2013 knowledge sharing program with hungary2013 ksp] hungary_final report_eng.pdfthe 2013 knowledge...

2013 Knowledge Sharing Program

with Hungary

2013 Knowledge Sharing Programwith Hungary:

Strategy for Crisis Management and Economic Development Policy for the Future Central

European Knowledge-based Hub

MINISTRY OF STRATEGYAND FINANCE Korea Development Institute

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Ministry of Strategy and Finance Government Complex-Sejong, 477, Galmae-ro, Sejong Special Self-Governing City 339-012, Korea

Tel. 82-44-215-7732 www.mosf.go.kr

Korea Development Institute15(Bangok-dong, Korea Development Institute), Giljae-gil, Sejong-si 339-007, Korea

Tel. 82-44-550-4114 www.kdi.re.kr

Knowledge Sharing Program Center for International Development, KDI● 15(Bangok-dong, Korea Development Institute), Giljae-gil, Sejong Special Self-Governing City 339-007, Korea● Tel. 044-550-4224

● cid.kdi.re.kr ● www.ksp.go.kr

2013 Knowledge Sharing Program with Hungary

KSP_헝가리(영문)_목차 2015.3.24 10:42 PM 페이지1 SJ_01

Strategy for Crisis Management and Economic Development Policy for the Future Central European

Knowledge-based Hub

Korea Development Institute (KDI)

Ministry of Strategy and Finance (MOSF), Republic of Korea

The Government of Hungary

Ministry for National Economy (MNE), Hungary

Hong Tack Chun, Executive Director, Center for International Development (CID), KDI

Ildong Koh, Director & Vice President at Department of North Korean Economy, KDI

Boli Kim, Research Associate, Division of Policy Consultation & Evaluation, CID, KDI

Hye Sun Lee, Research Associate, Division of Policy Consultation & Evaluation, CID, KDI

Dae-won Suh, Former Ambassador to Hungary

Wook Sohn, Professor, KDI School of Public Policy and Management (KDIS)

Chapter 1. Wook Sohn, Professor, KDIS

Chapter 2. Sung Jin Kang, Professor, Korea University

Chapter 3. Sherzod Shadikhodjaev, Associate professor, KDIS

Chapter 4. Jisun Baek, Assistant professor, KDIS

Nanhee Kim, Freelance Editor

Project Title

Prepared by

Supported by

Prepared for

In cooperation with

Program Directors

Program Officers

Senior Advisor

Project Manager

Authors

English Editor

2013 Knowledge Sharing Program with Hungary

Government Publications Registration Number 11-1051000-000482-01

ISBN 978-89-8063-861-1 94320

978-89-8063-849-9 (set)

Copyright 2014 by Ministry of Strategy and Finance, Republic of Korea


2013 Knowledge Sharing Program with Hungary:

Strategy for Crisis Management and Economic Development Policy for the Future Central

European Knowledge‐based Hub

Government Publications Registration Number

11-1051000-000482-01

MINISTRY OF STRATEGY AND FINANCE

Korea Development Institute

In the 21st century, knowledge is one of the key determinants of a country’s level of socio-economic development. Based on this recognition, Korea’s Knowledge Sharing Program (KSP)was launched in 2004 by the Ministry of Strategy and Finance (MOSF) and the KoreaDevelopment Institute (KDI).

KSP aims to share Korea’s experience and knowledge with the partner countries to achievemutual prosperity and cooperative partnership. Former high-ranking government officials aredirectly involved in the policy consultation to share their intimate knowledge of developmentchallenges, and to complement the analytical work of policy experts and specialists who haveextensive experience in their fields. The government officials and practitioners effectively pairup with their counterparts in the development partner countries to work jointly on pressingpolicy challenges and share development knowledge in the process. The program includespolicy research, consultation and capacity-building activities, all in all to provide comprehensiveand tailor-made assistance to the development partner countries in building a stablefoundation and fostering capabilities to pursue self-sustainable growth.

In 2013, policy consultation and capacity building workshop were carried out with 36partner countries covering over 140 research agendas. As a new partner country, Costa Rica,Belize, China, Russia, Hungary, Egypt were selected in consideration of the country’s policydemand, growth potential, and strategic economic partnership.

The 2013 Knowledge Sharing Program with Hungary was carried out with the aim ofexchanging socio-economic development experience of two countries for improving Hungary’spolicy making capacity and achieving her socio-economic development. Under the MOU signedbetween the Ministry of Strategy and Finance of Korea and the Ministry for National Economyof Hungary, the joint research and seminars were conducted in order to support theestablishment of “Strategy for Crisis Management and Economic Development Policy for theFuture Central European Knowledge-based Hub”.

I would like to take this opportunity to express my sincere gratitude to Senior Advisor Mr.Dae-won Suh, Project Manager Prof. Wook Sohn, as well as the project consultants includingProf. Sung Jin Kang, Prof. Sherzod Shadikhodjaev, and Prof. Jisun Baek for their immenseefforts in successfully completing the 2013 KSP with Hungary. I am also grateful to ExecutiveDirector Dr. Hong Tack Chun, Program Director Dr. Ildong Koh, and Program Officer Ms. Boli

Preface


Kim, and all members of the Center for International Development, KDI for their hard workand dedication to this program. Lastly, I extend my warmest thanks to the Hungariancounterparts, the Ministry of National Economy, National Innovation Office and other relatedagencies, program coordinators, and participants for showing active cooperation and greatsupport.

In your hands is the publication of the results of the 2013 KSP with Hungary. I believe thatKSP will serve as a valuable opportunity to further elevate mutual economic cooperation ofHungary and Korea to a new level. I sincerely hope the final research results on the selectedareas could be fully utilized to support Hungary in achieving economic development goal inthe near future.

Joon-Kyung KimPresident

Korea Development Institute


Contents2013 KSP with Hungary 015

Executive Summary 018

Chapter 1

Improving Economic Crisis Management Skills

Summary 028

1. Introduction 029

2. Economic Crisis Management in Hungary 031

2.1. Economic Circumstances Prior to the Global Financial Crisis of 2008 031

2.2. Crisis Management in 2008~2009 033

2.3. Crisis Management Since 2010 035

3. Experience of Economic Crisis Management in South Korea 039

4. Principles and Skills of Economic Crisis Management 043

4.1. Establishment of Early Detection Systems of Economic Crisis 045

4.2. Effort to Control the Propagation of Economic Crisis 047

4.3. Policy Response for Economic Stability 051

4.4. Analysis of the Causes of the Crisis and Establishment of the Principle of Crisis Management 053

4.5. Recovering Reputation through the Crisis Management Process 055

4.6. Improving Economic Fundamentals Using Applicable Policy Measures for Preventing

Future Crises 057

5. Conclusion and Future Research 060

References 063

APPENDIX 1 066

APPENDIX 2 085


Chapter 2

Foreign Direct Investment (FDI) Promotion

Summary 092

1. Introduction 093

2. Korean FDI Policies 095

2.1. Overview of Korean FDI Policies and Policy Agendas 095

2.2. Korean Free Economic Zone Policies 097

3. Sectoral FDI Policies 100

3.1. Parts and Materials 101

3.2. R&D 102

3.3. Semiconductors 103

3.4. Green Economy: Life Science and Renewables 103

3.5. Korean Distribution / Logistics 103

4. Comparative Study of Korean and Hungarian FDI Policies 103

4.1. Comparison of Korean and Hungarian FDI Inflows 104

4.2. Trade Structure and Industrial Structure 106

4.2.1. Trade Structure 106

4.2.2. Hungarian Industrial Structure 111

4.3. Korean and Hungarian FDI Policies 113

4.3.1. Korean FDI Policies 113

4.3.2. Hungarian FDI Policies 114

4.4. Comparison of FDI Policies in Korea and 8 East Asian Countries 118

4.4.1. FDI Policies in 8 East Asian Countries 118

4.4.2. Comparison of FDI Policies in Korea and 8 East Asian Countries 120

5. Conclusion and Policy Suggestions 121

References 126

APPENDIX 1 129

APPENDIX 2 137


Chapter 3

Special Economic Zones in Hungary: New Perspectives from the Korean Experience

Summary 144

1. Introduction 145

2. Overview of SEZs 146

2.1. The Taxonomy of SEZs 146

2.2. SEZs as an Economic Policy Tool 149

3. Hungary’s SEZ Policy 151

3.1. Main Industries and Investment Promotion System 151

3.2. SEZ Policy 154

3.2.1. Industrial Parks 154

3.2.2. Free Enterprise Zones 158

4. Korea’s SEZ Policy 159

4.1. Background 159

4.2. State of Play 161

4.2.1. Foreign Investment Zones 162

4.2.2. Free Trade Zones 164

4.2.3. Free Economic Zones 166

5. Recommendations 180

5.1. Why Korea’s Experience Matters 181

5.2. Suggestions 183

References 190

Contents


Chapter 4

Strengthening R&D Capabilities: By Fostering Innovative SMEs

Summary 194

1. Introduction 197

2. Overview of Hungary’s Research, Development and Innovation Activities 199

3. Korea's Experience 204

3.1. Policy Fund Financing System 207

3.1.1. SBC’s Policy Funds 209

3.1.2. Corporate Evaluation System 211

3.2. Support for Venture Businesses 214

3.2.1. Stimulating Venture Investment 215

3.2.2. KOSDAQ Market 218

3.2.3. Entrepreneurship Education and Business Incubators 219

4. Implications and Policy Recommendations 222

4.1. Policy Fund Financing System 223

4.1.1. Corporate Evaluation System 224

4.1.2. Policy Funds in Connection with R&D Projects 225

4.2. Policies to Foster Innovative SMEs and Business Startups 225

5. Conclusion and Further Study 228

References 230


Contents | List of Tables

Chapter 1

<Table 1-1> Major Economic Indicators of Hungary and South Korea 044

<Table 1-2> The Number of Economic Crisis Management Meetings Held 051

<Table 1-3> Comparison of the Early Stage of the Two Crises of South Korea 054

Chapter 2

<Table 2-1> Current Status of Foreign Investment in Free Economic Zones 098

<Table 2-2> Current Status of Businesses in Free Economic Zones (As of End-2012) 098

<Table 2-3> Comparison of Domestic and Foreign Free Economic Zone Incentives 099

<Table 2-4> Sectoral FDI Policies 100

<Table 2-5> Industrial Complexes for Parts and Materials Sector 102

<Table 2-6> Annual Trend of FDI Stocks in Korea and Hungary 104

<Table 2-7> Annual Trend of FDI Flows in Korea and Hungary 105

<Table 2-8> Trend in Korea’s Trade with Hungary (2012) (SITC 1-digit) 106

<Table 2-9> Trend in Korea’s Trade with Hungary in Manufacturing (SITC 2-digit) 108

<Table 2-10> Trend in Korea’s Trade with Hungary in Machinery and Transport Equipment

(SITC 2-digit) 108

<Table 2-11> Trend in Hungary’s Foreign Trade (SITC 1-digit) 109

<Table 2-12> Trend in Hungary’s Foreign Trade in Manufacturing and Machinery

and Transport Equipment (SITC 2-digit) 110

<Table 2-13> Industrial Structure in Hungary 111

<Table 2-14> Hungary’s Global Competitiveness Index (GCI) 117

<Table 2-15> Comparison of Investment Incentive of Major Asian Countries 121

<Table 2-16> Comparison of Investment Incentives of the Visegrad Group 124

Chapter 3

<Table 3-1> Export Processing Zones in Numbers 147

<Table 3-2> Classification of SEZs 148

<Table 3-3> Benefits and Costs of SEZ Policy 150


<Table 3-4> Approval Criteria for Industrial Park Applications 156

<Table 3-5> Key Characteristics of Foreign Investment Zones 164

<Table 3-6> Incentives in Free Trade Zones 165

<Table 3-7> Status of Free Economic Zones (as of September 2013) 168

<Table 3-8> Incentives in Free Economic Zones 173

<Table 3-9> State of Play in Attraction of Foreign Investment to Free Economic Zones 179

<Table 3-10> The Number of Enterprises in Free Economic Zones 180

<Table 3-11> Doing Business in Hungary and Korea

Chapter 4

<Table 4-1> Venture and Growth Capital Financing in Hungary, 2007-2011 203

<Table 4-2> Distribution of Firms 2008-2011 205

<Table 4-3> Main Functions of SBC 209

<Table 4-4> SBC’s Policy Funds 210

<Table 4-5> Yearly Progress of Fund Sources 216

<Table 4-6> Example of Listing Requirements 219

<Table 4-7> Budget and Number of Supported Business Incubators 221

<Table 4-8> Performance of Business Incubators 221

<Table 4-9> SBC’s Youth Entrepreneurship Training Program 222


Contents | List of Figures

Chapter 1

[Figure 1-1] Policy Package in Response to the 2008 Economic Crisis in Korea 042

[Figure 1-2] Classification of Current Debt 048

[Figure 1-3] Comparison of the Early Stage of the Two Crises of South Korea 054

Chapter 2

[Figure 2-1] The Effect of FDI on Economic Growth/Development 094

[Figure 2-2] Linkage Effects Structure 123

Chapter 3

[Figure 3-1] Hungarian Industrial Parks (1997-2009) 155

[Figure 3-2] Incentives within Free Enterprise Zones 158

[Figure 3-3] SEZ Locations in Korea 162

[Figure 3-4] Implementation of a Free Economic Zone Project 166

[Figure 3-5] Map of the Incheon Free Economic Zone 171

[Figure 3-6] Grievance Resolution by the Office of the Foreign Investment Ombudsman 178

[Figure 3-7] Hungary’s Business Environment Rankings 181

[Figure 3-8] Administrative Burdens in OECD Countries 186

Chapter 4

[Figure 4-1] Gross Domestic Expenditure on R&D, compared to GDP 200

[Figure 4-2] Business R&D Intensity 2011 201

[Figure 4-3] Product of Process Innovators in 2008-2010 201

[Figure 4-4] Venture Capital Investment, compared to GDP 203

[Figure 4-5] Gross Domestic Expenditure on R&D 206

[Figure 4-6] The Role of Policy Funds 207

[Figure 4-7] Policy Fund Support System in Korea 208

[Figure 4-8] Corporate Evaluation Rating Process as of 2011 212

[Figure 4-9] Rating Process of KTRS 213

[Figure 4-10] Operation Structure of KFoF 217

[Figure 4-11] Trend of New Investment on Venture Business 217

[Figure 4-12] Operational Structure of Angel Matching Fund 218


Contents | List of Appendix Tables

Chapter 1

<Appendix Table 1> Summary of the Economic Crisis Meetings 086

Chapter 2

<Appendix Table 1> Performance Evaluation of Public Enterprise privatization 132

<Appendix Table 2> Outcome of Sale of Shares to Foreign Capital during Public Enterprise

Privatization 133

<Appendix Table 3> Characteristics of SME Policies by Period 134

<Appendix Table 4> SME Policies to Foster Globally Competitive SME 135

<Appendix Table 5> Samsung’s Mutual Growth Program 136


Contents | List of Appendix Figures

Chapter 1

[Appendix Figure 1] General Government Budget Deficit and Gross Debt 067

[Appendix Figure 2] Decomposition of GDP Growth 067

[Appendix Figure 3] Private Sector Loans 068

[Appendix Figure 4] Net External Debt and Current Account 068

[Appendix Figure 5] Yields and Base Rate 068

[Appendix Figure 6] HUF/EUR Exchange Rate 068

[Appendix Figure 7] NPL and CAR 072

[Appendix Figure 8] General Government Budget Deficit and Cross Debt 074

[Appendix Figure 9] Decomposition of GDP Growth 074

[Appendix Figure 10] Private Sector Loans 074

[Appendix Figure 11] Net External Debt and Current Account 074

[Appendix Figure 12] CDS and Base Rate 075

[Appendix Figure 13] HUF/EUR Exchange Rate 075

[Appendix Figure 14] Structure of Expenditure 079

[Appendix Figure 15] Employment and Unemployment 083

[Appendix Figure 16] Gross Foreign Debt 083

[Appendix Figure 17] Trade Balance 083

[Appendix Figure 18] Financing Capacity/Need of the Economy 083


2013 KSP with Hungary 015

The Knowledge Sharing Program (KSP) with Hungary was first launched in 2013following a mutual agreement between Hungary and Korea with the theme,“Strategy for Crisis Management and Economic Development Policy for the FutureCentral European Knowledge-based Hub.” In line with the Hungarian government’seffort to transform its stagnant economy into a new European economic hub, thisjoint research and policy consultation between the two parties is not only timely butimportant as well.

The key objective of the KSP is to assist partner country’s enhancement of nationalcompetitiveness and institutional restructuring by sharing Korea’s developmentexperience. The KSP with Hungary has a special meaning considering the economicstatus itself, as Hungary is neither a member of ODA recipient countries nor low-income countries, but an upper middle-income country with the OECD and EUmembership. There is a big difference from other partner countries in defining theKSP in terms of a share of responsibility. The joint study and ownership was enhancedand emphasized in implementing the research under the close cooperation of bothcountries. This also aims to foster a mutually beneficial relationship by providingpractical and concrete policy suggestions. This interactive consultation will last forthree years as signed in the MOU between the Ministry of Strategy and Finance(MOSF) of Korea and the Ministry for National Economy (MNE) of Hungary.

Policy consultation for the 2013 KSP with Hungary consists of four research topicsselected in accordance with priority demands of the Hungarian government. As animplementing organ, the Korea Development Institute (KDI) teamed up a group of

2013 KSP with Hungary

Boli Kim (Program Officer, Korea Development Institute)


016 2013 Knowledge Sharing Program with the Hungary

experts headed by a senior advisor, Dae-won Suh, a former ambassador to Hungary.Each researcher was paired with a head of the working groups from the Hungarianside in order to gain useful data and information as well as advice on the contents ofthe research.

The table below lists the four consultation areas and researchers for the 2013 KSPwith Hungary.

Under the auspice of MOSF and MNE, the 2013 KSP commenced with the DemandSurvey and Pilot Study in November 16~21, 2013 when the Korean research teamvisited Budapest, Hungary. In a kick-off meeting with the Hungarian governmentofficials, the Korean delegation introduced the KSP and presented Korea’s experiencein relation to each topic. The Korean experts had a separate meeting with workinggroups with intention to identify current issues and problems to solve within thescope of KSP. During the meeting local consultants were selected on the basis of theirexpertise and position in the area of consultation. In addition, the contents of costsharing as well as a future plan for the project were discussed between workinggroups of both sides.

MOSF and MNE concluded the MOU for effective implementation of the KSP. ThisMOU was signed between Oh-seok Hyun, Vice Prime Minister and Minister ofStrategy and Finance and Varga Mihály, the Minister of National Economy on 25November 2013 during Mr. Vargá’s visit to Korea. Both ministers emphasized the

Strategy for Crisis Management and Economic Development Policy for

the Future Central European Knowledge-based Hub

Senior Advisor: His Excellency Dae-won Suh(Former Ambassador to Hungary)

Project Manager: Dr. Il-Dong Koh (KDI)

Consultation Topics Researchers

Improving Economic Crisis Management SkillsProf. Wook Sohn (KDI School of Public Policy andManagement, KDIS)/ Project ManagerMr. Márton Szili (MNE)

Foreign Direct Investment (FDI) PromotionProf. Sung Jin Kang (Korea University)Mr. András Szilágyi (MNE)

Special Economic Zones in HungaryProf. Sherzod Shadikhodjaev (KDIS)Mr. Ádám Nagy (MNE)

Strengthening R&D CapabilitiesProf. Jisun Baek (KDIS)Mr. Zoltán Peredy (National Innovation Office, NIH)


2013 KSP with Hungary 017

importance of KSP with regard to the future prospect of economic cooperation.Under the MOU, the project length of the KSP will last for three years unless one ofthe parties withdraws the agreement.

The Korean delegation conducted an Additional Field Survey during February15~20, 2014 to develop research analysis and gain useful advice from the Hungarianside. The Korean experts accompanied by the local consultants visited FDI firms inHungary invested by Korean companies such as Samsung Electronics, KDB Bank, andHankook Tire in an effort to examine overall business environment of FDI firms inHungary and to collect firm-specific information from these companies concerningoperation, management, and economic incentives provided by Hungarian centraland local governments. The experts also undertook a separate schedule according tothe consultation topics for further research, visiting the Central Bank of Hungary,MNE, National Innovation Office, HITA and so on. On the last day of the schedule,the Korean experts made a presentation on the progress of the study together withthe findings from the additional field study while local consultants made commentsand gave feedbacks on the research.

A group of local consultants headed by Dr. Ádám Nagy, visited Korea toparticipate in the Interim Reporting and Policy Practitioner’s Workshop during 31April ~ 6 May 2014. Both parties made presentations on the research during thereporting session, and developed the composition and integrity of the researchthroughout a close consultation during the stay. The delegation also had a series ofmeetings with relevant Korean institutes and experts, from public sectors includingMOSF, the Ministry of Trade, Industry and Energy (MOTIE), and Incheon FreeEconomic Zone (IFEZ) to the private sectors such as Samsung Electronics, etc. Duringthe meeting with Dr. Hong Tack Chun, Executive Director of the Center forInternational Development (CID) at KDI, the delegation proposed a formalpresentation ceremony of a final KSP report to the Minister of National Economy as acommemoration concluding the 2013 KSP. Both parties agreed upon the proposaland discussed on the due dates of the completion of the report.

The Final Reporting session and Senior Policy Dialogue is expected to be held inOctober 2014. The schedule was postponed as consequence of the academic review,and professional editing of the final report. This report is to be delivered to theMinister of National Economy during the delegation’s visit to Hungary in October.Through the high-official policy talks, the final result of the policy recommendationswill be presented, and the participants are to engage in active discussions anddebates regarding the utilization of the research outcome. Adding to the successfulconclusion of the 2013 KSP, the discussion on new topics for the 2014 KSP should becarried out, either as intensified version of the previous research or as a completelynew area of research.



Executive Summary

Wook Sohn (KDI School of Public Policy and Management)

The 2013 Knowledge Sharing Program with Hungary was carried out under theMOU signed between the Ministry of Strategy and Finance of Korea and the Ministryfor National Economy of Hungary. The 2013 KSP with Hungary is the first-evercooperation within the KSP program. The main purpose of the program is to shareexperience and ideas in improving Korea and Hungary’s policy making capacity andachieving socio-economic development.

The 2013 KSP with Hungary, entitled the “Strategy for Crisis Management andEconomic Development Policy for the Future Central European Knowledge-basedHub,” covers four key policy areas, which were chosen on the basis of policy priorityof the Hungarian government. These are: 1) Improving Economic Crisis ManagementSkills, 2) Foreign Direct Investment (FDI) Promotion, 3) Special Economic Zones inHungary: New Perspectives from the Korean Experience, and 4) Strengthening R&DCapabilities: By Fostering Innovative SMEs. Our findings and policy recommendationsfor each policy area are as follows.

1. Improving Economic Crisis Management Skills

The global financial crisis initiated from the U.S. in 2008 drove the world’sfinancial system and economy into turmoil, including Hungary and South Korea. In itsarticle of February 26, 2009, the Economist predicted that these two countries wouldbe the most vulnerable and would most likely be sacrificed in the midst of the



financial crisis. Hungary received a financial bailout from the European Union (EU)and the International Monetary Fund (IMF) in 2008. The programs proposed by thoseorganizations could technically avert the default, but did not improve economicresilience and public and external debt increased further. From mid-2010, proactiverestructuring polices were initiated to strengthen economic fundamentals. SouthKorea also experienced turmoil in the financial markets and a contraction in its realeconomy during the global financial crisis of 2008, but its crisis was overcome earlierthan that of other nations so that its economic status was stabilized.

A concrete solution in overcoming a financial crisis depends mainly on the initialconditions and basic structures of the economy as well as on the marketcircumstances at the time of the crisis. However, the objectives of economic crisismanagement are common to all countries, which is to overcome the crisis as early aspossible and to strengthen the economic fundamentals in preparation for such crisesin the future. This chapter presents the cases of Hungary and South Korea inovercoming the 2008 economic crisis and provides recommendations for improvingthe economic crisis management skills taking into consideration the differences ineconomic structure and conditions of the two countries.

Policy recommendations are made to comply with the six stages of the crisismanagement from the perspectives of organizational behavior and publicadministration based on the experience of South Korea. They are; (1) operation ofthe early warning system, (2) control of crisis spreading to other sectors, (3) short-term macroeconomic measures for economic stabilization, (4) analysis on the causesof crisis and establishment of crisis response principles, (5) management ofinternational reputation while overcoming the crisis, and (6) restructuring to preventfuture crises.

Although South Korea was slightly unstable due to the external mega-shock thataffected the world in 2008, it rebounded with “earlier-than-expected” stability.Although there were many factors that ameliorated and absorbed the shock quickly,but the most important factor was the improvement of economic fundamentals thatwere made previously using policy measures that went beyond short-termmacroeconomic aspects during the restructuring phase of the 1997 crisis.

Although a short-term contingent measure seems effective, if it is run excessively,it could incur mid- to long-term problems such as the weakening of economicfundamentals and distortions to the incentive structure. Therefore, emergencymeasures implemented in the face of the crisis should revert to normal measures atan appropriate time, and the restructuring required for the improvement ineconomic fundamentals should be enforced continuously, regardless of the economicrecovery, to ensure the best methods in response to other crises in the future.



It is known that the Hungarian government has been implementing economicreforms in earnest since 2010, and their effects are now visible. However, the effectsfrom macroeconomic policies and economic reform should be continually monitoredto improve further effects. In particular, economic reform measures should continuefocused on the sustainable growth driving forces among various measures to improveHungary’s economic fundamentals. Such adjustment of economic structures on amid-term basis could be a buffer that effectively overcomes other economic crises inthe future.

2. Foreign Direct Investment (FDI) Promotion

When proposing policy recommendations for Hungary based on Korea’sexperience, we had to consider the Hungarian government’s position as an EUmember nation, most likely not being able to implement policies with strong politicalwill as in Korea’s case. Hence, instead of unilaterally conveying Korea’s experience,this chapter summarizes the general FDI policies of Korea including the publicenterprise privatization policies and small and medium enterprise (SME) policies thatHungary requested to be included in this KSP project based on the discussion andresearch with Hungarian researchers. Moreover, this chapter aims to make a fewsuggestions on Hungarian FDI promotion policies through the comparative study ofHungary.

Based on the review of Korea’s FDI policies and a comparative study betweenKorea and Hungary, this chapter proposes the following six major policy suggestions.First, Hungary needs to consider unbalanced development strategy. EU policies are infavor of balanced development in order to reach leveling of development in thedifferent regions of Europe, which is very difficult to achieve. Thus it might beonerous for the Hungarian government to spare its political determination to followthe EU’s policy directions for unbalanced development.

Second, it is critical to establish a control tower and an organization dedicated toFDI. In order for well-intentioned policies to be implemented effectively, an efficientdecision-making system must be established. Hungary also needs to organize acontrol tower that coordinates opinions of the central and local governments andmake decisions regarding the establishment of industrial complexes.

Third, implementing policies that promote agglomeration are necessary. Toenhance the cumulative effect of industrial zones to its greatest extent, relevantpolicies need to be altered so as to focus investment on certain areas.

Fourth, the country is in great need of maximizing backward and forward linkage



effects by nurturing the parts and materials industry. The growth in this industry willenable Hungary to minimize its trade deficit into surplus with Korea and localize theproduction of goods.

Fifth, the country needs to pursue long-term effects of privatization of state-owned enterprises (SOEs). Based on Korea’s case, this paper suggests theestablishment of policies that boost public sector privatization that contribute to SOEreforms as well as trade deficit reduction or strategies that link the public sectorprivatization with FDI.

Last but not least, a comparative study on business environment should be carriedout. The World Bank’s Doing Business Report (DBR) gives evidence that companiesfind it relatively more difficult to invest and carry out their businesses in Hungarycompared to its neighboring countries like the Czech Republic, Slovakia, and Poland.Based on a comparative study among the Visegrad Group - the Czech Republic,Slovakia, Poland, and Hungary - the Hungarian government must put efforts tocreate an attractive investment climate and business environment in order to attractFDI into the country.

Since Hungary has reached a certain level of economic development, it would beless meaningful to unilaterally share Korea’s experience as in previous KSP projects.Hence this chapter organized its contents based on Hungary’s opinions drawn fromdiscussions with Hungarian researchers and emphasized the link between existingpolicies and FDI policies as well as the efficient role of the government instead of theneed for strong policy instruments. Also, this chapter aims to share the FDI policies ofKorea and Hungary by discussing the strategic partnerships that are promoted by theHungarian government. This approach is quite different from the previous KSPproject methods.

We believe that the contents and suggestions of this chapter will contribute to theexpansion of FDI inflows of Hungary, and at the same time, we expect the researchdirection of this chapter to provide a useful direction to the KSP projects that will beconducted for Hungary as well as other developing nations.

3. Special Economic Zones in Hungary: New Perspectives from the Korean Experience

Special Economic Zones (SEZs) aim to create a unique business environment withina designated area in a particular country to promote certain policy objectives.Notwithstanding their varieties, most of the SEZs share some common features, suchas a geographically limited (usually fenced-in) area, single management, incentives



for in-zone-located companies, and streamlined administrative procedures. Currently,there are around 3,500 SEZs in over 130 countries including Hungary and Korea.

Hungary’s SEZs are represented by industrial parks and free enterprise zones. Withthe first industrial park established in 1997, Hungary operates more than 200industrial parks today. Since 2013, the government has also opened science andtechnology parks - a subset of industrial parks - that focus mainly on research anddevelopment activities. Moreover, over 1,000 free enterprise zones have recentlybeen established in 47 underdeveloped regions. Both industrial parks and freeenterprise zones offer various incentives to residing companies in accordance withHungarian legislation and European Union law.

In Korea, a first SEZ was opened in the early 1970s. Currently, there are three typesof SEZs. Foreign investment zones constitute, for example, areas with lands leased ortransferred to foreign-invested companies from existing national industrialcomplexes, or areas in which a foreign investor intends to invest. Free trade zonesfocus on manufacturing, logistics, distribution and trade, which are mainly openwithin industrial complexes, airports, seaports, distribution complexes, or freightterminals. As a new paradigm in Korea’s SEZ policy, free economic zones seek acomplex development of industry, business (commerce), logistics and housing forforeign businessmen and their families through providing pleasant living conditionsand environment.

The Hungarian government could expand the role of SEZs in furthering economicreforms aimed at easing regulations on doing business. Given the longer experience(as compared to Hungary) in implementing the SEZ regime, Korea’s case of SEZs - bothsuccesses and failures - would be useful for Hungary. In this respect, a customizedmodel of Korean free economic zones could be a worthwhile candidate for Hungary.Just as Korea created free economic zones in pursuit of its goal to become aNortheast Asian economic hub through nurturing new growth engines going beyondtraditional sectors, Hungary, recently affected by the financial crisis in Europe, couldalso use free economic zones to become an economic hub in Central and EasternEurope.

The Korean concept of free economic zones is different from Hungarian industrialparks and free enterprise zones in that it pursues a complex development of industry,business (commerce), logistics and housing within a pre-defined large area, such as,for example, a new town or city, with all necessary infrastructure made available.Moreover, free economic zones help to improve foreigners’ living conditions throughreducing foreigner-specific restrictions that are otherwise difficult to remove on anationwide basis, or creating necessary facilities.



At the outset, only one pilot free economic zone, possibly incorporating someexisting SEZs, could be opened in Hungary, though the number of such zones may beincreased in the future. As selection of an appropriate site has a tremendous impacton the zone’s success, the government may weigh, at least, two locational options:either to open it in a poor region with generous financial incentives available toenterprises, or in an advanced region near the capital city with an easy access to high-quality infrastructure, skilled labor and a big market.

The Korean experience suggests that for better coordination and consistency inthe SEZ policy it is necessary that a single government agency is in charge of allexisting special zones. Establishing an ombudsman system - similar to Korea’s system -would also be a good administrative attempt to enhance the business climate inHungary. On the other hand, not all features of the Korean model are applicable inHungarian circumstances. For example, Korea’s current practice of treating foreigncompanies more favorably than domestic ones within free economic zones may notwork in Hungary.

The complexity of this project requires a thorough feasibility study for theproposed zone in the closest context of Hungary’s circumstances. This could become anew topic for the future Korea-Hungary Knowledge Sharing Program. In addition,two countries could and should regularly cooperate at both public and private levelswith a view to exploring and conducting joint projects in each other’s SEZs. Such SEZ-related cooperation will help both sides to further advance into each other’s marketsas well as the respective regional market.

4. Strengthening R&D Capabilities: By Fostering Innovative SMEs

Hungary has made progress in catching up with the high-income OECD countriesin many aspects, equipped with high quality human capital and a high degree ofopenness of the economy. However, the level of innovation activities andperformance still show some rooms for improvement. The main weaknesses ofHungary include low R&D expenditure, particularly from business R&D investment,and lack of innovation activities among SMEs.

In order to strengthen Hungary’s research, development and innovation (RDI)capabilities, it is necessary to thoroughly analyze the entire innovation system, whichincludes knowledge generating system and industrial system. Among many vitalcomponents to raise RDI capabilities of one country, this report focuses on fosteringinnovative enterprises, an important pillar of national innovation system. Inparticular, the emphasis will be on small- and medium-size enterprises (SMEs) that



will play a pivotal role in the utilization of R&D results. The report contains cases ofthe major policies that promote innovative SMEs and their innovation activities toassist their spontaneous growth, accompanying the in-depth discussion andprecautions regarding the policies to strengthen Hungary’s RDI capabilities. Amongmany policy tools used for the Korean innovative SME development system, thereport focuses on policy fund financing system, and fostering venture businesses.

First, it must always be kept in mind that the purpose of policy funds is tostrengthen SMEs’ capabilities and not to resolve SMEs’ financial difficulties. TheKorean government has selectively supported industries that significantly contributedto the national economy using policy fund financing, expecting a rapid growth in thetargeted industries. However, there have been concerns that those support measuresmay distort the direction of technology progress and may impede restructuring forSME competitiveness. Therefore, the policy fund financing must be provided topromote innovation activities of SMEs, which in turn will foster innovative SMEs.Direct financial support for SMEs should play only a supplementary role in order tomaintain a market-friendly financing environment, and the government should makean effort to establish a financing environment, which can efficiently allocateresources.

Another critical concern raised about policy funds is selecting appropriaterecipients. Just as a corporate assessment system selects recipients very carefully, somust the policy fund financing system. And as such, Hungary should analyze itsassessment system and improve it to be more objective and consistent as well as towell reflect the policy goal. As the goal of policy funds is to foster innovative andtechnology-based SMEs, it would be desirable for Hungary to elaborate a corporateevaluation system, which focuses on company’s technology excellence and businessfeasibility rather than financial history unlike the most corporate evaluation systems,which are based on credit ratings. In addition, the government must establish amonitoring system and an evaluation scheme as policy funds to foster SMEs’innovation capabilities can be easily misused due to a large number of firms.

Third, it is vital to implement diverse and extensive business policies in the earlystage of venture business development to foster venture businesses and to promoteventure business startups. The support should include establishing a financial system,which provides financial resources to startup ventures such as venture capital andangel investment because startup businesses are likely to be underinvested despitetheir growth potential. Hungary should take into consideration in establishinginfrastructure for SME M&A or IPO mechanism customized to SMEs, which facilitateSMEs’ equity financing and sustainable growth of venture capital investment.

Fourth, Hungary should consider introducing policy measures to support joint


R&D projects with universities or research institutes, which can provide humanresources and facilities instead of just providing funding. Even if there is enoughventure capital and financial support from the government, SMEs cannot successfullyachieve innovation if they lack R&D capabilities such as human capital andequipment. In a similar manner, Hungary should consider introducing One-stop ClinicService, which provides solutions to SMEs’ problems based on expert analysis oncompany’s technology and management.

Fifth, Hungary should nurture more prospective entrepreneurs who are ready forstartup through entrepreneurship education because the basic premise of policies tosupport innovative SMEs is that there are enough good innovative businesses, whichcan attract investors and that the SMEs have strong innovation capabilities. It shouldconsider providing all resources needed for starting a business to potentialentrepreneurs with innovative ideas in order to increase the success rate of startupbusinesses.

Last but not least, it should be well noted that the most important element toenhance R&D capabilities is the pool of people with innovative ideas. In order tomake the policies more effective and successfully connect innovative ideas tocommercialization for companies, Hungary should first evaluate its own nationalinnovation system, maintain infrastructure for innovation activities, and examine thecapabilities of universities and research institutes, which are responsible forknowledge generation and dissemination. Furthermore, Hungary should considerintroducing some policy measures to promote business R&D investment such as taxbenefits or other incentives based on the analysis of potential effects. In addition,Hungary should examine its infrastructure that is used to commercialize theoutcomes from basic research, in which Hungary shows its excellence, and create anappropriate environment for R&D commercialization to pursue utilization-orientedR&D.



KSP_헝가리(영문)_1~2장 2015.2.24 3:27 PM 페이지142 SJ_01


Strategy for Crisis Management and Economic Development Policy

for the Future Central European Knowledge-based Hub

Improving Economic Crisis Management Skills

Chapter1


028 2013 Knowledge Sharing Program with Hungary

Improving Economic Crisis ManagementSkills

Wook Sohn (KDI School of Public Policy and Management)

■ Chapter 01

Summary

The global financial crisis initiated from the U.S. in 2008 drove the world’sfinancial system and economy into turmoil, including Hungary and South Korea. In itsarticle of February 26, 2009, the Economist predicted that these two countries wouldbe the most vulnerable and would most likely not pull through the financial crisis.Hungary received a financial bailout from the European Union (EU) and theInternational Monetary Fund (IMF) in 2008. The program proposed by thoseorganizations could technically avert the default, but did not improve the resilienceof the economy and public and external debt increased further. From mid-2010,proactive restructuring polices were initiated to strengthen economic fundamentals.South Korea also experienced turmoil in the financial markets and a contraction in itsreal economy during the global financial crisis of 2008, but its crisis was overcomeearlier than that of other nations so that its economic status was stabilized.

The objectives of economic crisis management are to overcome the crisis as earlyas possible and to strengthen the economic fundamentals in preparation for suchcrises in the future. However, a concrete solution in overcoming a financial crisisdepends mainly on the initial conditions and basic structures of the economy as wellas on the market circumstances at the time of the crisis. In this chapter, I present thecases of Hungary and South Korea in overcoming the 2008 economic crisis and makerecommendations for improving the skills of economic crisis management with aconsideration of the differences in economic structure and conditions of the twocountries.


In general, an economic crisis management system of a nation is classified largelyinto foreign exchange, macro-economy, public finance, financial markets, andcorporate sectors. In this chapter, policy recommendations are made to comply withthe six stages of the crisis management from the perspectives of organizationalbehavior and public administration based on the experience of South Korea. Theyare; (1) operation of the early warning system, (2) control of crisis spreading to othersectors, (3) short-term macroeconomic measures for economic stabilization, (4)analysis on the causes of crisis and establishment of crisis response principles, (5)management of international reputation while overcoming the crisis, and (6)restructuring to prevent future crises.

Although a short-term contingent measure seems effective, if it is run excessively,it could incur mid- to long-term problems such as the weakening of economicfundamentals and distortions to the incentive structure. Therefore, emergencymeasures implemented in the face of the crisis should revert to normal measures atan appropriate time, and the restructuring required for the improvement ineconomic fundamentals should be enforced continuously, regardless of the economicrecovery, to ensure the best methods in response to other crises in the future. In thisprocess, it is critical to reflect analysis on applicable side effects and monitoring resultswhen executing policies, whether they are emergency measures or are reformedpolicies for economic restructuring.

It is known that the Hungarian government has been implementing economicreforms in earnest since 2010, and their effects are now visible. However, the effectsfrom macroeconomic policies and economic reform should be continually monitoredto improve further effects. In particular, economic reform measures should continuefocused on the sustainable growth driving forces among various measures to improveHungary’s economic fundamentals. Such adjustment of economic structures on amid-term basis could be a buffer that effectively overcomes other economic crises inthe future.

