In the shadows of coronavirus: Where is Hungarian companies’ competitiveness heading?

2021-02-23

The most often raised issue with SMEs in Hungary is that they are lagging behind larger firms and their western rivals in terms of productivity, which is the added value produced by a worker in a given timeframe. The low productivity, in turn, holds the entire Hungarian economy back.

By Political Capital

Small and medium-sized enterprises (SME) make up 99 percent of all companies in Hungary, produce over 50 percent of Hungarian GDP and employ almost 70 percent of the Hungarian workforce. Their importance makes their efficiency, competitiveness in comparison to international companies cardinal questions. The most often raised issue with SMEs, especially domestic ones, is that they are lagging behind larger firms and their western rivals in terms of productivity, which is the added value produced by a worker in a given timeframe. The low productivity, in turn, holds the entire Hungarian economy back.

Naturally, this statement is a generalization not following contemporary trends, as – if one takes a closer look – the world, development of SMEs is much more diverse than this simple description. The word itself encompasses a very heterogenous circle of companies; everyone from sole traders through Hungarian-owned medium-sized firms to the Hungarian sister companies of multinational corporations are categorized as an SME. However, in reality, they are facing vastly different challenges, have different perspectives, and they need to be supported with aid tailored to their specificities. Unfortunately, micro companies with one or two people can often be categorized as enterprises borne out of necessity. In contrast, there are numerous small firms with serious growth potential. Among mid-sized corporations, there are plenty of successful ones ready to make the jump to the international market and many of whom are already a part of the international supply chain.

Specific challenges

At the same time, we can find a few problems, specificities relevant to the entire domestic SME sector even if we take into account its diversity. A few of these are the result of slowly-changing (sometimes cultural) traits, others are the consequences of Hungary’s role in the global economy. “There are few successful, substantial companies in Hungary founded after the democratic transition. This is not generally characteristic of Central- and Eastern European states, and it is certainly not a coincidence” – said Gábor Békés, a researcher at the Central European University and the Institute of Economics, to Political Capital. Békés says it is notable that the largest companies (and the richest ones) in Hungary do not achieve their results due to success on the international stage; more and more political actors and their interests show up on this list. This also suggests that political connections could strongly influence the growth potential and expected results of a company, which institutionalizes bad habits among smaller firms as well: if firms are forced to focus on human relations and getting the right connections instead of developing successful business models, their competitiveness will suffer in the long-term.

Various state support schemes, which have mostly been financed using EU funds since 2004, are only aggravating these tendencies. Economists often argue that the EU subsidies allocated to the country almost did more harm than good because their effect is similar to a country finding a valuable raw material on its territory and then organizing the entire state around extracting and selling that particular material. An economy optimized to “withdraw” EU funds works similarly, where numerous companies build their existence on the availability of subsidies instead of producing a truly successful product. Moreover, weak institutions and questionable legal security (which often trounces Hungary’s score in international competitiveness reports) also contribute to holding back some actors from growing over a certain level, or they move their enterprise abroad in fear of political risks.

The list of general factors hindering competitiveness and efficiency do not stop at potential problems arising due to the business environment. “We often observe in the Hungarian SME sector that owners do not wish to further improve the enterprise after achieving a certain level of income” – KPMG director András Kaszap told Political Capital. “In the founders’ generation, many owners-directors are satisfied with building a medium-sized firm, which offers sufficient income to their families. They do not want to take a loan to expand, develop, export or become the supplier for a large company even if their firm has the necessary traits to do so.” He says that this sort of risk aversion is a cultural characteristic specific to Eastern Europe, which is ongoing change, albeit slowly: it is less prevalent among young company heads. This is confirmed by empirical data, a 2019 research project implemented by the Lendület research group found that Hungarian SMEs are more passive and less likely to turn to innovation to develop further.         

