employees per plant.

®See Mann 1991.

10 respects, the State’s approach may make sense. First, spinning-off and selling separately such auxiliary pieces of the SOE, such as the cafeteria function, or the retail and wholesale distribution facilities, is an uncontroversial form of restructuring. But Hungary is also splitting multiplant SOEs into separate firms and giving greater autonomy to management of each of the production units to act independently of each other and of the State.’

Splitting multi-plant SOEs automatically creates smaller economic units, yielding two advantages: each unit is more likely to be privatized faster, and each is more likely to act like a private enterprise until it is privatized. The smaller units are better targets for privatization for reasons that ultimately come down to considerations of cost and coordination. It is easier to find a buyer when the required financial investment to buy a plant is smaller. Privatization-from-within is more likely with a smaller firm since getting a core group of internal investors together is less difficult. Moreover, the prospect of being privatized quickly, particularly via internal investor buyout, will induce the smaller production unit to act like a private enterprise, responding to market forces and trying to maximize profits. Finally, the smaller enterprises are likely to have greater flexibility to restructure production to better use labor and to more effectively target a product market, foreign or domestic. Table 3 shows how the average number of employees per plant has changed partly on account of

this restructuring.

7See Szabo 1992.

9 not expect these firms to be the main contributors to improved export performance.

Restructuring state-owned enterprises so that they respond better to market forces is integral to the transition to the market economy. So far, about one-half of Hungary’s state-owned enterprises (representing about 35-40 percent of state-owned assets) has begun the restructuring and privatization process. About 10 percent of state assets are now privately owned, of which about 8 percent is foreign owned.

Hungary has chosen not to use a mass privatization approach to changing ownership of firms in the state sector, although this approach has not been ruled out for the future.> Instead, it is now using several market-based methods of auction and insider or outsider buyout schemes to transfer ownership to a strategic investor who will undertake the restructuring necessary to create more efficient units. These case-by-case methods may take more time than the mass privatization methods, although the reward should be a tighter relationship between ownership and control, and therefore superior economic performance of the firm.® However, because a case-by-case approach takes time, it is important to make the state firms as efficient as possible, pending their sale. One approach the State has been taking is direct restructuring of some enterprises.

Should the State restructure an SOE to improve its operation pending a future sale? During the central planning regime, the State showed little

ability to create economically rational production units. However, in two

°See Csepi and Lukacs, 1992 and Gatsios, 1992 for more on Hungary's privatization programs.

°See Mann, Lenway, and Utter, 1993.

Ill. Hungarian Industry in Transition

In 1989, Hungary began a multi-pronged approach to structural transformation of its industry and economy. Policies to encourage the development of the SME sector were needed. However, as the experience of the industrial cooperatives shows, a robust SME sector also requires the replacement of a state-regulated macroeconomy with an endogenously stable and competitive economic environment. This latter transition requires a clear legal framework of property rights, balanced fiscal and monetary policies, competition policy (particularly price and trade liberalization), financial market reforms, and business information and education. Numerous papers have been written on these requirements.‘ This paper focuses on the government policies to encourage the SME sector and the consequences for export performance.

New private enterprises are a key component of the SME sector. Legalizing private ownership of the means of production and the hiring of labor, as well as legalizing the concept of profit are prerequisites. Hungary eliminated limits on the ownership of capital and on the number of employees an entrepreneur could hire in 1989. Data suggest that private entrepreneurs have exploded with some 60,000 new private enterprises as of 1991. Most of these firms are the very smallest, and are concentrated in the service sector of the domestic economy. This makes sense given the lack of service sector establishments under centralized planning. Moreover, as a source of employment for labor released from down-sizing SOEs, these establishments are

very important. However, because they are concentrated in services, we would

“See, for example, Blanchard, et al.

7 effort to develop SMEs through industrial cooperatives, the manufacturing sector as a whole remained dominated by the large and mega enterprises, which accounted for 18 percent of firms, 83 percent of employment, and 40 percent of output.