1. Introduction

The global financial crisis initiated from the U.S. in 2008 drove the world’sfinancial system and economy into turmoil, irrespective of whether affected nationswere advanced or developing. Hungary and South Korea were no exception. In itsarticle of February 26, 2009, the U.K. journal, Economist, predicted that Hungary andSouth Korea, in particular, would be the most vulnerable countries and would mostlikely not to overcome the financial crisis, which drew much attention all over theworld.

Chapter 1 _ Improving Economic Crisis Management Skills 029


Hungary received a financial bailout from the European Union (EU) and theInternational Monetary Fund (IMF) in 2008. The program proposed by thoseorganizations could technically avert the default, but did not improve Hungary’seconomic resilience and public and external debt increased further. From mid-2010,after the closing of the EU/IMF Program, proactive restructuring polices were initiatedto strengthen economic fundamentals. South Korea also experienced turmoil in thefinancial markets and a contraction in its real economy during the global financialcrisis of 2008, but it rebounded relatively quick compared to other nations and thus,its economic status was stabilized rapidly.

This chapter will discuss the management systems that operated in Hungary andSouth Korea during such economic crisis. The underlying objective of economic crisismanagement is to overcome a crisis as quickly as possible and to strengthen theeconomic fundamentals in preparation for such crises in the future. However, aconcrete solution in overcoming a financial crisis largely depends on the initialconditions and basic structures of the economy as well as on the marketcircumstances at the time of the crisis.

It is generally known, that an economic crisis management system of a nation isclassified into foreign exchange, macro-economy, public finance, financial markets,and corporate sectors. On the other hand, the risk management system is functionallyapproachable by dividing it into the identification of crisis, crisis management, andeconomic restructuring. In this chapter, policy recommendations are provided tocomply with the framework of the crisis management from the theories oforganizational behavior and public administration based on the Korean experienceof overcoming a crisis.

Economic crisis management used in most countries can largely be classified intosix steps, similar to the steps that organizations use. These steps are; (1) earlydetection of the crisis, (2) deterrence of the spread of the crisis, (3) measures foreconomic normalization, (4) analysis of the causes of the crisis and the establishmentof policy directions, (5) management of the reputation of the national economy, and(6) improvement in economic fundamentals using applicable policy measures for theprevention of a future crisis. This chapter will present policy-relatedrecommendations with respect to the basic directions and skills for economic crisismanagement under the above framework.

In Sections 2 and 3, the experiences of economic crisis management of Hungaryand South Korea in the face of the global financial crisis in 2008 are briefly described.In Section 4, the principles and skills for the preferred economic crisis managementare discussed systematically, based on the experience of Korea. In Section 5, aconclusion points to some areas that need special attention during the



implementation of economic crisis management and the tasks required to improveeconomic fundamentals in order to overcome any future economic crisis in Hungary.

2. Economic Crisis Management in Hungary1)

The Hungarian economy has experienced a few double dip recessions since 2008.The first recession was due to the global financial economy in 2008, while the secondwas due to the Eurozone crisis initiated by the Greece default crisis. The first crisis wasovercome thanks to the bailout by the EU and IMF however, Hungary’s economicfundamentals did not improve and the public debt further increased, which in turnled to the second crisis caused by the distress of certain countries’ debt crisis in theEurozone. At this stage, the Hungarian government realized that the key toeconomic crisis management was not to provide temporary short-term crisisresponses but to face and solve the restructuring challenges of the economy. Withouteconomic restructuring Hungary will face another economic crisis in the near futuredue to its vulnerability arising from weak economic fundamentals.

Since then, the Hungarian government has aimed to restrain the ever increasingpublic debt and drive comprehensive economic reforms to expand growth potentialand create employment. As a result, the public debt has been downturned again,while the red figures in its public finance have maintained within 3% of the grossdomestic product (GDP), and the rates of employment and labor market participationhave increased compared to those before the crisis. This indicates a positive prospect.

The economic situation in Hungary prior to the financial crisis in 2008 wasvulnerable to any economic crisis, but its economic management system changeddramatically after experiencing two economic crises. Now the Hungarian economy ismore resilient in response to any economic crisis, due to stable macroeconomicconditions and improvement in its economic indicators compared to the past.

2.1 Economic Circumstances Prior to the Global

Financial Crisis of 2008

The Hungarian economy prior to the financial crisis in 2008 had an economicstructure that was vulnerable to economic crises due to the macroeconomic andfinancial imbalance incurred by economic policies in operation since 2002. The publicdebt had increased to a high level, and the majority was foreign debt. In addition,Hungary’s competitiveness had deteriorated and its employment rate continued to


1) This section is based on the report written by the Ministry for National Economy of Hungary. Further details about

the experience of economic crisis management in Hungary can be found in Appendix 1.


decline, while the required structural reform was continuously delayed. In particular,budgetary policy was highly expansionary from 2002 to 2006, generating budgetdeficit more than 8% of GDP in average. During that period, a generous expansion inthe social safety net such as wage increases in the public sector, and individualincome tax exemption for those who earned below the minimum wage wereimplemented, resulting in a sharp increase of real wages as well as a GDP growth rateabove the potential growth rate. The economic growth was accelerated by loans inthe private sector, which were denominated mainly in foreign currency as well asdomestic spending due to the expansionary fiscal policy, while the excessivespending, accompanied by a low savings ratio, incurred a high current account deficitand a sudden increase of foreign debt.

According to Sobják (2013), the Hungarian economy was already experiencing aproblem and was slowing down way before the 2008 financial crisis. As a result, theimpact of the crisis was more severe on Hungary compared to other nations andHungary was the first country to receive a bailout from the IMF in October 2008.Magas (2010) describes the economic crisis in Central and Eastern European countries,including Hungary. Magas claims that the economic policies of Hungary that hadbeen enforced since 2004 made the Hungarian economy vulnerable to the 2008financial crisis, and the establishment of economic policies and countermeasuresagainst the crisis taken by a small-sized open economy that only recently joined theEU, such as Hungary, had more limitations than expected.

In response to this, the Hungarian National Bank (Magyar Nemzeti Bank, MNB),the nation’s central bank, maintained a high benchmark interest rate and respondedto inflation risk caused by the growth above the potential growth rate, which wasfollowed by the increase of foreign loans at a low interest rate, thereby diminishingthe effects of monetary policy using interest rate.2) In particular, the accumulation offoreign currency denominated credit became a major risk factor at the time of thefinancial crisis in 2008. Foreign banks that were able to borrow foreign currenciesmore easily than the Hungarian local banks provided foreign currency loans withrates much lower than the Hungarian Forint (HUF) loans in order to expand theirmarket share, and the loan-to-deposit ratio increased from below 100% in 2002 to160% in 2008.

The vulnerability of the Hungarian economy prior to the financial crisis was mainlydue to excessive loans in the public and private sectors. The public debt reached 73%


2) Gereben, Karvalits, and Kocsis (2011) argue that when small-sized open economies that were highly

dependent on the US dollar face an economic crisis, their monetary policies were prone to lose effectiveness,

and this increase the risk of financial instability. In particular, they discuss how a high level of foreign currency

denominated debt weakened the interest rate and exchange rate channels in monetary policy, highlighting the

weakening of the exchange rate channel in Hungary.


of GDP, which was higher than that of the neighboring countries at the end of 2008,and the total foreign debt as of end-2008 reached 120% of GDP. The householdsector, which was indebted excessively in foreign loans compared to its income, wasexposed to the risks of foreign exchange and insolvency, while the official foreignexchange reserves reached below the short-term foreign debt in 2007 and continueduntil September 2008 to record the lowest mark at 84% of short-term foreign debt.

The US-led financial crisis in October 2008 affected the European Union, includingHungary, at the same time. The collapse of investment confidence in Forint-denominated assets reflected the fact that the Hungarian economy had the weakesteconomic fundamentals in that region at that time. The insufficient foreign exchangereserve of the MNB and excessive foreign currency exposure were the two majorculprits to the collapse. The credit default swap (CDS) spread of Hungary increasedfrom 100bp in mid-2008 to 550bp in October of that same year. As a result, thegovernment bond sale failed, and the bond interest rate increased much higher thanthat of other nations in the region. Due to the withdrawal of foreign capital, thenominal foreign exchange rate declined by 25%, which had a large negative effecton both the credit stocks in the private sector and the public and private debt inforeign currency. In the real economy sector, as the debt service burden increased,accompanied by a decrease in disposable income, it created a much biggerconsumption drop, which could not be explained merely by economic doldrums, andthe liquidity depletion in the international market significantly increased the fund-raising costs.

2.2. Crisis Management in 2008~2009

In the face of the financial crisis in 2008, the Hungarian government neededimmediate monetary and financial policy measures to prevent a default as well as tosupport the banking systems; these measures included an increase in the depositinsurance limit, enhancing capital adequacy ratio of banks, and implementing theVienna Initiative.3) However, Hungary had no other choice but to apply for a loanfrom the EU/IMF, which in turn was forced to put emergency measures in place torestore public finances and economic resilience according to the loan programs of theEU/IMF. The greatest portion of the EU/IMF loans was spent to repay the debts andcover the budget deficit as well as using it to strengthen the banking systems andincrease the foreign exchange reserves.

Similar to banks in other countries, the Hungarian banks also faced a liquidityproblem as the crisis emerged. To resolve this problem, the MNB planned an


3) The Vienna Initiative is an agreement made between the Western European banks and international

organizations in February 2009 in order to prevent the Western European banks from competitively

withdrawing funds from Eastern European subsidiary banks.


emergency measure. This measure included a reduction of required reserves of banksand an expansion of a range of eligible collaterals as well as a measure to provideliquidity such as government bond purchase in the secondary market. In addition,foreign exchange liquidity conditions improved through the foreign exchange swapwith the European Central Bank and the Swiss Central Bank, which was a necessarymeasure due to the high proportion of foreign debt. Hungary’s monetary policy tooklead in increasing the benchmark interest rate by the Hungarian National Bank inorder to defend the Forint currency value, even under the situation where a liquiditysupply was urgently needed. Furthermore, even with increasing unemployment dueto the economic crisis, commercial banks increased their foreign currency lendingrate, and the weak Forint currency brought heavier burden on debtors. On the otherhand, the banking system endured this period without restructuring. Although theamount of loans was reduced and nonperforming loan portfolios continued, foreignbanks provided capital, and liquidity was supplied with the help of their parentbanks. Hungarian banks were assisted by the EU/IMF program.4)

Hungary could not take advantage of fiscal policy as an effective means in theface of the crisis. Although other EU countries injected 200 billion Euros, whichaccounted for 1.5% of EU GDP, through various programs aimed at restoring theEuropean economy, the fiscal policy was run tightly to restore trust in the Hungarianeconomy. Wages were frozen to restrain public expenditure, while budgetary rulesand a Fiscal Council were established in order to secure governing rules in terms ofbudget operation as well as to reduce public expenditures such as various kinds ofbenefits and subsidies.

In the labor market, some measures were introduced to coordinate with theaustere stance of fiscal policy and to protect jobs. For workers, one day out of fiveworking days was set as a training day, and this was assisted by the EU fund. Inaddition, various improvements in the pension system such as the extension ofretirement age, strict application of rules regarding early retirement, removal of thethirteenth month welfare benefit, and strict application of disability pension ruleswere put in place. These steps had a positive impact on sustainable growth andincreased labor participation.

Furthermore, Terazi and enel (2011) classify the countries that had recently joinedthe EU into four groups depending on how they responded to the financial crisis.Hungary was categorized in a group with Latvia and Romania because these nationsaccepted bailouts from the IMF. Among these, Hungary was regarded as the mostsuccessful country with regard to fiscal deficit reduction following the financial crisis.Other nations such as the Czech Republic, Poland, Slovenia, and Slovakia were


4) The ex-post evaluations of the measures for economic reform in countries in Latin America and Eastern

Europe that accepted IMF bailouts can be found in Pop-Eleches (2009).


classified in a group that showed fiscal deficits of 6~8% of GDP, while Bulgaria andEstonia were categorized in a group that had fiscal deficits of less than 3% of GDP in2009 and were considered as countries with a relatively stable fiscal balance.Lithuania was categorized in a group that did not receive a bailout from the IMFdespite rapid GDP decline and a large fiscal deficit.

2.3 Crisis Management Since 2010

Although Hungary’s default could have been avoided thanks to its crisismanagement in 2008 and 2009, it did not mean that the most important structuralproblem in the Hungarian economy was resolved. The Hungarian financial marketwas still vulnerable and its economic resilience did not improve. Public debt increasedeven further, from 73% of GDP in 2008 to 85.3% in the second quarter of 2010, andthe proportion of foreign currency debt increased as well.5)

Early in 2010, the external macroeconomic environment became aggravatedagain due to a Greek default and the euro zone debt crisis. The surroundingcountries in the Euro region, which had maintained a relatively high debt ratio, werecontinually under stress due to the suspicion on their ability to repay debts, while therisk expansion in the financial market was followed by the excessive expansion of riskaversion tendency. This subsequently resulted in a real economic downturn for theentire region of Europe. The trust in the Hungarian economy was aggravated again.Due to the ever increasing public debt issue being raised again, the Hungarian CDSspread increased rapidly by about 700bp followed by the Forint currency depreciationand the ongoing crisis that was more severe than that at the end of 2008.

Although the objectives of the 2008-09 crisis management could have been metby spending cuts with respect to wages and pension expenditures, which wereachievable through the EU/IMF program, structural reforms were not addressed.Under these circumstances, the new government that took office in mid-2010realized that the risk of crisis could not be avoided without resolving such structuralproblems in the Hungarian economy, as was also recommended by the EU. Thedevelopment of the European debt crisis in 2010 required another means of crisismanagement, but the Hungarian government had little room to try other policies.

At that time, international financial markets were very sensitive towardsHungary’s public foreign debt. Hence the top priority of the Hungarian governmentwas to overturn the increasing trend of public debt, putting important measures in


5) Cordero (2009) argues that the IMF bailout and its policy recommendations worsened the economic

circumstances in Hungary, Latvia, and Ukraine. These three nations already had economic structures that

were vulnerable to external shocks before the bailout, while the procyclical policies adopted by the IMF and

the governments in response to the crisis aggravated the economic circumstances.


place to strengthen regulations and the structure of public finance. After 2012, theHungarian constitution established the Debt Break Rule, in which a budget cannot bemore than 50% of debt ratio. If the debt ratio exceeds 50%, a budget policy will beimplemented to guarantee reduction in the debt ratio. Compliance with this rule ismonitored by the Fiscal Council.

In addition to such a tight budget restriction, structural reforms were alsoimplemented, which led to budgetary savings. However, the Hungarian governmentno longer had room to delay structural reform. The Hungarian government initiatedthis reform in terms of expenditure in order to first extend potential growth byutilizing the accumulated assets of pension fund. Thanks to the pension asset sale,the public debt decreased and social security contributions were exclusively allocatedin the budget, while budget expenditure decreased by about 1.5% of GDP each year.The structural reforms that brought changes in the pension system contributed to theincrease in participation rate and other reforms including improved efficiency inpublic administration of local municipalities.

Tax reform was also utilized as a major policy tool in preparation for the agingsociety and poor labor market conditions in order to increase growth potential.Overall, the total tax burden decreased from 40% of GDP in 2008 to 39% in 2013.The Hungarian government also attempted tax rate changes: Increasing tax rates onconsumption and in areas that induce negative externality (e.g., environment or sintax, etc.) while decreasing tax rates on labor incomes. A flat income tax rate of 16%was much lower than the average tax rate of the progressive tax system in the past.

In relation to this, Dolls, Fuest, and Peichl (2012) analyze automatic stabilizers offiscal policy with regard to the U.S. and the EU nations. They find that fiscal policy inHungary absorbed 48% of the economic shock, which was higher than that of theU.S. and other western European nations possibly due to the strong progressiveincome tax in the past.6) The authors also report a negative correlation between fiscalstimulus policy in response to the financial crisis and the automatic stabilizationcoefficient, thereby claiming that nations with large automatic stabilizationcoefficients tend to have less aggressive fiscal stimulus program. Furthermore, theyargue that the larger the fiscal deficit and the greater the importance ofinternational trade in the overall economy, the lower the size of fiscal stimulus.

For the corporate sector, the tax burden was alleviated for manufacturing andexport companies as well as for SMEs. On the other hand, tax rates increased in


6) Some may argue that the current flat income tax scheme in Hungary may have weakened the absorption

capacity of fiscal policy in response to income shocks in comparison with the past. However, further

investigation is necessary to support the argument because the Hungarian flat tax system is paired with a

generous child tax allowance which reduces the tax rate for families with the highest marginal propensity to

consume.


certain service sectors such as energy and banking sectors, which are mostlydominated by multinational companies, and where a small number of companiessecured stable market positions and no significant resistance to the tax rate increasecould be found due to high profitability.

The Hungarian government sought to provide comprehensive measures to reducethe burden for households that were suffering from foreign currency loans, since thegovernment identified the excessive foreign currency loans in the household sector asthe fundamental reason why the Hungarian economy had been vulnerable to thechanges in external circumstances. The household sector had experienced not onlythe increases in interest burden but also insolvency risk and consumption downturn,which in turn developed into an overall social problem as the principal loan amountincreased due to the depreciation of Forint currency. Furthermore, as the increase innonperforming bank loan portfolios was regarded as a threat to the economy,measures to provide customized solutions for specific households were included inthe policy (e.g., early repayment, fixed exchange rate program, partial debt relief,change to other loans for delinquent loans over 90 days, and interest subsidies).These measures had a great impact, since they were available for more than 85% ofthe households that were indebted in foreign currency.

A reform to strengthen flexibility of the labor market was also conducted, aimedto increase the employment rate and participation in the labor market. The provisionof incentives in the labor market had the effect of reducing employment costs whenhiring the most disadvantaged groups in the labor market (e.g., job seekers below 25years old or over 55 years old, long-term unemployed, and women returning frommaternity leave), while the expansion of public work projects reintegrated theunemployed into the labor market in order to improve the employment rate. Inaddition, more flexible work environment was created for both employees andemployers thanks to the revision of the labor and employment law, and various typesof employment contracts were allowed.

The fertility rate in Hungary was 1.3 births per woman, which was lower than the1.6 average of the EU nations. The Hungarian rate was the lowest in Europe hence,the aged dependency ratio was expected to increase from 26.6% in 2010 to 63.1% by2060; this was reflected in the long-term policy objectives. The Hungariangovernment strengthened family-friendly incentive policies, while the parliamentenacted a law concerning family protection, which included various types of familysupport policies such as family assistance, maternity support, cash support for familyplanning, support policy after birth, child protection benefits, and gas expenseassistance for families with more than three children. Moreover, the changes in thepension system enforced since 2009 would significantly reduce public pensionexpenditures in the future, where the retirement age was planned to increase to 65years of age by 2021.



Recently, the tight monetary policy enforced for so long was changed into asupport of economic stimulus. The benchmark interest rate of the MNB was held at7% up to the first half of 2012. Since August 2012, the rate has been graduallyreduced and is now at 2.4% (May 28, 2014), as the effects of the economicstabilization policy of the government and the recovery of global investors’confidence are at hand.

As of August 2013, the MNB established a growth plan to facilitate loans for SMEsand has supported fund assistance for them. This is similar to the financial assistancefor local SMEs through the aggregate credit ceiling system that has long beenprovided by the central bank in Korea. This program had a number of steps. Forexample, the MNB assisted funding with no interest for participating financialinstitutions as the first step of the Funding for Growth Scheme (FGS), and thesefinancial institutions operate the loan program with a 2.5% interest rate difference inmaximum targeting of SMEs. The FGS expanded both the supply and demand forfunding and as such the Hungarian National Bank expanded funding supportthrough this scheme because the first step was very successful.

The regulation and supervision of the financial system were strengthened, andthe supervisory authorities strengthened their role and the means by which theyfunctioned in order to perform comprehensive supervision over the operation offinancial institutions. In particular, the protection of financial consumers wasemphasized as the main duty of the supervisory institutions, which was directlyrelated to the problem of excessive foreign currency debt of households. In 2011, themacro prudential functions of the MNB were extended and further refined. Forexample, the MNB set the legislation into force regarding additional requirementsfor liquidity, preparation and execution of the capital buffer for economyadjustment, and minimization of the bankruptcy probability of the major financialinstitutions in order to systematically prevent the accumulation of liquidity risk.Thanks to the delegation of the new policy measures to the MNB and the integrationof the Hungarian Financial Supervisory Authority (HFSA) in 2013, a wide range offinancial market information can be used not only for micro and macroprudentialregulations but also for consumer protection, financial market supervision, andmonetary policy information.

In the face of the insolvency problem related to household debt, the condition ofhousehold loan was transparent and predictable thanks to the newly establishedlegislation. The objectives of the new legislation were to prevent the occurrence ofrisky loan types and included measures to limit the banks’ unilateral modification ofloan contracts. The mortgage interest rate is now linked to the benchmark interestrate in a transparent way, or it consists of a long-term basis fixed rate (for three, five,and ten years). The loan interest rate was restricted to over a level of 240bp of the



benchmark interest rate of the Hungarian National Bank, while a new regulation wasestablished to repay the foreign currency loan by means of the benchmark foreignexchange rate.

As such, the crisis measures taken by the Hungarian government are consideredhighly comprehensible. Kovács and Halmosi (2010) analyze in detail the similaritiesand differences of 27 EU nations in terms of their policy responses to the 2008financial crisis. According to their analysis, Hungary activated the most extensive crisismeasures among all EU nations, as Hungary instituted numerous policies in all areas(reductions in state budget expenditures, increases and decreases in tax rates forspecific sectors, increased borrowing from money markets for current financing,loans from international financial organizations, introduction of special bank taxes,special taxes in service sectors, establishment of new managing and control agenciesin state budget management, labor market intervention, economic (consumption)stimulus programs, utilization of private pension fund assets, and transformation ofthe rules of the operation of public finances) with only an exception of individualbank bailout. The authors argue that the banking tax adopted by Hungary wasradical to some extent considering the Hungarian financial and banking structureand they conclude that it may deteriorate the financial intermediary function in thebanking sector.

In addition, Csaba (2013), at an international conference, announced thatHungary’s unconventional economic policies were criticized by international societiesand interest groups because Hungary employed a double standard to subjectivelyinterpreting the basic economic facts. He asked the Hungarian government toenforce more transparent and accountable polices and return to the rule of lawrather than rule by the law.

3. Experience of Economic Crisis Management in South Korea

South Korea had shown consistent macroeconomic growth and a stable foreignexchange market until the Lehman Brothers bankruptcy set the financial markets ofthe world in turmoil. However, like those of other advanced and developingcountries, the Korean economy did not escape the financial market disarray. Stockprices dropped sharply along with the depreciation of Korean Won followed by acredit crunch. As a result, contraction of capital investment and a downturn indomestic consumption as well as a sharp decrease in exports due to the reduction ofglobal demand followed. Ultimately, South Korea recorded a negative growth in thefourth quarter of 2008.



The financial crisis in 2008 had two phases. The first phase was due to theinstability of financial markets triggered by the Lehman Brothers bankruptcy inSeptember 2008, in which the exchange rate of Korean Won against the US dollardepreciated from KRW 1,100 to KRW 1,500, while foreign exchange reservesdecreased from USD 240 billion at the end of September to USD 200 billion inDecember. The South Korea Stock Market (KOSPI) dropped sharply by 30% by theend of 2008. The top priority then was to stabilize the foreign exchange market. TheKorean government guaranteed the foreign debt borrowed at Korean domesticbanks and contracted a currency swap with the U.S., Japan, and China in order tofacilitate the stabilization of foreign exchange market thereby preventing the rapidoutflow of foreign capital. Afterwards, a rapid decrease in exports to foreign tradepartners occurred due to the economic stagnation of advanced countries followed bythe emergence of real economy stagnation in Korea. The Korean government thenput a number of policy packages into force, focusing on liquidity provision foreconomic recovery. For example, they ensured liquidity supply through expandedfinancial and monetary policies, strengthening the soundness of financial institutions,restructuring of companies, and strengthening the social safety net (see Figure 1-1).

First, the Korean government performed economic stimulation in terms offinancial policies in order to activate the domestic economy in the short term. Anexpansionary fiscal policy was executed based on sound government finance, whichwas credited with the economic stabilization through the traditional balancedbudget. With the supplementary budget, 7.4% of GDP was set to be used for taxreduction and government expenditure expansion, and this measure was also set tobe executed earlier than later. The welfare expansion was carefully planned in orderfor the fiscal expansion not to cause any future structural fiscal problems, focusing onthe mid- to long-term growth-based provision.

Second, the Korean policy authorities adopted preemptive measures of providingliquidity to the financial and corporate sectors along with economic stimulus, forexample, by reducing the benchmark interest rate by 3 percentage pointsimmediately after the financial crisis. Such interest rate cut contributed to the lowborrowing cost of loans for both companies and households as well as consideredvery effective in preventing instability in the mortgage loan market. In addition, inthe face of the financial crisis, South Korea faced liquidity problems as global banksavoided loan extensions (deleveraging) for Korean companies. To resolve this issue,the Korean government provided incentives to encourage banks to extend companyloans. The Korean government extended the loan maturity date for SMEsadditionally as well as increasing the credit guarantee amount for government-sponsored agencies. Moreover, the Korean government provided bond marketstabilization funds of KRW10 trillion to support liquidity of the bond and commercialpaper markets. Through the above fund, the speculative-grade corporate bonds and



asset-backed commercial papers (ABCPs) below BBB grade were purchased, therebycontributing to the relief of liquidity problem in the bond market.

Third, a measure to strengthen the soundness of banks was enforced. First, KRW20 trillion worth of funds were provided by the Bank of Korea (BOK), the nation’scentral bank, and another state bank called the Korea Development Bank as well asby the private sector, in order to help domestic commercial banks to raise the BIScapital adequacy ratio. As a result, domestic banks were able to be aggressive infinancing issuing preferred stock, hybrid securities, and subordinated bonds. Inaddition, the Korea Asset Management Corporation (KAMCO) introduced a plan toset up a restructuring fund worth of KRW 40 trillion through which nonperformingassets of companies under the restructuring process and bad loans of financialinstitutions could be purchased. This beef-up of soundness in the financial sector wasconducted with respect to market mechanisms and the voluntary participation offinancial institutions.

Fourth, corporate restructuring took place. One of the lessons that Korea hadlearned from the financial crisis in 1997 was the importance of preemptive corporaterestructuring. Preemptive corporate restructuring could ultimately save the cost ofrestructuring in the financial sector and could prevent employment slowdown andprotect the social safety net. The corporate restructuring was led by the creditorfinancial institutions, which divided companies facing difficulty in business in sectionssuch as construction and shipbuilding industries under the classification of normal,having a temporary liquidity shortage, showing signs of insolvency but survivable,and being unable to survive based on survivability in the future. According to theseclassification results, additional liquidity support, workout programs, or bankruptcyprocedures were chosen, and these actions played a role in blocking potentialinstability factors in advance for the overall industries and in deflecting negativeviews of Korean companies. Tax incentives and government guarantees were alsoprovided to encourage participation in corporate restructuring plans.

Fifth, there remains the securing of social safety net. Despite the government’svarious measures to produce recovery in the real sector, difficulties experienced bylow-income households could be aggravated and continue due to the overalleconomic downturn faced by the world. The Korean government endeavored tomake sure that various social safety nets were expanded in order for unemploymentand poverty to not threaten the overall social order. The Korean government exertedall efforts not only to provide credit support for low-income borrowers through jobsharing initiatives and credit recovery funds, but also through job creation. Thegovernment provided assistance such as tax benefits for companies whose workersand employers cooperated in job sharing efforts, ran internship programs for youth,and strengthened employment training with the help of government budget.



As such policy initiatives were paid off, an economic recovery in earnest finallyarrived in the second quarter of 2009. The financial market returned to normal fromAugust 2009 onward, while signs of export demand recovery were detected as well inthe export sector. After the second quarter of 2009, a growth in the economy wasseen, and the economic forecasts of international organizations and globalinvestment banks adjusted the official growth rate of the Korean economy upwardin their macroeconomic indicators.

Both Hungary and South Korea were singled out as the most vulnerable countriesby the international press with regard to facing the 2008 global financial crisis. South


Figure 1-1 Policy Package in Processed to the 2008 Economic Crisis in Korea

Sources: Financial Services Commission of Korea (2009a).

Real Sector Financial SectorCorporate

RestructuringSoical Safety Net

Fiscal Stimulus Package Liquidiy provision Financial Sector

Stimulus package: 6.7% of GDP

Fiscal expansion: 18 tril. won

Tax cuts: 35 tril. won

Additional expenditure: Enough roomwith relatively sound fiscal position

Policy rate out: from5.25% to 2.0%

Won liquidity provision:23.3 tril. won

Foreign currency liquilditprovision: 66 bil. won

Second round of credit evaluation on construction and ship-building sectors

Evaluation of large corporations financialsituation

Parallel pursuit of

Credit recovery supportfor low-incomehoseholds through debt restructuring andrefinancing at lowerrates

Promotion of microcredit

Stronger protection formicrofinance users

Corporate Sector:Liquidity Provsion

EnhancingBanks’ Soundness

Liquidity Provision

Extension of all of SMELoans due this year: 160 tril. won

Increased guaranteethrough Kodit andkibo: 18 tril. won

Stabilization ofCorporate bondmarket through BondMarket StabilizationFund

market-style estructuring

Promotion of corporaterestructuring fund

KDB promote private investment

Government support forexpedient restructuring

Estabilshment of acorporate restructuringfund by KAMCO

Finandal and tax support

Encourage banks toexpand their capital

Launching of BankRecapitalizationFund: 20 tril. won

Purchase of banks’bad assets throughKAMCO: 4-5 tril. won

Job sharing throughemployment supprtallowances and work-hour reduction

Revamp the NationalBasic Livelihood SecuritySystem

Better education welfarefor low-income families

Better support for theself-employed and SMEs

Creditor financial institution-led restructuring


Korea returned to a stabilized economy in a relatively short period of time, whereasHungary took a considerably longer time to return to normal. These differences werebasically due to the different initial conditions in the economic activities and financialmarkets of the two countries when facing the crisis. <Table 1-1> shows that the majorindicators of two nations in terms of vulnerability in the areas of foreign exchange,macro economy, public finance, and financial sector in the third quarter of 2008when the crisis hit the countries (numbers in the parentheses indicate how the majorvariables of the two nations had improved by the third quarter of 2013, which wasfive years from the third quarter in 2008). It is notable that the preconditions of theHungarian economy and financial markets were similar to those of South Korea in1997 and 2008 crises. The higher economic growth rate than its potential rate,continuing current account deficit and high inflation rate in Hungary were similar toKorea prior to its 1997 crisis, and the high dependence on foreign debt of companiesand increasing loan to deposit ratio due to household debt were quality the same asKorea prior to the 2008 crisis.

4. Principles and Skills of Economic Crisis Management

Crisis management in an organization begins with the immediate crisismanagement consisting of signal detection, or how quickly the crisis is detected,followed by incident containment, which controls the propagation of the crisis asmuch as possible and leads to business resumption. This all ends with what can belearned from this crisis followed by an analysis on the impacts of the crisis on thereputation of the organization with an investment of available resources to preventand overcome other crises and to prepare in advance for any crisis in the future(Pearson and Clair, 1998).

All economic crisis management should not deviate much from these steps. Thesteps are as follows: (1) detect a crisis as early as possible; (2) suppress propagation ofthe crisis to other economic sectors; and (3) enforce all measures applicable tostabilize the economy as quickly as possible. Additional steps are (4) analyze thecauses of the crisis to establish the principles of crisis management; (5) examine whatthe impacts of the crisis were on the reputation of the national economy during thecrisis management process; and (6) improve economic fundamentals by means ofapplicable policy measures in order to prevent crises in the future.



In addition to the above steps, the political situation and the national leadershipat the time of the economic crisis can also influence the direction of economic crisismanagement. At the time of the crisis, a ruling party may have the opportunity toattain more confidence from the citizens as a result of an effective response to thecrisis. On the other hand, it may face a political crisis as a result of opposition partiespresenting probable causes of the crisis. When the financial crisis in 2008 affectedHungary, the ruling government was in its later stages and it could not avoid criticismon what had caused the crisis. This influenced the government regarding how tomanage the crisis.

Langhammer and Heilmann (2010) also argue that economic crisis can beovercome through efficient political structures and governance systems thateffectively implement economic policies that support economic crisis management.They assert that economic crisis management of the Hungarian government after the2008 crisis should be considered as a success in view of the political circumstances andconflicts at the time.


Table 1-1 Major Economic Indicators of Hungary and South Korea

Sources: various statistics from the Bank of Korea, the Hungarian central bank (MNB) and Hungarian Central Statistical Office.

Sector VariablesHungary Korea

3Q 2008 3Q 2013 3Q 2013

Foreignexchange

Net external asset/GDPShort-term foreign debt/GDPShort-term foreign debt/ foreign reserve

-50.918.2116.5

-35.217.154.6

2.9 18.279.1

14.4 9.4 33.1

Macro economy

GDP growth rateConsumption growth rateInvestment growth rateCurrent account balance (mil. USD)Unemployment rateEmployment growth rate

1.00.93.4

-11,4087.8-1.4

1.70.78.9

4,10610.10.6

3.3 -0.1-0.8

-4,4203.1 0.6

3.3 1.0 1.0

23,7823.0 1.7

Public finance

Fiscal balance/GDPGovernment debt/GDP(Government debt + public debt) /GDP

-3.566.066.0

-2.880.380.3

1.5 27.4 62.7

1.1 39.0 85.3

Financial sector

Changes in stock pricePrivate sector loan growth rateGross foreign debt/total debtNPL loan ratioBIS capital adequacy ratioReturn on assetCentral bank benchmark interest rateLoan to deposit ratio

-27.118.5116.92.610.21.28.50151.7

0.40.0

118.714.217.40.53.60107.3

-18.6 13.8 11.0 0.8110.65 0.495.25 139.4

0.7 8.6 9.1 1.79 15.05 0.46 2.50 113.7

Household debt/disposable incomeHousehold debt/GDP

59.135.5

51.730.2

138.7 83.3

156.6 91.6

3Q 2008


In the case of South Korea, the Asian financial crisis in 1997 was managed by anewly established government early in 1998, and the global financial crisis in 2008was also dealt with by a government that was newly established half a year beforethe crisis broke out. Both these ruling governments were free from criticisms thatblamed the government for the cause of the crises, and they were thereby able to setup preemptive crisis management policies.7)

In this section, improvement in the system is emphasized as a main focus, on thebasis of the above six steps of economic crisis management in order to provide policyimplications based on the experience of Hungary and South Korea.

4.1. Establishment of Early Detection Systems of Economic Crisis

It is necessary to constantly monitor the risk levels regarding the onset of a crisis inthe future by developing overall leading indicators that show early warning signs ofan economic crisis. According to the overall leading indicators, one of the fiveconditions (normal, caution, warning, quasi-emergency, and emergency) is chosen,and the policy measures specified for each indicator are searched. The details of thepolicy measures will be determined via the collaboration between the central bankand crisis-related ministries, depending on the circumstances of the domestic andinternational economy and the causes of the crisis.

A model of an economic crisis is mainly set by means of macroeconomic variables.Thus, it would be a complementary measure to run microscopic monitoring systemson the finance industry using the information from financial institutions such as bankbalance sheets. This is because countries of emerging economies may quite oftenexperience foreign exchange and banking crises at the same time.

The quantitative crisis prediction using the early warning model is produced basedon past crises that have occurred assuming that the same patterns of themacroeconomic variables would be repeated prior to the crisis outbreak. However,this assumption may be wrong in reality given that other causes of crisis that werenot experienced in the past may exist, and the time difference between the causesand the actual crisis outbreak may vary. Thus, a close look at some specific mainvariables at the same time as the use of the early warning model is necessary. Forexample, most major financial press assess the risk level of countries with emergingeconomies on the basis of a ratio of foreign exchange reserves to short-term external


7) Boin et al. (2005) presented an analysis on the results of strategic tasks that face the government such as

political risk and opportunity, wrong decision making under the crisis situation, errors that need to be avoided,

and processes that can depart from the crisis situation.


debt or current account deficit, or a ratio of GDP to total external debt as some of themajor crisis monitoring variables. In addition, qualitative monitoring must also beconducted because limitations of economic models will be experienced during animmediate crisis while collecting the leading indicators in the early warning model.

As South Korea faced the foreign exchange crisis in 1997, the importance of earlywarning system was recognized and therefore, an organization was established thatwas responsible for the operation of quantitative early warning model as well asmarket monitoring. On April 1, 1999, the Korea Center for International Finance(KCIF) was newly established to oversee the early warning model of foreign exchangeas well as to analyze the country risk, identify trends, and provide analysis andresearch on the domestic and international financial markets.

Concerning a proactive monitoring system for economic crisis, recent emphasis hasbeen placed not only on the balance of flow variables (e.g., traditional currentaccount balances and fiscal deficits), but also on the prudentiality of stock variables(e.g., the balance sheets of the main economic actors). South Korea also recognizedthe importance of prudentiality in such balance sheets, developing them byintroducing various monitoring systems such as foreign and national debtmanagement systems, and by strengthening regulation systems to ensure that theprudentiality of bank balance sheets was maintained in the banking sector.Furthermore, international institutions such as the Bank for International Settlementand the Financial Stability Board newly emphasized the policy concept of macro-prudential management following the 2008 Global financial crisis. South Koreaintroduced and enforced a macro-prudential policy, particularly in the areas ofmanaging capital movements and the soundness of household debt.

The Bank of Korea also launched a Financial Stability Index (FSI) and announced itregularly. The FSI is a quantitative evaluation of financial stability of Korea withvarious indicators (input indicators) that represent financial stability beingtransformed into a single index. More specifically, it consists of one composite indexand indices from six sectors-banking, financial market, foreign exchange, realeconomy, household, and corporate sectors. The FSI is measured between 0(minimum) and 100 (maximum). Instability increases as this index gets closer to 100.This index is utilized as an indicator to determine macro-prudential policy byidentifying the overall financial volatility. Initially, 48 indicators were employed tocalculate the index but now only 21 indicators, which are available every month, areused in the up-to-date record. In addition, the optimal threshold of the FSI is now setusing the noise-to-signal ratio (NTSR) approach to distinguish stability of the financialsystem into normal, warning, and crisis phase in order to improve early warningfunctions. If the FSI indicates a value between 8 and 21, this indicates a warningphase, while a crisis phase is indicated by the FSI of 22 or more.



International financial institutions and the central banks of major nationsdeveloped various different financial stability indices and utilized them in the earlywarning system. For example, the Emerging Market and Advanced EconomyFinancial Stress Index of the IMF (since April 2009), the Composite Indicator ofSystemic Stress (CISS) of the ECB (since June 2010), the Swedish Stress Index of theSweden Central Bank (since November 2009), the Financial Stress Index of theCanadian Central Bank (since June 2006), the Financial Stability Condition Index ofthe Netherland Central Bank (since March 2006), the Stress Index of the Swiss CentralBank (since January 2010), and the Financial Stress Index of the Federal Reserve Banksof Cleveland and St. Louis (since January 2009 and January 2010, respectively) havebeen set and implemented.

Hungary, which is a member of the EU and the Organization for EconomicCooperation and Development (OECD), also complies with common guidelinesregarding the regulations and financial operations as the European Commission andthe OECD run the desk that analyzes the Hungarian economic status.8) However, it isrecommended for Hungary that a constant monitoring system on its own financialand economic status be developed and an early warning model be established.

4.2. Effort to Control the Propagation of Economic Crisis

In the psychology of an economy, inflation expectations and investmentpsychology are two of the significant factors that influence real economic variables.As the global financial crisis was spreading to emerging economies, the negativeevaluation of these countries was based on the real macroeconomic financialvariables. In addition, worsening investor sentiment had put even greater burden ontheir negative evaluation. Thus, it is critical to put efforts in mitigating investorsentiment as well as subsequent foreign capital outflow at the onset of a crisis.

