It’s time to say: Hungary is struggling with a new addiction

What makes the “sick man of Europe” sick?

The term “Sick Man of Europe”, which is often used to this day, was used in 1998 by a German economist, Holger Schmieding, when he described Germany, which was struggling with quite serious economic problems after reunification. More than 25 years have passed since then, during which time a lot has changed. This epithet was temporarily removed from the public discourse with the implementation of the reforms called “Agenda 2010”. However, the emphasis is on the “transitional” adjective, since it seems that

the German economy continues to struggle with significant structural problems, which really showed themselves as a result of the external shocks of recent years.

Although the volume of German industrial production reached its peak before the pandemic and began to decline, the economy had absolutely nothing to do with the shock effects of the past four years. Of these, the energy price explosion is perhaps the first to be mentioned, as it hit the heart of the economy, which was built on cheap energy. Although in 2024, electricity prices for German companies have roughly returned to pre-2020 levels, this is not nearly the case for gas, as you still have to pay two or three times more for it.

However, expensive energy is only one reason for the weakening of German industry, which is also reflected in the lack of structural (physical and digital) investments, which resulted in a deterioration in competitiveness. Of course, the German debt brake limits the room for maneuver in relation to other eurozone member states, but the 2009 constitutional amendment can hardly be held responsible even for the failed reforms in the previous years.

The current industrial malaise can also be linked to the current point in the inventory cycle. If not in all sub-sectors, but looking at the industry as an aggregate, stocks are absolutely full, and the stock of new orders is quite low. It stems from all of this also a very low indicator of capacity utilization, which stood at 81 percent in the first quarter of 2024. Of course, this does not seem so bad at first glance, especially compared to the Hungarian value of 70 percent, but it is still the lowest value in the last 30 years, if the crises of 2008 and 2020 are excluded.

To mention one more reason that may be related to the current problems: the issue of Chinese overcapacity, which affects not only the German but also the European economy, a key sector, the automobile industry itself. This is because, according to European legal standards, Chinese companies gain an unfair competitive advantage in the production of electric cars due to endless state subsidies, and then they often sell much cheaper new energy vehicles (NEVs) to the world at dumping prices.

And all of this negatively affects the European and, of course, its crown jewel, the German car industry.

The automotive industry, which in recent years has also moved in the direction of electric car production. And if, after the initial customs measures, a meaningful trade war finally breaks out between China and the EU, then the European economy may also be the major sufferer, which the biggest business leaders are well aware of.

Let’s also sweep around our own house

All in all, a combination of several factors is causing the weakening of German and European industry, which From Hungary’s point of view, it is the number one reason that can be used to explain the slowdown in external demand. Because if our largest trade partner – with whom we conduct almost 25 percent of foreign trade – cannot get its industry back on its feet, then Hungarian industry will also suffer. But of course, in the end, German industry is not only based on German domestic demand. The entire global value chain suffers when there is no demand for manufactured goods due to peak inventories and the precautionary motive of households.

In other words, Germany can be directly blamed, but at the end of the day we are talking about a global problem.

The reason why this industrial problem inflates in the case of the Hungarian economy is mainly because the domestic economic structure is still export-oriented, and because of this it is clearly dependent on the development of external demand. In this regard, after joining the EU, we only increased our reliance on external demand, as the share of exports in the gross domestic product rose from 62.5 percent to 81.2 percent between 2005 and 2023. Moreover, from the point of view of the vulnerability of the economy, it is also worth considering import exposure, so the indicator that captures the openness of the economy perhaps illustrates the picture even better. The openness of the economy is reflected in the ratio of exports and imports to GDP, where the value of the indicator increased from 128 percent to 157 percent between 2005 and 2023.

However, it can be highlighted as a positive point that in the last 20 years, the shift has been in a positive direction from the point of view of net exports. The share of exports (+18.7 percentage points) increased almost twice as much as that of imports (+10.3 percentage points). At the same time, in terms of the openness of the economy, it is important to mention that 157 percent does not represent the historical peak, since in 2014 the indicator stood at 168 percent (the year 2022 is not taken into account, since the outlier adat).

But why is it important to put the dependence on external demand into context?