Why did the cooperative movement not have a greater impact on the industrial structure in Hungary? The government gave these firms greater decision-making autonomy regarding labor inputs and production technology. However, the overall economic environment exhibited few of the characteristics of a market economy. In particular, prices were still regulated. Consequently, cooperative Managers, in fact, had few decisions to make in response to market forces. This suggests that the SME sector could not develop until the country made a commitment to market economy, particularly to

free prices and liberalize trade.

Table 7

EC Imports from Hungary Ranked by Growth

% change Value mil ECU

Rank 1991/89 Category 1989 1991 1 1920.3 Cereals, flour, starch 0.1 2.7 2 559.4 Ships, boats 0.5 3.3 3 516.9 Knitted/crocheted fabrics 1.1 6.5 4 500.0 Headgear 0.1 0.7 5 450.2 Railway related 3.6 20.1 6 449.6 Lead and lead articles 0.2 1.2 7 320.8 Misc. edible preparations 1.8 7.4 8 304.1 Umbrellas and parts 0.1 0.6 9 264.9 Pharmaceuticals 3.1 11.3 10 209.9 Tools, tableware of metal 3.5 10.8 11 182.5 Wood pulp, scrap paper 0.2 0.5 12 180.6 Misc. base metal articles 2.4 6.6 13 176.4 Clocks, time switches 1.1 3.0 14 153.7 Non-rail vehicles & parts 22.1 56.2 15 133.2 Edible fruit & nuts 30.2 70.3 16 123.0 Glass & glassware 24.2 53.9 17 121.7 Arms, ammunition, & parts 1.1 2.5 18 119.2 Prepared fruits & vegs. 39.1 85.6 19 112.6 Tobacco 2.1 4.4 20 99.0 Iron and steel articles 56.8 113.0 21 98.3 Matches, pyrotechnics 1.1 2.1 22 98.2 Cocoa and cocoa products 2.3 4.5 23 97.7 Misc. small manufactures 2.3 4.5 24 95.7 Meat & fish preparations 39.6 77.4 25 95.2 Plastics 80.8 157.8

26 95.1 Furniture, prefab buildings 58.5 114.1

Source: EC, External Trade, Series C

Table 8 (1) (2) (3) (4) (5) (6) (7) Real Share exports/ % non # empl/ for inv. ECU EC GDP exports rod. sales ruble plant change price — “pe 1990 1990 1989 89&90 89-90 89&90 bil ECU

X Coefficient(s) 12567.86 170586.4 162262.7 -116.96 -2.96011 -23694.3. -17.2788

Std Err of Coef. 3950.106 29494.02 30241.57 24.48335 6.103562 24157.5 7.49016 Constant 0 Std Err of Y Est 30633.85 R Squared 0.508293 No. of Observations 52

Degrees of Freedom 45

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IFDP NUMBER

445

444

443

442

441

440

439

438

437

436

435

434

433

Please address requests for co

International Finance Discussion Papers TITLES

1993 Industry Restructuring and Export Performance: Evidence on the Transition in Hungary

Exchange Rates and Foreign Direct Investment: A Note

Global versus Country-Specific Productivity Shocks and the Current Account

The GATT's Contribution to Economic Recovery in Post-War Western Europe

A Utility Based Comparison of Some Models of Exchange Rate Volatility

Cointegration Tests in the Presence of Structural Breaks

1992

Life Expectancy of International Cartels: An Empirical Analysis

Daily Bundesbank and Federal Reserve Intervention and the Conditional Variance Tale in DM/$-Returns

War and Peace: Recovering the Market's Probability Distribution of Crude Oil Futures Prices During the Gulf Crisis

Growth, Political Instability, and the Defense Burden

Foreign Exchange Policy, Monetary Policy, and Capital Market Liberalization in Korea

The Political Economy of the Won: U.S.-Korean Bilateral Negotiations on Exchange Rates

Import Demand and Supply with Relatively Few Theoretical or Empirical Puzzles

AUTHOR (s )