In South Korea, investor sentiment also played a detrimental role in the expansion

of the crisis. The contraction of economic growth in Korea was three times larger

than that of the U.S., which was the source of the crisis. This indicated that there

were other reasons for the contraction beyond the fact that the Korean economy is

highly dependent on export-based trade. As Korea realized decreases in exports, the

country’s capability to preserve its foreign exchange reserves through export was

doubted. Even if Korea has the sixth-largest foreign exchange reserves in the world, a

high ratio of Korea’s short-term foreign debt to the foreign exchange reserves was

highlighted in comparison to other emerging economies, thereby negatively

impacting investment sentiment in Korea. As a result, foreign capital rapidly flew out


8) In the European Commission, there is a research division of economists in charge of France, Belgium,

Luxembourg, and Hungary, while the OECD also has an economic research group for Belgium and Hungary.


of Korea, and the Korean won depreciated by 30%, which was the largest

devaluation in Asian currencies since the financial crisis evolved. The foreign capital

outflow was then followed by a sharp decline in asset prices and expansion in credit

risk in Korea creating an overall instability in the financial market, which resulted in a

downturn of private consumption and facility investment.

Under such circumstances, in its article dated February 26, 2009, the UK journal,

Economist, reported that South Korea was the fourth most vulnerable country to the

financial crisis followed by South Africa, Hungary, and Poland. The article was written

in the midst of the 2008 financial crisis, which by then had spread all over the world.

The Korean government doubted the credibility of this report and took to persuade

global investment banks that had influenced the report by enthusiastically presenting

the accurate status of the Korean economy and its financial market.

The Korean government not only advertised the prospect of positive GDP growth

during the first quarter of 2009, but also actively and analytically explained that the

current crisis was considerably different from that of the 1997 crisis. That is, the

Korean government emphasized that Korea’s foreign exchange reserves of over USD

200 billion was the sixth-largest in the world and that the current account surplus was

expected as well to hold prudentiality in the corporate sector in sufficient liquidity.

The government also explained that the rate of nonperforming loans (NPL) in the


Figure 1-2 Classification of Current Debt

Sources: Financial Services Commission of Korea (2009a)


finance sector was low, while household loans, linked with the housing market, were

also kept sound due to strict regulations and supervision. Moreover, the government

distributed materials in which issues that might be important to the media and

foreign investment banks were answered issue by issue.

In the case of South Korea, the presence of external debts were explained using

<Figure 1-2> to underline that there was no negative impact on the Korean economy

regarding the status of current liabilities with a remaining maturity of less than one

year. The total current foreign debt with a maturity date at the end-2009 amounted

to USD 194 billion, which consists of USD 151 billion in short-term debt and USD 43

billion in long-term debt. However, taking the non-obligatory liabilities such as the

bonds of KRW denominated liabilities issued by the Korean government, the Central

Bank and the foreign exchange trade hedging into account, the liability that must be

repaid by the banks in Korea, foreign bank branches in Korea, and Korean

corporations amounted to about USD 124 billion. This amount is considerably smaller

than the foreign exchange reserves held by South Korea, which is USD 200 billion.

Moreover, the roll-over ratio of foreign debts was close to 100% and foreign

investors had already withdrawn a large amount of their invested money in the

previous year, which means that Korea’s capital market was now less dependent on

foreign investment. This showed that the possibility of a large capital outflow from

the stock and bond markets in Korea was manageable.

The effort to change the viewpoints of investment banks and the media on the

Korean economy to a positive one played a major role in changing Korea’s image in

the financial and media world to an image of a country with the fastest recovery in

the face of the 2008 financial crisis. The foreign press significantly changed its view on

Korea after April 2009. For example, Bloomberg reported that South Korea would be

the first country to see recovery in the world economy from its lowest point. The

article stated that if you are looking for signs the world economy is bottoming out,

South Korea could be the place. The Financial Times also reported Korea’s economic

performance as a harbinger of a slowing of the global economic downturn, noting

that its economy squeezed out 0.2 percent sequential growth in the first quarter

after contracting rapidly in late 2008. There were also different but all positive

comments from various investment banks: Standard Chartered (“the worst may be

over”), Barclays (“the concern over foreign currency liquidity has been removed”),

Deutsche Bank (”the government response was strikingly effective”), and Citibank

(”success in policy makers’ efforts”).

In the case of Hungary, such efforts made by the Hungarian government during

the expansion of the 2008 financial crisis could not be heard, because the Hungarian

economy was undoubtedly in a highly vulnerable state. After 2010, the Hungarian



government enforced, in earnest, some overall economic reform programs for the tax

system and labor reform, but the country was again classified as a country of risk

when the U.S. government announced its quantitative easing program early in 2014.9)

Public and foreign debts are decreasing continually although they are still at a high

level in regional comparison. Hungary needs to make more efforts to advertise and

explain the positive effect of restructuring it has conducted in order to maintain its

economic fundamentals.

One of the other factors that contributed to such a rapid change in the viewpointson Korea was the emergency response meeting organized and operated by theKorean government for the purpose of diminishing anxiety of the Korean peopleand recovering investment sentiment. This means that establishing policy governancesuch as information sharing and cooperation system between relevant agencies oncrisis management policy at the time of crisis was recognized as an important task inaddition to the software or contents of economic crisis management.

On July 11, 2008, the Korean government organized the Crisis Management andMeasure Meeting chaired by the minister from the Ministry of Strategy and Financeand participated by related ministers in order to overcome the crisis faced by theKorean economy due to worsening external economic conditions such as high oilprices.10) The Crisis Management and Measure Meetings continued until December2010, and it was reconvened from October 2011 to February 7, 2013. A total of 167meetings were held to discuss 530 agendas such as strengthening crisis response,improving economic fundamentals, and economic stability for citizens. Among theagendas, those concerning crisis response constituted the largest number, 105agendas (see Table 1-2). In particular, the “Intensive Monitoring System” was inoperation during the European financial crisis with a total of 14 relevant agendas.The meetings were held as a part of the function of crisis response and managementsystem dealing with such issues as the global economic crisis, preemptive and rapidresponse to North Korea-related risk, adjustment of economic policies, and newpolicy agenda presentation. The outcomes from the meetings were announcedimmediately after each meeting to the public contributing to market stability andpsychological effects. (For more information on the Crisis Management and MeasureMeeting, please refer to the Appendix 2.)


9) A report in the Financial Times in January 2014 designated Turkey, South Africa, Chile, India, Indonesia, Hungary,

Brazil, and Poland as the“Fragile 8.”

10) The participating ministries were the Ministry of Strategy and Finance, Ministry of Knowledge Economy, Ministry of

Land, Transport and Maritime Affairs, Ministry of Public Administration and Security, Ministry of Health, Welfare

and Family Affairs, Ministry of Agriculture, Forestry and Fisheries, Ministry of Labor, Ministry of Education, Science

and Technology, the chairperson of the Financial Services Commission and the chairperson of Fair Trade, which

are all ministers from the related ministries regarding economy and social policies.


4.3. Policy Response for Economic Stability

The global contagion of economic crisis to emerging economies starts with theinstability of foreign exchange and financial markets, conventionally followed by acredit crunch due to aggravated borrowing conditions. In the real economy, it startedwith an external export downturn due to the global economic slowdown followedby an overall economic downturn. The slowdown in the real economy creates avicious cycle with an increase of bankruptcy risk in households and companiesfollowed by worsening insolvency problems in the overall finance sector.

A policy direction that can avoid such circumstances consists of four stages. In thefirst stage, liquidity is supplied to the market to relieve the credit crunch, and in thesecond stage, the government purchases nonperforming assets. In the third stage,financial institutions’ capital is strengthened through the injection of governmentfund, and finally, in the fourth stage, the nationalization of bad financial institutionscan be considered. However, such options are not plausible for countries with noavailable government funding and so the deficit will increase due to excessivegovernment debt.

South Korea responded with macroeconomic policies immediately after the 2008financial crisis to contain the crisis as early as possible before it developed into afinancial chaos. The response was quite different from what had been done duringthe 1997 Asian foreign exchange crisis.11) The pricing in the foreign exchange marketwas not distorted but remained normal. There was a single goal, which was economicrecovery by means of foreign exchange, monetary, and financial policies all pointingin the same direction and proceeding in an orderly fashion with a quick response,thereby securing confidence of main actors of the economy.

First, regarding foreign exchange policies, the Korean government’s response to

the depreciating Korean Won in 1997 was defending its currency value through

direct market intervention until the foreign exchange reserves were depleted. On the


11) The experience regarding economic crisis management, including the macroeconomic policies of major Asian

countries (including South Korea) at the time of the 1997 Asian financial crisis can be found in Tran (2002).

Table 1-2 The Number of Economic Crisis Management Meetings Held

2008 2009 2010 2011 2012-13 Total

Number ofmeetings

25 30 36 36 40 167

Number ofagendas

72 86 100 123 149 530


other hand, after the Lehman Brothers bankruptcy in 2008, the Korean government

made an effort to secure foreign currency liquidity as well as to facilitate market

stability by contracting a currency swap with the central banks of the U.S., Japan, and

China. It intervened directly in the foreign exchange market only at a minimal level

when the Korean Won depreciated rapidly in the early stage of the crisis. This policy

direction contributed in preventing depletion of foreign exchange reserves. Also, it

prevented speculators from attaining an advantage as well as contributed to the

surplus trend of the current account through the automatic adjustment function of

foreign exchange market.12) As such, the Korean government aimed to protect the

banking system by providing foreign currency liquidity to reduce short-term debts

rather than intervening actively in the market to defend the Korean Won from

depreciation.

As liquidity in the foreign exchange market was secured through the currency

swap in the face of devaluating Korean Won in the foreign exchange market and as

market stability was facilitated, the monetary policy concentrated boldly on

economic recovery through the domestic liquidity supply. The Bank of Korea cut the

benchmark interest rate from 5% to 2% during four months from October 2008 to

January 2009, the largest and fastest cut in the history of Korean monetary policy.

The interest cut also contributed to lowering the debt burden of households and

companies as well as preventing the downturn of asset prices. This was in contrast to

the 30% increase in the short-term interest rate as the Korean government accepted

the IMF recommendation in 1997. The most urgent policy goal in 1997 was to

minimize the possibility of national default, since the foreign exchange reserves were

nearly depleted due to market intervention. However, this policy direction deepened

the economic doldrums and aggravated the employment market further as a side

effect.

The basic direction for the financial policy was based on the expansionary fiscal

policy in both periods. The budget deficits were also set to a similar level, about 3%

of GDP. One way in which the two periods were different from each other was that a

supplementary budget of about 1% of GDP was announced and executed early in

the 2008 crisis, while the financial execution speed was much slower in the 1997


12) One of the reasons why Korea had a relatively quick recovery in export was that Korea had exerted efforts

toward the Chinese market. In 2008, the share of China in terms of Korea� export market accounted for nearly

30%, which was close to the sum of all trading amounts including the U.S., the EU, and Japan. Thus, the

structure of Korean export market made a quicker recovery than any other countries (Cho, 2012b).

13) According to Cho (2012a), since the IMF bailout in 1997, the IMF recommended that the Korean government

maintain a balanced budget but changed its recommendation to a deficit budget as the economic circumstances

worsened. Even the level of deficit budget was progressively modified from 0.8% of GDP in February 1998 to

1.75% in May, 4.0% in July, and 5% in October.


crisis.13) That is, implementing fiscal policies immediately could be conducive to quick

conversion into an earlier stabilization phase during a crisis considering the time lag

of macroeconomic policy once it has been implemented.

4.4. Analysis of the Causes of the Crisis and Establishment of the Principle of Crisis Management

Both economic crises of 1997 and 2008 in South Korea were triggered by externalfactors such as the depreciation of Thai Baht and the Lehman Brothers bankruptcy.However, as for the fundamental causes, the former was due to the vulnerability offinancial and economic fundamentals, while the latter was due to the instability inthe external sector. That is, domestic demand in the 1997-98 period contributed tothe GDP downturn, although export demand continued to increase. On the otherhand, the external demand in the 2008 crisis was the main factor in the GDPdownturn, although the downturn of domestic demand was not that severe,relatively. Even though a period of turmoil had to be endured in 1997 after the IMFbailout due to a harsh restructuring process and high unemployment, the 2008 crisiswas overcome quite quickly, recovering stability within six months, despite theunprecedented strong external shock.

Such results could be achieved by the accumulation of experience and principlesobtained from analyzing the process of overcoming the crisis in 1997. In addition, theKorean government learned that economic crises will come again and withoutcontinuous restructuring in the corporate and financial sectors as well as the constantenforcement of the principles Korea will be faced with another 1997 situation.

The imminent tasks that must be done in the face of a financial crisis aresummarized as follows: Stabilization of financial market, securing confidence of themain economic agents, harmonization of macroeconomic policies, mitigation of taxburden, and prevention of moral hazards. To achieve such tasks, the following threeprinciples must be set in place: Prompt measures, accurate incentive structures in thepolicies, and comprehensive and reliable policies. Through such principles, thepropagation of economic instability can be prevented and growing anxiety in thefinancial and real sectors can be stopped, thereby minimizing the cost of crisisrecovery on a long-term basis. These principles of crisis management wereimplemented as planned at the time of 2008 crisis.

The policies of structural reforms enforced since the 1997 crisis provided SouthKorea with more buffers in response to crises compared to other emerging econo-mies in 2008 (see Figure 1-3). First, the foreign exchange reserves help to controlanxiousness on foreign capital outflow, and the negative assessment on the Koreaneconomy due to excessive short-term foreign debts was also resolved due to



sufficient foreign exchange reserves, which allowed a quick recovery of market trustthanks to the government guarantee on external debt.14)

Second, the sound financial status of companies, in particular conglomerates,contributed greatly to the absorption of foreign demand reduction and the creditcrunch from the 2008 crisis. Since the 1997 crisis, bold restructuring of domesticcompanies has been carried out led by the Korean government and as a result,financial stability of most companies improved considerably. The debt-to-equity ratio,on average, in the corporate sector decreased from more than 400% in 1997 toabout 100% in 2008, and their profitability also improved considerably.15) Increasingthe economic size and ensuring steady revenue generation of corporations are alsoconducive to coping with such an economic crisis.16)


14) The analysis of an appropriate level of foreign exchange reserves can be determined by many variables such

as the size of current transactions (import and export), exposure to capital transactions (foreign debt), maintaining

cost for foreign exchange reserves due to lower profit of foreign currency revenue than domestic interest rate,

foreign exchange system, and the size of national economy. In the case of South Korea, an appropriate (or

sufficient) level of foreign exchange reserves has been maintained since the 1997 crisis.

15) Cho, Kang, and Kim (2012) discuss in detail how the restructuring of insolvent companies was carried out by the

Korean government to cope with the economic crisis in terms of regulation and systems.

16) Although the analysis was not on the country level, the regression analysis on Hungarian corporations conducted

by Czibik, Mako, and Toth (2010) show that the larger the number of employees and the higher the revenue, the

better the sales environment, which was at the time of the economic crisis. And, these corporations also utilized

subsidies from the government and the EU better.

Figure 1-3 Comparison of the Early Stage of the Two Crises of South Korea

Sources: Financial Services Commission of Korea (2009a)


Third, the capital adequacy ratio of financial institutions (BIS ratio), on average,

also improved significantly indicating that the soundness of financial institutions was

strengthened. This was a result from strong restructuring led by the government

after the 1997 crisis by means of streamlining insolvent institutions and the purchase

and assumption of assets and liabilities targeting various types of financial institutions

such as banks, savings banks, and cooperative societies. As a result, absorbing shocks

was much faster during the 2008 crisis.

Fourth, concerns over excessive debt in the household sector were crucial in

relation to falling house prices around the world, but this was not a serious problem

in South Korea. The household sector in Korea also experienced a significant

mortgage loan increase as real estate investment increased just as in other countries.

However, the Korean government had already introduced the regulations on loan-

to-value (LTV) ratio and debt-to-income (DTI) ratio prior to 2008, which determined

loan amounts in connection with the borrower’s income level and house value for

housing purchases in order to provide a buffer in preparation for bad loan

prevention caused by decline in housing prices, which were the major regulations

that enabled the country to overcome the 2008 crisis in the household sector.

4.5. Recovering Reputation through the Crisis Management Process

An article on the Financial Times on January 25, 2014, pointed South Korea as

standing strong against economic crisis risk, due to currency depreciation in other

emerging economies since the downsizing of quantitative easing in the U.S. The

countries with highest risk are Argentina, Venezuela, and Ukraine, and the countries

with the second highest risk are Turkey, South Africa, Indonesia, Thailand, Chile, and

Peru. Hungary fell under the third highest risk group, and the so-called BRICs (Brazil,

Russia, India and China) were in the fourth highest risk group. South Korea was

included in the fifth group, which included the safest countries.

This report reflects the fact that Korea’s restructuring effort has been recognized,

which extended to strengthening the soundness of corporations and financial

institutions and making every effort to ensure effective responses to external shocks

based on the experience of the 1997 crisis that brought shame to the proud nation of

Korea barrowing money from the IMF. Korea has put forth efforts to ensure an

appropriate level of foreign exchange reserves, control on excessive increase of short-

term foreign debt, maintain the current account surplus as well as bank’s prudential

ratio, and monitor household debt and the housing market, which are indicators that

external rating agencies pay attention to. To achieve these levels, effective responses

have been set in place to pursue policy combinations between financial supervisory



policies and macroeconomic policies such as financial, monetary, and foreign

exchange policies. Such policy direction of the Korean government was also in

harmony with the policy stance of international organizations like the OECD and the

IMF.

Korea continues to make improvements by putting required measures in placedespite having effectively overcome the financial crisis in 2008. A measure to imposea macro prudential stability levy on non-core foreign currency liabilities was enforcedin August 2011 in order to regulate excessive foreign currency borrowing by banksaiming to reduce short-term foreign debt and long-term borrowing. This measure isclosely related to the analysis done by the investment banks and by the press at thetime of the crisis in 2008, where South Korea was classified as one of the riskyemerging countries because of its excessive level of short-term debt. Global liquiditywas supplied to Central and Eastern Europe, including Hungary, by the WesternEuropean banks as a form of non-core liability, and it therefore flowed intohouseholds and public corporations. Under such circumstances, it would be helpful toalleviate the pro-cyclicality and financial vulnerability of emerging market countriesthrough the efficient management of global liquidity via the regulations introducedby South Korea.

The Hungarian policy response was implemented according to the EU/IMFprogram since the 2008 bailout, and many reforms have been made since the 2010European financial crisis, which is why the Hungarian policies are in harmony withthe EU and OECD recommendations. Since 2010, the Hungarian government hasenforced various policies for boosting growth using driving forces such as tax reformand increased labor market flexibility-regarded as some of the contributors to therecent economic recovery. Many other measures were implanted to reducebudgetary deficit and public debt. In addition, the EU recommended policies tookinto consideration the reality of corresponding countries to achieve the common goalof the member countries, providing specific methods based on the specialconsiderations of each nation. The EU assessed the Hungarian policies, in whichpension reform and the strengthening of labor market flexibility were two of thewell-established policies among the economic reforms.

However, some issues were raised by international organizations like the EU,OECD, and IMF regarding the above policies. Hence, it would be wise for theHungarian government to review some of the policies again according to therecommendations given by these international organizations for further revisions, ifnecessary. Policies that do not align with the international society could mean badreputation in the global community, which can bring weakness in the face of othercrises.



In particular, a report recently published by the EU assessed the Hungarianeconomy (European Commission, 2014). The report points out that some indicatorscontinue to show imbalance in macroeconomy. In particular, a high level of publicand private debts and the vulnerable banking sector were singled out, as these willhinder improvements in the economic imbalance and eventually make it difficult toachieve the goals of economic policies. Therefore, the report suggested that theeconomic situations should be closely monitored and proactive policy responsesshould be implemented to resolve some of the issues.

A survey recently published by the OECD (2014) notes that the Hungarianeconomy was moving away from the economic downturn in early 2013, but theeconomy was still stagnant and its growth potential weak due to low investmentand employment. Thus, the survey recommended that the Hungarian governmentstrongly push forth proactive restructuring and reform and further suggested policydirections in many areas, including the monetary policy, financial stability, fiscalpolicy, and employment and labor market.

4.6. Improving Economic Fundamentals Using Applicable Policy Measures for Preventing Future Crises

The two separate economic crises in South Korea in the last 20 years weretriggered by the Thai Baht collapse and the Lehman Brothers bankruptcy althoughtheir causes and effects were different. In 1997, the vulnerability of domesticcorporations and financial institutions brought some of them down due tobankruptcy, mergers and acquisitions, and the purchase and assumption of assets andliabilities followed by high unemployment and an overall economic collapse.However, although South Korea was slightly unstable in the 2008 crisis due toexternal mega shock that affected the entire world, it returned to safety faster thanmany experts had expected.

Although there were many factors that helped with the earlier relieve of theshock the most important reason was the improved economic fundamentals thatwere set up through applicable policy measures. The Korean government did notstop at short-term macroeconomic measures during the recovery period of the 1997crisis but took further steps to strengthen Korea’s economic fundamentals. Somepolicies contributed to the soundness of domestic financial system while otherpolicies helped to recover exports and the financial soundness of corporations.

On December 4, 1997, two weeks after the IMF bailout application date, whichwas November 22, 1997, the Korean government announced a plan for the closure ofbanks with many bad loans and vulnerable financial structure as it considered theimprovement of its credit rating with respect to the international community as part



of the restructuring process in the banking sector. On February 27, 1998, twelvefailing banks were announced and the submission of a recapitalization plan wasrequested. Then, on June 29, the government announced a closure of five banks outof the twelve after the examination of their recapitalization plans, which was the firstsuch closure of banks in the Korean history. In addition, a continuous restructuring ofthe finance sector was conducted, so that the number of financial institutions, whichwas 2,100 at the end of 1997, decreased to 1,300 by the end of 2006.17)

Along with this decisive measure, the Korean government proceeded withrestructuring of insolvent companies simultaneously. On January 13, 1998, thegovernment announced a ban of companies that had vulnerable financial structuresand on May 9, the creditor banks selected a candidate group consisting of 313companies, most of them with conglomerate affiliations. Finally, 55 bankruptcompanies were chosen as the results of the evaluation on June 18, 1998 (Sohn andMin, 2008). The effect of this series of restructuring was also seen in the analysis ofthe volatility in the stock market. For example, Sohn and Choi (2010) showed thatmarket volatility decreased, while volatility specific to companies increased after thefinancial crisis in contrast to data from Japan. They argue that the increase involatility which was specific to a company represented an easy differentiationbetween companies with or without sound financial structure, so that a process ofcleaning out insolvent companies in the recession period due to the companyrestructuring led by the government could be implemented appropriately.

In association with this, Krueger (2009) compared in detail the experience ofrestructuring between Japan and Korea, in which a decisive difference between thetwo nations was the determination and the driving speed of restructuring led by thegovernments. In the case of Korea, nonperforming assets were sold through theKorean Asset Management Corporation, and debt reduction in companies wasstrongly requested by the Korean government. On the other hand, Krueger criticizedthe fact that Japan was too slow and did too little. In particular, the most importantthing that Japan did was ever greening, which recovered the so-called zombiecompanies that were not capable of surviving on their own. Caballero, Hoshi, andKashyap (2009) also claimed that a negative correlation was found between theincrease of such zombie companies and the increase in the productivity of the entirenation.


17) Sohn (2010) and Choi and Sohn (2011) analyzed changes in loans in five banks that were in good shape as well

as the reaction in the stock market due to the purchase and assumption of assets and liabilities of companies

that had loan contracts with the five closed banks. The analyses reveal that the loan amounts of companies

borrowed newly from the five banks in good shape and their performance in the stock market showed more

increase than those of companies that had borrowed previously from these banks before this event. These

results are evidence of evergreening that prevents company insolvency and clear signaling for newly traded

companies would contribute to such a result.


From the experience of the Hungarian economic crisis management, several issuescan be noted. The 2008-09 crisis management, assisted by the EU/IMF, did notimprove the flexibility of the Hungarian economy, and public debt increased evenfurther. This was because the policy response during the 2008-09 period onlyconcentrated on short-term measures such as a tight fiscal policy, which was relativelyeasy, but did not address structural reforms.

Dapontas (2011) analyzes the fundamental causes of financial crises based on theHungarian case in 2008 and 2009. The author concludes that the structural problemsof the Hungarian economy were the fundamental cause of the crisis followed by anincreasing risk aversion of investors from regression analyses where the forwardspread of the Hungarian forint (HUF) was set as an dependent variable, while thecurrent account balance, risk contagion, economic freedom, foreign exchangereserves, loan rate spread, inflation, and GNP were set as the explanatory variables.

The new administration in Hungary in 2010 needed to achieve financial and fiscalstabilization in response to various issues it faced, and it also needed to set theexisting economic system onto a sustainable growth path in order to respond to theglobal economic environment at the same time amidst the continuing financial crisis.In addition, the Hungarian government drove policies on the basis of growthpotential and increasing employment by applying innovative measures to currenteconomic policies in order to prevent an economic downturn and social tension.18)

The result of enforcing such policies seems to be achieving visible outcomes. Thepublic debt decreased from 85.3% in the second quarter of 2010 to 79.2% in 2013,while the fiscal deficit was maintained well below 3% of GDP. As a result, the EUstopped enforcing measures for excessive fiscal deficit in 2013. In addition, as a resultof various tax reforms, public expenditures, and the restructuring in the labor market,the employment rate and the rate of participation in the labor market continued toincrease. For example, the unemployment rate was less than 8%, which is muchlower than the 12% average in the Eurozone, and the employment rate increased by3.7 percentage points to 52.6%. With the reform of the pension system along witheffective budget control, Hungary is now regarded as one of the low-risk countries interms of sustainability of public finance among the EU countries (SustainabilityReport published by the European Commission in December 2012).


18) The details of the reforms and restructuring by the Korean government to create a new driving force to overcome

the economic crisis can be found in Lim, Lee, and Han (2011).


5. Conclusion and Future Research

In previous sections, the examples from both Hungary and South Korea in

overcoming the 2008 economic crisis were discussed and six step-by-step policy

recommendations were presented. The six recommendations were; the development

and operation of the early warning system, control of the propagation of the crisis to

other sectors, short-term macroeconomic measures for economic stabilization,

analysis on the causes of the crisis, establishment of crisis response principles,

management of international reputation while overcoming the crisis, and

restructuring for crisis prevention in the future.

Two categories can be classified as the factors that helped the Korean economy

not to fall into economic collapse (Cho, 2012a). The first category is its economic

fundamentals prior to the crisis, which were sufficient foreign exchange reserves,

improved financial structure of companies, securing the soundness of financial

institutions, and financial regulations that controlled the risk of bad household loans.

The second category consists of macroeconomic policies that are complementary to

one another and that respect the market. These policies were no market intervention

in the name of defense against depreciating Korean Won, a monetary policy focused

on domestic economic stimulation, and expansionary fiscal policy enforced at an early

stage.

One thing that must be addressed is a temptation faced by the policy decision

makers. This is the so-called time inconsistency, which refers to a policy error used on

a short-term basis due to its immediate effect but in the end, incurs a large cost to

the economy if it is run on a long-term basis. A large number of policy makers may be

tempted to delay or scrap policies that are helpful for the improvement of economic

fundamentals via a restructuring that has been planned earlier and which may cause

all economic actors a lot of pain when the economy enters a recovery phase due to a

variety of short-term macroeconomic measures.

In addition, although a short-term contingent measure seems effective if it is run

excessively it could incur mid- to long-term problems such as the weakening of

economic fundamentals and the distortion of incentive structure. Therefore,

emergency measures implemented in the face of a crisis should revert to normal

measures at an appropriate time, and the restructuring required for the

improvement of the economic fundamentals should be enforced continuously,

regardless of the economic recovery to ensure the best methods in response to other

crises in the future. In this process, it is critical to reflect the analysis of applicable side



effects and monitoring results in the execution of policies, whether they are

emergency measures or are reformed policies for economic restructuring.

It is known that the Hungarian government has implemented economic reforms

in earnest since 2010, and their effects are now visible. However, as mentioned

above, the effects from the macroeconomic policies and economic reform should be

monitored constantly to improve further effects.

In particular, economic reform measures should continue focused on the

identification of sustainable growth driving forces among various measures to

improve Hungary’s economic fundamentals. Such adjustment in the economic

structure on a mid-term basis could be a buffer that effectively overcomes other

economic crises in the future.

As a first task, a finance support policy to foster SMEs should be considered.

Expanding support for SMEs require a measure of liquidity supply utilizing the

Central Bank’s authority to issue money while maintaining fiscal soundness.

Second, financial regulations by which the financial and asset markets can

respond to external financial crises should be considered. Financial regulations that

do not contradict the regulation direction of the EU should be considered so that

companies and households are able to effectively minimize the risk of foreign

exchange rate changes and the economy can efficiently respond to rapid foreign

capital outflow.

Third, continuous efforts should be put forth in order to increase policy effects

such as increasing labor market flexibility that could improve employment rate, tax,

pension reform, and measures for the social safety net.

Finally, although the excessive dependence on international trade cannot be

resolved in a short time, research should be done on lessening this dependency. For

example, an economic model should be set up to examine the effects of currency

depreciation on the real economy and the effects of trade partner diversification on

the current account.



Acknowledgments

I am grateful to Benedek Nobilis, LászlóSzabó, Vera Takács, Bálint Hámori, andÁgnes Magai (Ministry for National Economy), Csaba Balogh and Gergely Fábián(National Bank of Hungary), Péter Heim and Péter Virovácz (Századvég EconomicResearch), László Jankovics (European Commission Representative Office in Hungary),Mihály Kovács (European Commission), Alvaro Pina and Sanne Zwart (OECD), JoonhoHahm (Yonsei University), and an anonymous referee for their valuable informationand meaningful suggestions. I also give many thanks to Márton Szili (Ministry forNational Economy) who gave me insightful and valuable comments and suggestionson the earlier versions of the manuscript of this chapter. Without his help, this paperwould have not been finished.



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1. Introduction

The Hungarian economy experienced a few double-dip recessions overthe last years. First it was seriously hit by the financial crisis that started in late 2008and second at the time of the Greek default. The crisis management in 2008-2009assisted by the EU/IMF technically averted the default, but did not improve economicresilience as such public and external debt increased further. In 2010, Hungary hadeven higher debt stocks than in late 2008. The crisis management in 2010 was basedon the recognition that Hungary cannot escape from the dangers of crisis withoutaddressing the real structural challenges of the economy. The aim of the governmentwas to reverse the increasing public and external debt and implement comprehensivereforms to increase growth potential and employment. In 2014, economic indicatorsshow positive results from the Hungarian crisis management. Public debt is on adeclining path, the budget deficit is below 3% of GDP, and both employment rateand labor market participation are above pre-crisis levels and on the rise.

This report assesses the experience of the crisis management during thepast years. It describes the economic situation prevailing before the financial crisisof 2008, which gives answers why the crisis was so serious in Hungary and whateconomic situation is to be avoided. After that, it presents and compares the crisismanagement in the two waves of the financial crisis. Finally, it sums up the result of


Appendix 1Economic Crisis Management in Hungary19)

■ Chapter 01

19) This Appendix is a summary report on Hungary’s economic crisis management experience written by the Ministry

for National Economy of Hungary.


the crisis management, which shows that by 2014, Hungary became much moreresilient to eventual crises as a consequence of a stable macroeconomic situation andimproving economic indicators both on external and internal balances.

2. Economic Conditions in Hungary before the 2008 Global Financial and Economic Crisis

The economic policy prevailing before the financial crisis of 2008 led tolarge macro-fiscal imbalances. As a consequence of the economic policy pursuedfrom 2002 to late 2008, public and external debt increased to high levels,competitiveness deteriorated, employment rate was low, the needed structuralreforms were delayed continuously and a high share of both public and private debtwas denominated in foreign currency.

In 2002-06 the fiscal policy was extremely loose generating large budgetdeficits averaging 8% of GDP (Figure 1). The fiscal expansion put public debt on anincreasing path and the share of government bonds owned by non-residentsincreased. Fiscal stimulus measures encompassing, among many others, theintroduction of the 13th month payments of pensions, the extension of largelyuntargeted and generous social safety net, wage increases in the public sector - whichalso affected private sector wage developments - the exemption of personal incometax on minimum wage etc., increased real disposable income significantly andbolstered households’ and as a consequence of enhanced demand, corporate


Appendix Figure 1 Appendix Figure 2


consumption and investment pushing real GDP growth above its potential rate. Thestructure of economic growth was largely driven by domestic consumption (Figure 2)fuelled by fiscal incentives and accelerating private sector borrowing with loansincreasingly denominated in foreign currency (Figure 3). This model ofoverconsumption accompanied by low savings rate resulted in high current accountdeficits and a dramatic increase of external debt (Figure 4).

The central bank reacted to inflationary risks linked to the positive output gapwith keeping the policy rate and thus nominal interest rates relatively high (Figure 5).



Sources: Eurostat, Hungarian Debt Management Agency, MNB


Sources: Reuters, MNB.


Later, as a result of increased foreign borrowing, the pass-through of monetary policyvia interest rates weakened further, complicating the conduct of monetary policy.

The accumulation of FX denominated credits had become one of themain sources of financial vulnerability by late 2008. On the demand side, thewrong fiscal and monetary policy mix created incentives to get indebted into FXrather than forint. The combination of loose fiscal policy and tight monetary policykept the policy rate high, which led to persistent interest rate differential betweenthe forint and low-rate foreign currencies. The tight monetary policy and theprospective of euro adoption spurred the overly optimistic expectations with regardto the movement of the forint exchange rates, which had been and was expected tobe stable in the future. Against this background, forint loans became totallyuncompetitive due to their high interest rates. In addition, loose fiscal policy createdpositive prospects towards future incomes, which in general created demand forloans. On supply side, foreign-owned banks saw FX loans as an opportunity toacquire market share by offering FX loan at much lower rate than the forintdenominated ones, since they had an easier access to FX financing compared to thedomestic-owned ones. Furthermore, it seemed to be less risky for foreign-ownedbanks to offer loans in the same FX. The reactions of the relevant authorities were farfrom being enough to stop FX debt accumulation. As a result, banks’ leverageincreased substantially while - partly due to the lack of sufficient deposits - the loan-to-deposit ratio deteriorated and reached an average of around 160% in 2008 from aratio below 100% in 2002.

Before the outbreak of the financial crisis the vulnerability of theHungarian economy had increased to a large extent notably by the excessiveborrowing by both the public and private sectors. Although fiscal consolidationstarted in late 2006 (the general government deficit shrank, from 9.4% in 2006 to3.7% of GDP in 2008), the composition of the adjustment was extremely harmful forboth the real GDP growth and the growth potential of the Hungarian economy (realGDP growth fell from 3.9% in 2006 to 0.1% in 2007). Public debt amounted to 73%of GDP by the end of 2008, far above the levels seen in neighboring countries,reflecting the large fiscal deficits of the first half of the decade. Private sector debtalso grew rapidly, with gross external debt at close to 120% of GDP in late 2008. As aresult of FX borrowing, households were increasingly exposed to exchange rate risksand because of their excessive borrowing relative to income, also to insolvency risk.Moreover, gross official FX reserves fell below the short-term foreign debt in 2007and reached a low in September 2008 covering only 84% of short-term external debtwhich was another source of vulnerability.

In mid-October 2008, the financial crisis reached the EU and at the sametime Hungary. Investor confidence in forint-denominated assets collapsed reflecting



the fact that by that time Hungary had the weakest fundamentals in the region. Themain concerns of investors were the insufficient FX reserves of the central bank andthe strong reliance of the banking system on wholesale FX-funding. The HungarianCDS spread rose from 100 basis points in mid-2008 to 550 basis points in October2008. As a result, government bond auctions began to fail and bond yields surged(Figure 5), rising by much higher margins than in regional peers. The stock ofgovernment bonds owned by foreign investors sharply fell and the duration profileof the public debt significantly shortened. As a consequence of the phenomenon ofsudden stop and capital flight the nominal exchange rate of the forint fell by 25% inOctober 2008. The depreciation of the forint (Figure 6) had a large impact on bothpublic debt and private sector credit stocks denominated in foreign currency. Thesurge of the installments on FX loans escalated debt service burdens accompanied bythe fall in disposable incomes related, in particular, to job losses and resulted in amuch more contracted consumption than it would have been justified by therecession itself. The drying up of liquidity in international markets raised financingcosts significantly and caused refinancing difficulties for banks. Reduced liquidity inFX swap markets aggravated the situation as many banks had substantial FX netassets.

3. Crisis Management in 2008-2009

The financial crisis in late 2008 required quick reaction to avert default.Quick steps were taken in the monetary policy (lowering reserve requirements,expansion of the range of collaterals, introduction of the FX swap tenders, andnarrowing interest rate corridor), the budgetary policy, and the banking system (theVienna Initiative, increase of deposit guarantee limit, facility for bankrecapitalization). Hungary had to apply for EU/IMF loans. Urgent measures took placein a fast pace to restore financing of public finances and the economy, butcomprehensive structural reforms were delayed until after 2010.

The financing was resolved with the EU/IMF financial assistance programof EUR 19 billion ( 18% of GDP), of which finally EUR 14.2 billion was drawnbetween October 2008 and September 2009. The largest part of this loan served tofinance deficit and debt, but a considerable part financed two funds made availablefor the strengthening of the banking system. In addition, another part was directlydrawn down by the central bank to increase its FX reserves and consequently did notappear in the public debt figure.

Similarly to other developed countries, banks in Hungary faced liquidityproblems after the outbreak of the crisis. Actually, there was ample HUFliquidity, but due to the lack of confidence they were reluctant to lend to each other.



In addition, Hungary was the most hard-hit by the crowding-out effect of theincreased western European financing needs, and the side-effects of certain ECBmeasures. On the one hand, CEE region’s government bonds denominated innational currency were not affected by the extension of assets accepted as collateralby the ECB. On the other hand, parent companies of the foreign-owned Hungarianbanks tried to address their own liquidity problems by withdrawing liquidity fromHungarian subsidiaries, which overall aggravated the liquidity situation in theHungarian banking system.

In order to address the liquidity problem, the central bank introduced anumber of non-conventional measures. These included general liquidityenhancing measures such as the reduction of the mandatory reserve ratio for banks(from 5% to 2% applied by the ECB), the expansion of the range of eligible collateralas well as the purchase of government bonds in the secondary market. In late 2008,the central bank bought government bonds at a magnitude of HUF 200 billion (0.8%of GDP) and in early 2010, mortgage bonds at HUF 36 billion (0.1% of GDP).20) Inaddition, banks could have access to HUF credit with longer maturities than usualamong the normal instruments; furthermore, owing to the agreement with the ECBand the Swiss National Bank, the banking sector also had access to FX liquiditythrough FX swaps.21) FX liquidity was also necessary due to the high level of FXindebtedness. The interest rate corridor was also halved (from 1% to 0.5%) forthe period of most reduced liquidity. As an answer to the rapidly growing pressureon the exchange rate, the base rate was raised by 300 basis points from 8.5% to11.5% in October 2008.

The measures to reinforce financial supervision and address thechallenges of FX debtors were insufficient. The crisis management with theassistance of EU/IMF included several steps to tackle these problems, but these stepscould not prevent FX debtors from increasing monthly payments and banks fromincreasing non-performing loans. In 2009, banks unilaterally increased interest rateson FX loans in a period when some FX debtors lost their jobs due to the economiccrisis. In addition, exchange rate depreciation increased their burden even further.

The banking system weathered through the critical times without majorshocks. Although lending activity declined and the portfolio quality of banksdeteriorated, their capital position remained stable (Figure 7). The foreign-ownedbanks were provided capital, and apart from the very first period, liquidity from theirparent companies and Hungarian ones were supported by the two funds set up using


20) Zoltán Molnár: About the interbank HUF liquidity-what does the MNB’s new liquidity forecast show?, MMB bulletin,

December 2010.