Precisely because the “2024-2030 competitiveness strategy” published by the government explicitly states the goal that product exports should rise to 100 percent of GDP. This would mean that the dependence on exports would be increased from the already high value of 81.2 percent, which would further strengthen the external dependence relationship. We are not alone in this opinion, as the Magyar Nemzeti Bank also mentions this criticism In Pareto’s Deep Analysis.

Not to mention the fact that, due to the economic structure, increasing the share of exports would also lead to an increase in the country’s import demand, so the economy’s openness (dependence on foreign trade) would also increase. And this shift would be completely opposite to the dynamics seen between 2014 and 2020, when it was possible to reduce the openness of the economy, i.e. to alleviate the dependence on external demand by boosting internal demand.

Also worth mentioning is the suggestion that domestic suppliers should be involved in global production chains at a higher level. Although this sounds good in theory, in practice it can be a problem if the economic policy says all-in to ensure the entire vertical supply chain of a single sector. And this sector is none other than vehicle production, which has a roughly 26 percent weight within the manufacturing industry. And if demand at the highest level, i.e. for the completed car, moderates, then the negative spillover effect trickles down the entire supply chain, worsening the outlook everywhere.

In addition, the exposure is only aggravated if we are talking about an overweight in a sector whose demand is cyclically sensitive.

If the global economy is doing well, there will be demand for cars (whether with any drive) or electronic products. If the cart is not running, it acts as a brake. The greater the weight of such sectors, the greater the fluctuations in the domestic economy.

In theory, diversification within the chain, i.e. broadening the supplier network, seems like a good decision. After all, a more heterogeneous economic structure is indeed emerging at the four-digit TEÁOR level, and we feel that the number of important sectors is expanding. On the other hand, in reality this is only an illusion, since at the end of the day almost exclusively the demand for cars can determine the performance of the Hungarian industry, which is believed to be diversified, because no matter how broad the supplier sector is, their production also depends on customer demand for the final product. The electrical equipment manufacturing subsector, which has been on the upswing in recent years, can be classified in the same category, since electric batteries, as a main component, can also be associated with electric vehicle manufacturing.

Addiction upon addiction

It would therefore be worth considering that, from the point of view of improving the growth prospects of the Hungarian economy, the solution may not be to go all-in on a single industry, but to increase the long-pronounced domestic added value. In this regard, the lag in relation to the EU is quite significant, as the domestic added value appearing in Hungarian exports was only 52 percent in 2020, which puts us fifth from the back in the ranking based on the OECD analysis.

And if we take into account the FDI investments aimed at battery production announced in recent years, it is feared that with the acceleration of new capacities, the domestic added value within exports will decrease even further. The OECD announced in November 2023 from his analysis it turns out that the domestic added value of the vehicle manufacturing subsector, which represents the largest weight within the manufacturing industry, was 32.6 percent in 2020. And if we examine the domestic added value of the previously mentioned electrical equipment manufacturing sub-sector, we get a slightly better picture, since here the domestic added value is around 45%.

In relation to battery production, let’s ignore the significant energy intensity of the activity, from which point of view Hungary has absolutely no comparative advantage. However, let’s not forget the fact that the proportion of imported intermediate inputs used for a unit of export in this sector can be put at 78 percent. And if we look at the vehicle manufacturing industry, this ratio can be put at 88.4 percent, so simplified:

almost the same amount of import is needed for one unit of export.

And if the Hungarian economic policy consciously moves in the direction of increasing the weight of the manufacturing industry within the share of GDP, giving priority to the production of vehicles and electrical equipment, then this can result not only in the reduction of domestic added value, but also in the external dependence of the economy.

In our opinion, the poor performance of Hungarian industry (and economy) cannot be blamed solely on the Germans, as the problem is partly global, partly German and partly Hungarian economic policy, industrial strategy and structural problems. It would therefore be time to say what has perhaps never been said so clearly:

Hungary has an addiction problem.

And no, we are not talking about energy imports, but industrial exports. Of course, it is much easier to say that an economic structure based on a strong internal market would bring more stable industrial growth than to implement this structure.

The cover image is an illustration. Cover image source: Getty Images