Valerie J. Chang Catherine L. Mann

Guy V.G. Stevens

Reuven Glick Kenneth Rogoff

Douglas A. Irwin

Kenneth D. West Hali J. Edison Dongchul Cho

Julia Campos Neil R. Ericsson David F. Hendry

Jaime Marquez

Geert J. Almekinders Sylvester C.W. Eijffinger

William R. Melick Charles P. Thomas

Stephen Brock Blomberg

Deborah J. Lindner

Andrew M. Warner

pies to International Finance Discussion Papers,

Division of International Finance, Stop 24, Board of Governors of the Federal

Reserve System, Washington, D.C.

20551.

IFDP NUMBER

432

431

430

429

428

427

426

425

424

423

422

421

420

International Finance Discussion Papers

TITLES

1992

The Liquidity Premium in Average Interest Rates

The Power of Cointegration Tests

The Adequacy of the Data on U.S. International Financial Transactions: A Federal Reserve Perspective

Whom can we trust to run the Fed? Theoretical support for the founders views

Stochastic Behavior of the World Economy under Alternative Policy Regimes

Real Exchange Rates: Measurement and Implications for Predicting U.S. External Imbalances

Central Banks’ Use in East Asia of Money Market Instruments in the Conduct of Monetary Policy

Purchasing Power Parity and Uncovered Interest Rate Parity: The United States 1974 - 1990

Fiscal Implications of the Transition from Planned to Market Economy

Does World Investment Demand Determine U.S. Exports?

The Autonomy of Trade Elasticities: Choice and Consequences

German Unification and the European Monetary System: A Quantitative Analysis

Taxation and Inflation: A New Explanation for Current Account Balances

AUTHOR(s

Wilbur John Coleman ITI Christian Gilles Pamela Labadie Jeroen J.M. Kremers Neil R. Ericsson Juan J. Dolado

Lois E. Stekler Edwin M. Truman Jon Faust

Joseph E. Gagnon Ralph W. Tryon

Jaime Marquez

Robert F. Emery

Hali J. Edison William R. Melick

R. Sean Craig Catherine L. Mann

Andrew M. Warner

Jaime Marquez

Gwyn Adams Lewis Alexander Joseph Gagnon

Tamim Bayoumi Joseph Gagnon

Cite this document

APA

Valerie J. Chang and Catherine L. Mann (1993). Industry Restructuring and Export Performance: Evidence on the Transition in Hungary (IFDP 1993-445). Board of Governors of the Federal Reserve System, International Finance Discussion Papers. https://whenthefedspeaks.com/doc/ifdp_1993-445

BibTeX

@techreport{wtfs_ifdp_1993_445,
  author = {Valerie J. Chang and Catherine L. Mann},
  title = {Industry Restructuring and Export Performance: Evidence on the Transition in Hungary},
  type = {International Finance Discussion Papers},
  number = {1993-445},
  institution = {Board of Governors of the Federal Reserve System},
  year = {1993},
  url = {https://whenthefedspeaks.com/doc/ifdp_1993-445},
  abstract = {Robust and numerous small and medium-size enterprises (SMEs) are a hallmark of the market economy and development of these firms is an integral part of the structural transformation of the economies of East-Central Europe (ECE). Data for Hungary on changes in the size distribution of firms and their importance for output and employment indicates that industry restructuring is taking place. One measure of the success of restructuring is export performance. That is, increased exports by those industries undergoing restructuring suggests that the process is creating firms that are successfully responding to market demand and international price signals. Disaggregated industry data from Hungary support the propositions that restructured industries and industries that have historically been important for domestic and export markets have become more important exporters. Moreover, it appears that Hungarian exporters have been effectively exploiting the switch from the CMEA market and the opening up of the border with the European Community. However, perhaps because of the short time series of the investigation, it is too early to tell whether Hungarian exports will respond systematically to standard determinants of trade, such as changes in EC income and relative prices.},
}