21) See more details on FX swaps in István Mák and Judit Páles: The role of the FX swap market in the Hungarian

financial system, MNB bulletin, May 2009.


the EU/IMF program, consisting aroundHUF 600 billion (2.3% of GDP) funding.The Capital Base Enhancement Fund wassized to bring the eligible banks’ capitaladequacy ratio (CAR) up to 14%. TheGuarantee Fund was meant to bringcomfort to the providers of wholesalefunding and secure refinancing of theeligible banks. Banks could have used thisfunding with the condition that theywould primarily use the enhancedliquidity to finance the real economy.Finally, three domestic banks receivedfinancial support of HUF 700 billion (2.7%of GDP) from the state using the EU/IMFloans. This support was predominantlyused to enhance liquidity of the banks and a small part, HUF 30 billion (0.1% of GDP),was used to increase capital. Furthermore, financial stability was also underpinned bythe extended guarantee on deposits (limit doubled by the deposit insurance fundand unlimited commitment by the government) and the Vienna Initiative. TheVienna Initiative ensured smooth functioning of subsidiaries of foreign-owned banksthat prevailed in the Hungarian banking sector. Under the Vienna Initiative, foreign-owned banks pledged that they would keep providing credit to the real economiesof their host countries during the crisis. As the new wave of the Eurozone crisisunfolded towards the end of 2011, the Vienna Initiative 2.0 was launched. It aimed tosmooth the deleveraging process in emerging Europe and ensure closer coordinationbetween home and host country’s supervision.

Hungary could not use budgetary policy as a tool to mitigate the impactof the crisis. While the EU elaborated the European Economic Recovery Plan andinjected EUR 200 billion (1.5% of GDP) into the economy through various programs(public support for investment in infrastructure and green energy, car scrapingschemes, guarantees and loan subsidies, lower taxes and social security contribution),in Hungary, in the absence of fiscal room for maneuver, restrictive fiscal policy wasneeded in an environment of rapidly deteriorating confidence. The pro-cyclicalbudgetary policy (structural adjustment of 2.3% in 2009) intensified the negativeeffect of the financial crisis and had a very negative impact on economic growth(GDP fell by 6.8% in 2009). Significant budgetary adjustment was expected both bythe market and the EU/IMF financial assistance program. Public expenditures werecontained by freezing wages and various subsidies. In order to assure budgetarydiscipline, fiscal framework was reinforced by fiscal rules and setting up a FiscalCouncil. Changes in social benefits also decreased expenditures (shorter eligibility


Appendix Figure 7

Sources: MNB.


period for maternity payments and family allowances, more restriction for sick-pay,housing, gas and other price subsidies).

Measures were introduced to dampen the negative effect of the crisis onlabor market and preserve jobs. One day of training of the five working days aweek could be financed by the state, if enterprises undertook not to lay off. Thismeasure was supported by EU funds. Furthermore, a special program was introducedto help unemployed persons reintegrate in the labor market. Under the program,persons of active age who were at a disadvantage in the labor market could onlyobtain benefit if they were employed in a public work scheme instead of regularsocial allowance. In addition, numerous parametric changes were implemented tothe pension system (stricter indexation, increase in retirement age, stricter rules forearly retirement, abolishment of 13th month entitlement, and stricter application ofdisability pension rules), which had a positive effect on the participation rate and onlong-term sustainability.

The financing conditions gradually normalized in 2009 supported by thespill-over effect of improving external environment. From April 2009 onwards,exchange rate developments and debt financing conditions gradually returned tonormal, government bonds could be sold at auctions again, and spreads fellconsiderably (by 4-5 percentage points). The country’s default risk also decreasedsubstantially, even though the CDS spread failed to return to the pre-crisis levels. Thefiscal and monetary stimulus measures in the EU and in the US had a significantpositive effect on Hungarian assets. In view of the expected favorable inflationarydevelopments and the reduction of the premium required from Hungary, the baserate was gradually cut by a total of 6.25 percentage points, between November 2008and April 2010.

4. Crisis Management from Mid-2010

The crisis management in late 2008 and in 2009 could technically avert thedefault, but did not address the most important structural challenges of theHungarian economy. The resilience of the economy did not improve significantly,which kept Hungary vulnerable on financial markets. From 2008, public debtincreased further from 73% of GDP to 85.3% in Q2 2010 (Figure 8). This increase,apart from the debt increasing effect of the deficit, was also due to the denominatoreffect of the significant economic recession in 2009 and the depreciation of theexchange rate by more than 5%. In addition, growth potential and employment rateweakened further. In 2010, economic growth recovered as a correction of the largedecline in 2009 and owing to the spill-over effect of the significant anti-cyclicalbudgetary stimulus measures in the EU. The main driver of the growth in 2010 wasthe net exports (Figure 9).



While real economy showed some positive signs and flow indicators started tomove to the right territory, some important stock indicators such as public debt andexternal debt were even higher than at the time of the first episode of the crisis(Figures 8 and 11). Moreover the FX currency share of the debt was also higher.

In the beginning of the 2010s, as a result of the distress about a Greekdefault and the following Eurozone sovereign debt crisis, externalmacroeconomic environment deteriorated significantly. From early 2010,periphery countries of the euro area with relatively high debt stocks were under




Sources: Eurostat, Hungarian Debt Management Agency, MNB.


pressure and their ability to repay debt was continuously questioned. The increasingturbulence on the financial markets led to another wave of risk aversion and hadrepercussions on the real economy throughout Europe, which both weighed heavilyon the Hungarian economy.

Confidence towards Hungary deteriorated again, which pointed out thedeficiencies of the crisis management in late 2008 and in 2009. High and increasingpublic debt kept Hungary as a vulnerable country in the eyes of financial markets.The Hungarian CDS spreads jumped to above 700bp (Figure 12) and exchange ratedepreciated (Figure 13). This episode of the crisis was more prolonged than the onein late 2008.

The crisis management in 2008-2009 concentrated to easy, largeexpenditure cuts, but tension in the budget remained high. The fiscalconsolidation in 2008-2009 did not change the underlying budgetary developments;therefore, fundamental problems remained in the system. The low-hanging fruitswere already collected under the IMF program (painful, but technically easilyimplemented big chunks in public wages and pensions), but the essentials of deepmicro-structural reforms were not elaborated. The increasing trend of the budgetarydeficit was not broken by the fast consolidation of 2008-2009 and the governmenthad to take decisive steps in 2010.

The new government taking office in mid-2010 realized that Hungarycould not escape from the danger of the crisis without addressing the realstructural challenges of the economy. The new episode of the economic crisis



Sources: Reuters, MNB.


started in 2010 requested different method of crisis management. The governmenthad to take into account the gradually deteriorating situation in the Eurozone, whichsignificantly narrowed the room for maneuver in the economic policy. At that timefinancial market was sensitive to the evolution of the public and external debttherefore, the government’s main priority was to reverse the increasing path of thepublic debt. Important steps were taken to reinforce fiscal framework and discipline.Since 2012, the Hungarian Fundamental Law includes a debt break rule, according towhich the budget cannot be adopted if it results in a debt ratio above 50%, or aslong as debt ratio exceeds 50% the budget has to ensure a declining debt ratio. Thecompliance of this rule is monitored by the Fiscal Council. Public debt can bedecreased by conducting sound budgetary policy and increasing growth potential. Ingeneral, the period of fiscal consolidation is not the best time for structural reforms,but further delays in structural reforms were not possible.

The government first created budgetary room for growth enhancingreforms by using the accumulated assets of the mandatory pension funds andimplementing structural reform on the expenditure side of the budget. In thissituation, there were strong arguments to use assets of the mandatory pension fundto improve budgetary situation. First, markets followed closely the debtdevelopments and second, experience showed that asset management of these fundswas extremely weak. The systemic change in the pension system improved thebudgetary situation in two channels. It decreased gross debt by almost 10% of GDP(only government bond share of the mandatory pension funds decreased imminentlythe debt ratio, while other assets decreased debt in subsequent years in line withtheir selling) and it decreased budgetary expenditures by almost 1.5% of GDP eachyear, since the social security contribution paid before to mandatory pension fundswas redirected to the budget. Some structural reforms did not only increasedparticipation rate (e.g. pension system), or improved the efficiency of the publicadministration (e.g. reform in local governments), but also contributed to reducebudgetary expenditures.

The change in the tax system was one of the main tools to raise growthpotential, support labor market and demography. Overall, the tax burden onthe economy decreased. Tax revenues as a percentage of GDP, compared with pre-crisis levels, decreased by more than 1%, while the total tax burden on the economyfrom 40% in 2008 to around 39% of GDP in 2013. While decreasing the taxcentralization ratio, the government also made substantial changes in the structureof the tax system. Changes focused primarily on reducing the share of taxes on laborincome, while increasing the weight of taxes on turnover/consumption and negativeexternalities (such as environmental and sin taxes). Flat tax rate of 16% wasintroduced on personal income tax (PIT), which caused a much lower tax burden onincome than the previously applied progressive PIT. Concerning the corporate sector,



the restructuring of tax burdens entailed a decreasing tax burden formanufacturer/exporting companies and SMEs and an increasing ratio for highlyprofitable service provider industries with stable market position (energy and banksector), often dominated by a few large companies in the domestic market. Thisrealignment was fostered by increasing the upper threshold of the 10% corporatetax rate as well as by the introduction of two new optional tax types for smallenterprises (KATA, KIVA).

The government took comprehensive measures to reduce the burden ofhouseholds with FX loans. High external debt and the high share of FXdenominated household’s debt weighed on economic growth and was a source ofvulnerability (Figure 10). The monthly debt service of households significantlyincreased due to the increased interest rate burden and the depreciation of thecurrency. This problem concerned so many debtors that it did not have only anadverse effect on consumption but it created a much wider challenge to the wholesociety- it had become a public policy issue. In addition, financial stability was alsoendangered by the rising non-performing portfolio of the banks; therefore, it wasalso an interest of the banks to find a solution. Measures offered tailor-madesolutions for the specific groups of households (including an early repayment scheme,fixed exchange rate program, National Asset Management Company, conversion ofloans and partial debt relief of FX-debtors overdue by more than 90 days, interestsubsidy, and Social Family Home Construction Program). These measures are availablefor 85% of FX indebted households and 363 thousand of them lived the opportunityso far.

A growth-friendly restructuring of public expenditures took place in theframework of the SzéllKálmán Plan announced in March 2011. It containedstructural measures affecting mainly the expenditure side of the budget, expected toincrease the growth potential, while contributing to the reduction of the budgetarydeficit in a permanent manner. These reforms encompassed inter alia the pensionsystem, disability schemes, unemployment benefits, health, education and the localgovernment system. The SzéllKálmán Plan had a major influence on the structure ofthe budgets from 2012. (Details in Box 1).

As a consequence of the effective measures on the expenditure side of thebudget, the redistribution rate decreased. The total redistribution rate includes EUtransfers, which have to be netted out to see the real developments. Totalexpenditures without EU transfers decreased by 3-4 percentage points from 2009 to2013. Furthermore, the structure of the expenditure became more efficient. Theshare of the compensation to employee and social transfers decreased, or in COFOGterms, general public services and social protection expenditures declined (Figure 14).




é á á

Measures concerning employment and labor market in order to motivate inactive groups to

return to the labor market:

- Stricter conditions for job search allowance (upper limit decreased from 120% of the

minimum wage to the exact amount of the minimum wage and the maximum eligibility

period decreased from 270 to 90 days).

- The upper limit of sick pay benefit was reduced from four times the minimum wage to

twice the minimum wage.

- The overall amount of different social transfers was capped.

- Nominal level of family allowance was fixed.

- Wages of public work scheme are lower than the minimum wage.

Measures concerning pension system in order to increase the effective retirement age and

to enhance sustainability:

- The indexing method for pensions was changed; it corresponds to the increase of the

CPI.

- Pensions in former early retirement schemes and former disability pensions are now

considered ”ther benefits” rather than pensions, which are financed from outside the

Pension Insurance Fund.

- The possibility of early retirement was abolished, but the benefits determined earlier are

further disbursed.

- Review of disability pensions.

- As of 1 July 2013, it is not allowed for persons working in the public sector to receive

both wage and pension (or benefits before retirement age).

Health care:

- Expenditures on pharmaceutical subsidies, which were high in international comparison

substantially decreased (generic program, strengthening the price competition between

pharmaceutical manufacturers and distributors, etc.).

- Reorganisation of the system of hospitals in the framework of local government reform.

Local government system:

- Reorganisation of the structure of tasks of local governments: local governments retain

only those tasks where local decision-making is indispensable. Review of the system

covered the following areas: healthcare, administration, public education, social care

and child protection, community culture, and disaster management.

- Take over the debt of local governments.

- Government control concerning debt-generating transactions of local governments.


Reforms fostering a more flexible and better functioning labor marketwere undertaken to boost employment and labor market participation.Further to the changes in the tax regime, incentives were also enhanced by thelaunch of the Job Protection Action Plan, which decreased the cost of employers, ifthey hired employees from a targeted group of people that were in the worst labormarket position (persons below 25 years or above 55 years of age, long-termunemployed, mothers returning to work after maternity leave). The extension ofpublic work schemes aimed at helping unemployed reintegrate to the labor market(which effect was to be further enhanced by the revision of disability pensionentitlements). Various training organized in the framework of the public workprograms was also to foster employability of participating persons. Moreover, laborcode modified considerably. The new labor code created more flexible workingenvironment for both employees and employers. It opens the ways of various unusualworking contracts, considerably simplifies working time arrangement taking intoaccount the specific needs of certain economic sectors and provides for the possibilityof the government establishing statutory differentiated minimum wages, etc.

Trend change in demography is considered as an important long-termstrategy of the government. The challenges coming from the demography isreflected by the evolution of the old-age dependency ratio, which will increase from26.6 in 2010 to 63.1 in 2060.22) One of the key causes of adverse demographic trends islow fertility rate. The fertility rate in Hungary is one of the lowest in Europe,


Appendix Figure 14] Structure of Expenditure

Sources: Eurostat.

2009 2011

22) Aging report 2012, European Commission, old-age dependency ratio: people aged 65 or above relative to those

aged 15-64.


accounting for only 1.3 compared to a 1.6 EU average. In order to increase thewillingness to have children the government reinforced the family-friendly incentivesystem and the Parliament adopted the Act on Family Protection. Decisive elementsof the measures included various forms of pecuniary support to families such asfamily allowance, maternity support, cash support for parenthood, life-startingsupport, child protection benefit, gas price subsidy for families with three or morechildren, and the family tax relief introduced in 2011. These measures are expected tomitigate the projected aging of the Hungarian population.

Parametric changes to the pension system implemented in severalphases in 2009 and 2011 significantly reduced future public pensionexpenditures. In conformity with best international practices, the main direction ofthe measures is to rise retirement age in line with increasing life expectancy, asignificant increase in effective retirement age and change of indexation. Theretirement age increases gradually to 65 by 2021, while pursuant to the regulationadopted in 2011 reforming provisions for persons under the retirement age, theeffective retirement age will increase significantly. This measure closed all possibilityto exit from the labor market before reaching statutory retirement age. All thesemeasures have a beneficial effect not only on the pension system but also onemployment.

Hungary became one of the best performers in terms of sustainability ofpublic finances among EU countries, as a result of parametric changes in thepension system coupled with the effective budgetary consolidation. The positiveresults are also confirmed by the most recent Sustainability Report prepared by theEuropean Commission in December 2012. In its report, the European Commissionstates that Hungary is a low-risk country regarding the sustainability of the publicfinance in the short, medium and long term, alike. Only 4 other countries receivedsuch a favorable rating. Apart from that, the European Commission also claims thatthe debt rate will decrease well below 60% of GDP by 2030, provided that the levelof structural primary balance planned for 2014 in the convergence program of April2013 is maintained.

Monetary policy could support the economic policy only recently. Whilethe quick monetary policy answers were effective in averting the worst scenario inlate 2008 and early 2009, it could not contribute to economic growth during thesubsequent couple of years. In the first half of 2012, the central bank base rate was7%. The stabilization measures of the government, its firm commitment to achievingthe deficit target and, on the other side, positive global investor sentiment reducedthe yield required from government securities. This allowed the Monetary Council ofthe MNB to start an interest rate cut cycle in August 2012, reducing the base rategradually by 460 basis points in aggregate. Accordingly, the central bank base rate



sank to 2.4%, an all-time low, at the end of May 2014.

In April 2013, the central bank launched the Funding for Growth Schemeto facilitate lending to SMEs. The program has several pillars. Within theframework of Pillar I of the FGS, the MNB provided refinancing loans with 0%interest to the participating credit institutions, which could further lend these loansto SMEs with an interest margin capped at 2.5%. These loans could exclusively beused for investment, working capital financing, pre-financing EU funds, or for theredemptions of existing forint loans. SME customers could use loans received underPillar II for the redemption of FX loans. The Funding for Growth Scheme led to asignificant improvement in borrowers’ access to credit. Lending under the FGSamounted to a total of HUF 701 billion. Consequently, the FGS had a significantimpact on the activity of participants on the supply and demand sides. Given thesuccess of the first round of the Funding for Growth Scheme, the central bankdecided to continue the Scheme in September 2013. In the next phase of the FGS HUF500 billion is available, which may be raised up to HUF 2,000 billion in an availabilityperiod from 1 October 2013 to 31 December 2014.

The regulation and supervision of the financial system was reinforced.Tasks and tools of the supervisory authority were extended, which enabled it to carryout a more comprehensive control on the operation of the financial institutions.Since 2011, an effective mandatory extensive review was introduced, which had to beperformed regularly. Consumer protection in financial issues was integrated into thesupervisory authority partly as recognition of the importance of the challengesrelated to FX debtors. In 2011, the macro-prudential functions of the MNB werebroadened and made more specific. The governor of the MNB can issue decrees toprevent excessive credit outflow, on liquidity requirements to prevent the build-up ofsystemic liquidity risks, on the conditions of the timing, build-up and operation of thecountercyclical capital buffer, and on additional requirements to reduce theprobability of default of systemically important financial institutions. The crisishighlighted that in the existing framework, the tripartite institutional structure toensure financial stability has major flaws. In October 2013, micro-prudentialregulation was integrated into the MNB. Due to the delegation of new tools to theMNB and the integration of the Hungarian Financial Supervisory Authority (HFSA)into the MNB broader information will be available for micro- and macro-prudentialregulation as well as monetary policy. In addition, actions taken by the regulatoryauthority will be more consistent and a broader set of tools will be directly availablefor the central bank to prevent the build-up of risks at individual or systemic level orto resolve crisis situations that have already occurred in a fast and efficient manner.The consumer protection and market supervision functions of the HFSA were alsointegrated into the central bank.



The condition of households’ lending became more transparent andpredictable by introducing new rules. The aim of the new rules is to prevent theoccurrence of the harmful lending behavior prevailing before the crisis. New ruleslimit the cases when banks can modify unilaterally the loan contract. The interest rateof mortgage loans has to be linked to a reference interest rate in a transparentmanner, or has to be fixed for a long period (3, 5 or 10 years). In parallel to thenegative list a positive creditor list was introduced, which registers those creditorswho delivers reimbursement in time. Total interest paid on a loan was capped at alevel of 240 basis points above the central bank base rate. FX mortgage loan have tobe reimbursed at the central exchange rate.

5. Lessons Learned from the Crisis and Crisis Management

The crisis management in 2008-2009 assisted by the EU/IMF did notimprove the resilience of the economy and public and external debtincreased further. The measures in 2008-2009 concentrated to easy, largeexpenditure cuts, but the essentials and deep micro-structural reforms were notelaborated. The increasing trend of the budgetary deficit was not broken and in2010, the government faced again the challenge of fiscal consolidation.

The new administration taking office in 2010 faced multiple challenges: Ithad to create both fiscal and financial stability, and set the economy onto a path ofsustainable growth while simultaneously coping with an unfavorable globaleconomic environment suffering from a prolonged fiscal-financial crisis. In order toavoid further economic recession and social tensions, the government applied a mixof both traditional and innovative measures in its economic policy. The government’smain priority was to reverse the increasing path of the public debt while increasinggrowth potential and employment.

The results of the crisis management since mid-2010 are visible. Theunfavorable macroeconomic trends of the previous period had been reversed. Publicdebt is on a declining path, it decreased from 85.3% in Q2 2010 to 79.2% in 2013.Since 2011, deficit has been below 3% of GDP (4.3% surplus in 2011, 2.1% and 2.2%deficit in 2012 and 2013, respectively) and it is expected to remain well below 3%deficit in 2013, as well. As a consequence of the good budgetary performance, the EUlifted the excessive deficit procedure on Hungary in 2013, while still 17 EU membersare under the procedure.

As a result of various structural measures and the changes in the taxsystem, employment rate and labor market participation is on the rise.



Employment levels hit a 21-year high. By the end of 2013, Hungary could claim morethan 4m in work (Figure 15), a jump of 255,000 in employment since mid-2010. Itmeans that the employment rate has jumped by 3.7 percentage points, to 52.6%,while the unemployment rate has dropped to below 8%, i.e. significantly below theEurozone average of 12%.

Recent data show that as the growth of the economy accelerates,internal and external balances are also improving. Thus, unlike in the past, thegrowth path is expected to be sustainable and more balanced since it is driven not




Sources: Eurostat, MN.


only by external but also increasingly by domestic factors. There are two importantaspects, which should be taken into account when assessing the Hungarian economicgrowth prospect. While fiscal consolidation and the on-going deleveraging process ofthe banking system have had a positive effect on macroeconomic balances and havebuilt the basis of a sustainable growth path, these two processes have decreased theopportunity for economic policy to restart economic growth. Despite the fact thatthese developments hold back the economy, GDP grew at a comparable rate to theother EU countries in 2013. Against this background the external debt has reduced(Figure 16) owing to the significantly improved financing capacity of the economy.All these developments are supported by a strong export performance (Figure 17),which shows the strengths and the potential of the Hungarian economy.



1. History and Contents of the Meetings

In July 2008, the Korean government began to operate the “Economic CrisisManagement Meeting (hereafter, the ECMM)” presided by the Minister of Strategyand Finance and participated by relevant ministers in order to overcome the crisisfaced by the Korean economy due to high oil prices. The existing “Economic PolicyCoordination Meeting” was promoted to the ECMM and was held regularly everyFriday. These meetings were participated by such ministries as the Ministry ofStrategy and Finance, Ministry of Knowledge Economy, Ministry of Land, Transportand Maritime Affairs, Ministry of Public Administration and Security, Ministry ofHealth, Welfare and Family Affairs, Ministry of Agriculture, Forestry and Fisheries,Ministry of Labor, Ministry of Education, Science and Technology, Financial ServicesCommission, and Fair Trade Commission.

The contents of the ECMM were: (1) Review and response to macroeconomictrend such as growth and current account balance, (2) Energy-related issues such asenergy demand and supply, oil price trend, and energy saving, (3) Price trend andmeasures for consumer price stabilization, (4) Public welfare and stabilizationmeasures, (5) Review and response to financial market trend, (6) Stabilization of thereal estate market, (7) Review the progress status of the crisis management andmeasures as well as the establishment of the second stage driving strategy.


Appendix 2Economic Crisis Management Meetings in Korea23)

■ Chapter 01

23) This Appendix is a summary of press release by the Ministry of Strategy and Finance in July 8, 2008 and

February 7, 2013 regarding the economic crisis management meetings.


Since then, there were 164 ECMM meeting and a total of 519 issues discussed until2012. Since 2008, the number of meetings held and agendas discussed have increasedsteadily and in 2012, there were 37 meetings with 138 agendas. Along with the crisisresponse, heightening economic vitality, industry stimulation, preparation for thefuture, protection for vulnerable groups, and strengthening national competitivenesshave been discussed intensively. The classification and the number of agendas alongwith remarks are provided in Table 1.


Appendix Table 1 Summary of the Economic Crisis Meetings

AgendasNumber of

AgendasRemarks

Crisis response 105

Rapid and preemptive response to crisis situations such as high oil prices,global financial crisis, earthquake in Japan, bombardment of Yeonpyeong,and death of Jongil Kim

* Economic condition was in the agenda due to high oil prices (Feb. 2008),global financial crisis (Oct. 2008), bombardment of Yeonpyeong,earthquake in Japan, death of Jong-il Kim (Nov. 2010, Feb. 2011, andDec. 2011).

* “Intensive Monitoring System” set in place due to Europe’s financial crisis(14 agendas in discussion in total since Jun. 2012)

HeighteningEconomic vitalityand industrystimulation

176

Heightening economic vitality such as investment and national economyvitalization, job creation, and improvement on corporate businessenvironment.

* Investment stimulation (Jun. 2009, May 2012), national economyactivation (Jul. 2011), and job creation (Apr. 2010, May 2012), etc.

* Improvement on business environment (16 agendas in total for five yearswere in discussion to provide comprehensive measures for improvementon business environment.)

Discussion over competitiveness of individual industries such as serviceindustry and state-of-the-art fusion industry.

* Service industry stimulation (18 agendas in total in five years introduced forcomprehensive measures for tourism, contents, and medical industry)

* Strengthening shipping industry competitiveness (Sep. 2010), Plantequipment industry (Sep. 2010), Re-manufacturing industry (Aug. 2011),Change of machinery industry into service (Apr. 2012), and Industrialfusion development plan (Aug. 2012), etc.

New growth drivingforce, energy, and

future-oriented policy98

Future-oriented policy was in discussion such as creation of industries for newgrowth driving force and green growth and preparation of aging society.

* Driving plan for new growth driving force (Apr. 2009), proliferation of ITfusion industry (Jul. 2010), private sector R&D stimulation (Jun. 2009, Nov.2011), national greenhouse gas reduction target (Nov. 2009), and agenda inrelation to the 100-years old policy (four agendas in Sep. to Dec. 2011), etc.


2. Assessment of the Meetings

In the midst of the global financial crisis and North Korea issues, the ECMM wasfunctioning well to respond to the crisis preemptively and rapidly as a part of thecrisis response and management system. Until the current administration (Feb. 2013),the meeting acted as a major policy coordination tool for crisis management. Themeetings ran parallel with providing economic policy coordination and suggestion ofnew policy agendas. The policy coordination with inter-ministerial disagreement isresolved as well as identification and coordination of policies that needed to haveinter-ministerial agreements.

However, the meetings lacked providing opportunities for free debates beforecontroversial inter-ministerial policies were finalized. For instance, only five agendas,including an ease of railway operation monopoly and activation of investment onfree economic zone, etc. were allowed free discussions in 2012. The meetings neededto be run as complementary to other meetings such as the National PolicyCoordination Meeting, Foreign Economic Minstrel Meeting, and Consumer PriceInter-ministerial Meeting, etc. in which officials of inter-ministerial level participate interms of agenda identification and introduction of agendas.

Main characteristics of the ECMM can be summarized as follows.


Appendix Table 1 Continue

AgendasNumber of

AgendasRemarks

New growth drivingforce, energy, andfuture-oriented

policy

98

Future-oriented policy was in discussion such as creation of industries for newgrowth driving force and green growth and preparation of aging society.

* Driving plan for new growth driving force (Apr. 2009), proliferation of ITfusion industry (Jul. 2010), private sector R&D stimulation (Jun. 2009, Nov.2011), national greenhouse gas reduction target (Nov. 2009), and agenda inrelation to the 100-years old policy (four agendas in Sep. to Dec. 2011), etc.

Protection ofvulnerable groupsand strengthening

nationalcompetitiveness

61

Under the mutual growth philosophy, protection of vulnerable groups andstrengthening competitiveness have been driven in areas of agriculture, smalland medium-sized companies, and self-employed companies.

* Food industry development measures (Nov. 2008), improvement onsubcontractor trade order (May 2010), protection of technology andhuman resources in small and medium companies (Aug. 2011, Nov.2012), heightening competitiveness for small businesses (Dec. 2008, Sep.2012), etc.

Other agendas 79Public sector reform, status of controversial bills, and policy drivingperformance review were also in discussion


(1) Development of the intensive review system on economic issues. In relation tothe presence of global crisis, the “intensive monitoring system” was run continuouslyto monitor national and international economic trend and major issues. Everymeeting incorporated various national and international risk factors or economictrends into the agenda. During each first meeting of the month selected a majorindustry to review the recent trends and policy direction of that industry.

(2) Practical discussions on controversial issues. Issues to be discussed during themeeting were actively identified and introduced for interactive discussions on currentand controversial issues. The ECMM was promoted actively as a venue for activedebates with regards to controversial policies. Discussions on organizing coordinationon issues that require pre-arrangement were also made.

(3) Strengthening feedbacks from the meetings. Regarding the progress ofpolicies decided in the ECMM: a system was put in place to check the progress of thepolicies twice a year at the first and second half of the year. Review reports wereproduced to check whether decided issues were put into action as planned. Issuesintroduced at the first half were reviewed in July while issues introduced at thesecond half were reviewed in December. If the policies confirmed in the meetingrequired budget or tax assistance, subsequent actions were encouraged to be put inplace. Incentives such as tax reform or budget priority were provided to take theissues into consideration. In 2013, the budget for the decided issues at the ECMM wasconsulted to be passed as priority in budget deliberations.

(4) Strengthening communication with economic sectors. The meeting was heldwith economic sectors and the market participants to deliver the contents andintentions of policies and communicate with them. Some examples are discussion onthe implementation of FTA with the Korea Chamber of Commerce in March 21,2012and a discussion on political and economic trends in China and their implicationswith the Export-Import Bank of Korea in Oct 31, 2012.Participation of researchinstitutions and experts were actively sought by the ECMM to reflect the voices of themarkets and experts in the private sector.In 2012, 27 research institutions and privateorganizations participated in the meeting 23 times in total. Active advertisement ofthe comprehensive measures determined at the ECMM was required for publicawareness on the measures via the related inter-ministerial briefing.

(5) Increase of coordination effectiveness at the ECMM. Attempts were made torevise related regulations to increase coordination effectiveness as much as possibleat the ECMM. For critical policies, a measure was put into place to introduce the issuein priority at the meeting. For example, projects that were expected to greatlyinfluence the national economy, projects that require large budget in the future, andprojects that caused disagreement between ministries, etc. If changes such as a



creation of new ministry or agency due to government organization reform occurredin the future, members of the ECMM were also changed accordingly. If a relativelyquick discussion was required for policies that involved only a few ministers, it wasencouraged to have an unofficial meeting between related ministers before or afterthe formal meeting.






Foreign Direct Investment (FDI)Promotion

Chapter2


Summary

It is safe to say that Korea is the only country to achieve high economic growth ina short period of time through the expanded participation of the private sector in theeconomy with government support. The economic development strategy promotedunder strong and efficient government leadership in the early stage of economicdevelopment favored the unbalanced development strategy that promoted exportsby focusing on large companies and the heavy chemical industries.

Hungary’s responsibility as an EU member prevents the government fromimplementing policies with strong political will as in the Korean case. Nevertheless, ithas to promote policies to differentiate from neighboring competitors whilefollowing the policy directions of the EU. This chapter aims to share Korea’s foreigndirect investment (FDI) experience that played a crucial role as an economic resourceduring Korea’s economic development and suggest policies to expand Hungary’s FDIpromotion.

Based on the review of Korea’s FDI policies and a comparative study betweenKorea and Hungary, this chapter proposes the following six major policy suggestions.First, Hungary needs to consider unbalanced development strategy. EU policies are infavor of balanced development in order to reach a leveling of development invarious regions of Europe, which makes the task very difficult. Thus it might be toughfor the Hungarian government to spare its political determination to follow the EU’spolicy directions for unbalanced development.

Foreign Direct Investment (FDI) Promotion

Sung Jin Kang (Korea University)

■ Chapter 02



Second, it is necessary to establish a control tower and an organization dedicatedto FDI. In order for well-intentioned policies to be implemented effectively, anefficient decision-making system must be established. Hungary also needs to organizea control tower that coordinate opinions of the central and local governments andmake decisions regarding the establishment of industrial complexes.

Third, implementing policies that promote agglomeration are necessary. Toenhance the cumulative effect of industrial zones to the greatest extent, relevantpolicies need to be altered so as to focus investment in certain areas.

Fourth, the country is in great need of maximizing backward and forward linkageeffects by nurturing the parts and materials industry. The growth in this industry willenable Hungary to minimize its trade deficit into surplus with Korea and localize theproduction of goods.

Fifth, the country needs to pursue long-term effects of privatization of SOEs(state-owned enterprises). Based on Korea’s case, this paper suggests Hungary toestablish policies that help the public sector privatization contribute to SOE reformsand trade deficit reduction or strategies that link the public sector privatization withFDI.

Last but not least, a comparative study on business environment should be carriedout. The World Bank’s Doing Business Report (DBR) presents evidence that companiesfind it relatively more difficult to make investment and carry out their business inHungary compared to its neighboring countries: the Czech Republic, Slovakia, andPoland. Based on a comparative study between Hungary and the Visegrad Group -the Czech Republic, Slovakia, Poland, and Hungary - the Hungarian government hasto create an attractive investment climate and make up for weaknesses to encourageFDI into the country.

1. Introduction

Korea is the only country to achieve unprecedented high economic growth in ashort period of time through the expanded participation of the private sector in theeconomy with government support. The economic development strategy promotedunder strong government leadership in the early stage of economic developmentfavored the unbalanced development strategy promoting exports by focusing onspecific regions, large companies and the heavy chemical industries. It achievedsubstantial success in the beginning even when the infrastructure was weak.However, its various inefficiency problems were addressed over time.1) Therefore,after the 1980s, the government introduced aggressive privatization and

Chapter 2 _ Foreign Direct Investment (FDI) Promotion 093


deregulation policies in order to solve the inefficiency problems caused by theeconomic policies focused on the heavy chemical industry and public sector. Theywere extensively implemented, yet the government imposed limits on foreignownership and full privatization in the major infra-industries such as electricity andtelecommunications.

Since the 1990s, Hungary has been transitioning towards capitalism and joined theEU in 2004. Hence its responsibility as an EU member prevents the government fromimplementing policies with strong political will as in the Korean case. Nevertheless,Hungary has to promote policies to differentiate from neighboring competitors whilefollowing the policy directions of the EU. This paper aims to share Korea’s foreigndirect investment (FDI) experience that played a crucial role as an economic resourceduring Korea’s economic development and suggest policies to expand Hungary’s FDIpromotion.

FDI is directly linked to economic growth or economic development (see [Figure 2-1]). FDI has significant impacts on growth and development in both the short andlong run. In the short run, FDI enhances capital formation and promotes investment.In the long run, FDI generates both competition and anti-competition effects as wellas linkage effects such as technology transfer through R&D (Kang and Sohn, 2009;Kang and Lee, 2011; Yoon and Kang, 2013). Thus the expansion of FDI inflows must

1) Korea has pursued unbalanced economic development strategies under which the government made economic

development plans and granted subsidies to certain strategic sectors such as the heavy and chemical industry

(HCI), thereby affecting the distribution of resources. In addition, export-oriented industries, industrial complexes such

as Free Export Zone (FEZ), and big businesses received preferential benefits from the government. On the contrary,

Hungary has pursued balanced growth with the change of system from socialism to capitalism and its accession to

the European Union. These differences should be taken into consideration while forging bilateral development ties.

Figure 2-1 The Effect of FDI on Economic Growth/Development

Source: Created by the author.



be emphasized in economic development policies since it secures resources to financeinvestments and also generates economic spillover effects across various sectors.

Korea’s experience of economic development and, in particular, its policies for FDIinflows provide Hungary with many lessons. However, policy suggestions mustincorporate the current situation of Hungary when sharing Korea’s experience. Mostimportantly, it must be noted that Korea’s economic growth gradually inducedprivatization and liberalization under strong government leadership, which will bedifficult for the Hungarian government to attempt due to its EU membership.

This paper aims to share with Hungary the Korean FDI experience that served asan important resource for investment during Korea’s economic development, takinginto account the differences in Hungary and Korea’s economic developmentexperiences and the policy directions of the EU.2)

Section 2 will provide an overview of Korean FDI policies and describe the changesin the policies and policy agendas. Then it will discuss the Free Economic Zone (FEZ)policies, which falls under the FDI policies. Section 3 will discuss the sectoral FDIpolicies in Korea, and Section 4 provides a comparative study of FDI policies in Koreaand Hungary. In Section 5, the paper concludes and provides policy suggestions forHungary.

2. Korean FDI Policies3)

2.1. Overview of Korean FDI Policies and Policy Agendas

The FDI policies in Korea are divided into three stages of economic development.The first stage is from 1960 to 1983. During this initial economic development stage,resources for investment were mainly secured from foreign aids and debt, and therewas more dependence on foreign debt rather than on FDI. Also, the governmentimplemented policies to promote investment and business activities in the sectorschosen with strategic targets.

The second stage is from 1984 to 1997, and the means to raise capital changedfrom foreign debt to FDI inflows. Especially, the international foreign debt crisis inthe early 1980s meant that FDI became a more attractive option than foreign debt

2) Other section discusses FDI in Korean industrial complexes in detail, so this section includes only the FEZ policies

to avoid overlap.

3) During the research and discussions with Hungarian researchers, Hungary wanted to understand Korea's policies

on the privatization of public enterprises. Since this topic is less relevant to FDI policies, it was added as [Appendix 1].



that was more sensitive to international economic policies and placed greater burdenon indebted countries. However, Korea joined the OECD in 1994, and this becamethe turning point for the extensive liberalization of the capital market including FDIinflows.

The third stage is from 1998 to the present and FDI has been playing a morecrucial role than foreign debt in raising capital, yet both are still used as policy tools.The incentives to expand FDI inflows include tax reduction, cash support, streamliningof administrative procedures and deregulation. In 1998, the Foreign InvestmentPromotion Act was enacted, and as a result, extensive efforts to open the sectors andpursue FDI liberalization policies accelerated. Also, the Free Economic Zones (FEZs)were established to expand FDI inflows.

As discussed above, FDI played a crucial role in securing resources for investmentduring Korea’s economic development. The Ministry of Trade, Industry and Energy isthe central government department in charge of economic affairs and has served as acontrol tower to promote FDI policies. Under the jurisdiction of the Ministry of Trade,Industry and Energy, agencies such as KOTRA and Invest Korea support and performtasks to promote FDI. KOTRA supports overseas investment, foreign investment andoverseas expansion of small and medium enterprises (SMEs). Invest Korea providesconsulting services and one-stop counseling to foreign-invested enterprises in Koreaabout investment procedures, laws, taxes, accounting and accommodations. Based onthe roles of the government agencies and institutions, the Korean governmentprovided various incentives such as tax reduction, cash support and employmentsubsidies to expand FDI inflows. In particular, the FEZs were established to open thedomestic market to foreign capital and expand capital inflows in the short run. ThusKorea has increased the level of capital liberalization and expanded FDI inflows. Itseconomic growth experience has served as a role model for many developing nations.

However, Korea’s FDI policies were not implemented adequately enough forother countries to necessarily learn from. Currently, Korea is pursuing the model fordeveloping nations despite being in its current stage of economic development, thusit is essential for the policy directions to pursue FDI policies of developed nations. Inorder to increase the FDI inflows toward Korea and pursue FDI policies of developednations, the efforts to enhance the policy environment must continue.

First, Korea’s labor market and related systems must be more flexible. Second, it isnecessary to streamline various licensing procedures. Third, the reverse discriminationagainst domestic businesses and investors must be dealt with. It is essential to treatthe domestic and foreign capital equally and in turn induce the synergistic effect.Fourth, the current policies provide investment incentives only if the size of theinvestment meets the condition set for each industry. This restriction must be relaxed



gradually. Fifth, when the policies to expand investment are established orimplemented, the spillover effects of the investment are substantial, and it isnecessary to target the investment for the industry sectors that can contribute to theimprovement of the industrial structure. In Korea, the strategic industries weredecided by the government and FDI policies to attract foreign investors werefollowed. The FDI promotion policies in Korea list the sectors in which specificbenefits were given to FDI. These policies sometimes have conflicts with marketmechanism. For example, the FDI policies gave favors to FDIs going into themanufacturing sectors while FDI for the service sectors received none.

2.2. Korean Free Economic Zone Policies

The FDI policies in Korea have been implemented in various ways since the earlystage of its economic development. For instance, the free trade zones and foreigninvestment zones were established early on, and recently, the policies for FEZs havebeen implemented. In this section, the recent FEZ policies will be discussed. Othereconomic zones will be covered in another chapter.4)

In 1995, Korea emphasized the need to emerge as a business hub in NortheastAsia through the expansion of FDI inflows. To that end, the government provideddiverse incentives and lifted regulations to create a favorable business climate forforeign individuals and institutional investors. FEZs were established as part of thisprocess.

