Over the last several years, CIPE frequently observed that the quality of foreign investments impacts domestic business ecosystems and institutional performance. However, questions remain about the ways that these processes are evolving. To further CIPE’s exploration into this phenomenon and continue to uncover the business and governance implications of opaque investments, PPL worked with researcher Jozsef Peter Martin to produce From Dual Economy to Parallel Universes: Attitudes and Coping Strategies of Businesses vis-a-vis Crony State Capitalism.
This research paper investigates new and pressing challenges for the European Union (EU), an entity that has generally faced low threats of authoritarianism from within. Some countries in the EU such as Hungary (the focus of this research) are experiencing increasing levels of state capture and systemic corruption, accompanied by high degrees of foreign investment, despite membership within international institutions that are market oriented. These developments imply blurred boundaries between public and private interests. Experts say that this is one of many indications of backsliding within established market-oriented organizations.
The research findings – that membership in pro-market multilateral organizations is not a guarantee of pro-market or democratic practices – highlight￼ the importance of CIPE’s work in several of our focus areas, including promoting Accountable Investment, Anti-Corruption, and Enterprise Ecosystems. Despite steady economic growth and high levels of foreign direct investment, the research shows that in Hungary the corresponding benefits often fail to reach domestic enterprises and that structural problems such as low productivity and poor efficacy are beginning to emerge in the state. Through these findings we uncover new information for CIPE’s activities in these thematic areas.
That membership in pro-market multilateral organizations is not a guarantee of pro-market or democratic practices highlights the importance of CIPE’s work in promoting Accountable Investment, Anti-Corruption, and Enterprise Ecosystems.
An “investment paradox” is occurring in this context, as high levels of foreign investment continue despite frequent and even systemic violations of the rule of law and centralized corruption outlined in the research.
CIPE has observed investment paradoxes before, and in response encourages accountable investment. CIPE promotes accountable investment because financial investments can have a significant positive or negative impact on market and democratic institutions in recipient countries. When investments arrive to the recipient in an opaque manner, lack a market orientation, and exploit governance gaps, it often widens those same governance gaps and reproduces corrupt business practices.
The research describes Hungarian Strategic Partnership Agreements (SPAs), which are special economic agreements between the public sector and specific private sector firms. SPAs promulgate corruption via “vague provisions” concerning “economic cooperation” in exchange for specific activities. SPAs originally emerged as a solution to the impasse between the public sector and multinational companies because they, in principle, aim to restore dialogue and create new lobbying opportunities. Cooperation between the public and private sector under an SPA typically manifests as support for research and development or financial incentives such as exclusion from certain regulatory hurdles or taxes. In practice though, SPAs often lack clear accountability mechanisms, and the mechanisms that do exist are not accountable to the public. The research suggests that these “opaque formulations” enable hidden special conditions, such as unfair tax relief or regulatory exemptions.
In practice, Strategic Partner Agreements often lack clear accountability mechanisms, and the mechanisms that do exist are not accountable to the public.
SPA arrangements contribute to the emerging “dual economy,” where the Hungarian economy is becoming dependent on large and (relatively) productive multinational companies, leaving behind the many small and comparatively less productive small-to-medium enterprises (SMEs). According to SME owners interviewed during the research, large corporations investing in Hungary are crowding out domestic SMEs. Moreover, SPAs provide favorable entry conditions to new markets in Hungary, and as a result, SME owners perceive corruption between multinationals and local suppliers. The oligarchs, entrepreneurs, and companies who have struck SPAs with the government dominate the construction, tourism, energy, media, and other industries “prone to imminent profit creation” such as casinos and waste management.
The main method guiding this arrangement is the process of “wealth transformation” – or the process of nationalization then re-privatization of those companies in an SPA arrangement. For example, Magyar Bank Holding is a conglomerate of three commercial banks that first experienced foreign ownership, then nationalization, and finally landed in the majority share control of a close ally to the government. These practices enable private entities to enter the economy through a convoluted process, resulting in their reallocation to a closed network of political and economic allies.
These cases present enormous challenges to free markets and undermine the ability of democracy to deliver for its citizens. Ensuring an inclusive playing field for all entrepreneurs means building an “enterprise ecosystem.” The cases explored in this paper highlight both a common challenge to enterprise ecosystems – in the form of opaque investment through SPAs – but also an empirical observation about the benefits and costs of different forms of foreign investment. Though Hungary is deeply integrated into the European economy, and receives considerable amounts of foreign investment, the quality of these investments reinforces a skewed playing field that leads to increased levels of economic and political corruption and the retrenchment of markets and democracy.
This research provides insight into the nature of state-business relations inside of one of the world’s most significant blocs of established democratic market-oriented countries. Though the EU encourages democratic and market-oriented practices, and requires them for admittance, backsliding continues to be a growing concern. The findings highlight an increasing need to address how powerful companies may take advantage of special agreements or regulatory and taxation loopholes to the disadvantage of domestic SMEs.
Through coalition building, establishing unified standards of conduct, public-private dialogues, and disseminating anti-corruption lessons, we can create a fairer, more transparent, and more accountable economic arena.
However, in response to these challenges, there are cases of smaller-scale private enterprises leading by example. The research mentions the Hungarian Business Leaders Forum (HBLF), which is an association of 38 members promoting social responsibility and cooperation among businesses. Through its code of ethics, HBLF promotes transparency and fair business practices for its members. However, the private sector should intensify and expand these efforts to achieve lasting success. Of the many examples of business advocacy through collective action, CIPE’s work in Thailand is a north star.
In Approaches to Collective Action: How Businesses Together Can Lead the Fight Against Corruption, CIPE explains how collective action, which is a “coordinated, sustained process of cooperation” can “reduce the incentives and opportunities for corruption.” Beginning in 2010, CIPE has worked with the Thai Institute of Directors (IOD) to create a coalition of Thai businesses to mitigate corruption. Some of these steps involve:
- Implementing anti-corruption policies and compliance programs;
- Disclosing internal practices; and
- Providing guidance on fair business conduct to managers and employees.
Through coalition building, establishing unified standards of conduct, public-private dialogues, and disseminating anti-corruption lessons to stakeholders, we can create a fairer, more transparent, and more accountable economic arena. Collective action is a powerful tool for the private sector, and as From Dual Economy to Parallel Universes: Attitudes and Coping Strategies of Businesses vis-a-vis Crony State Capitalism suggests, one that could benefit Hungary’s SMEs and domestic private sector – paving the way for healthier markets and a more robust democracy.
Editor’s Note: Author Adam Goldstein is an Associate Program Officer with CIPE’s Policy and Program Learning Applied Research Unit. The team works with CIPE’s leadership to identify knowledge gaps in programmatic priorities, creating a learning agenda through the organization’s expanding network of international scholars and in-house research. This article is part of a new Policy Solutions issue paper and webinar series synthesizing recent research and findings that intersect with core CIPE areas of practice. The inaugural event is scheduled for May 9. Please join us by registering here.