Another important, SME-specific issue is that firms have a hard time finding the platform to develop by being embedded into international value chains. “Research suggests that knowledge transfer only applies to the best companies, only they can benefit from taking best practices from good companies operating in their neighborhood” – said Békés. He thinks that numerous Hungarian research projects pointed out that firms’ development is hindered not necessarily by a lack of capital but insufficient management and the bad stimuli mentioned above. Thus, economic relations with successful companies could best be used if smaller firms learnt the management knowledge, workflow, labor organization practices they possess, which would help them take a step forward towards high value-added activities.

Corona effects

The environment is nowadays defined by the coronavirus and the consequent economic recession in the SME sector. András Kaszap says based on a 2020 company survey that medium-sized enterprises proved to be the most resilient among Hungarian SMEs, only 5 percent of them said that their revenue would fall by over 25 percent compared to 2019. Smaller and micro corporations faced a much more challenging time. However, generalized data covers up considerable variation across these firms: the nature of the current crisis dictates that the services sector – which includes tourism and hospitality-focused firms – suffered the most, while some sectors in industry and commerce could even grow, regardless of their size.

Smaller companies were hit not only by falling revenues but a lack of financing as well; firms in the most problematic sectors basically have no chance to secure any loans. KPMG estimates that the demand for corporate loans grew by about 50 percent, which are not satisfied by currently available solutions on the market.

The most frequently mentioned factor regarding the current situation is the pandemic’s effect on the labor market, which is substantial: around one-tenth of firms said they had to fire a considerable number of employees compared to their size, and one-fourth of them had to cut working hours. At the same time, András Kaszap does not believe this would become the most prevalent effect of the pandemic in the long-term, as employment levels would return to normal soon after the pandemic ends. The signs of a reorganizing, adapting labor market are visible already. 15-20 percent of companies delayed investments last year and even those who were not affected as negatively by the pandemic are unlikely to take risks to improve their business in this uncertain environment.

Smash to glass ceiling

The issue of SME development in Hungary has to be approached from two pathways: the general situation and the pandemic’s effects. Despite the above-mentioned, challenging general situation, multiple opinions and indicators suggests that positive change started in productivity a few years ago. The Hungarian Central Bank’s productivity report shows that Hungarian SMEs have started to close the gap to foreign rivals (although they still have considerable reserves in terms of growth, so we are far from putting an end to the dual structure of the Hungarian economy).

However, for the vast majority of Hungarian-owned SMEs to smash to glass ceiling, they must improve in the field of innovation drastically. This is a much more complex problem than it seems because it is certainly not enough for the state to pour money over the problem due to the issues with subsidies in Hungary discussed above – it would, in fact, produce a form of grotesque system of encouragement if the funding is not distributed based on professional considerations, independent of political factors.

András Kaszap believes that in a special situation like this, enterprises must receive swift help, investments and export must be encouraged, and employees must be kept. At the same time, it is important that these temporary extra funds only focus on moderating the effects of the recession, so firms can maintain their growing trajectory standing on their own two legs, without further aid.

Kaszap believes, based on his own experiences, that there are plenty of skills to develop among Hungarian SMEs, such as management knowledge and corporate affairs. This problem might be solved partly by a change of guard: second-generation corporate leaders taking over the business from their parents often studied in domestic and foreign universities or gained work experience abroad. They need not be explained the necessity of separating management and ownership functions, the basics of corporate-like operation and are more open to long-term development, KPMG says.

András Kaszab said that albeit the coronavirus pandemic strongly affected domestic SMEs on the side of financing and investments, there were positive developments that could improve their competitiveness in the long-term. First, numerous firms that are going through this period unaffected have become much more aware of risks, so their leaders see business, financial, legal compliance risks much more realistically and are consciously looking for solutions to these problems, for instance by diversifying their business models. This, overall, makes their business models healthier, just like digitalization and online sales do as a result of social distancing. Most firms had to turn to these solutions either voluntarily or out of necessity, but the majority of them had to develop in these fields anyway. The nature of consultancy-related requests support these hypotheses: during the economic recession, KPMG’s SME clients have turned to the company more frequently with questions about diversifying their business models, encouraging sales and improving efficiency. This was less characteristic of the SME sector before the pandemic, and this trend looks promising in terms of smaller and medium-sized firms’ long-term competitiveness.    

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