The FEZs were established with four purposes. They were designed to enhancenational competitiveness, serve as a center for future economic growth, promotebalanced regional development, and drive reforms in institutions.

The FEZs were established in order to induce foreign investment, boost nationalcompetitiveness, and support balanced regional development by enhancing thebusiness environment for foreign-invested enterprises and living conditions forforeigners (Article 1, Special Act on Designation and Management of Free EconomicZones). In 2002, the Special Act on Designation and Management of Free EconomicZones was enacted. In the following year, Incheon, Busan-Jinhae, and GwangyangBay Area were developed into the first FEZs. The Yellow Sea, Daegu-Gyungbuk andSaemangeum-Gunsan regions were designated as the second FEZs in 2008, and theEast Coast and ChungbukFEZs were added in 2013. Hence there are a total of eightFEZs in Korea, and they aim to promote finance, international distribution andlogistics, medical and biotechnology, education, culture and tourism (Korean FreeEconomic Zones, www.fez.go.kr, Accessed 11 March 2014).

4) This section explains only the free economic zones among various FDI policies. This is because the section for

industrial complexes provides explanations for various FDI policies.



The attraction of foreign investment to the free economic zones was not assubstantial as initially expected, and it has been steadily increasing, albeit slowly.Also, its share in the total foreign investment in Korea has been increasing as well(Refer to <Table 2-1>). By zone, Incheon hosted the largest number of businesses(876), and Busan-Jinhae hosted the largest number of foreign-invested enterprises(58) (Refer to <Table 2-2>).

Though Korea’s FEZ policies substantially contributed to the increase in FDIinflows and exports, there is still room for improvement. FEZs are oriented towardthe development of domestic industries, yet they are included in the FDI policies dueto their dependence on investment from foreign businesses and investors. Thus FEZsand FDI are closely linked. The expansion of FDI inflows not only secure resources forinvestment but also generate spillover effects across various sectors. FEZs can serve asan essential window for attracting foreign investment and generating economicspillover effects by providing promising industries with special treatment.

Table 2-1 Current Status of Foreign Investment in Free Economic Zones(Unit: USD 100 million)

Year 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total

Amount(%)

1.2(0.9)

1.2(0.9)

5.8(5.0)

1.3(1.2)

3.1(3.0)

2.3(2.4)

7.9(6.9)

9.5(7.2)

11.5(8.4)

5.2(15.5)

Table 2-2 Current Status of Businesses in Free Economic Zones (As of End-2012)

Source: The Ministry of Trade, Industry and Energy (2013), “Announcement of the First Free Economic Zone Basic Plan,”p.9.

Manufacturing Non-manufacturing

DomesticForeign-Invested

DomesticForeign-Invested

Incheon 51 6 775 44

Busan-Jinhae 567 25 - 33

Gwangyang Bay Area 60 13 19 26

The Yellow Sea 9 - - -

Daegu-Gyungbuk 10 - 55 1

Saemangeum-Gunsan 359 16 10 -

Total 1056 60 859 104

Note: The numbers in parentheses are the share of foreign investment in free economic zones in the total foreign investment inKorea (as reported).

Source: The Ministry of Trade, Industry and Energy (2013), “Announcement of the First Free Economic Zone Basic Plan,” p.9.



Hence if policies that maximize the synergistic effect between FDI and FEZ areestablished and implemented, they will play a crucial role in developing domesticindustries, increasing exports, and securing long-term resources for investment.Hence the problems of Korea’s FEZ policies must be addressed.

First, the policies were export-oriented and did not take domestic demand intoaccount. Second, while the policies draw short-term capital, they fail to achieve abetter balance between national and regional development and generate linkageeffects. Third, policies are oriented toward manufacturing, yet they are notappropriate for Korea in its current stage of economic development. Fourth,domestic investors and companies encounter reverse discrimination because foreigncapital receives preferential treatment. Furthermore, there is not much support forvertical mergers. To address these issues, the government needs to provide incentivesthat do not discriminate against domestic businesses and the manufacturing sector infavor of foreign businesses and the service sector. Fifth, the efforts to attract foreigninvestment are insufficient. Currently, visions for the development of FEZs are not

Table 2-3 Comparison of Domestic and Foreign Free Economic Zone Incentives

Source: Lee and Moon (2011), “The Illusion and Reality of Free Economic Zone,”p.11.

Category FEZ Singapore Hong KongShanghaiPudong

Dubai


Purpose

Agency incharge

Qualification

Establishment offree global city via

mixed-usedevelopment

EDB

Focus on financeand service

Focus on manufacturing

Focus on financeand service

Focus on tourism and logistics

Both domestic and foreign firms

Invest HKPudong

ManagementCommittee

Free-trade Zone Management

Office

Both domesticand

foreign firms

Both domesticand foreign firms

0%25%17.5%

No taxesNone

None None

None

None

The FEZCommittee


Corporate,income

taxes, etc. 100% for 3 years and 50% for 2

years


18%

No specific policy (flexibly granted,

maximum of 15 years)None

Flexible support based on EDB

regulations

Support based on Foreign

Investment Promotion Act

CorporateTax 25%

Tax reduction

Cash support


well-defined. Also, the zones are not differentiated, and development is beingdelayed in some zones. On top of that, the government has expanded zones solelyfor the balanced regional development without sufficient assessment of theperformance and effectiveness of relevant policies. Sixth, the system that promotesFEZ policies needs to be improved. In the case of FDI policies, the Ministry of Trade,Industry and Energy serves as a control tower and forms close interagencypartnerships for effective implementation of policies. Yet, the decision-makingsystem for FEZs consists of a tripartite party of FEZ authorities, local governments andcentral government (the Ministry of Trade Industry and Energy), making effectiveand prompt decision making difficult.

As mentioned above, some challenges manifested in Korea’s policies on FEZshould be handled to utilize FEZs to the fullest extent and expand FDI inflows. Also,when Korea shares its experience with Hungary, it should make sure that similarissues do not repeat.

3. Sectoral FDI Policies5)

This section summarizes the FDI policies for the main sectors that Hungary has a


Table 2-4 Sectoral FDI Policies

Source: Invest Korea(http://investkorea.org/ikwork/iko/kor/cont/contents.jsp?code=1010201) [Accessed 11 March 2014].

Industry Sectoral FDI Policies

5) During the research and discussions with Hungarian researchers, Hungary wanted to understand Korea's small and

medium enterprises (SMEs) policies. Since this topic is less relevant to sectoral FDI policies, it was added as

[Appendix 1].

- Parts material investment cooperation center (OASIS Center)- Establishment of parts material industrial complexParts material

Semiconductor

Pharmaceutical / Bio

Logistics andDistribution

- Establishment of industry-academic-institute joint research center for next generationmemory

- R&D tax reduction

- Budgeting for industries in National Research and Development Project Investmentfocused on BT (Bio Technology)

- Plans to support major pharmaceutical industry (Ministry of Health and Welfare)- Establishment of biofund to promote bio industry

- Special Act on Designation and Management of Free Economic Zones: income andcorporate tax reductions for firms with foreign investment for 5 years (100% for initial 3years, 50% for next 2 years, income and corporate taxes for 15 years, custom duties for5 years)


keen interest in. The sectors are parts and materials, R&D, semiconductors, greeneconomy including life science and energy, and logistics and distribution (Refer to<Table 2-4>).

3.1. Parts and Materials

The purpose of FDI and industrial policies is to increase exports and pursuedomestic demand and regional development. Yet, it is possible for trade deficit tooccur due to global outsourcing. Hence it is necessary to incorporate domestic partsin the industrial production and exports through FDI. In Korea, the policies topromote and develop the parts and materials industry are continually pursued sincethe 1970s, and the efforts to expand FDI inflows toward the parts and materialsindustry continue.

During the 1970s, the import-substitution policies for localization were pursued. Inthe 1980s and 1990s, the policies to diversify and localize imports were promoted. Asa result, import-substitution (localization) was carried out on about 4,000 general-purpose parts and materials. Yet, during this period, the efforts were restricted toshort-term support with more focus on low technology than on original technology(Bank of Korea, 2005, pp.17-19). In the 2000s, the Korean FDI policies for the partsand materials industry changed from the import-substitution strategy to that ofexport promotion. However, the focus is still on the mid- to short-term support fortechnology development, and the investment and support for original technology isinadequate.

Currently, the Overseas Advanced Parts and Materials Search Service andInformation System (OASIS) Center is being operated to promote the development ofand FDI inflows toward the parts and materials sector through various means such asestablishing the industrial complex. The OASIS Center was established as an affiliatedorganization of the Ministry of Trade, Industry and Energy in order to provideforeign investment enterprises and investors with a variety of information. It providesinvestment-related information and professional services (legal, accounting, validityanalysis, etc.), and it supports global partnership between domestic and foreignbusinesses.6) Also, it designated the industrial complexes in Gumi, Pohang and Iksanand the Busan-Jinhae FEZ for parts and materials to attract foreign investmenttoward the parts and materials sector (Refer to <Table 2-5>).


6) For detailed information about the OASIS Center, refer to the OASIS website

(http://www.pmcomplex.go.kr/Oasis/).[Accessed 11 March 2014]


3.2. R&D

The purposes of FDI policies for the R&D sector are technology transfer andproductivity improvement. Accordingly, the central and local governments providecash support to foreigners who meet the policy conditions and invest in the industrialsupport service sector and research for high-technology projects. The cash support inthe R&D sector is mainly for the high-technology parts and materials sector with largespillover and value-added effects. The cash support is, at least,5% of the FDI amount,and the financial fund ratio for land cost and rent is 30:70 in the capital area and60:40 in the non-capital area (KOTRA, 2013, p.41).

Also, the Ministry of Trade, Industry and Energy (2014, pp.7-14) established plansto provide customized support for the headquarters of the high-technology,industrial service global businesses and their R&D centers in order to expand FDIinflows in the R&D sector. It will first reduce income taxes for foreign engineers in theforeign-invested R&D centers until 2018 to secure foreign-skilled labor. Second, it willsupport R&D centers with factory sites as well as leases on buildings. Third, it will helpR&D centers build domestic networks through collaborative research with domesticindustries, universities and institutes. Thus it will establish infrastructure to attracthigh value-added investment that contributes substantially to the domestic economy.


Table 2-5 Industrial Complexes for Parts and Materials Sector

Source: Invest Korea(http://investkorea.org/ikwork/iko/kor/cont/contents.jsp?code=1010201).[Accessed 11 March 2014]

Industrialcomplex

Size and target industry sectorsResidentcompanies

6.785 million m2

Target industry sectorDisplay, mobile communications,

electronics, etc.

Pohang IndustrialComplex Target industry sector

Steelmaking, shipbuilding parts, materials,etc.

Busan-Jinhae FEZTarget industry sector

Auto parts, shipbuilding equipment andsupplies, etc.

Iksan IndustrialComplex Target industry sector

Automobiles, machinery and equipment,electronics and chemicals, etc.

Gumi IndustrialComplex

Total area

Total area

Total area

Total area

981,000 m2

4.662 million m2

2.794 million m2

8 companiesincluding Toray and

LPD

15 companiesincluding HHI andSeogyungMeditec

24 companiesincluding Hiragawa

and UNITECH

14 companiesincluding

AicelloMilimChemical


3.3. Semiconductors

FDI policies for the semiconductor sector include the Next-GenerationSemiconductors and System, IC 2015. Also, there is a tax reduction policy for the R&Dsector. According to Article 10 of the Tax Reduction and Exemption Control Act, thegovernment reduces 40% of the tax liability for the amount of the costs incurred inthe current year that exceeds the average of research and personnel training costsover the past four years for large and medium enterprises and 50% for SMEs.

3.4. Green Economy: Life Science and Renewables

In 2012, the investment budget for the national research and developmentproject emphasized IT (19.7%), BT (18.7%) and ET (16.0%) among the 6T that consistsof information technology (IT), biotechnology (BT), nanotechnology (NT), spacetechnology (ST), environment & energy technology (ET) and culture technology (CT).The investment in green economy-related technology in BT increased by 6.6% toKRW 2.68 trillion between 2011 and 2012, and the investment in green economy-related technology in ET increased by 4.1% to KRW 2.35 trillion from 2011 (theMinistry of Science, ICT and Future Planning and Korea Institute of S&T Evaluationand Planning, 2013, pp.21-23). The government concentrated its support on themedicine/bio industry among 6T, considering it as a promising industry forinvestment inducement. It also established plans to support the major pharmaceuticalindustry and biofund to develop the bio industry.

3.5. Korean Distribution / Logistics

According to the Special Act on Designation and Management of Free EconomicZones, the government reduces income and corporate taxes for foreign-investedenterprises (100% in the first three years and 50% in the next two years). Also,acquisition and property taxes are reduced for 15 years, and customs duties arereduced for five years. Moreover, the government hopes to set up policies toestablish and utilize integrated freight terminals, terminal facilities, towage, and portlogistics parks among the distribution / logistics facilities.

4. Comparative Study of Korean and Hungarian FDI Policies

This section compares the Korean and Hungarian FDI policies. Hungary’s tradedeficit with Korea is huge, so Hungary needs various policies to reduce the tradedeficit. For instance, Hungary can promote policies to develop the parts and materials



industry and vitalize the domestic businesses reducing the imports in this sector. Tothat end, this section first compares the FDI records of Korea and Hungary, examinesthe trade and industrial structure of the two countries, and compares the FDIpolicies.7) Identifying the sectors or industries in which Hungary has trade deficit willallow it to implement policies to develop domestic businesses in those sectors orindustries and induce FDI, although this is not within the scope of this paper. Thispaper further discusses the similarities and differences in the FDI policies of the twocountries and those of the major Asian countries.

4.1. Comparison of Korean and Hungarian FDI Inflows

Since 2001, the overseas and foreign direct investment between Korea andHungary has been generally increasing in terms of balance, inflow stocks and outflowstocks even though it faltered slightly after the 2008 global financial crisis. First, as[Table 2-6] shows, FDI stocks of Korea and Hungary was USD 156.1 billion and USD102.5 billion in 2012, respectively, and each of them was 13.8% and 82.3% of GDP.Meanwhile, the FDI size of Korea and Hungary was each USD 201.8 billion and USD


7) The policymakers in Hungary seemed to view the trade deficit with Korea very seriously. Yet, they seem to agree

that the imports of intermediate goods, rather than the trade of final goods, are relatively substantial in the trade

deficit structure, so Hungary can use the imports to manufacture final goods and increase exports. It is necessary to

analyze this issue with detail industrial codes later.

Table 2-6 Annual Trend of FDI Stocks in Korea and Hungary

Note: Numbers in parentheses are the ratio of FDI to GDP (%).Source: OECD(2014), “Most Recent FDIS tatistics for OECD and G20 Countries,” Tables 4, 5, 8, 9.

CountryFDI Outflows

2001 2003 2005 2007 2009 2010 2011 2012

Korea19,967 24,986 38,683 74,777 120,440 143,160 171,530 201,830

(4.0) (3.9) (4.6) (7.1) (14.4) (14.1) (15.4) (17.9)

Hungary1,554 3,509 7,810 17,320 19,735 20,435 23,861 34,079

(2.9) (4.2) (7.1) (12.7) (15.6) (16.0) (17.2) (27.4)

(Unit: USD million)

CountryFDI Inflows

2001 2003 2005 2007 2009 2010 2011 2012

Korea53,208 66,070 104,879 121,956 121,100 134,230 133,660 156,140

(10.5) (10.3) (12.4) (11.6) (14.5) (13.2) (12.0) (13.8)

Hungary27,378 48,345 61,110 95,463 98,800 90,780 84,541 102,512

(51.9) (57.9) (55.4) (70.1) (78.0) (70.9) (61.0) (82.3)


34.1 billion in the same year and represented 17.9% and 27.4%of GDP, respectively.The total amount of FDI inflows is larger for Korea, but the ratio of FDI inflows toGDP is higher for Hungary. In particular, Hungary experienced a substantial increasein FDI inflows after the mid-2000s. This seems to be due to the large-scale sale ofpublic enterprises for foreign capital based on the liberalization policy during thereform and opening up and the increase in investment in the region since Hungaryjoined the EU in 2004.8)

As <Table 2-7> shows, FDI inflows of Korea and Hungary were USD 5.0 billion andUSD 13.8.billion in 2012, respectively, and each of them was 0.4% and 11.1% of GDP.Meanwhile, the FDI outflows of Korea and Hungary was each USD 23.6 billion andUSD 11.2 billion in the same year and represented 2.1% and 9.0% of GDP,respectively.


8) The ratio of the FDI inflows in Hungary from the EU to the total FDI inflows in Hungary was 56.9% in 2004, 91.3% in

2005, 92.4% in 2006, 81.2% in 2007 and -225.2% in 2009, 45.3% in 2010, 89.3% in 2011, and 80.3% in 2012. Data is

for 25 EU nations for the period 2004-2006 and 27 EU nations for the period 2007-2012. The amount of FDI inflows

from EU to Hungary was -44.978 USD million in 2009, and the amount of FDI inflows from the world to Hungary

was 19.974 USD million during the same period. Hence the ratio of the amount of FDI inflows from the EU region to

the amount of FDI inflows from the world was negative in 2009 (stats.oecd.org, Accessed July 28, 2014).

Table 2-7 Annual Trend of FDI Flows in Korea and Hungary

Note: Numbers in parentheses are the ratio of FDI to GDP (%).Source: OECD(2014), “Most Recent FDIStatistics for OECD and G20Countries,” Tables2, 3, 8, 9.

CountryFDI Outflows

2001 2003 2005 2007 2009 2010 2011 2012

Korea2,196 4,135 6,366 19,720 17,197 23,278 20,355 23,627

-0.4 -0.6 -0.8 -1.9 -2.1 -2.3 -1.8 -2.1

Hungary368 1,644 2,179 3,622 1,885 1,149 4,682 11,152

-0.7 -2 -2 -2.7 -1.5 -0.9 -3.4 -9

(Unit: USD million)

CountryFDI Inflows

2001 2003 2005 2007 2009 2010 2011 2012

Korea3,528 3,526 6,309 1,784 2,249 1,094 4,661 4,999

-0.7 -0.5 -0.7 -0.2 -0.3 -0.1 -0.4 -0.4

Hungary3,936 2,137 7,711 5,447 1,997 2,204 5,856 13,786

-7.5 -2.6 -7 -4 -1.6 1.7 -4.2 -11.1


4.2. Trade Structure and Industrial Structure

Recent studies indicate that trade and FDI are positively related. Thus FDIpromotion will contribute to trade as well. Furthermore, FDI promotion policies canhelp improve trade surplus. Hungary has trade deficit with Korea thus it would bequite beneficial to attract more FDI in the sectors with trade deficit. This sectioninvestigates recent trend of trade structure (<Table 2-8>-<Table 2-12>) and industrystructure (<Table 2-13>).9)

4.2.1. Trade Structure

The structure of imports and exports between the two countries can be examinedwith the UN Comtrade data on the structure of Korea’s trade with Hungary. As[Table 2-8] shows, the previous exports decreased, yet the imports increased, resultingin a decline in Korea’s trade surpluses. In 2012, major Korean export sectors weremachinery and transport equipment (65.62%), miscellaneous manufactured articles(19.35%), chemicals and related products, n.e.s. (9.20%), and major Korean importsectors were machinery and transport equipment (51.80%), food and live animal(27.94%), miscellaneous manufactured articles (11.26%) in descending order of share.Korea experienced the largest trade surplus (USD 513.5 million) in the machinery and


9) In order to get more concrete inference on the relation between FDI and trade, it is necessary to see more

detailed industry classifications. However, this section uses only two digit classification due to space limit.

Table 2-8 Trend in Korea’s Trade with Hungary(2012) (SITC 1-digit)(Unit: USD thousands (%))

2001 2002

Export ImportExport-Import

ImportExport-Import

Food and live animal1,891(0.13)

87,496(18.58)

-85,605132,695(27.94)

-131,058

Beverages and tobacco27

(0.00) 44

(0.01) -17

127(0.03)

-20

Crude materials, inedible, exceptfuels

2,728(0.18)

898(0.19)

1,830186

(0.02)3,885(0.82)

-3,699

Mineral fuels, lubricants and relatedmaterials

0(0.00)

03

(0.00)0

(0.02)3

Animal and vegetable oils, fats andwaxes

742(0.16)

-742257

(0.05)-257

1,637(0.14)

107(0.01)

Export


transport equipment sector and the largest trade deficit (USD 131.0 million) in thefood and live animal sector.

Also, <Table 2-9> and <Table 2-10> show the import and export structure ofmanufacturing and machinery and transport equipment from the UN Comtradedouble-digit sector data.10) In the manufacturing sector, Korea’s major export sectorswere metal manufactures (32.51%), iron and steel (25.77%), textile yarn, fabrics, andmade-up articles, n.e.s., and related products (21.35%), and major import sectors arenon-metallic mineral manufactures (34.83%), rubber manufactures, n.e.s. (19.78%),leather, leather manufactures, n.e.s., and dressed furskins (19.60%).Telecommunications and sound-recording and reproducing apparatus andequipment (50.30%), road vehicles (20.62%), electronic equipment, apparatus andappliances and electrical parts (16.85%) were the leading Korean exports in themachinery/transport equipment sectors, and power-generating machinery andequipment (23.50%), electronic equipment, apparatus and appliances and electricalparts (20.94%), general industrial machinery and equipment, n.e.s., and machineparts, n.e.s. (18.53%) were the leading Korean imports.


10) Due to space limit, it is difficult to show all of the double-digit item data. For convenience, this section provides

tables only for the manufacturing and machinery and transport equipment sectors that account for substantial

portions of the trade between Korea and Hungary.

Table 2-8 Continue

Note: The data in this table is based on UN COMTRADE provided by WITS in World Bank, and this is relevant to Revision 4 (1-digit) ofSITC.

Source: UN Comtrade Trade Data (http://wits.worldbank.org), [Accessed 11 March 2014].

(Unit: USD thousands (%))

2001 2002


ImportExport-Import

Chemicals and related products,n.e.s.

114,580(7.76)

7,128(1.51)

107,452106,544(9.20)

8,960(1.89)

97,584

Manufactured goods classifiedchiefly by material

66,357(4.50)

8,780(1.86)

57,57765,429(5.65)

29,521(6.22)

35,908

Machinery and transportequipment

1,156,528(78.37)

317,959(67.51)

838,569759,530(65.62)

245,981(51.80)

513,549

Miscellaneous manufacturedarticles

133,165(9.02)

7,945(10.18)

85,220223,926(19.35)

53,476(11.26)

170,450

Commodities and transactions notclassified elsewhere in the SITC

285(0.02)

17(0.00)

268124

(0.01)124

Total 1,475,562 471,009 1,004,553 1,157,487 474,902 682,585

Export



Table 2-9 Trend in Korea’s Trade with Hungary in Manufacturing (SITC 2-digit)

Note1: Numbers in parentheses are the ratio of each sector to total exports and total imports (%).Note2: Data in this table is based on UN COMTRADE provided by WITS in World Bank, and this is relevant to Revision 4(2-digit) of SITC.

Top 3 sub-sectors in the table are among the manufactures and machinery/transport equipment sectors as of 2012.Source: UN Comtrade Trade Data (http://wits.worldbank.org), [Accessed 11 March 2014].Source: UN Comtrade Trade Data (http://wits.worldbank.org), [Accessed 11 March 2014].


Top 3 sub-sectors2010 2010 2011 2012

Exports

14,048(22.72)

17,911(26.99)

21,269(32.51)

31,545(51.02)

27,810(41.91)

16,862(25.77)

3,237(5.23)

5,623(8.47)

13,969(21.35)

Imports3,672(35.93)

3,060(34.85)

5,840(19.78)

14(0.14)

37(0.42)

5,786(19.60)

Table 2- 10 Trend in Korea’s Trade with Hungary in Machinery and Transport Equipment (SITC 2-digit)


Top 3 sub-sectors in the table are among the manufactures and machinery/transport equipment sectors as of 2012.Source: UN Comtrade Trade Data (http://wits.worldbank.org), [Accessed 11 March 2014].


Top 3 sub-sectors 2010 2011 2012

Exports

1,088,744(61.97)

587,526(50.80)

382,058(50.30)

Road vehicles170,522(9.71)

211,203(18.26)

156,624(20.62)

Electronic equipment, apparatus andappliances and electrical parts

326,985(18.61)

223,204(19.30)

127,954(16.85)

ImportsElectronic equipment, apparatus andappliances and electrical parts

46,856(18.51)

53,326(16.77)

51,518(20.94)

General industrial machinery andequipment, n.e.s., and machine parts, n.e.s.

24,665(9.74)

43,217(13.59)

45,591(18.53)

Metal manufactures

Iron and steel

Textile yarn, fabrics, and made-up articles,n.e.s., and related products

Leather, leather manufactures, n.e.s., anddressed furskins

Telecommunications and sound-recordingand reproducing apparatus and equipment

60,372(23.84)

90,758(28.54)

57,803(23.50)

Power-generating machinery andequipment

1,700(16.63)

1,660(18.90)

10,283(34.83)

Non-metallic mineral manufactures

Rubber manufactures, n.e.s.


<2-11> shows the trend in Hungary’s trade with the world. Hungary experienced atrade surplus of USD 8.74 billion in 2012, and the machinery and transport equipmentaccounted for the largest shares in exports (51.58%) and imports (41.54%).Manufactured goods classified chiefly by materials accounted for the second largestshares in exports (10.35%) and imports (12.79%). The machinery and transportequipment sector experienced the largest trade surplus (USD 13.9 billion), and themineral fuels, lubricants and related materials sector experienced the largest tradedeficit (USD 7.9 billion).


Table 2-11 Trend in Hungary’ Foreign Trade (SITC 1-digit)(Unit: USD million (%))

2001 2002


ImportExport-Import

Food and live animal7,299 (6.56)

4,212(4.16)

3,087 3,875 (4.11)

3,519

Beverages and tobacco401

(0.36) 486

(0.48) -85 420

(0.45)-65

Crude materials, inedible, exceptfuels

2,632 (2.37)

2,079 (2.05)

553 2,663(2.59)

1,847(1.96)

816

Mineral fuels, lubricants and relatedmaterials

3,878(3.49)

12,459 (12.29)

-8,581 4,053 (3.93)

11,955 (12.68)

-7,902

Animal and vegetable oils, fats andwaxes

506 (0.45)

293(0.29)

213 531(0.52)

208(0.22)

323

Chemicals and related products,n.e.s.

10,559 (9.49)

10,925 (10.78)

-366 10,500(10.19)

10,258 (10.88)

242

Manufactured goods classifiedchiefly by material

11,035 (9.92)

13,319 (13.14)

-2,284 10,665(10.35)

12,057 (12.79)

-1,392

Machinery and transportequipment

61,224 (55.05)

44,223(43.63)

17,001 53,134(51.58)

39,162 (41.54)

13,972

Miscellaneous manufacturedarticles

9,024 (8.11)

6,175 (6.09)

2,849 8,739(8.48)

5,567 (5.91)

3,172

Commodities and transactions notclassified elsewhere in the SITC

4,659 (4.19)

7,200 (7.10)

-2,541 4,972 (4.83)

8,918 (9.46)

-3,946

Total 111,217 101,370 9,847 103,006 94,266 8,740

Note: Data in this table is based on UN COMTRADE provided by WITS in World Bank, and this is relevant to Revision 4 (1-digit) of SITC.Source: UN Comtrade Trade Data (http://wits.worldbank.org), [Accessed 25July 2014].

Export

355(0.34)

7,394(7.18)



Table 2- 12


Sub-sectors in the table are among the manufactures and machinery/transport equipment sectors.Source: UN Comtrade Trade Data (http://wits.worldbank.org), [Accessed 25July 2014].

(Unit: USD million (%))

Sector

Sub-sectorExport Import Export-

Import(2012)2010 2011 2012 2010 2011 2012

Manufacturing

Leather, leather manufactures,n.e.s., and dressed furskins

232(2.18)

364(2.74)

330(2.74)

Rubber manufactures, n.e.s. 1,452 (16.45)

2,082 (18.87)

2,191(20.54)

872(8.04)

1,189 (8.93)

1,127(9.35)

1,064

Cork and wood manufactures428

(4.85) 442

(4.01)391

(3.66)284

(2.62) 298

(2.24) 262

(2.17) 129

Paper, paperboard and articles of paperpulp, of paper or of paperboard

1,115(12.63)

1,298 (11.76)

1,331(12.48)

1,278 (11.78)

1,424 (10.69)

1,275(10.57)

56

Textile yarn, fabrics, made-up articles,n.e.s., and related products

710 (8.04)

838 (7.59)

733(6.87)

988(9.11)

1,186 (8.91)

1,056 (8.76)

-323

Non-metallic mineralmanufactures, n.e.s.

1,197(13.56)

1,416(12.83)

1,331(12.48)

934(8.61)

1,032(7.74)

888(7.36)

43

Iron and steel1,031(11.68)

1,435(13.00)

1,404(13.16)

1,870(17.23)

2,518 (18.90)

2,343 (19.43)

-939

Non-ferrous metals890

(10.09)1,099 (9.96)

887(8.32)

1,939(17.87)

2,436(18.29)

2,047(16.98)

-1,160

Metal manufactures1,837(20.81)

2,228(21.19)

2,164(20.34)

2,391(22.04)

2,872(21.57)

2,729(22.64)

-565

Total8,827(100.0)

11,035(100.0)

10,665 (100.0)

10,849 (100.0)

13,319(100.0)

12,057 (100.0)

-1,392

Machinery

andtransportequipm

ent

Machinery specialized forparticular industries

1,253(2.30)

1,580(2.58)

1,446(2.72)

1,218 (3.03)

1,543(3.49)

1,495 (3.82)

-49

Metalworking machinery88

(0.16) 136

(0.22)126

(0.24)317

(0.79) 390

(0.88) 519

(1.33) -393

General industrial machineryand equipment, n.e.s., and

machine parts, n.e.s.

3,784(6.95)

4,865 (7.95)

4,585 (8.63)

4,344(10.81)

5,313 (12.02)

4,807(12.27)

-222

Office machines and automaticdata-processing machines

3,499(6.42)

3,958(6.46)

3,980(7.49)

2,514(6.26)

2,836(6.41)

2,773(7.08)

1,207

Telecommunications and sound-recording and reproducingapparatus and equipment

19,485(35.77)

18,483(30.19)

12,485(23.50)

11,010(27.40)

10,229(23.13)

9,075(23.17)

3,410

Electronic equipment, apparatusand appliances and electrical parts

10,092 (18.53)

12,391(20.24)

11,315(21.29)

12,446(30.98)

12,958(29.30)

10,502(26.82)

813

Road vehicles8,472(15.55)

10,132(16.55)

9,901(18.63)

4,787(11.92)

6,228(14.08)

5,684(14.51)

4,217

Other transport equipment374

(0.69)448

(0.73)345

(0.65)160(040)

282(0.64)

244(0.62)

101

Total54,465 (100.0)

61,224(100.0)

53,134 (100.0)

40,174(100.0)

44,223(100.0)

39,162 (100.0)

13,972

197(1.78)

167(1.90)

292(2.69)

-98

8,951(16.85)

3,378(8.41)

4,444 (10.05)

7,418(13.62)

9,231(15.08)

Power-generating machineryand equipment

4,8894,062(10.37)


<Table 2-12> shows the import and export structure of the manufacturing,machinery and transport equipment sectors, which consist of the leading tradeditems of Hungary, in the trade structure using SITC 1-digit.11) In the manufacturingsector, the major export items were rubber manufactures (20.54%) and metalmanufactures (20.81%), and the major import items were metal manufactures(22.64%), iron and steel (19.43%) and non-metallic mineral manufactures (16.98%).In the machinery and transport equipment sector, the major export items weretelecommunications and sound-recording and reproducing (23.50%), electronicequipment, apparatus, appliances and electrical parts (21.29%), and road vehicles(18.63%). The major import items were electronic equipment, apparatus, appliancesand electrical parts (26.82%), telecommunications and sound-recording andreproducing (23.17%), and road vehicles (14.51%). In the machinery and transportequipment sector, most of the subsectors experienced trade surpluses, and inparticular, the power-generating machinery and equipment (USD 4.8 billion) androad vehicles (USD 4.2 billion) subsectors experienced substantial trade surpluses.

4.2.2. Hungarian Industrial Structure

In the Hungarian industrial structure based on the value-added size, community,social and personal services (21.38%) account for the largest shares of the totalindustry value-added (see <Table 2-13>).Manufacturing (20.13%) and wholesale andretail trade; transportation and storage; accommodation and food service activities


Table 2- 13 Industrial Structure in Hungary(Unit: Scale (%))

Industry 2000 2003 2006 2009

Agriculture, forestry and fishing 5.86 4.58 4.17 3.45

Agriculture, hunting and forestry 5.85 4.57 4.15 3.43

Fishing and aquaculture 0.02 0.01 0.01 0.01

Mining and quarrying 0.26 0.23 0.24 0.26

Mining and quarrying of energy producing materials 0.10 0.07 0.07 0.14

Mining and quarrying except energy producing materials 0.16 0.16 0.16 0.12

Manufacturing 22.90 21.57 22.77 20.13

Food products, beverages and tobacco 3.31 3.16 2.53 2.58

Textiles, apparel, leather and related products 1.64 1.06 0.73 0.53

Wood and paper products, and printing 1.35 1.26 1.03 0.92

11) Due to space limit, it is difficult to show all of the double-digit item data. For convenience, this section provides

tables only for the manufacturing and machinery and transport equipment sectors that account for substantial

portions of the trade between Hungary and the world.



Table 2-13 Continue

(Unit: Scale (%))

Accommodation and food service activities 1.92 1.89 1.69 1.79

Information and communication 4.79 5.01 5.01 5.80

Publishing, audiovisual and broadcasting activities 0.74 1.03 1.14 1.59

Telecommunications 2.97 2.82 2.56 2.40

IT and other information services 1.09 1.15 1.31 1.81

FFiinnaanncciiaall aanndd iinnssuurraannccee aaccttiivviittiieess 3.67 4.10 4.82 4.83

Financial service activities, except insurance andpension funding

2.60 3.02 3.48 3.36

Insurance, reinsurance and pension funding, except compulsory social security

0.62 0.61 0.71 0.77

Activities auxiliary to financial service andinsurance activities

0.45 0.47 0.63 0.70

Real estate, renting and business activities 15.56 15.75 15.92 17.47

Real estate activities 8.87 8.21 7.95 9.03

Industry 2000 2003 2006 2009

Chemical, rubber, plastics, fuel products and other non-metallic mineral products

5.53 5.28 6.19 5.12

Basic metals and fabricated metal products, except machinery and equipment

2.29 1.98 2.21 1.62

Machinery and equipment 4.68 5.07 5.66 5.34

Transport equipment 3.14 2.82 3.51 2.92

Furniture; other manufacturing; repair and installation of machinery and equipment

0.96 0.95 0.92 1.10

Electricity, gas and water supply; sewerage, waste management and remediation activities

4.00 3.36 3.10 4.25

Electricity, gas, steam and air conditioning supply 2.99 2.38 2.00 3.05

Water supply; sewerage, waste management and remediation activities

1.01 0.98 1.10 1.20

Construction 5.33 5.47 5.12 4.87

Wholesale and retail trade; transportation and storage; accommodation and food service activities

16.69 17.17 17.83 17.57

Wholesale and retail trade, repair of motor ehicles and motorcycles

8.91 10.02 10.56 10.63

Transportation and storage 5.86 5.27 5.57 5.75


(17.57%) were the second and the third largest, respectively. Then, the table presentsthe following industries in descending order of their share of the total industry value-added: real estate, renting and business activities (17.47%), information andcommunication (5.80%), construction (4.87%), financial and insurance activities(4.83%), electricity, gas and water supply; sewerage, waste management andremediation activities (4.25%), agriculture, forestry and fishing (3.45%), and miningand quarrying (0.26%).

4.3. Korean and Hungarian FDI Policies

4.3.1. Korean FDI Policies

Korea successfully induced FDI inflows through policies based on the unbalanceddevelopment strategies such as the construction of free trade zones and industrialcomplexes, which induce concentrated investments in targeted regions. However, thepolitical effort for improving the business environment is somewhat inadequate. It isnecessary to improve labor-management relations, tax systems, domestic marketdemands, and administrative procedures. In addition, Korea should promote capitalinflows and outflows instead of concentrating only on the policies for FDI inflows. Atthe same time, it needs to implement FDI policies, which are suitable for the currentstage of its economic growth.

Moreover, Korea established the FEZs and achieved the successful attraction of FDIinflows into the FEZs with the strong political will of the government to promote thepolicies, high-quality human resources, airport and port facilities in the FEZs, and


Table 2-13 Continue(Unit: Scale (%))

Industry 2000 2003 2006 2009

Professional, scientific and technical activities; administrative and support service activities

6.69 7.55 7.97 8.44

Community, social and personal services 20.96 22.74 21.03 21.38

Public administration and defence; compulsory social security; education; human health and social work activities

17.79 19.70 18.17 18.44

Arts, entertainment, repair of household goods and other services

3.17 3.04 2.85 2.93

Total 100.00 100.00 100.00 100.00

Note: OECD STAN Databases provide the size of each industry’s value added for each country until 2009. Based on current values, weconverted each industrial value-added size of Hungary into the share in this table.

Source: OECD Statistics (stats.oecd.org), Structural Analysis(STAN) Databases (ISICRev.3), [Accessed 19 March 2014].


various incentives (tax reduction, cash support, and settlement with education,medical facilities, and housing). However, the Korean FDI policies must resolve anumber of issues. For instance, the functions of the FEZs overlap, and there exists agap between FDIand FEZ incentives. Also, the local governments operate the FEZs,and domestic businesses are discriminated against- for example, domestic firmsmoving into the Incheon FEZ are imposed three times the acquisition tax and fivetimes the corporate tax because of the factory location limit in the SeoulMetropolitan Area. Moreover, the goals and incentives of the FEZs are similar tothose in other countries, resulting in the lack of differentiation. When providingHungary with policy suggestions for FDI promotion, Korea must present the policydirections for resolving the above-mentioned issues in addition to sharing itssuccessful experience.

4.3.2. Hungarian FDI Policies

4.3.2.1. Economic Policies of Hungary and Main Features of FDI Policies

In the past, Hungary found itself in a special political and economic circumstancesas a new EU member and prioritized catching up with the other EU members. In thiscontext, the policies for competition were put aside at first, but their priorityincreased gradually. After joining the EU in 2004, Hungary was confronted by a bigchange in its policy environment. Hungary’s policies for competition and investmentincentives were changed according to the rules of EU.

It was necessary for Hungary as a member of EU to change its incentive systemsaccording to the policy direction of the EU. Hence the FDI policies of Hungary havebeen restricted in incentive competition by the EU rules, which put an upper limit onaid intensity. Also, they have been limited in the potential for active industry policies.On the contrary, the policies for improvement of the business environment such astax reduction, infrastructure development, and establishment of industrial complexeshave been allowed. Due to the change in incentive system, finance-related incentivesare emphasized, and companies are able to receive financial support through the co-financed operative program of the EU (Antalóczy et al., 2003, pp.188-190).

The Ministry for National Economy and the Hungarian Investment and TradeAgency (HITA) attract investment towards each sector through the cash supportpackage for foreign investment enterprises as of the time of elaborating the currentstudy. Subject to a Government Decree, if the related criteria for employmentgeneration by sector, investment location and investment amount are met, theGovernment approves on a case-by-case basis individual cash support for thebusiness. The EU set up the maximum regional subsidy intensity ratios of 10% of thecosts of the investment in the industrialized regions and 50% in the less developed



regions, and the different forms of cash support are limited by this framework (HITA,2013, p.1). This reflects EU policy for leveling development in different regions.

The FDI policies of Hungary have their limitations of policy enforcement in thatthey are restricted in aid intensity and potential for active industrial policies.Moreover, in the aspect of content, large projects for job creation have beenpreferred to the investment in the export-oriented service sector, and financialincentives have been limited to education, training, and job creation (Antalóczy et al.,2003, pp.188-190). Also development tax release of 80% is applicable, but within thelimits of aid intensity.

4.3.2.2. Strategic Cooperation with Foreign-Invested Enterprises12)

Since 2012, Hungary has enhanced the link between foreign-invested enterprisesand the Hungarian economy and boosted economic growth as well as nationalcompetitiveness by signing the Strategic Cooperation Agreements (SCAs) withforeign-invested enterprises in Hungary. The candidates for the strategic cooperationare foreign-invested enterprises in the manufacturing and service sectors, which hadoperated in Hungary for more than 5 years, employed over 1,000 people, andinvested more than HUF 5 billion (roughly EUR 16 million). The Hungariangovernment signs Memorandum of Understanding (MOU) with strategic partnerenterprises, and due to the EU competition regulations, the MOU is notdiscriminatory to third parties, no legal commitments are taken by the signingparties.

Nevertheless, when foreign-invested enterprises perform economic activities invarious regions in Hungary, the government supports the enterprises to form closeand strong ties with domestic material suppliers within the framework of thecompetition policies of Hungary and the EU. As part of such effort, the governmentseeks to implement 30 supply chain development programs between 2014 and 2020to contribute to the globalization of its SMEs.

The purpose of the SCAs is to promote inbound investment, and they aim toencourage foreign-invested enterprises to reinvest their earnings, increase theproduction of manufactured goods and services, and create new jobs. To that end,RDI (research and development, innovation) and vocational training cooperationwere designated as important cooperation areas.

Between 2013 and mid 2014, a total of 44 strategic agreements were signed,through which foreign-invested enterprises unveiled their plans to invest HUF 650


12) Please refer to Appendix 2 for more details. The information about the strategic cooperation with foreign-invested

enterprises is a summary of the document written by Szilágyi András of the Ministry for National Economy in Hungary.


billion (roughly EUR 2 billion) and create 5,500 new jobs. Among the 44 strategicpartners, 23 firms were based in the EU, and the other 21 were non-EU firms. Bycountry, the number of agreements the U.S. entered into was the greatest with 10,followed by Germany with 7. By industry, automotive, electronic, and pharmaceuticalfirms accounted for most agreements.

4.3.2.3. Investment Environment of Hungary: Pros and Cons

One of Hungary’s advantages is that Hungary became an attractive place forinvestment due to business regulatory reforms prior to the financial crisis. Throughthe reforms, property registration, construction permit process, and starting abusiness have become easier, and recently, the Magyary and Simple State programreduced the complicated regulatory processes.

Secondly, infrastructure of Hungary is the second best in the EU region, andbroadband penetration is evaluated to be higher than the regional average. Inparticular, the road quality in Hungary is in the best condition in the EU region(European Commission, 2014, p.46). Furthermore, the number of per-capita fixedbroadband internet subscriptions has grown more than three times within the last 6years, demonstrating the high quality of Hungary’s infrastructure. From [Table 2-14],the ranking in technological readiness for 2012-2013 was 49 out of 144 countries(World Economic Forum, 2013, pp.194-195).

Thirdly, the amendment of the labor law in 2011 resulted in higher flexibility inthe labor market and made hiring and firing easier. The flexibility of Hungary’s labormarket is evaluated to be high within the EU. Nevertheless, cooperation betweenworkers and employers decreased, and the flexibility in wage determinationdeclined. As a result, flexibility in terms of labor itself has deteriorated (EuropeanCommission, 2014, pp.45-47).

As weaknesses of Hungary in terms of its business environment, first, there existsvulnerability in the financial intermediation function. Public managementorganizations in charge of borrowers do not exist in Hungary. Moreover, venturecapital availability, financing through the stock market, and financial services andloans have been limited.

Secondly, according to European Commission (2014), policies of Hungary areunpredictable, and the level of investor protection is low. From the survey for thebusiness executive, policy stability among the barrier to business activities are rankedas 2nd. Hungary’s 13 tax systems provide a low level of incentives for investmentattraction. In particular, there have not been reforms in terms of investor-protection,and Hungary does not require transactions to be disclosed. As [Table 2-16] indicates,



the degree of protecting investors was 128th out of 189 countries.

Thirdly, there exist barriers to competition. Based on the OECD Product MarketRegulation (PMR) indicators, the barriers to the services sector in Hungary haveincreased rapidly in the last 10 years, and the legal barriers to entry have become thehighest in the EU. And European Commission (2014) indicates that the policies inHungary such as Plaza Stop Law, regulations in the district heating, wastemanagement, meal vouchers, tobacco retail and pharmaceutical retail sectors lead todecrease the economic actors in the market. The government has regulated pricesand price cuts regarding electricity, gas, and water under the government’s decisionin 2013. As a result, investment in those sectors has rapidly declined. In addition,complicated tax system and low business sophistication and innovation are alsopointed out (European Commission, 2014, pp.47-51). If the trend continues, the


Table 2-14 Hungary’s Global Competitiveness Index (GCI)

Indicator Rank(2012-2013) Rank(2011-2012)

GCI 60 48

Institutions 80 73

Infrastructure 50 46

Macroeconomic environment 44 67

Higher education and training 49 45

Goods market efficiency 67 55

Labor market efficiency 79 66

Cooperation in labor-employer relations 99 82

Flexibility of wage determination 72 41

Hiring and firing practices 50 50

Financial market development 72 63

Affordability of financial services 98 91

Financing through local equity market 114 110

Ease of access to loans 114 93

Venture capital availability 115 117

Technological readiness 49 36

Market size 52 52

Business sophistication 89 69

Innovation 37 34

Source: World Economic Forum (2013), “The Global Competitiveness Report 2012-2013,”pp.194-195.World Economic Forum (2012), “The Global Competitiveness Report 2011-2012,”pp.200-201.


European Commission (2014) indicates that it might weaken network infrastructurewith negative spill-over effects on all other sectors. These policies increase companyrunning costs and distort resource allocation across sectors.

4.4. Comparison of FDI Policies in Korea and 8 East Asian Countries

4.4.1. FDI Policies in 8 East Asian Countries13)

4.4.1.1. Indonesia

After allowing foreign investment in the mid-1980s, Indonesia implementedinvestment liberalization by allowing foreign equity participation up to 100% in1994. After the Asian financial crisis in 1997, FDI inflows into Indonesia have headedmostly for the service industry. This was mainly because the FDI for labor-intensiveindustries has increased in China, India and Vietnam whose labor costs are low, andrelatively, the FDI for service industries has increased in Indonesia. Moreover,investment incentives for the manufacturing sector have decreased due to domesticfactors such as the bureaucracy of Indonesia, high level of uncertainty, vulnerablesystem, corruption, anti-business labor regulations, and poor infrastructure.Relatively, FDI towards the service industry has increased.

4.4.1.2. Malaysia

As the first financial crisis occurred in the early 1980s, Malaysia changed itsstrategy from the government-led economic development strategy to the strategyled by the private sector. In this regard, the second manufacturing export promotionpolicy was implemented, and during this period, the regulations on equity restrictionrelated to FDI attraction in manufacturing were relaxed. Especially in 2009, Malaysiaannounced a vision to become a globally competitive Islamic financial hub by furtherrelaxing the regulations on financial services.

4.4.1.3. The Philippines

In 1987, the Philippines enacted the general investment law to promote foreigninvestment, integrating the previous regulations on investment strengthening therole of the Investment Committee. In 1991, the Philippines enacted the OverseasInvestment Law to relax regulations and adopted the flexible and open FDI policy,which allowed foreign equity participation up to 100% in sectors not prohibited toforeign investment. Despite various liberalization policies for the expansion of FDI


13) The contents on FDI policies of each country referred to Chapter 2 ~ Chapter 10 in Sussangkarn et al. (2011).


inflow attraction, the level of FDI inflows was not as high as expected, and theperformance of the economic policies of the Philippines has lagged behind that of itsneighboring countries in East and Southeast Asia. The reason for this can beexplained by the vulnerability of its infrastructure such as corruption, macroeconomicinstability, weak electricity supply, security, and regulatory uncertainty.

4.4.1.4. Singapore

Singapore is known to have a higher level of FDI in the service sector than that inthe manufacturing sector, and Singapore started to actively promote FDI attractiontowards the service industry with the 1991 Strategic Economic Plan. The plan includesthe strategies in trade, transport, logistics, telecommunications and financial servicesthat Singapore needs to develop into a regional service hub. In the 2000s, the lifesciences sector, which is a high value-added industry, has become designated as amain target for FDI promotion. In order to overcome its weaknesses as a nation witha small domestic market, Singapore has been supporting the R&D centers ofmultinational companies and has been providing various tax benefits in the medicaland life sciences sector, inducing the development of life sciences products globally.To sum up the successful FDI attraction factors of Singapore, there are relaxation ofregulations related to market access and foreign ownership, adequate infrastructureand human resources, investment preferential policies, consistency of policies, andpredictable political, social and economic environment.

4.4.1.5. Thailand

Thailand actively implemented export-oriented policies in the 1980s. During thisperiod, the low-cost labor and abundant natural resources in Thailand attractedforeign investment, and FDI inflows were concentrated especially on themanufacturing sector. In the World Bank survey, “Ease of Doing Business,” Thailandwas ranked 18th in 2007, and its rank climbed to 13th in 2009. The ease of tradingacross borders, property registration, and high level of investor protection seem tohave contributed to the increase in Thailand’s rank in the survey. However, the easeof starting up a business, paying taxes, and getting credit should be improved.

4.4.1.6. China

After joining the WTO in 2001, China has experienced a substantial increase in FDIinflows. It revised the economic regulations according to the requirements of theWTO and removed the factors that could prevent foreigners from investing in a formof a private enterprise, an incorporated partnership, or a joint-stock company.Currently, China has implemented more active policies that give national treatmentto foreign-invested enterprises and improve the ease of trade in addition to



providing incentives in forms of tax preferential policies. Also, China establishedspecial economic zones and designated development zones providing preferentialpolicies to the enterprises that invest in the high-technology sector in those areas.Before 2002, 70% of total FDI inflows was for the manufacturing sector, but recentlythe proportion of FDI in the service sector exceeded the proportion in themanufacturing sector.

4.4.1.7. Japan

After Japan joined the OECD in 1964, the existing Foreign Capital Control Law wasabolished, foreign capital was liberalized. Since the 1980s, the regulation on FDIinflows has been relaxed; furthermore, the policy direction has been changed toactively attract FDI since the mid-1990s. As a result of the policy discussion for FDIpromotion, the Japanese government established the Japan Investment Council (JIC)whose chairman was the prime minister. In order to overcome the long-termrecession, the Japanese government simplified investment procedures to expand FDIpromotion, relaxed regulations on investment and improved the environment forattraction of FDI based on M&A.

4.4.1.8. Vietnam

FDI inflows into Vietnam took place for the first time in December 1987, and later,laws were revised several times as part of an effort to create a friendly environmentfor foreign investors. FDI inflows to Vietnam slightly decreased between 1998 and2000 due to the Asian financial crisis in 1997, but later, the FDI inflows to Vietnamincreased again. The level of FDI inflows reached its peak in 2008. FDI mainly flowedinto manufacturing, hotel, tourism, real estate, and office and apartmentdevelopment. FDI towards manufacturing was able to be expanded not only by thelow labor costs in Vietnam but also by tax reduction, industrial zones (IZs), and exportprocessing zones (EPZs). Also, recently, as Vietnam increases the level of liberalizationin the service sector according to the suggestion of the WTO, FDI has increasinglyflowed into the service and high-tech sectors.

4.4.2. Comparison of FDI Policies in Korea and 8 East Asian Countries

Korea has implemented various policies domestically in order to expandinvestment attraction from foreign countries. Korea has granted incentives such astax reduction, cash support, and location support, and it has also put in a great dealof political effort such as relaxing various regulations on investment and simplifyingadministrative procedures. However, the comparison of Korea’s FDI policy directionto those of Indonesia, Malaysia, Singapore, the Philippines, Thailand, China, Japan



and Vietnam shows that Korea’s preferential policies for investment are limited interms of the scope of the industries receiving tax benefits(see <Table 2-15>).

5. Conclusion and Policy Suggestions

This chapter outlines the review of Korea’s FDI policies and a comparative studybetween Korea and Hungary. Based on these, the paper proposes the following sixmajor policy suggestions: 1) Address the need to implement an unbalanceddevelopment strategy, 2) Establish a control tower and an organization dedicated toFDI, 3) Implement policies to promote agglomeration, 4) Create chain effects byfostering the parts and material industry, 5) Pursue long-term effects of privatization,and 6) Conduct a comparative study on business conditions.

First, Hungary needs a strategy for unbalanced development. In contrast to whatmajor economies like Korea did, Hungary has pursued balanced growth.Conventional unbalanced development strategy policies include the establishment ofvarious industrial complexes, free trade zones and FEZs. In the case of Korea, FEZswere set up not only as part of a strategy for unbalanced development, but also as away to strike a balance in regional development. Indeed, it may be tough for theHungarian government to use its political will for unbalanced development based on


Table 2- 15 Comparison of Investment Incentive of Major Asian Countries

Country

Rank Starting a

Business

Dealingwith

Construction

Permits

GettingElectricity

RegisteringProperty

GettingCredit

ProtectingInvestors

PayingTaxes

TradingAcrossBorders2014 2013

Korea 6 7 34 18 75 13 52 25 3

China 96 99 158 185 48 73 98 120 74

Japan 27 23 120 91 56 28 16 140 23

Cambodia 137 135 184 161 118 42 80 65 23

Indonesia 120 116 175 88 101 6 52 137 54

Malaysia 6 8 16 43 35 1 4 36 5

Philippines 108 133 170 99 121 86 128 131 42

Singapore 1 1 3 3 28 3 2 5 1

Thailand 18 18 91 14 29 73 12 70 24

Vietnam 99 98 109 29 51 42 157 149 65

Source: World Bank (2014), Doing Business report of each country.

26

2

119

134

121

21

33

6

12

156


the EU’s policy directions. Nevertheless, it is necessary to share the benefits ofunbalanced development strategies and implement policies that maximize thesebenefits within the framework of the EU policies.

Second, it is necessary to establish a control tower and an organization dedicatedto FDI. In order for well-intentioned policies to be implemented effectively, anefficient decision-making system must be established. In Korea, FEZ authorities, localgovernments, and the central government form a triangle in the decision-makingsystem for FEZ policies, making effective and prompt decision making difficult.Hungary also needs to organize a control tower that coordinates opinions of thecentral and local governments and makes decision regarding the establishment ofindustrial complexes. To that end, it is necessary to complement and enhance the PMsystem that is suggested and implemented by many countries including Hungary.

The control tower would be assigned and be given the right to manage relevantpolicies and institutes, increase consistency of policy, and ensure efficiency in decision-making processes while the government plans strategies and assists authorities incharge to attract FDI in both public and private sectors.

Currently, in Korea, the Ministry of Trade, Industry and Energy that plays a pivotalrole in handling economic affairs takes charge of issues related to FDI. Under theleadership of the Ministry, agencies including KOTRA and Invest Korea promote FDI.In Hungary, the Ministry for National Economy and HITA play an essential role inimplementing Hungary’s FDI policies. The Ministry for National Economy is a centraladministrative entity that governs the overall economy in Hungary, and HITA is anindependent agency that governs the promotion of investment inflows towardHungary and overseas trade of SMEs. Based on Korea’s example, Hungary needs toclearly define the roles of the government agencies that serve as a control tower andthe institutions that implement policies and govern on-site businesses.

Third, implementing policies that promote agglomeration are necessary. Koreaestablished special zones and industrial complex to promote and expand domesticinvestment, and assist and nurture SMEs and the parts and materials industry. Thegoal of FEZs, Free Trade Areas (FTAs), and Foreign Investment Zones (FIZs) was to lureFDI.

Currently, industrial complexes are located throughout the nation. To enhancethe cumulative effect of industrial zones to the greatest extent, however, relevantpolicies need to be altered so as to focus investment on certain areas. In addition toexecuting policies that boost agglomeration, cutting infrastructure andtransportation costs will contribute to the maximization of chain effect amongindustries and companies.



Fourth, the country is in great need of maximizing backward and forward linkageeffects by nurturing the parts and materials industry. The growth in the industry willenable Hungary to turn its trade deficit into surplus and localize the production ofgoods. However, as a member state of the EU, the country is banned from providingstate subsidies in certain sectors or introducing policies that address the needs ofcertain fields. Against this backdrop, it may be wise to consider introducing anindustrial complex or a center dedicated to the production of parts and materials. Acase in point is Korea’s OASIS center that seeks to boost investment and cooperationin the industry.

Moreover, FDI-related policies should be aligned with industrial policies. In theprocess of its economic development, Korea has actively fulfilled industrial policyobjectives. Under a comprehensive economic growth strategy, Hungarian statepolicies should attract FDI, create FEZs, and develop the parts and materials industrysimultaneously (see [Figure 2-2]).

It is necessary for Hungary to introduce policies to draw foreign investment inSMEs and the parts and materials industry. In order to achieve this, the followingmust be done: First, the government should install agencies to support SMEs such asthe Small and Medium Business Administration and the Small and Medium BusinessCorporation. Second, an investment-friendly climate should be provided bymaintaining consistency of policy, easing tax burden, and strengthening financialintermediation services. Third, to assist SMEs to better integrate into Global ValueChains, corporate innovation should be facilitated through the expansion of R&Dinvestment.


Figure 2-2 Linkage Effects Structure

Source: Created by the author.


Fourth, the country needs to pursue long-term effects of privatization of SOEs.Instead of attaining short-term goals including accelerating capital inflows, Koreaconcentrated on improving management efficiency in the public sector in the longrun. Most policies on privatization were associated with FDI. As a result, privatizedSOEs have enjoyed enhanced profitability and productivity. Though permitted totake part in the privatization process, foreign investors were prohibited from owningmore than 50% of shares in key industries.

Hungary’s situation differs from that of Korea in that it has been trying toprivatize SOEs by selling stocks to foreign investors, not domestic investors. Therefore,based on Korea’s case, this paper suggests Hungary to establish policies that help thepublic sector privatization contribute to SOE reforms and trade deficit reduction orstrategies that link the public sector privatization with FDI.

Last but not least, a comparative study on business environment should be carriedout. The World Bank’s Doing Business Report (DBR) presents evidence that companiesfind it relatively hard to make investments and carry out their business in Hungarycompared to its neighboring countries: the Czech Republic, Slovakia, and Poland(Refer to <Table 2-16>).

In a survey on investment climate, Hungary ranked 54th overall, lagging behindPoland (45th) and Slovakia (49th). In terms of Getting Credit, Hungary came in 66th,


Table 2-16 Comparison of Investment Incentives of the Visegrad Group

Hungary Czech Republic Slovakia Poland

Rank(2014) 54 75 49 5

Rank (2013) 52 78 43 48

Starting a Business 59 146 80 116

Dealing with ConstructionPermits

47 86 53 88

Getting Electricity 112 146 65 137

Registering Property 45 37 11 54

Getting Credit 66 55 42 3

Protecting Investors 128 98 115 52

Paying Taxes 124 122 102 113

Trading Across Borders 70 68 108 49

Source: World Bank(2014). Doing Business report of each country.


far behind Poland (3rd), Slovakia (42nd), and Czech (55th). In the field of ResolvingInsolvency, Hungary took 70th place, greatly below Czech (29th), Poland (37th), andSlovakia (38th). Based on a comparative study between Hungary and the VisegrádGroup - the Czech Republic, Slovakia, Poland, and Hungary - the Hungariangovernment has to create an attractive investment climate and make up forweaknesses to encourage FDI into the country.



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1. Korean Public Enterprise Privatization Policies14)

1.1. Overview of Public Enterprise Privatization Policies

The policies for public enterprise privatization can be viewed as an FDI policy asthey allow foreign capital to participate in the privatization process. In Hungary,there has been an emphasis on budget deficit reduction through reforms in publicenterprises. This section will briefly introduce the process of public enterpriseprivatization in Korea.

Korea had to resort to privatization of public enterprises to deal with inefficiencycaused by their poor management, and foreign capital was allowed to participate inthe privatization process for the short-term capital inflow effect. Since the 1980s,Korea has introduced full-scale public enterprise privatization polices, and it becamenecessary to redefine the role of public enterprises to maintain internal stability ofthe national economy amidst the global trade liberalization and privatization. InDecember 1980, the Plan to Liberalize Commercial Banks was announced while theTemporary Act on Financial Institutions was repealed in 1982. Consequently, five


Appendix 1Korea’s Public Enterprise Privatization andSMEs Policies

■ Chapter 02

14) At Hungary’s request, this paper discusses privatization of State-Owned Enterprises (SOEs) and Small and Medium

Enterprises (SMEs) policy along with FDI policy. Hungary wanted to learn about Korea’s policy on SOEs

privatization in which foreign investment is only partially permitted. This is in stark contrast to Hungary’s policy

which allows unlimited foreign investment from the initial phase of privatization except for the financial sector.


commercial banks were privatized. In accordance with the two key global trends,trade liberalization and privatization, there was a growing need to redefine the roleof public enterprises to manage the economy in a stable manner. Unfortunately, dueto resistance from political and business communities, former governments with thepresidents Roh Tae-Woo and Kim Yeong-Sam failed to fully privatize the publicenterprises.

Since the outbreak of the Asian Financial Crisis in the late 1997, public enterpriseprivatization accelerated, and competition has been actively introduced in the publicsector in Korea. The First Plan for Privatization and Innovation in Management wasimplemented in July 1998. A month later, the Second Plan was executed. Under theseplans, the government set up policies to liberalize 11 public companies excludingthose in the financial sector.

Until 2002, 67 subsidiaries of SOEs were sold off (Research Center for SOEs, 2012,pp. 25-26). Former President Roh Moo-Hyun put a halt to privatization and focusedon enhancing management efficiency without selling SOEs. And former President LeeMyung-Bak reformed public institutions to increase efficiency.

In Korea, the subject of privatization included severely inefficient companies withmonopoly power in the market. Transferring ownership to the private sector byselling shares was the most common form of privatization in Korea. Restrictions onforeign investment in key industries have been gradually lifted. For instance, theTelecommunications Business Act revised in 2001 increased the ceiling on foreignownership from 33% to 49%, but limited foreign investors from becoming majorshareholders.

1.2. Examples of Public Enterprise Privatization

1.2.1. Electricity (KEPCO)

In the late 1980s, inefficient management in the electrical power industry, causedby KEPCO’s long-held monopoly, sparked discussions over the company’sprivatization. The government sold a 21% stake or 127,750 thousand shares tocitizens in August 1989. But the process was not completed because parties involveddid not come to an agreement over how to sell the remaining shares. The processregained momentum in the wake of the Asian Financial Crisis. In 1999, ADRs for thegovernment share of 5% (Amount issued: USD 760 million) were issued abroad. Inthe following year, EBs for the Korea Deposit Insurance Corporation’s 5.1% wereissued (Amount issued: USD1 billion) abroad. The government’s share in KEPCOdecreased from 77.8% in the late 1989 to 32.4% in the late 2001 (ElectricalRegulatory Commission, 2002, p.1).



With the National Assembly’s passage of bills on the restructuring of the powerindustry in December 2000, KEPCO spun off six subsidiaries, which began competingin the electricity generation business in 2001. In the same year, the Korea PowerExchange was established to ensure a reliable supply of power. In 2008, under theThird and Fifth Plan on the Advancement of the Public Sector, the governmentformulated plans to sell some of its shares in KEPCOE&C, KEPCOKPS, Korea ElectricPower Industrial Development Co., and LG Powercom Corp., which are KEPCO’sinvested companies. The government sought to enhance the efficiency ofmanagement of KEPCO by selling its shares, setting up subsidiaries, and introducingcompetition in the generation business in 2003 and the retail business in 2008.

1.2.2. Communications (KT)

Unlike KEPCO, KT sold 28.8% of its shares to domestic individual and institutionalinvestors through competitive bidding in OTC markets between 1993 and 1996 (Parkand Park, 2011, p.214; Choi et al., 2005, p.187). When it was listed on the Korea StockExchange in 1998, the government’s share accounted for 59%. In 1999, DRs wereissued in the New York Stock Exchange (NYSE) through which 6.7% of thegovernment’s share and 7.8% of new stocks were disposed. In 2001, DRs were issuedin NYSE and the London Stock Exchange through which 17.8% of the government’sshare were sold.

Amended in April 2001, the Telecommunications Business Act raised the ceiling onforeign ownership from 33% to 49%, but restricted foreign investors from becomingmajor shareholders (Park and Park, 2011, p. 215). KT was privatized with 11.8% of thegovernment’s shares sold overseas in December 2001 and 28.3% disposed toindividual and institutional investors through competitive bidding in OTC markets in2002 (Choi et al., 2005, p.187).

1.3. Outcome of Public Enterprise Privatization

In the perspective of the national economy, the Korea Institute of Public Finance(KIPF) assessed the outcome of the privatization of the seven public enterprises,which were privatized during former President Kim Daejung’s Administration. Thereport showed that while producer surplus and profit and productivity improved to agreat extent, consumer welfare did not. Also, the KIPF carried out an analysis ofwhether the above seven companies showed significant changes in median values ofperformance indicators before and after privatization. Findings suggest thatprofitability, efficiency, and capital structure did better, while sales growth ratestagnated and employment decreased (KIPF, 2007, pp.112-113).

<Appendix Table 1> summarizes the performance evaluation results of public



enterprise privatization. There has not been specific effect on consumer surplusexcept for a slight decrease in communication fare for KT. Other effects such asproducer surplus, profits, and productivity were shown to be positive throughprivatization. In summary, privatization contributes to improvement on profitability,efficiency, and capital structure while growth rate of sales remains almost the sameand employment decreases.

In the ”Evaluation and future challenges of privatization,” Park and Park (2011)reviewed and examined the outcome of privatization of the above seven companiesby industry. According to the report, the productivity and efficiency of themanufacturing sector had a great potential because the market was highlyconcentrated and suppliers held a great market power. A review on indicatorsdescribed that ”Efficiency” improved more than ”Growth,” a reflection that SOEshave focused on growth rather than profitability or productivity. Through anexamination of the effectiveness of privatization, the report also stated that theprocess increased value-added productivity and efficiency, and influencedprofitability as well (Park and Park, 2011, pp.561-562).

The research team utilized the Korea Investors Service’s KISVALUE and launchedan empirical study on the productivity and profitability of privatization. The teamunveiled that large cap manufacturers showed great improvement in bothproductivity and profitability. Furthermore, the two indicators significantlyprogressed even when some factors such as the type, size, development history,industry, and financial position of companies were controlled. This was particularlytrue for SOEs with the government as a big shareholder (Park and Park, 2011, p.535).

Initially, the privatization of public enterprises aimed to improve the inefficiency


Appendix Table 1 Performance Evaluation of Public Enterprise privatization

Sector POSCO

Doosan Heavy

Industries and

Construction

DOPCO KT KT&G

Government

Designated

Textbook

KTB

Consumer welfare + +

Producer profit and productivity

+ + + + + + +

Effect onintermediate goods

- - - -

Spill-over effectand linkage effect

+ + +

Source: KIPF (2007), “Evaluation of Public Enterprise Privatization,” p.112.


caused by poor management in the public enterprises. Yet, it attracted foreigncapital as well since foreign capital was allowed to participate in the privatizationprocess. As <Appendix Table 2> shows, the financial revenue and foreign exchangeinflows from the sale of KT shares to foreign capital were USD 6.55 billion (includingBW and EB), USD 1.69 billion from POSCO, USD 1.75 billion from KEPCO, and USD1.19 billion from KT&G. In particular, the financial revenue and foreign exchangeinflows from the issue of overseas DR of KEPCO, KT and POSCO were USD 4.25 billionin 1999. Such cases were indirect investment (FPI), rather than direct investment (FDI).The financial revenue and foreign exchange inflows from the sale of publicenterprises to foreign capital were substantial, considering the total foreign directinvestment was USD 11 billion (amount arrived) in 1999.15)

2. Korean SME Policies

In the past, Korea implemented policies oriented toward manufacturing, yetpolicies have actively taken SMEs into account since the 1990s. Between 1993 and1997, the policies sought to enhance self-reliance through autonomy andcompetition, and between 1997 and 2002, they supported venture businesses in theIT sector to start up. Between 2003 and 2007, the policies aimed to promoteinnovative SMEs and boost their competitiveness for transition into the innovation-


Appendix Table 2 Outcome of Sale of Shares to Foreign Capital during Public Enterprise Privatization

DatePublic

EnterpriseOutcome

1998. 12. 11. POSCO 1st Issue of Overseas DR (0.35 USD billion)

1999. 03. 26. KEPCO Issue of Overseas DR(0.75 USD billion)

1999. 05. 26. KT Issue of Overseas DR(2.49 USD billion)

1999. 07. 14. POSCO 2nd Issue of Overseas DR (1.01 USD billion)

2000. 09. 29. POSCO 3rd Issue of Overseas DR (0.33 USD billion)

2000. 10. 11. EPCO Issue of Overseas EB(1 USD billion)

2001. 06. 27. KT Issue of Overseas ADR (2.24 USD billion)

2001. 10. 24. KT&G Issue of Overseas DR and EB (1.19 USD billion)

2002. 01. KTIssue of Overseas BW (0.5 USD billion),Issue of EB (1.32 USD billion)

Source: The Ministry of Strategy and Finance (1999, p.3; 2000, p.2; 2001, p.1), Electricity Regulatory Commission (2002), pp.1-6.

15) The Ministry of Trade, Industry and Energy. Statistics for Foreign Investment

(http://www.motie.go.kr/motie/in/it/investstats/investstats.jsp)[Accessed July 26, 2014], KOTRA (2000), p. 21.


led economy. Between 2008 and 2012, the policies emphasized deregulation andshared growth with major companies. <Appendix Table 3> summarizes the SMEpolicies in detail by period.

SME policies need to consider the domestic supply chain, technologicalinnovation, and the link with major companies. Also, it is necessary to link the partsmaterials policies with the SME policies in order to enhance and develop thedomestic supply chain. SMEs need to produce marketable final goods based ontechnological innovation so that they can secure domestic and internationalcompetitiveness.

In Korea, the Ministry of Trade, Industry and Energy takes the lead in formulatingand implementing SME policies which aims to foster globally competitive specializedcompanies by creating a cooperative ecosystem and enhance the exportcompetitiveness of SMEs (Refer to <Appendix Table 4>). Other detailed policies arecarried out as well to help SMEs find tomorrow’s growth engines, boost vitality of thelocal economy, and expand businesses abroad.


Appendix Table 3 Characteristics of SME Policies by Period

Category

1993~1997

Autonomy and

Competition

Period

1998~2002

Venture

Business

Promotion

Period

2003~2007

Innovation

Promotion

Period

2008~2012

Mutual Growth

Period

Main Objectives

To enhance self-reliance throughautonomy andcompetition

Government supportfor venture

businesses in the ITsector

To transition intoinnovation-led

economy, promoteinnovative SMEs and

boost theircompetitiveness

To promotederegulation and

shared growth withmajor companies

Main Methods Support Support SupportInitial support andlater regulation

Governance

Established the Smalland Medium

BusinessAdministration

Established thePresidential

Commission onSmall and Medium

Enterprise

Small and MediumBusiness

Administration

Small and MediumBusiness

Administration

Achievements

Eased manpowershortage in SMEsdue to influx offoreign workers

Achievements inchanges in industrialstructure despite the

venture bubble

Strove to easemanpower shortage

in SMEs througheconomic

cooperation withNorth Korea

The focus of medium-term policies shiftedfrom manufacturingto small businesses

Source: The Korean Association for Policy Studies (2012), “The 50-Year History of Small and Medium Enterprise Policies and the Futureof Small and Medium Enterprise Policies,” p.81.



On the other hand, Samsung, one of the most successful major companies inKorea, expanded the operation of the support program to help its outstanding first-tier suppliers become global companies in accordance with the government’s will topursue policies for mutual growth of major companies and small and mediumenterprises (SMEs). The program promotes various mutual growth programs such astraining, technological support and support funds for its suppliers. Samsung’s case is arole model for Korea and the national-scale strategies and business programs for SMEcapacity development in Hungary. <Appendix Table 5> summarizes the discussion ofSamsung’s mutual growth program in detail.

Appendix Table 4 SME Policies to Foster Globally Competitive SME

Increase R&D support for SMEs; Limit the supervision by large businesses to certain projects such as high riskprojects- Execute creative ideas through the expansion of R&D contests* Support for customized technical development (in contests): KRW 54 billion (2012) KRW 170 billion (2017)

Nurture technology industry experts that globally competitive specialized companies need; Provide customizedpatent analysis services including the management of intellectual property and the enhancement of companyresponse to IP-related conflicts* Increase the share of personnel expenses in ATC and World Class 300 projects (KRW 114 billion)* Customized patent analysis: KRW 3.5 billion for 110 companies (2012) 5 billion for 150 companies (2013)

Customized support for promising SMEs that seek to expand businesses abroad / - Work with relevantagencies and come up with “Services Package” that sets out customized measures to help SMEs expand theirbusinesses abroad* KOTRA (Education, consulting, exhibition, local experts in IT Plant, and buyers), OKTA (Make use of Korea

traders’ network), Korea Trade Insurance Corporation (Trade insurance), Korea Finance Corporation (Fundsupport), etc.

- Form a global mentor group and share experiences and know-how acquired through expanding overseas;Provide export finance support based on corporate credit scores regardless of export performance in theprevious year

Find SMEs with growth potential through fact-finding surveys; Register them with SME Profile ManagementSystem; Provide them with differentiated service* Support provided to promising SMEs recognized by the Small and Medium Business Administration, the

Advanced Technology Center (ATC), and World Class 300 as well as companies which produce World-Class Korean Products

Source: The Ministry of Trade, Industry and Energy (http://www.motie.go.kr),[Accessed 11 March 2014].



Appendix Table 5 Samsung’s Mutual Growth Program

Implementation

PlanContent

Shared Growthwith Suppliers

- Elevate qualified 2nd and 3rd tier suppliers into 1st tier suppliers- Cultivate global SMEs- Implement fast-track “Temporary Supplier Registration Policy” for SMEs with

innovative ideas or new technologies- Create a fund for Technology Innovation Contest- Strengthen supplier communication

Fostering GloballyCompetitive SMEs

- Designated 28 “Globally Competitive SMEs” in August 2011- Financial investment for technology development and operation- Collaboration with R&D and manufacturing personnel from Samsung Electronics- Free on-site consultation

ComprehensiveSupplier

CompetitivenessImprovement Program

- Created a “Supplier Support Fund” of KRW 1 trillion in partnership with theIndustrial Bank of Korea for suppliers (KRW 560 billion was loaned as of the endof 2011)

- Elevate qualified second- and third-tier suppliers with satisfactory technology andquality qualification into first-tier suppliers

- Improvement of payment schedule (from twice a month to four times a month)- Training support (expanded training opportunities for second-tier suppliers)

Open Innovation

- Open Sourcing program- Collaboration for joint-development with SMEs with innovative ideas or new

technologies with or without prior business relationship- New technology development contest program- Technology development funding to SMEs with promising ideas and

technologies- When development is successfully completed, the SME can start business

relationships with Samsung Electronics

Communication byTop Executives

- Shared Growth Day- Samsung Electronics executives visit supplier sites on a regular basis- Executives communicated with 736 suppliers over 50 times in August 2011

Source: Samsung Electronics (2012), “Mutual Growth,” pp.42-45.



1. The Motivation and the Goals

In the past few years, Hungary has proven to be successful in facing variouschallenges including economic crisis management, performing structural changes inthe economy, executing budgetary reforms to regain macroeconomic stability, andputting the country on the growth path despite the unfavorable internationalenvironment. The foreign invested companies were key players in this processcontributing to the growth of the economic output of Hungary, enhancement of itsexports, and considerably decreasing the unemployment rate.

On the other hand, the Government of Hungary has also realized thatinternational production, trade and investments are increasingly organized withinthe so-called Global Value Chains (GVCs) and decided to strengthen the cooperationwith the major players of GVCs already present in Hungary.

After the decision taken in 2012, around 50 foreign large investors and theirsubsidiaries in Hungary were contacted by the Ministry for National Economy ofHungary, proposing them to conclude the so-called “Strategic CooperationAgreements” (SCAs).

The main political aim to conclude such an agreement was to reach a deeperintegration of foreign-invested companies into the Hungarian economy, reinforcingtheir role in the development of the country’s competitiveness and in theimplementation of the Hungarian Government’s economic growth policy.

Appendix 2Boosting Reinvestments:Strategic Cooperation AgreementsThe Hungarian experience

Szilágyi András (Ministry for National Economy)

■ Chapter 02



2. Selection procedure and the Preparation of the SCAs

The Hungarian Government approached those foreign-invested manufacturingand service providing companies, which have considerably contributed to theHungarian GDP growth through their already established facilities as well as have animportant role in export output and job creation and are willing to enhance theirpresence in Hungary. Companies with long-term presence in the country proved tobe reliable and constructive partners in the past decades and as such they weretargeted first. Some basic standards were defined to evaluate the possible partnerssuch as considering companies with at least 5 years of economic activity in Hungary,with investments of, at least, HUF5 billion (around EUR16 million), employing morethan 1,000 workers and having a measurable rate of local subcontractors. Thiscriterion was not applied very strictly and served mainly as a guideline for theselection of partners.

Most of the foreign companies contacted answered very positively to the newidea in concluding a Strategic Cooperation Agreement, and only a few decided notto enter into such commitment. After the first agreements were signed, aconsiderable number of companies asked to join showing their readiness tocooperate with the Government.

Contacts were made with the local subsidiary of the multinational company but inmany cases, the proposal to sign an SCA was so highly appreciated in the company’sheadquarters that several agreements were signed by high representatives of theMNC’s Board of Directors.

It is important to point out that the Strategic Partnership Agreements concludedare Memorandums of Understanding with no legal commitment on behalf of thesigning Parties, excluding any discrimination against third parties and neitherproviding any privileges to the strategic partner. The EU prohibits any discriminationon national basis, hence, several big Hungarian companies also were among theselected partners.

The decision to sign an SCA with a particular company is always drawn by theGovernment. The preparation of the Agreement is preceded by negotiationsbetween the Parties concentrated on the future expansion plans of the company inHungary.

3. Main Elements of the SCA

The structure of the Strategic Partnership Agreement clearly reflects the maingoals defined by the Government of Hungary when elaborating the new concept of



strengthening cooperation with the key foreign economic players.

The concluded agreements aim to increase investment, in particular the re-investment of earned profits, amplifying production and service activity leading tojob creation, but also motivate to participate in human resources development, RD&Iactivities, supply chain development with the participation of local SMEs, and activeinvolvement in social life of local communities. Through this deeper embedding offoreign companies in the Hungarian economy the Government expects to reduce thenegative effects of the so-called “dual economy.”

The declaration of the long-term strategic partnership between the Governmentand the foreign company is a key element of the SCA.

Boosting investment, profit reinvestment activities, and expansion of productionand service activities of foreign investors in Hungary were among the main targets ofthe agreement. Several companies declared their readiness to make new investmentand included indicative statements on the planned expansion of capacities in theAgreement itself.

4. The SCAs have also defined a set of other important cooperation areas.

One of those is the research, development and innovation area. In line with theHungarian FDI promotion policy goal to attract more foreign capital in higher value-added activities, especially in RD&I, the strategic partners are considering to enhancethose activities cooperating with Hungarian educational and research institutions andcenters.

The next important area is vocational training cooperation where the strategicpartners could contribute to the development of training systems in order to adjustthe existing system to meet market demand, expand dual vocational training,establish vocational workshops, etc.

The foreign companies established in Hungary have different levels of integrationin the local economy but, in general, their relationship with the nationalsubcontractors, being mainly SMEs, is very weak. While respecting the EU andHungarian competition rules, the SCA supports the development of a strongercooperation between the multinational company and its potential Hungarian partsand material suppliers through the realization of different contractor’s developmentand training programs. The local SMEs could actively enhance the country’s exportoutput since they deliver parts to be integrated into the final export products, andalso could be incorporated into the global resourcing of the multinational partner



company. The Hungarian Government’s aim is to realize 30 supply chaindevelopment programs between 2014-20 in order to support Hungary’s SMEs tobecome global companies.

In addition to the above mentioned targets, through the SCA the Governmentalso invites strategic partners to actively participate in the public life of localcommunities being involved in education, cultural, sports activities, social, andhealthcare.

The SCA also serves as an important promotional tool for Hungary becausesigning SCA proves that strategic partners believe Hungary as an excellent investmentdestination. Country promotion also includes organizing professional conferencesand training programs in Hungary, thereby familiarizing employees and businesspartners with Hungary.

5. Mutual Confidence Building - the Establishment of Working Groups

Probably, the most important aspect of the Strategic Cooperation Agreements isthe establishment of a working group (WG) between the strategic partner and theGovernment. Involved Parties commit themselves to meet, at least, every six month torevise the current status and outstanding issues of their cooperation. Themanagement of the working groups falls under the responsibility of the Ministry forNational Economy on the Government side.

On the one hand, the working group meeting creates an excellent forum forfrequent consultations, exchange of views on development plans and tasks,definition of the way forward in some concrete issues related to different fields ofcooperation (R+D, dual training, supply chain development, etc.)

On the other hand, the WG meetings give a floor for discussions regarding theregulatory framework effecting the investment and business environment, where thestrategic partners can deliver their opinion and suggestions to modify specific policyor legislation in order to improve the country’s competitiveness.

The expected outcome of this mutual confidence building process is the formationof a better and predictable investment climate, which leads to new investments,delivering new jobs, higher level of RD&I activities, development of the local SMEs,export growth and so on.


6. Preliminary Results

Since the elaboration of the “Strategic Cooperation Agreements” concept startedonly in 2012, it would be quiet early to make a detailed evaluation of the results nowalthough 44 agreements have been concluded, mostly signed in 2013-14.

Nevertheless, there is a common understanding between the Government ofHungary and its strategic partners that the Agreements are creating a win-winsituation for both Parties. For the Hungarian economy, it is important to havereliable, job creating partners with strong will to expand their activities in thecountry, meanwhile the partnership gives predictability for long-term investmentplanning for the companies.

Motivated by the recovery of the Hungarian economy, the investment activity ofthe foreign investors is on the rise. Several big companies announced the expansionof their facilities, e.g. Hankook, Bridgestone, Continental, General Electric, RobertBosch, ZF-Lenk systeme, Infineon, and new green field investments started by Takataand Procter&Gamble.

The 44 strategic partners announced investment plans for approximately HUF650billion (approx. EUR 2 billion), creating 5,500 new work places.

Looking at the geographical distribution of strategic partners, 21 SCAs wereconcluded with companies outside Europe, while among the 23 Europeans there are3 Hungarian companies. US companies are leading with 10 agreements, followed byGermany with 7. Most of the agreements were signed with partners in theautomotive industry, followed by electronics and pharmaceutical industry. Severalservice providers also entered the circle of strategic partners. Both the geographicaldistribution and division between branches reflect the current structure of theaccumulated FDI stock in Hungary.

The initiative of the Government of Hungary to conclude Strategic PartnershipAgreements with major economic players of the world economy is giving its firstfruits, but the impact of the partnership could be assessed only on the longer run.The Government of Hungary is willing to support this cooperation with all availabletools to lead it to success.






Special Economic Zones in Hungary:New Perspectives from the Korean

Experience

Chapter3

KSP_헝가리(영문)_3-4장 2015.2.16 6:28 AM 페이지23 SJ_01

Summary

Special Economic Zones (SEZs) aim to create a unique business environment withina designated area in a particular country to promote certain policy objectives.Notwithstanding their varieties, most of the SEZs share some common features suchas geographically delimited (usually fenced-in) area, single management, incentivesfor in-zone-located companies, and streamlined administrative procedures. Currently,there are around 3,500 SEZs in over 130 countries including Hungary and Korea.

Hungary’s SEZs are represented by industrial parks and free enterprise zones. Withthe first industrial park established in 1997, Hungary operates more than 200industrial parks today. Since 2013, the government has also opened science andtechnology parks - a subset of industrial parks - that focus mainly on research anddevelopment activities. Moreover, over 1,000 free enterprise zones have recentlybeen established in 47 underdeveloped regions. Both industrial parks and freeenterprise zones offer various incentives to residing companies in accordance withHungarian legislation and European Union law.


Special Economic Zones in Hungary: New Perspectives from the KoreanExperience

Sherzod Shadikhodjaev (KDI School of Public Policy and Management)*

■ Chapter 03

* Many thanks go to Ádám Nagy (Ministry for National Economy, Hungary), ErnöRadics (Ministry for National

Economy, Hungary), Norbert Mórucz (Association of Industrial, Science, Innovation and Technology Parks,

Hungary), Péter Bakonyi (Budapest University of Technology and Economics), Balint Hartmann (Budapest

University of Technology and Economics), JuditCzakó (HITA), BalázsSzungert (HITA), Marcell Tatai-Szabó (HITA),

Yongsuk Kim (KOTRA, Budapest), Byung Eun Yoon (KOTRA, Budapest), Hoje Kang (Korea Research Institute

for Human Settlements), an anonymous referee and many others who shared his/her professional expertise on

the topic and/or gave valuable comments on earlier drafts.

KSP_헝가리(영문)_3-4장 2015.2.24 3:36 PM 페이지144 SJ_01

* Many thanks go to Ádám Nagy (Ministry for National Economy, Hungary), Ernö Radics (Ministry for National

Economy, Hungary), Norbert Mórucz (Association of Industrial, Science, Innovation and Technology Parks,

Hungary), Péter Bakonyi (Budapest University of Technology and Economics), Balint Hartmann (Budapest

University of Technology and Economics), Judit Czakó (HITA), Balázs Szungert (HITA), Marcell Tatai-Szabó

(HITA), Yongsuk Kim (KOTRA, Budapest), Byung Eun Yoon (KOTRA, Budapest), Hoje Kang (Korea Research

Institute for Human Settlements), an anonymous referee and many others who shared his/her professional

expertise on the topic and/or gave valuable comments on earlier drafts.

In Korea, a first SEZ was opened in the early 1970s. Currently, there are three typesof SEZs. Foreign investment zones constitute areas with e.g. lands leased ortransferred to foreign-invested companies from existing national industrialcomplexes, or areas in which a foreign investor intends to invest. Free trade zonesfocusing on manufacturing, logistics, distribution and trade are opened mainly inindustrial complexes, airports, seaports, distribution complexes, or freight terminals.As a new paradigm in Korea’s SEZ policy, free economic zones seek a complexdevelopment of industry, business (commerce), logistics and housing, and intend toprovide pleasant living conditions for foreigners.

The Hungarian government could expand the role of SEZs in pursuing boldeconomic reforms aimed at easing “doing business.” In this respect, a customizedmodel of Korean free economic zones could be a worthwhile candidate for beinglaunched in Hungary. At the outset, only one pilot free economic zone, possiblyincorporating some existing SEZs, could be opened though the number of such zonesmay be increased in the future. But the complexity of this project requires a thoroughfeasibility study for the proposed zone in the closest context of Hungary’scircumstances. This could become a new topic for a future Korea-HungaryKnowledge Sharing Program. Finally, two countries should regularly cooperate atboth public and private levels with a view to exploring and conducting joint projectsin each other’s SEZs.

1. Introduction

Special economic zones (SEZs) have proliferated across the globe as a means ofproviding a favourable business climate for economic operators in a respectivecountry’s designated area. Associated with certain costs and benefits, SEZs naturallyrequire a serious examination before their launch and regular assessments in thepost-establishment stage.

SEZs have been an important element of the governmental policy in bothHungary and Korea. They have been used to develop particular regions and thenational economy as a whole through enhancement of production capacities andcompetitiveness of enterprises, promotion of employment and investment activities.

This Chapter aims to offer some thoughts on what aspects of the Koreanexperience could be applied to the Hungarian SEZ system. For this purpose, thisanalysis will proceed in four parts. Section 1 will make a short introduction to theconcept of SEZs discussing the taxonomy and role of zones, in general. Sections 2 and3 will examine the SEZ policy in Hungary and Korea, respectively. Based on theobservations from the preceding parts, the final section will explain the importance

Chapter 3 _ Special Economic Zones in Hungary: New Perspectives from the Korean Experience 145


of Korea’s case and advance some practical recommendations for the Hungarian site.As the main conclusion, this study suggests that Hungary consider opening a freeeconomic zone similar to the Korean model but adjusted to local circumstances, andthat both countries explore the ways of conducting joint projects related to SEZs.

2. Overview of SEZs

2.1. The Taxonomy of SEZs

The basic idea of having SEZs is to create and operate a unique businessenvironment within a designated area - which is in many aspects distinct from whatapplies elsewhere - to promote certain policy objectives. Notwithstanding variety oftheir types, most of the SEZs share some common features such as geographicallydelimited (usually fenced-in) area, single management, incentives for in-zone-locatedcompanies, and streamlined administrative procedures. Unless otherwise specified,this Chapter will refer to “SEZs” as a generic term for all kinds of “exceptional” zoneswithin a country’s territory that are designed for a favourable business climate.

SEZ-like free zones have existed for centuries. They were originally established toencourage entrepôt trade, and normally took the form of citywide zones located oninternational trade routes, such as Gibraltar (1704), Singapore (1819), Hong Kong(1848), Hamburg (1888), and Copenhagen (1891). But modern SEZs only began toexist starting in the late 1950s, with the set up of Ireland’s Shannon Free Zone in 1959being widely recognized as the first modern model of SEZs.2)

With respect to data on the global state of play in SEZs, figures vary from sourceto source because of different methodologies and definitions of SEZs. An often-citeddatabase of the International Labour Office (ILO) illustrated in <Table 3-1> points outrapid growth in the number of export processing zones in the last few decades, from79 in 25 countries in 1977 to about 3,500 in 130 countries in 2009. The ILO definesexport processing zones as “industrial zones with special incentives set up to attractforeign investors in which imported materials undergo some degree of processingbefore being exported again.”


1) FIAS [The Multi-donor Investment Climate Advisory Service of the World Bank Group], “Special Economic Zones:

Performance, Lessons Learned, and Implications for Zone Development,”2008, p.9.

2) Michael Engman et al., “Export Processing Zones: Past and Future Role in Trade and Development,”OECD

Trade Policy Working Paper No. 53, TD/TC/WP (2006)39/FINAL (23 May 2007), p.11.


1)

The International Convention on the Simplification and Harmonization ofCustoms Procedures3) as amended (commonly known as the “Revised KyotoConvention”) - a key international agreement on customs administration - definesthe term “free zone” as “a part of the territory of a Contracting Party where anygoods introduced are generally regarded, insofar as import duties and taxes areconcerned, as being outside the Customs territory.”4) Accordingly, two maincharacteristics of free zones are distinguishable: (1) free zones as an integral part ofthe national territory; and (2) goods entering the zone as deemed, for the purposesof some fiscal measures, to be outside the customs territory, i.e. the territory in whichnational customs law applies. Thus, “exterritorial” features of free zones are evidentfrom three factors. First, goods shipped from a free zone into the rest of the country’sterritory or vice-versa are considered as if they were respectively imported to orexported from the national customs territory. Second, goods in free zones arenormally subject to flexible customs control - measures applied by the customsauthorities to ensure compliance with national customs law - usually limited togeneral checks of goods only. Third, goods entering free zones normally enjoyexclusive tax and customs benefits.5)

Pursuant to FIAS (2008), before the 1970s, most zones were clustered mainly inWestern Europe, but in the 1980s the zone development trend expanded to newregions, including South Asia, South America, and Sub-Saharan Africa andsubsequently to Eastern and Central Europe, the Commonwealth of IndependentStates, Middle East, and North Africa. Currently, most of the zones are concentratedin Asia and Pacific, Latin America, Central and Eastern Europe, and Central Asia, withover 2,300 zones located in 119 developing and transition economies. The Asia-Pacificregion has been a leading region in the SEZ development. Zones in this region are


3) Done at Kyoto on 18 May 1973 and revised on 26 June 1999.

4) Chapter 2, Specific Annex D of the Revised Kyoto Convention.

5) Sherzod Shadikhodjaev, “International Regulation of Free Zones: An Analysis of Multilateral Customs and Trade Rules,”

World Trade Review (Cambridge University Press), Vol. 10, No. 2 (2011), pp.192-193.

Table 3-1 Export Processing Zones in Numbers

1977 1986 1995 1997 2002 2009

Employment(million workers)

N/A N/A N/A 18 30 66

Export processingzones (number)

79 176 500 845 3,000 3,500

Countries withexport processingzones (number)

25 47 73 93 116 130

Source: ILO, “Good Practices in Labour Inspection in Export Processing Zones,” 2012, p.7.


mostly run by the central government or relevant government agencies. As for theproduct specialization, the majority of SEZ companies are involved in labor-intensiveand assembling activities in apparel, textiles, electrical and electronic sectors thoughtheir share in the overall worldwide zone output is gradually decreasing now.6)

FIAS (2008) divides SEZs in six groups, as shown in <Table 3-2> though this classifi-cation is, of course, without prejudice to other possible classifications. For instance,depending on the type of activities (be it trade, manufacturing or services), the ILOdistinguishes free ports, SEZs, industrial free zones/export processing zones,


6) See FIAS (2008), supra note 1, pp.23-28.

7) Engman et al. (2007), supra note 2, p.15.

Table 3-2 Classification of SEZs

Type of ZoneDevelopment

ObjectivePhysical

ConfigurationTypical

LocationEligible

ActivitiesMarkets Examples

Free Trade Zone(CommercialFree Zone)

Support tradeSize < 50hectares

Ports of entryEntrepót andtrade-related

activities

Domestic, re-export

Colon FreeZone, Panama

TraditionalExport

Processing Zone

Exportmanufacturing

Size < 100hectares; total

areadesignated as

an exportprocessing

zone

NoneManufacturing,

otherprocessing

Mostly exportKarachi Export

ProcessingZone, Pakistan

Hybrid ExportProcessing

Zone

Exportmanufacturing

Size < 100hectares; only

part of thearea

designated asan exportprocessing

zone

NoneManufacturing,

otherprocessing

Export anddomestic

Lat KrabangIndustrialEstate,

Thailand

Free PortIntegrated

developmentSize > 100

km2 None Multi-useDomestic,

internal andexport

Aqaba SEZ,Jordan

Enterprise Zone,Empowerment,

Urban FreeZones

Urbanrevitalization

Size < 50hectares

Distressedurban or rural

areasMulti-use Domestic

EmpowermentZone, Chicago

Single-FactoryExport

Processing Zone

Exportmanufacturing

Designationfor individualenterprises

CountrywideManufacturing,

otherprocessing

ExportMauritius,Mexico,

Madagascar

Source: FIAS, “Special Economic Zones: Performance, Lessons Learned, and Implications for Zone Development,” 2008, p.10.


enterprise zones, information processing zones, financial services zones andcommercial free zones.7) Moreover, legislation of each relevant country provides itsown classification of zones, so that what is considered a free trade zone in onecountry may not fit this definition in another country.

Pursuant to FIAS (2008), free trade zones are “small, fenced-in, duty-free areas,offering warehousing, storage, and distribution facilities for trade, transhipment, andre-export operations, located in most ports of entry around the world.” Exportprocessing zones are industrial sites with special incentives and facilities formanufacturing and associated activities aimed mostly at export markets. Whiletraditional export processing zones are open exclusively to export-orientedenterprises, hybrid export processing zones typically consist of a general zone open toall industries regardless of export orientation and a separate area for export-orientedenterprises registered in the zone. In most Asian countries with hybrid exportprocessing zones, separate areas within the zone are required to be fenced-in, but inmany Latin American countries no such a requirement exists. Freeports typicallyoccupy much larger areas and accommodate all types of activities, including tourismand retail sales, and allow people to reside on site. Enterprise zones are created to“revitalize distressed urban or rural areas through tax incentives and financialgrants.” Most zones are in developed countries including the United States, France,and the United Kingdom. Finally, single-factory export processing zones in e.g.Mauritius, Madagascar, Mexico, Costa Rica, the United States, and Sri Lanka offerincentives to individual enterprises irrespective of their location. In other words, theydo not have to be within a designated zone to receive benefits.8)

Despite their variety, SEZs are all common in providing certain incentives thatmake them exclusive sites. According to Engman et al. (2007), most typical incentivesare; (1) enhanced physical infrastructure (enhanced access to transport and logisticalnetworks, telecommunications networks and utility services, etc.), (2) streamlinedadministrative services (single window or one-stop shop government services, fasttrack customs services, simplified licensing procedures, etc.), (3) fiscal incentives(tax/duty exemptions, reductions or refunds), and (4) export promotion services(business advisory services, sales and marketing support, finance, and export creditservices).9)

2.2. SEZs as an Economic Policy Tool

Most common rationales for the SEZ development are as follows. First, SEZs maybe considered as part of novel economic reforms whereby the government employsnew tools - typically relaxation of state regulations, liberalization of economic and


8) FIAS (2008), supra note 1, pp.10-11.

9) Engman et al. (2007), supra note 2, p.17.


administrative policies - within the SEZ and then extend them to the entire country ifthey succeed in the SEZ. In other words, SEZs may serve as experimental laboratoriesfor testing new policy approaches.

Second, SEZs, especially export processing zones, are created to increase exportperformance of local industries. They promote and often diversify export-orientedmanufacturing sectors. For this purpose, countries may conduct robust liberalizationin regulatory and trade policies within a fenced-in zone while still keeping theirprotective barriers in out-of-zone areas intact.

Third, SEZs are designed to attract investments and, in particular, foreign directinvestments (FDIs). To this end, SEZs usually offer improved infrastructure, convenientaccess to outside and local market, full package of various incentives, and astrengthened investment regime. Some SEZs are open exclusively to FDIs while othersdo not differentiate between overseas and domestic investors. In countries with aliberal trade regime, inducement of investment becomes a primary goal of SEZs.

Fourth, SEZs create additional jobs inside and outside the zone through backwardlinkages. As demonstrated in <Table 3-1> above, the global employment rate in exportprocessing zones in 2009 was about 3.7 times more than that in 1997.

Fifth, some countries establish SEZs in disadvantaged areas to reach a morebalanced intra-regional development. Not only better infrastructure, productionfacilities and logistical linkages, but also new jobs may contribute to this goal.

Sixth, SEZs may generate transfer of technologies, know-how, and necessary skillsfrom foreign enterprises operating in the zone to local enterprises and workers. Inmany cases, local companies will be involved in production of non-traditional goodsand be forced to manufacture at high quality standards - something which requires


Table 3-3 Benefits and Costs of SEZ Policy

Benefits Costs or Loss of Revenue

Export growthForeign direct investmentForeign exchange earningsEmploymentTechnology transfersInformation exchange with companiesGovernment revenue

Infrastructure investmentAdministrative costs (setting up of separateadministrative arrangements)Foregone tax revenue (tariffs, income tax and othertaxes forgone)SubsidiesSocial and environmental costs (potential loss ofworker rights and protection afforded undernational laws and regulations and possibledegradation of the environment)

Source: Michael Engman et al., “Export Processing Zones: Past and Future Role in Trade and Development,” 2007, p.23.


continuous training of their workers and management.

SEZs are always associated with certain costs and benefits, as illustrated in <Table3-3>. Thus, a thorough cost-benefit analysis should precede an actual launch of a zone.

The growth of foreign exchange earnings, FDIs, and exports are frequently citedas major benefits of SEZs. For instance, SEZs account for more than 80% ofcumulative FDI in China; the share of FDI in Mexico’s SEZs (maquiladoras) to total FDIincreased from 6%in 1994 to 23% in 2000.10) Moreover, SEZs account for a significantshare of manufactured exports in many regions, especially in the Middle East, NorthAfrica and Sub-Saharan Africa, with SEZ exports constituting more than 40% ofglobal exports.11) Although the direct employment impact of zones is rather marginal,indirect employment through backward linkages effects can be substantial.Furthermore, governments gain budgetary revenues from income taxes onemployees, import duties, and taxes on SEZ-made goods sold to the domestic market,corporate income taxes (if not exempted for zone-located enterprises), servicescharges, rental fees, and others.

As for the costs, government’s infrastructure investment constitutes the mostsignificant public expenditure in many countries. Infrastructure costs includeexpenditures for construction of buildings, roads as well as electricity and watersupply systems. In many cases, countries will establish separate bodies for themanagement of SEZ-related issues, so that SEZs may create extra administrative costs.Tax holidays or below-market utility rates constitute public revenues forgone. It isalso possible that land and building rates in the zone are set below cost-recoverylevels, and the government provides some preferential financial aid to the zone-located enterprises. Finally, certain social or environmental costs may also beassociated with the operation of SEZs. This is the case where SEZs provide “favorable”business climate through the use of weaker labor or environmental standards such ase.g. bans on the right to strike, restriction of the right to collective bargaining, low airpollution, or low public health standards.

3. Hungary’s SEZ Policy

3.1. Main Industries and Investment Promotion System12)

Hungary’s main industries are automobiles, electronics, pharmaceuticals and


10) FIAS (2008), supra note 1, p.35; Engman et al. (2007), supra note 2, p.26.

11) FIAS (2008), supra note 1, pp.35-36.

12) Most parts of this sub-section are based on HITA, Investing Guide Hungary 2014: Why Invest in Hungary?, 2014,

pp.12-36.


medical technology, information and telecommunications (ICT), and food industry.

The automotive sector, represented by more than 700 companies employing atotal of 115,000 people, generates almost 18% of country’s total exports. Four largeautomotive Original Equipment Manufacturers (OEMs) have set up productionfacilities in Hungary: Suzuki, Audi, Opel, and Daimler. Serial production of Mercedes-Benz cars began in Kecskemét in March 2012. A number of multinational automotivecompanies have set up research and development (R&D) centers in Hungary.

The electronics industry accounts for 22% of total Hungarian manufacturingproduction and 25% of total production in Central and East Europe making thecountry the largest electronics producer in the region. Around 112,000 people areemployed in the sector. In addition, several global OEMs, six out of the Top 10Electronic Manufacturing Services providers in Europe are present in Hungary. Someof the companies such as National Instruments and Jabil also conduct R&D activities.

With its century-long tradition, Hungary’s pharmaceutical industry is the strongestin the region, and attractive to life science companies intending further expansion inthis region and beyond.

The Hungarian ICT sector leads the region in computer assembly andcommunications equipment manufacturing, and employs around 150,000 people.

The food industry - the processing of meat, coffee, tea, fruits and vegetables,manufacturing of soft drinks and etc. - generates 8% of the country’s exports and126,000 jobs.

Hungary’s good infrastructure, cheap but skilled labor force - which is especiallystrong in engineering, medicine and (life) sciences - and central location in Centraland Eastern Europe make it an attractive destination for investment. The Hungariangovernment promotes investments in both manufacturing and services includingR&D, and puts emphasis on increasing competitiveness of small and medium-sizedenterprises (SMEs) and job creation.

Hungary joined the European Union (EU) in 2004. The EU membership offers itsmembers all benefits of a common market: free movement of goods, services, capitaland labor. At the same time, it limits members’ freedom to promote local industries.In particular, Article 107 (ex Article 87 TEC) of the EU Treaty regulates State aid issuesby restricting the use of government subsidies: “any aid granted by a Member Stateor through State resources in any form whatsoever, which distorts or threatens todistort competition by favoring certain undertakings or the production of certaingoods shall, in so far as it affects trade between Member States, be incompatible with



the internal market.” Accordingly, government support of specific enterprises orproduction of specific goods is not allowed. Certain subsidies may be considered ascompatible with the EU’s internal market. These include, inter alia, aid for theeconomic development of areas with the abnormally low standard of living or seriousunderemployment or aid for the development of certain economic activities ofcertain economic areas to the extent that it does not negatively affect tradingconditions and competition in the EU.

Hungary’s incentives for investments may take the form of; (1) cash subsidies fromthe Hungarian budget or EU funds, (2) tax benefits, (3) low-interest loans, and (4)land available for free or at reduced prices. For instance, investment-related cashsubsidies from the Hungarian sources are focused on implementing investmentprojects (e.g. purchasing assets, construction work, etc.), creating new jobs andtraining of employees. EU-funded cash grants are given to projects for economicdevelopment and innovation, human resources development, energy and resourceefficiency, and regional development, among others. Foreign and domesticenterprises are equally eligible for these benefits.

Incentives are granted in compliance with a regional intensity ratio - themaximum value of the total of various incentives in proportion to the amount ofinvestment made in a particular region. Thus, the amount of incentives for the samevalue of investment will differ depending on the corresponding intensity ratio. Inother words, investments in Hungary’s poor regions, unlike developed ones, areeligible for greater incentives. In 2007-2013, all seven regions of Hungary werequalified for incentives, with the intensity ratio varying between 10% and 50% forbig companies, and additional increase of the ratios by 10 or 20 percentage points forSMEs. These numbers have changed recently. For the 2014-2020 period, the intensityratios have been lowered for most regions except less-developed ones for which the50% ratio remains. The modifications strongly affect the Central Hungarian regionwhere the regional intensity ratio will vary between 0% and 35% from 1 July 2014depending on the location. For Budapest, the intensity ratio will be 0% forinvestment subsidies, but training and R&D subsidies will still be available until 2020.

With about 40 big companies in Hungary that have made large investments to thenational economy and created a considerable number of jobs, the governmentconcluded strategic partnership agreements. These companies may enjoy streamlinedadministrative procedures, such as faster-than-usual government approvals, andcloser cooperation with the government in resolving any difficulties they haveencountered. As a strong basis for long-term cooperation with the expectation ofkeeping job creation on a high level, the strategic partnership agreements are notpublished in order to keep the partners’ confidential information.



As for the institutional framework, the main government agency in charge offoreign investment promotion is the Hungarian Investment and Trade Agency (HITA).It was established in January 2011 under the supervision of the Prime Minister’sOffice to encourage international business activities of Hungarian SMEs and foreignbusinesses to invest in Hungary.

3.2. SEZ Policy

Similar to the Revised Kyoto Convention above, EU law uses the term “free zone”to mean a special area within the customs territory of the Community, with goodsplaced within these areas to be free of import duties, value-added tax and otherimport charges. Non-Community goods stored in the zone are considered as not yetimported to the Community’s customs territory, while certain Community goodsstored in free zones can be considered as already exported. Import and exportdeclarations are required only when the goods leave the free zone. The free zonessimplify trading procedures reducing customs formalities. There are around 74 freezones within the EU but none in Hungary.13)

As discussed below, Hungary operates industrial parks and free enterprise zonesthat do not fall within the EU’s definition of “free zones,” but may nevertheless beviewed as SEZs.

3.2.1. Industrial Parks

Hungary’s first industrial park was established in 1997. There are currently 203zones of which about 120 locations are available for new investments. In January2013, the Hungarian government introduced a new type of industrial parks - scienceand technology parks - to highlight R&D activities that must be conducted there.14)

According to the Ministry for National Economy of Hungary, nearly 4,000companies are settled in industrial parks. They employ, in total, more than 180,000people, and account for 30% of national industrial output and more than USD 40billion in annual revenue. Most of the industrial parks (51%) are owned by localgovernments with the remainder owned by Hungarian investors (31%), foreign


13) See European Commission, “Free Zones,”

http://ec.europa.eu/taxation_customs/customs/procedural_aspects/imports/free_zones/index_en.htm; “Free Zones in

Existence and in Operation in the Community, as notified by the Member States to the Commission”(as of 13

August 2013),

http://ec.europa.eu/taxation_customs/resources/documents/customs/procedural_aspects/imports/free_zones/list_

freezones.pdf.

14) Unless otherwise specified, most of the factual information about Hungarian industrial parks and free enterprise zones

is largely based on Ministry for National Economy of Hungary, “Special Economic Zones in Hungary,”presentation

by Ádám Nagy (Department for Industry and Construction Economy), Seoul, 31 March 2014.


investors (9%), regional local governments (2%), and others (7%).

The designation and opening of industrial parks is generally a “bottom-up”process whereby enterprises that intend to invest or have invested in a particular siteapply for the government’s designation of that site as an industrial park. The title“industrial park” makes the resident enterprises eligible for certain benefits andpreferences.

The government grants the title to the requested site with requirements to bemet within the period of five years. The minimum requirements in terms of the area,the number of enterprises and employees are shown in <Table 3-4>. Should theindustrial park fail to reach the specified levels, the government withdraws the title,so that benefits for the enterprises concerned are terminated. All industrial park titleholders must submit a report on a yearly basis to the Ministry for National Economyin which they present all relevant details and prove their continuous fulfilment of theminimum requirements.


[Figure 3-1] Hungarian Industrial Parks (1997-2009)

Source: Ministry for National Development and Economy of Hungary, 2010.


The Ministry for National Economy is a key government authority in charge ofindustrial parks. In addition, the Industrial Park Council serves as a consultative andadvisory body with the task to opine on submitted applications for the “industrialpark” title, expansion of industrial parks, modification of terms and conditions of thegranted title, and etc. The Council is chaired by the Deputy State Secretary forInternal Economy in the Ministry for National Economy and includes representativesof other public bodies and associations.15)

With respect to incentives, enterprises in the park may benefit from EU’s fundingmechanisms. There are two main types of complex EU funds: grants for specificprojects followed by a public announcement and public contracts to purchase goodsand services through public procurement. The grants are included mainly in theStructural and Investment Funds to support economic development. In addition,financial support is available under the Economic Development and InnovationOperational Program, which serves to stimulate the growth of the Hungarianeconomy. This program allocates available resources to five major fields:

employment and job creation;competitiveness and growth potential;R&D, innovation activities and knowledge economy;integrated nfo-communications development; andlow-carbon economy, environmental protection, and resource efficiency.

Along with the financial support, industrial parks provide enterprises with basic


Table 3-4 Approval Criteria for Industrial Park Applications

Types of

Industrial

Parks

Conditions Minimum AreaMinimum Number

of EnterprisesMinimum Number of

Employees

Industrial

Park

At the moment of atitle application

20 ha 5 100

5 years later - 10

Science and

Technology

Park

At the moment of atitle application

10 ha 5 75 + R&D activity

5 years later - 10 150 + R&D activity

Source: Drawn up by the author on the basis of Ministry for National Economy of Hungary, “Special Economic Zones in Hungary,”presentation by Ádám Nagy, Seoul, 31 March 2014.

15) Hungary’s Industrial Park Portal, “Industrial Park Council,”

https://www.ipariparkokmagyarorszag.hu/en/industrial_park_council.


infrastructure needed for production (e.g. energy, water, and waste-watertreatment), and a wide range of quality services such as guarding, cleaning, postalservices, medical services, banking and legal services, and others. Moreover, throughrelated technological work stages, industrial parks enable evolution of professionalcooperation aimed at cutting production costs.

To give an example, the Budaörs Industrial and Technology Park is one of themost successful industrial parks in Hungary. Being granted the title in 1999, it wascreated in the former military industrial zone. The park occupies 60 hectares close toHungary’s three main highways near Budapest, employs 3,000 people in about 300SMEs operating there. The SMEs are involved in both manufacturing (food industry,pharmaceuticals, electronics, machinery, etc.) and services (banking, customs services,etc.). For its achievements, this park was named the “Best Hungarian Industrial Park”according to the 2013 award by the Association of Industrial Parks.16)

The Hungarian government is currently interested in raising the quality of theexisting industrial parks rather than opening new ones. With the EU funds for theperiod of 2014-2020 available to industrial park title holders from the fourth quarterof 2014 onwards, the government will focus on granting the funds for two types ofindustrial parks. Hungary will protect the ones that are operating as regionalindustrial centers, and secure the ground of development of the industrial parks withgood facilities and with the potential of improvement in both the number ofenterprises and the number of jobs.

The information above lets us briefly summarize some specific features ofHungary’s industrial parks. Industrial parks are established by either localgovernments or private companies according to the basic legal standards set by agovernmental decree. The title holder applicant must meet minimal expectations interms of area and employment. Such a “bottom-up” approach allows companies tofreely choose the site (location) that they wish to be designated as an “industrialpark.” This title enables them to benefit from sources designated to industrial parksin the Operative Programme for the EU budget of 2014-2020. Second, generalindustrial parks do not need to be specialized on specific products, services oractivities. Thus, a park may, in principle, accommodate enterprises from varioussectors. On the other hand, the recently introduced title, “science and technologyparks,” shows a shift towards greater specialization. Finally, the “industrial park”status is granted for a short but extendable period - something that allows thegovernment to quickly respond where parks do not work appropriately. In particular,it can abolish the title where the minimum legal standards for the park’smaintenance are not met.


16) Based on materials obtained during the KSP delegation’s visit to the Budaörs Industrial and Technology Park on

19 February 2014.


3.2.2. Free Enterprise Zones

In February 2013, the Hungarian government promulgated a decree for theestablishment of “free enterprise zones” in country’s underdeveloped regions. Todate, 1,080 such zones were designated in 47 small regions.17) Free enterprise zonesoffer three kinds of allowances outlined in Figure 3-2.

The “development tax allowance” offers corporate income tax reduction for up to

80% for 10 years for those projects in the zone that have an investment value of at

least HUF 100 million (EUR 0.33 million) and result in creation of a new facility,

extension of an existing facility or a fundamental modification of products, services or

the production or service process. The development tax allowance does not require

creation of new workplaces.

The “social contribution allowance” and the “vocational training contribution

allowance” are available to investors after any new employee (minimum one

employee) is hired. Common conditions for both allowances are as follows:

The employer increases new workplaces for at least 3 years.

The new workforce is employed in employment relationship.The employee has not belonged to the average number of employees of theemployer or its related company for one year before the starting date of


17) Unless otherwise specified, the factual information on free enterprise zones is drawn from HITA, “Free Enterprise

Zones,”2013.

[Figure 3- 2] Incentives within Free Enterprise Zones

Source: HITA, “he Role of HITA in Investment Promotion,” presentation by Judit Czak?, Budapest, 19 February 2014.


employment.

Its registered residence (for at least six months) is in the zone.

Its job location is in the zone.

The post of the new employee was not subsidized by the National Employment

Fund.

From our perspective, free enterprise zones are different from industrial parks

basically in three ways. First, they are currently opened only in Hungary’s least

developed regions. This fact distinguishes them from industrial parks that are present

across the country. Thus, regional development considerations are key rationales for

launching free enterprise zones. Second, they are designated by the government in

advance irrespective of potential investors’ requests. In other words, unlike industrial

parks, free enterprise zones typically undergo the “top-down” establishment process.

Third, the government provides unique fiscal incentives. Because of the very short

period of the existence of free enterprise zones, it remains yet to be seen how well

this new system will work.

4. Korea’s SEZ Policy

4.1. Background

Korea’s free zone history dates back to the 1960s when the government decided

to shift from an import substitution policy to an outward-looking export promotion

trade policy. The idea of launching special zones was initially proposed by the

Federation of Korean Industries. During its visit to the Kaoshiung export processing

zone in Taiwan in the late 1960s, a federation’s delegation was so impressed by the

attained results there that they tabled their recommendation to the government to

establish a similar zone in Korea.

This led to the enactment of the Free Export Zone Establishment Act in 1970 and

the subsequent establishment of two special zones in the early 1970s: one in Masan

on the southeastern coast of the Korean peninsula and the other in Iri (now Iksan) of

the mid-western coast. They were fenced territories beyond general customs and tax

regimes. As Article 2 of the Act in question stated, a “free export zone” was an area

having the characteristics of a bonded area where the application of pertinent laws

and regulations would be waived or relaxed in whole or in part.

Inspired by the experience of Hong Kong, Singapore and Taiwan, the Korean

government hoped that the new zones would attract foreign investment to the

export-oriented manufacturing industry.18) The Masan Free Export Zone has achieved



tremendous results. As observed by Oh (1993), capital inflows into this zone increased

from USD 1.2 million in 1970 to USD 88.9 million in 1975; the average investment per

enterprise rose from USD 238,700 in 1971 to USD 1,871,100 in 1986. In 1970, there

were only 4 firms there, but the number of firms sharply increased to 115 by 1973. In

the period of 1971-1991, exports from the Masan zone accounted for 2-4% of total

national exports with electronics and electrical goods being major exports going

basically to Japan, United States and Western Europe.19)

Many factors contributed to the Masan zone’s success. These are, inter alia, a

convenient location near the seaport with a skilled labor force from adjacent

industrial complexes; well-developed infrastructure (electricity supply, highway

transportation, and communication facilities); the existence of foreign multinationals

such as Sony and Sanyo (Japan) and Nokia (Finland) in the zone; backward linkages

with local industries and subcontractors; and in-zone improvement of technological

capabilities of workers and their circulation into out-of-zone local firms.20)

In contrast, the Iri zone failed to repeat the Masan zone’s success. In 1991, total

investment stood at USD 49 million and only 22 firms were operating there with only

one third of the area being developed. Oh (1993) explained this poor performance

with an inadequate infrastructure and the lack of easy access to raw materials,

among other reasons.21)

In the early 2000s, Korea’s SEZ policy has substantially been reformed. In

particular, free export zones were reorganized to free trade zones to link free

manufacturing to free trade and logistics activities. In addition, the concept of free

economic zones was introduced as nation’s new zone development paradigm. Free

trade zones and free economic zones - together with foreign investment zones

introduced by the Foreign Investment Promotion Act (1998) - are three types of SEZs

that are currently operating in Korea. A short comparison of these zones is provided

in <Annex 3-1> to this Chapter.

It should be noted that SEZs in Korea have been operating in addition to

industrial complexes (in Korean “sanuptanji,” sometimes translated into English as

“industrial parks”) - special industrial sites developed via ex-ante master planning,


18) Peter G. Warr, “Korea’s Masan Free Export Zone: Benefits and Costs,”The Developing Economies, Vol. 22, No. 2

(1984), p.169.

19) Wonsun Oh, “Export Processing Zones in the Republic of Korea: Economic Impact and Social Issues,”ILO Working

Paper No. 75 (1993), pp.8-15.

20) Yong-Seok Choi, “Development Strategies for Special Economic Zones in Myanmar,”in KSP Report, Priority

Assignments for Economic Development of Myanmar, Ministry of Strategy and Finance, Korea, 2012, pp.155-157.

21) Oh (1993), supra note 19, pp.10-11.


follow-up management and production-supporting facilities. Industrial complexes

have played a significant role in the industrialization of the country through

nurturing particular sectors, namely light industries (mainly textiles) in the 1960s,

heavy industries (petrochemicals, steel, etc.) in the 1970s, and high-tech industries

(semiconductors, electronics, information technology, and bio-industry) over the

1980s-2000s.22) Since the launch of the first industrial complex in Ulsan in 1962, the

number of industrial complexes has rapidly increased. As of the end-2013, there were

1,033 industrial complexes housing 80,547 enterprises and employing 2,010,509

workers.23) Industrial complexes account for roughly 62% of manufacturing output

and 80% of exports.24)

Despite the existence of industrial complexes, the Korean government has also

utilized SEZs with the purpose to expand FDI inflows, support export-oriented

industries, and improve business environment as well as foreigners’ living conditions.

At the same time, industrial complexes and SEZs can be interlinked to some extent.

We will see below that existing industrial complexes may also become a SEZ or part

thereof if they satisfy the conditions determined in the respective law. In this case,

industrial complexes will provide SEZ-specific incentives to residing enterprises, in

particular foreign-invested enterprises.

4.2. State of Play

At present, the Korean legal framework for SEZs largely consists of laws and

regulations related to both foreign investment and SEZs. These include, in particular:

(1) the Foreign Investment Promotion Act (1998) and the Presidential Enforcement

Decree of the Foreign Investment Promotion Act (1998), (2) the Act on Designation

and Management of Free Trade Zones (2000) and the Presidential Enforcement

Decree of the Act on Designation and Management of Free Trade Zones (2000), (3)

the Special Act on Designation and Management of Free Economic Zones (2002), and

the Presidential Enforcement Decree of the Special Act on Designation and

Management of Free Economic Zones (2003).


22) See Hyeyoung Cho, 2011 Modularization of Korea� Development Experience: Industrial Park Development Strategy

and Management Practices, Ministry of Strategy and Finance, Korea, 2012, pp.32-65.

23) Korea Industrial Complex Corporation� database for the fourth quarter of 2013, at

http://www.e-cluster.net/new_app/indust/stat/danji_stat_list.jsp?BOARDNO=10113.

24) Cho (2012), supra note 22, p.18.


4.2.1. Foreign Investment Zones

Article 18 of the Foreign Investment Promotion Act authorizes local governments

to designate a foreign investment zone. The term “foreign investment zone”

embraces; (1) a zone for leasing or transferring lands to foreign-invested companies

from existing national industrial complexes; (2) a zone in which a foreign investor

intends to invest; (3) a zone for leasing or transferring lands to foreign-invested R&D


[[Figure 3-3] SEZ Locations in Korea

Source: Sang Young Lee, “FDI Site Support & Permit System,” 2011.Note: “FIZ” stands for “Foreign Investment Zone,”“FTZ” for “Free Trade Zone,” and “FEZ” for “Free Economic Zone.”


companies from among zones designated by a presidential decree; and (4) a zone for

leasing or transferring lands to foreign-invested companies engaged in any service

industry that has a high added value, such as finance, and is designated by a

presidential decree. Article 2.6 of the same Act defines “foreign-invested companies”

(or enterprises) as companies in which foreign investors have invested.

The central and local governments jointly purchase lands and lease them to

foreign-invested companies to relieve the financial burden on the applicant

companies. In addition, foreign investment zones offer various tax or rental fee

reductions and exemptions.

There are complex-type and individual-type foreign investment zones. Complex-

type zones refer to areas of national or general regional industrial complexes that are

designated for lease or sale. This type of foreign investment zones is aimed at

foreign-invested SMEs. Enterprises eligible for lease or purchase of lots in complex-

type zones are generally enterprises accompanying high technology, corporate

research labs and R&D firms, multipurpose logistics terminal enterprises, and others.

For the designation of complex-type foreign investment zone, the relevant local

government must secure demand for over 60% of the candidate area (at least 33,000 m2

and over 50% of the non-metropolitan area to be designated as a small-scale foreign

investment zone, and submit the designation plan to the Ministry of Trade, Industry

and Energy for deliberation.25)

Individual-type foreign investment zones attract large foreign-invested companies

and are designated as units of these companies’ establishment. The legislation

envisages the minimum amount of FDI to be made in a prospective FIZ: USD 30

million for manufacturing or high-technology enterprises; USD 20 million for tourism,

industry-supporting service enterprises (other than logistics); USD 10 million for

logistics and social overhead capital; and USD 2 million for R&D facilities.26)

As of December 2012, there were 19 complex-type and 60 individual-type foreign

investment zones in Korea. <Table 3-5> briefly describes their main characteristics.


25) KOTRA, Doing Business in Korea, 2013, p.46.

26) Ibid, p.47.


4.2.2. Free Trade Zones

Free trade zones are areas - industrial complexes, airports, seaports, distributioncomplexes, freight terminals and others - where free activities of manufacturing,logistics, distribution and trade are guaranteed pursuant to relevant laws. Therationale for the launch of such zones is to generate synergy effects throughclustering enterprises in manufacturing and logistics sectors. Free trade zones areconsidered as being out of the nation’s customs territory, so that the country’sCustoms Act generally does not apply here.27)


Table 3-5 Key Characteristics of Foreign Investment Zones

Category Complex Type Individual Type

OverviewAreas are designated in advance to attractsmall- and medium-sized foreign-investedcompanies (since 1994).

Areas are designated upon the request offoreign investors who would make large-scale investments (since 1997).

Location Industrial complexNo limitations (areas that foreign investorsprefer)

Requirement fordesignation

(or occupancy)

Foreign investment ratio shall be 30% ormore.

The investment amount shall be more thanthe required minimum amount by businesssector (USD 30million for manufacturing,USD 20 million for tourism, USD 10 millionfor logistics, etc.).

Site support

Land is purchased before it is leased tocompanies.Subsidies for purchase cost:- Seoul metropolitan area: 40%, other areas:75%

Land purchase cost is subsidized (ifrequested).Share of the subsidy:- Seoul metropolitan area: 40%, other areas:75%

Tax reduction orexemption(CorporateTax, customs duties,acquisition tax, etc.)

Qualifications- Manufacturing: USD 10 million or more- Logistics: USD 5 million or moreReduction or exemption period- National tax (5 years) is exempted 100%for 3 years, and reduced 50% for thefollowing 2 years

- Local tax is reduced or exempted for theduration of up to 15 years

Qualifications- The same as requirement for designationReduction or exemption period- National tax (7 years) is exempted 100%for 5 years, and reduced 50% for thefollowing 2 years

- Local tax is reduced or exempted for theduration of up to 15 years

Reduction orexemption of rent

Rent is reduced or exempted by 75-100%(when necessary, the central or localgovernments purchase and lease land).

Rent is exempted 100% (when necessary,the central or local governments purchaseand lease land).

Source: KOTRA, Doing Business in Korea, 2013, p.47.

27) See Articles 2 and 3 of the Act on Designation and Management of Free Trade Zones, Korea.


Fiscal incentives such as e.g. tax benefits vary depending on the type of businessand the investment size. Zone-located enterprises do not have to go throughcomplicated duty/tax refunds with regard to the goods for export that they haveproduced within a zone with the use of imported inputs. Besides preferentialconditions for the lease of in-zone lands and facilities, they can also benefit from one-stop administrative services for investment reports, various approval or permissionprocedures needed for e.g. construction works, export and import transactions, andother operations. All major incentives in free trade zones are shown in <Table 3-6>.

Entities eligible for the in-zone location comprise, in particular, export-orientedmanufacturing companies, foreign-invested companies in the manufacturing orknowledge services sector, companies in the wholesale export/import business,logistics companies for (un)loading, transportation, storing, and exhibitions etc., andcompanies supporting tenant companies through finance, customs clearance, dataprocessing, and necessary operations.28)


Table 3-6 Incentives in Free Trade Zones

Category Qualifications Details

Tax reduction orexemption

Business accompanying high technology&industry-supporting service businessManufacturing: USD 10 million or moreLogistics: USD 5 million or more

National tax (corporation tax, income tax):for fiveyears (100% for 3 years, 50% forthe following 2 years)Acquisition, registration, and aggregateincome tax:100% exemption for 15 years

Special cases oncustoms duties

Customs duties are exempted on foreign goods, since the Customs Act is not applied infree trade zones.Customs duties are exempted or refunded for domestic goods whose import declarationis made in freetrade zones.

Exemption ofvalue-added tax

Domestic goods whose import declaration is made in free trade zonesForeign goods and services supplied or provided among companies in free trade zones

Rent reduction orexemption

100% exemption from rent:- Foreign-invested companies with a new foreign investment amount of USD 10 millionor more- Foreign-invested companies with a foreign investment ratio of over 30%, and a newforeign investment

- amount of USD 1 million or more- New foreign investment of USD 500,000 or more in high technology business,

businesses accompanying high technology & industry-supporting service businessesSource:KOTRA, Doing Business in Korea, 2013, p.56.

Source: KOTRA, Doing Business in Korea, 2013, p.47.

28) See Article 10 of the Act on Designation And Management of Free Trade Zones, Korea.


As of March 2010, there were eight industrial complex-type free trade zones inMasan, Gunsan, Daebul, Iksan, Donghae, Yulchon, Ulsan, and Gimje, one airport-typeFTZ in Incheon International Airport, and five seaport-type FTZs in Incheon, Busan,Gwangyang, Pohang, and Dangjin. In 2010, a total of 182 companies operated in FTZs,with 11,184 workers employed and USD 234 million of foreign investment attracted.29)

4.2.3. Free Economic Zones

Free economic zones aim to improve the business environment for foreign-invested enterprises and living conditions for foreigners. The rationale for thisconcept was to make Korea a Northeast Asian business hub where free economiczones would serve as centers for global networking, Northeast Asian logistics,research, and production for cutting-edge technologies (such as IT, BT, NT, CT) andknowledge-based industries, and corporate settlement.30)

Free economic zones are equipped with infrastructure such as high-tech industrialcomplexes and facilities to support corporate activities. They also intend to provide apleasant living environment to attract excellent human resources at home andabroad. Major sectors operating in zones include manufacturing industry, logistics,medical services, education, foreign broadcasting, tourism, financial services, and etc.The main difference between free economic zones and other types of comparablezones is in that the former pursue a complex development of industry, business(commerce), logistics, and housing.

As the last section of this Chapter will suggest opening a free economic zone inHungary, this section will discuss this type of SEZs in a more detailed way.

The implementation of a free economic zone project proceeds in three majorsteps including designation, development, and investment- and living-conditions-related stages.


29) Sang Young Lee,“FDI Site Support & Permit System,”KICOX et al., 2010, p.49.

30) See Korea’s Free Economic Zone Planning Office, http://www.fez.go.kr/en/what-is-free-economic-zone.jsp.

[Figure 3-4] Implementation of a Free Economic Zone Project


In each of these implementation stages, the government - both central andregional/local - plays an important role, as considered below.

4.2.3.1. Designation

The Minister of Trade, Industry and Energy sets a ten-year Basic Plan for FreeEconomic Zones (hereinafter the “Basic Plan”) to be reviewed every five years where(s)he elaborates on the main purposes and medium- and long-term development offree economic zones, attraction of foreign investment, differentiated developmentstrategies for each zone, incentives, and other necessary matters.31) The First Basic Plancovering the period of 2013-2022 was adopted under Notification No. 2013-74 (July2013) of the Ministry of Trade, Industry and Energy.

A free economic zone is designated by the Minister of Trade, Industry and Energyeither, (1) on the request by a city mayor or provincial governor or (2) on his/her owninitiative. In the first case, the request must be submitted together with adevelopment plan for a proposed zone. The development plan must specify, inparticular, the area and location of the zone, the need for such zone, finance-inducement plans, various infrastructure development plans including healthcare,educational and welfare facilities, programs for attracting industries, and others.Should the development plan concern matters related to industrial complexes, therequesting mayor or governor must consult with the Minister of Land, Infrastructureand Land before submitting his/her request for the designation of a free economiczone. The designation of the zone is possible after consultations with the heads ofrelevant administrative bodies and deliberations in the Free Economic ZoneCommittee of the Ministry of Trade, Industry and Energy. In the second case above,the Minister may designate the zone after obtaining consent thereto from thecompetent mayor or governor and the Free Economic Zone Committee’s review.32)

The conditions for the designation of a free economic zone comprise a number oflegally defined criteria, such as; (1) consistency with the Basic Plan, (2) sufficiency of amove-in demand by domestic and overseas companies, (3) the environment forforeigners’ settlement, (4) availability of land as well as metropolitantraffic/information networks, water and electricity supply, and other infrastructuralfacilities, (5) economic feasibility of a zone development, (6) financial burden on localgovernments, feasibility of ways of securing financial resources including privatecapital, and (7) availability of professional manpower, sustainable development, andothers.33)


31) Articles 3.2 and 3.3 of the Special Act on Designation and Management of Free Economic Zones, Korea.

32) Articles 4 and 6 of Special Act on Designation and Management of Free Economic Zones, Korea.

33) Article 5 of the Special Act on Designation and Management of Free Economic Zones, Korea.



Table 3-7 Status of Free Economic Zones (as of September 2013)

Name Incheon Busan-JinhaeGwangyangbay

areaYellow Sea

Area 169.5㎢ 83.1㎢ 85.12㎢ 13.84㎢

Launch Date(Designation Date):

Y/M/D

2004.10.15(2003.08.11)

2004.3.30 (2003.10.27)

2004.3.24 (2003.10.27)

2008.7.22 (2008.4.25)

Airport/PortIncheon Int 1

AirportIncheon Port

Gimhae AirportNew Busan Port

Gwangyang PortYeosu Airport

Pyeongtaek PortDangjin Port

DevelopmentPeriod

Year ofCompletion

2020 2020 2020 2020

ProcessⅠ. 03 ~ 09Ⅱ. 10 ~ 14Ⅲ. 15 ~ 20

Ⅰ. 04 ~ 06Ⅱ. 07 ~ 15Ⅲ. 11 ~ 20

Ⅰ. 04 ~ 10Ⅱ. 11 ~ 15Ⅲ. 16 ~ 20

Ⅰ. 08 ~ 13Ⅱ. 14 ~ 20

Major Industriesunder the Basic

Plan

- Business/Finance - Logistics - High-tech - Medical/ BT - Education - Culture/Tourism

- Logistics - High-tech - New city - Tourism/Leisure - Education/Medical

- Logistics - Manufacturing - Offshore - Tourism/Leisure

- Auto parts - Semiconductor/LCD - Steel/Petrochemistry

NameDaegu-

GyeongbukSaemangeun-Gunsan

East Coast ChungBuk

Year ofCompletion

ProcessⅠ. 08 ~ 13 Ⅱ. 14 ~ 20

Ⅰ. 08 ~ 20 Ⅰ. 13 ~ 24 Ⅰ. 13 ~ 20

Source: Korea’s Free Economic Zone Planning Office, http://www.fez.go.kr/en/what-is-free-economic-zone.jsp.

Area

Launch Date(Designation Date):

Y/M/D

2008.08.13(2008.04.25)

Airport/Port

Major Industriesunder the Basic

Plan

2020 2020 20202024DevelopmentPeriod

- U-IT - High-techTransport Part

- Green energy - KnowledgeService

- Automobile/Shipbuilding

- Machinery/ Parts - Renewable Energy

- Tourism/ Leisure

- High-tech Components &Materials

- Logistics - R&D - Tourism/ Leisure

- BIO - Airline/Air Machine

- Tourism/ Leisure - Auto Parts

Daegu Int 1 Airport

Gunsan PortSaemangeum Port

YangYang Int 1Airport Donghae Port

Cheongju Int 1Airport

2008.08.28(2008.04.25)

2013.07.09(2013.02.04)

2013.04.26(2013.02.04)

30.04㎢ 50.3㎢ 8.25㎢ 9.08㎢


To date, eight free economic zones have been designated, with most of them tobe completed by 2020. They are as follows:

First phase of designation (2003): Incheon, Busan-Jinhae, Gwangyang bay areaSecond phase (2008): Yellow Sea, Daegu-Gyeongbuk, Saemangeum-GunsanThird phase (2013): ChungBuk, East Coast

For the sake of a greater differentiation of the existing zones, the First Basic Plandetermined three priority business categories for each zone, as follows:34)

Incheon: aviation logistics, bio-industry, and knowledge-based services;Busan-Jinhae: complex logistics, advanced transportation/machine parts, andleisure/recreation;Gwangyang bay area: petrochemicals, steel-related industry, and port logistics; Yellow Sea: steel materials, automotive application components, and IT-relatedparts and components;Daegu-Gyeongbuk: IT convergence, advanced transportation/machine parts,and advanced medicals;Saemangeun-Gunsan: auto machine/parts, renewable energy, and marineleisure/tourism; East Coast: metal and new materials, port logistics, and tourism/leisure; ChungBuk: bio-industry, new IT, and auto/aviation parts.

4.2.3.2. Development

A city mayor or provincial governor designates a zone development projectoperator among the State, local governments, administrative bodies, publiccorporations, regional corporations or certain private entities with capital. In thecourse of the operator’s selection, they consider, inter alia, the candidate’s capacity toattract foreign investment, financial solidity, and experience with similardevelopment projects.35)

Within two years of its designation, the development project operator mustdevise an implementation plan for developing the zone to be approved by the mayoror governor concerned. The operator must commence the development project, inprinciple, within one year from the approval of the implementation plan. Anydeveloped land or installed facilities under the relevant operator’s implementationplan cannot be used before the work completion inspection by the mayor/governorin charge.36)


34) Ministry of Trade, Industry and Energy of Korea, “The First Basic Plan for Free Economic Zones (2013-2022),”

Notification No. 2013-74 (July 2013), pp.81-88.

35) Article 8.3 of the Special Act on Designation and Management of Free Economic Zones, Korea.

36) Articles 9, 12, and 14 of the Special Act on Designation and Management of Free Economic Zones, Korea.


All expenses associated with the development projects are borne, as a generalrule, by the operators concerned. But, the State or local governments may grant fiscalincentives - reduction of or exemption from corporate tax, income tax, customsduties, acquisition tax, registration tax, and property tax, and other charges - to theoperator if this is necessary for the smooth implementation of the zone developmentproject.37)

The First Basic Plan envisages main development directions for free economiczones aimed at nurturing four fundamental bases such as; (1) a global business base,(2) a future industry growth base, (3) a regional economy development base, and (4)a regulatory reforms base.38)

In the first capacity above, free economic zones should become a site for world-market-oriented business cooperation among global enterprises, universities,research institutes and international organizations. For this, the government intendsto improve the incentive system for investors and adjust living conditions forforeigners to international standards.

In the second capacity, free economic zones should develop into a focal point forfostering next-generation industries by attracting domestic and overseas advancedtechnologies and human and material resources. To this end, the governmentcommits to build a high-tech manufacturing and services infrastructure, and operatea flexible support program to provide necessary information, finance, andmanpower.

In the third capacity, free economic zones should serve as a regional economicdevelopment base by enhancing linkages with leading industries within themetropolitan area where the zone concerned is located. This requires specializationof free economic zones and differentiation between them and other similar zones.

Finally, free economic zones should act as sites for reforms of governmentregulations concerning location conditions, labor, environment, metropolitan areas,and etc. The results of such regulatory reforms within the zone will gradually beextended to all parts of the country.

The Incheon Free Economic Zone has so far been most developed among theeight designated zones.39) It is located in the west coast region close to the capital city


37) Articles 14.2 and 15 of Special Act on Designation and Management of Free Economic Zones, Korea.

38) This and the following paragraphs on development directions of free economic zones are drawn from Ministry of

Trade, Industry and Energy of Korea (2013), supra note 34, p.18.

39) The following information about the Incheon Free Economic Zone is drawn from Incheon Free Economic Authority,

http://www.ifez.go.kr; Korea� Free Economic Zone Planning Office, http://www.fez.go.kr; Global Green Growth

Institute (GGGI), “GGGI Opens Liaison Office in Songdo,”4 December 2013, http://gggi.org/gggi-opens-liaison-office-

in-songdo; Lee Sun-young, “Korea Approves First Foreign Casino Operator,”The Korea Herald, 19 March 2014.


(approximately 50km distance from central Seoul), and is within 1-2 hour’s travel timeto China and Japan. As seen from Figure 3-5, this zone - with the estimatedpopulation of 512,000 people and the total area of three times the size of Manhattan- consists of three parts: Songdo, Yeongjong, and Cheongna.

Songdo is designed for; (1) international business via hosting multinationals and

(regional)headquarters of international organizations, convention centers, and trade

centers, (2) IT, BT, R&D projects, and (3) foreign schools and hospitals. In December

2013, the Global Green Growth Institute opened its liaison office in Songdo,

following the opening there of a new World Bank office and the United Nation’s

Green Climate Fund. It is noteworthy that this is the first time not only for Korea but

also for Asia to host a large global environmental agency such as the Green Climate

Fund, as most of the environmental organizations are located in Europe.

Yeongjong - the island where Incheon International Airport is situated -is being

promoted as the center of the aviation industry. It accommodates; (1) industrial

complexes (semiconductor and related parts, automobiles, computer software,


[Figure 3-5] Map of the Incheon Free Economic Zone

Source:Incheon Free Economic Zone Authority, http://www.ifez.go.kr/jsp/eng/about/about1.jsp.


medicine/medical products, etc.) and logistics terminals, (2) a customs free zone (air

cargo warehouse, international courier centers, etc.), and (3) tourism/leisure facilities

(hotels, golf courses, theme parks, and others). Among most recent projects, the

Korean government preliminarily approved in March 2014 a foreign consortium’s

plan to open a foreigner-only casino resort in Yeongjong. This is a USD 700 million

project of Las Vegas-based casino operator Caesars Entertainment and Indonesian

conglomerate Lippo Group that will be completed by 2018 and include a casino,

hotels, restaurants, shopping, and other commercial facilities.

Cheongna is the place for theme parks, a cutting-edge industry district, leisure and

sport facilities and foreign elementary and secondary schools. It is a location base for

e.g. the Incheon High-tech Park (automobile parts, new materials, IT, advanced R&D

and robotics industry, etc.) and the Dalton International School.

By the completion of the development plan, the Incheon Free Economic Zone

should become a mega-city containing extensive business districts, leisure and

education facilities and pleasant residential areas.

4.2.3.3. Investment and Foreigners’ Living Conditions

The State or local governments may provide various incentives to foreign-invested

enterprises in a free economic zone. The local government may subsidize expenses

arising from developing sites to be rented to foreign-invested enterprises providing

the reduction of or exemption from the rent for land, installing and operating

medical, educational, and research facilities, and building houses for foreigners with

the aim of attracting foreign-invested enterprises. Moreover, foreign-invested

enterprises may be granted the rent reduction or exemption for national or public

property.40)

As seen from <Table 3-8>, free economic zones offer a wide range of fiscal and

non-fiscal benefits through tax incentives and deregulations concerning the

establishment and operation of foreign education institutions and hospitals, the use

of foreign currency, and the provision of foreign broadcasting programs. Foreign

language services and financial support are provided as well.





Table 3-8 Incentives in Free Economic Zones

Tax type

Reduction period

/percentage of

reduction

Conditions for tax

reduction

Foreign-invested

companiesin free

economiczones

Nationaltax

Corporate taxIncome tax

5 years: 100%2 years: 50%

- Manufacturing: Investment of USD 30million or more

- Tourism: USD 20 million or more- Logistics: USD 10 million or more- R&D: USD 2 million or more

3 years: 100%2 years: 50%

- Manufacturing: USD 10 million or more- Tourism: USD 10 million or more- Logistics: USD 5 million or more- Medical institution: USD 5 million or more- R&D: USD 1 million or more

Customsduties

Exempt for 5 years fromthedate of import declaration

- Imported capital goods

Local tax

Acquisition tax 15 years: 100% - Manufacturing: USD 10 million or more- Tourism: USD 10 million or more- Logistics: USD 5 million or more- Medical institution: - USD 5 million or more- R&D: USD 1 million or more

Property tax 15 years: 100%

Developmentproject

implementer infree economic

zones

Nationaltax

Corporate taxIncome tax

3 years : 100%2 years : 50%

- Foreign-invested amount: USD 30million or more, or

- The ratio of foreign investment: 50% ormore

- Total development project expense:USD 500 million or more

Customsduties

Exempt for 5 years fromthe date of importdeclaration

- Imported capital goods

Local taxAcquisition tax,

property tax 15 years: 100%

- Foreign-invested amount: USD 30million or more, or

- The ratio of foreign investment: 50%or more

- Total development project expense:USD 500 million or more

Financialsupport

Reduction or exemption of charges including farmland preparation charge on developmentproject operatorsProvision of government funds for basic facilitiesReduction or exemption of rent for foreign-invested companies (up to 100%)

Improvementof business

environmentfor foreign-

investedcompanies

Regulations on the Seoul metropolitan area such as factory location limits are not applied in freeeconomic zones.Obligation to hire people of distinguished service to the state is exempted.Unpaid holidays for employees in foreign-invested companies are increased, and the period ofemployee dispatch and business sectors subject to dispatch are expanded.


Foreign-invested enterprises in free economic zones are exempted from theapplication of certain laws and regulations regarding employment, metropolitanarea readjustment planning, and State property issues. The State and localgovernments provide preferential assistance in the construction of infrastructuressuch as roads and water supply.41)

As for special measures to improve living conditions for foreigners, they concernforeign language services, foreign currency transactions, foreign schools and medicalinstitutions, casino business, foreign broadcasts, rental houses, and immigrationissues. It is remarkable that, with respect to free economic zones, these measuresremove or soften many restrictions and requirements that otherwise apply in the restof Korea.

The mayor/governor and the head of local governments must render foreignlanguage services through the issuance, receipt, and handling of official documentsin foreign languages - in English and, if need be, other languages - with the aim ofenhancing the convenience of foreign-invested enterprises and foreigners residing ina free economic zone.42)

With respect to financial transactions within the zone, the price in an ordinarytransaction of less than USD 10,000 may be paid directly by foreign means ofpayment between the parties of a such transaction.43)


Table 3-8 Continue

Tax type

Reduction period

/percentage of

reduction

Conditions for tax

reduction

Improvementof living

conditionsfor foreignnationals

Establishment of foreign educational institutions (primary, middle, high school, and university) isallowed.Establishment of foreign hospitals (which also treat Korean nationals) is allowed.Foreign language services are provided at government and public offices and foreignbroadcasting programs are retransmitted.

Streamlinedadministrativeprocedures

Authorization and permission under 36 Acts are provided at once by approving executionplans.The Free Economic Zone Authority is established as a one-stop service provider.

Source:KOTRA, Doing Business in Korea, 2013, pp.58-59.

41) Articles 17 and 18 of the Special Act on Designation and Management of Free Economic Zones, Korea.

42) Article 20 of the Special Act on Designation and Management of Free Economic Zones, Korea; the corresponding

Presidential Decree.

43) Article 21 of the Special Act on Designation and Management of Free Economic Zones, Korea; the corresponding

Presidential Decree.


Any incorporated foreign educational institution may establish a foreign

educational institution in any free economic zone subject to approval by the Minister

of Education. In the event that a Korean national intends to enroll in any foreign

educational institution in the zone, the State cannot restrict his/her admission on the

grounds of a foreign residency requirement. The State or local governments may

provide foreign schools and foreign kindergartens established in the zone with funds

needed for e.g. purchase of sites or installation of facilities.44)

Opening of foreign medical institutions -general hospitals, hospitals, dental

hospitals, or convalescent hospitals with foreign investment ratio being 50% or more -

in a free economic zone is possible subject to permission from the Minister of Health

and Welfare. Moreover, foreigners may open a foreigner-only pharmacy after

completion of appropriate registration procedures. Any holder of a foreign medical

license, foreign dental license, or foreign pharmaceutical license may, if (s)he meets

the standards set by the Minister of Health and Welfare, work for a zone-located

foreign medical institution or foreigner-only pharmacy. In such cases, the holder of a

foreign medical license or foreign dental license is not allowed to render medical or

dental services beyond the scope of permitted duties.45)

The Minister of Culture, Sports and Tourism may grant permits to operate a

foreigner-only casino business in a free economic zone provided that, inter alia, the

amount of foreign investment in the tourism business within a zone is USD 500

million or more and money to be invested is not gains from crimes.46)

Any integrated broadcasting business that runs broadcasting business covering

free economic zones may constitute and operate channels used to retransmit foreign

broadcasts to such zones.47)

Any development project operator must supply construction sites for houses,

accounting for up to 10% of the total number of houses to be supplied in the

relevant project district unit, for the sites for constructing foreigner-only rental

houses. Such houses are prohibited from being sold unless and until ten years have

elapsed from the rent commencement date.48)

As for immigration issues, the visa issuance procedures and maximum period of

stay for foreigners working for zone-located, foreign-invested enterprises may be








adjusted as a result of consultations between the Minister of Justice and the Minister

of Trade, Industry and Energy.49)

4.2.3.4. Administration

The Free Economic Zone Committee of the Ministry of Trade, Industry and Energydeliberates and makes a resolution on various matters concerning basic policy andsystem with regard to free economic zones, designation (revocation or alteration ofdesignation) or development of a zone, provision of administrative services forforeign-invested enterprises in a zone, and coordination of opinions with the headsof central administrative agencies and the mayor/governor in connection with freeeconomic zones.50) The Committee is chaired by the Minister, and comprises viceministers of relevant government ministries, and representatives of the private sector.The Free Economic Zone Planning Office under the Ministry of Trade, Industry andEnergy offers working-level assistance (e.g. preparation of the agenda) to thisCommittee.

Local governments deal with a number of administrative affairs concerning e.g.supervision of housing associations, supply of housing, construction permits andmanagement of buildings, environmental impact assessments, waste management,soil environment conservation, sewerage system management, utilization andmanagement of forests, and other necessary matters specified by law.51)

To perform the administrative functions above, the mayor/governor concernedestablishes an administrative body- a “Free Economic Zone Authority”- and appointsits head with the three-year term of office after consulting with the Minister ofTrade, Industry and Energy. The Free Economic Zone Authority is staffed basically bypublic officials.52)

A branch office of any incorporated association that performs commercialarbitrations may be set up in the Free Economic Zone Authority with a view tosettling zone-related commercial disputes.53)

In order to resolve any difficulties suffered by foreign-invested enterprises andforeigners in their management and living in a free economic zone, themayor/governor appoints an ombudsman for three years from among persons with aforeign language proficiency and extensive experience in dealing with foreign





52) Article 27.2-5 of the Special Act on Designation and Management of Free Economic Zones, Korea.



investment. The ombudsman of a free economic zone collects information aboutforeign-invested enterprises’ management difficulties and foreigners’ living problemswithin the zone as well as puts forward suggestions to responsible administrativebodies. The ombudsman may ask any administrative or relevant bodies forcooperation, and the latter must respond within seven days. The ombudsman mustanalyze results of handing problems every three month and report thereon to theFree Economic Zone Committee within one month of the end of each quarter.

For the sake of efficiency, the free economic zone ombudsman must closelycooperate with the Office of Foreign Investment Ombudsman under the KoreaTrade-Investment Promotion Agency (KOTRA).54) In the light of the evaluation bymany international organizations and foreign governments as a “best practiceexample,” Korea’s foreign investment ombudsman system deserves furtherexplanation.55) It was introduced in 1999 as part of the rapid liberalization of theforeign investment regime to address post-investment management and daily-lifedifficulties experienced by foreign investors and to improve the overall businessclimate in Korea. The foreign investment ombudsman is commissioned by thePresident, on a recommendation of the Minister of Trade, Industry and Energy forthree years to deal with the following mandate:56)

investigation of and tackling difficulties faced by foreign investment andforeign-invested enterprises; advancement of recommendations for improving the foreign investmentsystem, the implementation thereof to relevant administrative agencies andpublic bodies; and other necessary matters for resolving problems of foreign investment andforeign-invested enterprises.

In the Office of the Foreign Investment Ombudsman, specialists in labor, taxation,finance, construction, and other fields provide foreign-invested companies one-on-one service in investigating and resolving a wide range of grievances. The Officecollects and analyzes information concerning the problems foreign firms experience,request the cooperation and recommend the implementation thereof to relevantadministrative agencies, propose new policies to improve the foreign investmentpromotion system, and carry out other necessary tasks to assist foreign-investedcompanies in solving their grievances. As is evident from [Figure 3-6], more than4,000 grievance cases have been resolved so far.


54) Article 28 of the Special Act on Designation and Management of Free Economic Zones, Korea; Article 29 of the

corresponding Presidential Decree.

55) Françoise Nicolas et al., “Lessons from Investment Policy Reform in Korea,”OECD Working Papers on International

Investment, 2013/02, OECD Publishing, p.25.

56) Article 15-2(2) of the Foreign Investment Promotion Act, Korea; Article 21-3(1)-(2) of the corresponding Presidential

Decree.


4.2.3.5. Evaluation of Free Economic Zones

The First Basic Plan was adopted ten years after the designation of the first freeeconomic zones in Korea. Until then, free economic zones have been launchedwithout a comprehensive nationwide master plan. The rationale for the adoption ofthe Basic Plan was to address the absence of a development vision, lack of zone-specific differentiation, delays in development of some zones, insufficiency offoreign investment attracted, and other problems that the free economic zoneshave faced.57)


[Figure 3-6] Grievance Resolution by the Office of the Foreign Investment Ombudsman

Source: Office of the Foreign Investment Ombudsman of Korea, “Statistical Data,” http://www.i-ombudsman.or.kr/eng/au/index.jsp?num=9.

57) Ministry of Trade, Industry and Energy of Korea (2013), supra note 34, p.3.


Considering the current state of play, the overall evaluation of the free economiczones is that, despite their importance, they have not yet progressed in the way thegovernment initially anticipated. Preliminary results and problems associated withthese zones can be summarized as follows.

As of July 2013, more than half (55.6%) of the total territory of all eight freeeconomic zones remained non-developed. Although free economic zones are long-term projects planned for 15-20 years, the development rate is still lower than it wasinitially predicted. Such a slow progress has been caused by, inter alia, the globaleconomic downturn, the slowdown in the local real estate market, a sudden surge ofthe land price following the designation of free economic zones, the existence ofcertain regulatory restrictions, overlaps with other comparable zones and otherfactors that have lessened the attractiveness and economic feasibility of freeeconomic zones.58) According to the First Basic Plan, the designated free economiczones should be fully developed by 2022.

As seen from <Table 3-9>, over 2004-2012, free economic zones were able toattract foreign investment in the amount of USD 6.78 billion that accounts for only6% of the total amount of foreign investment induced to the country during thesame period though the pace of investment inflows has increased since 2009. TheBasic Plan envisages USD 20 billion as a target for the attraction of foreigninvestment for the next decade (2013-2022).59)

According to the First Basic Plan, free economic zones (in particular, in Incheon)have succeeded in attracting superb foreign educational institutions and researchinstitutes with three kindergartens/schools, three graduate schools and six researchinstitutes opened, and three colleges/graduate schools to be founded soon. There arememorandums of understanding with seven colleges/graduate schools and three


58) Ibid., pp.8, 14, 21.

59) Ibid., p.21.

Table 3-9 State of Play in Attraction of Foreign Investment to Free Economic Zones

Year ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 Total

Amount inbillion USD(Share in

nationwideforeign

investmentinflows, %)

0.12(0.9)

0.58(5.0)

0.13(1.2)

0.31(3.0)

0.23(2.4)

0.79(6.9)

0.95(7.2)

1.15(8.4)

2.52(15.5)

6.78(6.0)

Source: Ministry of Trade, Industry and Energy of Korea, “The First Basic Plan for Free Economic Zones (2013-2022),” p.9.


research institutes.60)

As of the end of 2012, 1,915 domestic enterprises and 164 foreign-investedenterprises moved into the free economic zones.61) <Table 3-10> shows that most ofthe enterprises are concentrated in Incheon (876), followed by Busan-Jinhae (625),Saemanguem-Gunsan (385), and so on.

Notwithstanding the recent increase, the current level of foreign investmentinflows is still beyond the government’s expectations. This can be explained, inparticular, with the absence of a comprehensive strategy of attracting foreigninvestment to free economic zones, competition among these zones due to overlapsin development strategies and business sectors as well as the lack of anchorenterprises in the zones.62) As the current incentive system within free economic zonesis designed basically to the advantage of foreign investors, this state of play may alsohave discouraged investment by domestic companies.

5. Recommendations

In previous sections, we discussed both Hungarian and Korean SEZ policies.Compared to Hungary, Korea has more leeway to promote zone-located enterprisesas it is not constrained by EU law. It is true that both Korea and Hungary are equally


60) Ibid., p.9.

61) Ibid.

62) Ibid, p.10.

Table 3-10 State of Play in Attraction of Foreign Investment to Free Economic Zones

IncheonBusan-

Jinhae

Gwangy

ang bay

area

Yellow

Sea

Daegu-

Gyeong

buk

Saeman

geum-

Gunsan

Total

D F D F D F D F D F D F D F Total

Manufacturing

51 6 567 25 60 13 9 - 10 - 359 16 1,056 60 1,116

Non-manufact

uring 775 44 - 33 19 26 - - 55 1 10 - 859 104 963

Total 826 50 567 58 79 39 9 - 65 1 369 16 1,915 164 2.079

Source: Ministry of Trade, Industry and Energy of Korea, “The First Basic Plan for Free Economic Zones (2013-2022),” p.9. Note:“D” stands for domestic enterprises, “F” stands for foreign-invested enterprises.


subject to the World Trade Organization’s rules that limit its members’ freedom tosubsidize specific enterprises, industries or regions,63) but the EU has additionalstandards for State aid and its own enforcement mechanism. Notwithstanding thedifferences between Hungary and Korea’s SEZs, we believe that some aspects of theKorean experience may be useful for Hungary’s SEZ policy.

5.1. Why Korea’s Experience Matters

As we can see from international competitiveness indices in [Figure 3-7], theHungarian business environment has generally deteriorated over the last decade.Moreover, the European Commission states that Hungary has become the “leastattractive” among its regional peers - the Visegrád-4 countries - with the “lowestinvestment rate” among them.64)


63) More specifically, see Shadikhodjaev (2011), supra note 5, pp.202-208.

64) See European Commission (2014), “Macroeconomic Imbalances: Hungary 2014,”Occasional Papers 180 (March

2014), p.44.

[Figure 3-7] Hungary’s Business Environment Rankings

Source: European Commission (2014), “Macroeconomic Imbalances: Hungary 2014,” p.43.


The European Commission explains the downward trends in Hungary’s businessclimate with a slow financial market development, a low degree of investors’protection partly resulting from policy unpredictability and high taxes, reducedcompetition in certain services sectors, and a low business sophistication rate.65) Theslow financial market development in Hungary has begun in 2012 and is mostlybased on the industrial sector. As indicated by the Central Statistics Office ofHungary, the total industrial production in the first five months of 2014 has been 9%higher than it was in the first five months of 2013.

The World Bank’s Doing Business annual reports evaluate business regulationsand their enforcement across 189 economies and selected cities at the sub-nationaland regional level. Given a general correlation between the overall ease of doingbusiness and FDIs,66) the Doing Business indicators are worth considering in evaluatingthe investment climate of a particular country.

In all but one criterion in <Table 3-11>, Korea has a higher position, compared toHungary in the ranking of the ease of doing business in the world. In 2013, Koreawas among top 10 countries with the most favorable business environment. One canassume that this is partially due to Korea’s 40-plus years’ experience in operation of


65) See ibid, pp.47-51.

66) See John Anderson and Adrian Gonzalez, “Does Doing Business Matter for Foreign Direct Investment?,”2013,

http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-Reports/English/DB13-

Chapters/DB13-CS-Doing-Business-matter-for-FDI.pdf.

Table 3-11 Doing Business in Hungary and Korea

CriteriaRanks among 189 Economies

Hungary Korea

Starting a Business 59 34

Dealing with Construction Permits 47 18

Getting Electricity 112 2

Registering Property 45 75

Getting Credit 55 13

Protecting Investors 128 52

Paying Taxes 124 25

Trading Across Borders 70 3

Enforcing Contracts 15 2

Resolving Insolvency 70 15

Overall rank 54 7

Source: Word Bank, Doing Business 2014: Hungary, pp.7-8, 2013; Doing Business 2014: Korea, Rep., pp.7-8, 2013.


various SEZs. Indeed, SEZs have often been utilized by many countries includingKorea as areas for testing business liberalization policies and measures prior to theirapplication on a nationwide scale. Therefore, Hungary could expand the role of SEZsin pursuing bold economic reforms aimed at easing doing business.

Given the longer experience (as compared to Hungary) in utilizing the SEZ regime,we believe that Korea’s case of SEZs - both success and failure stories - would beuseful for Hungary in this field.

5.2. Suggestions

As most of Hungary’s trade occurs within EU’s common market with around 75%of exports going to the EU market, Korea’s model of free trade zones do not seem tobe an attractive scheme for Hungary. Perhaps for this reason, Hungary does not have“free zones” within the meaning of EU law - the term that, in our opinion, greatlyresembles the concept of Korea’s free trade zones. Korean-style foreign investmentzones replicate many features of Hungary’s industrial parks that appear to havegenerally worked well so far. Thus, it is unlikely that foreign investment zones as aSEZ model could offer much benefit in Hungary’s circumstances. On the other hand,free enterprise zones seem to be quite unique to Hungary, so that it appears to bemeaningless to draw possible implications from the Korean case for these zones. Inany event, the objective evaluation of the free-enterprise-zone regime is hardlypossible in the present stage given its very short history.

Among the existing SEZ types in Korea, we consider the model of free economiczones as a most worthwhile candidate for the launch in Hungary. The Koreanconcept of free economic zones is different from Hungarian industrial parks and freeenterprise zones in that it pursues a complex development of industry, commerce,logistics and housing within a pre-defined large area, such as e.g. a new town or city,with all necessary infrastructural facilities made available.

Notwithstanding the general criticism that Korea’s free economic zones have sofar not succeeded enough to meet initial expectations, one should bear in mind thatthese are long-term projects not finalized yet. Just as Korea began to search for newgrowth engines beyond the manufacturing sector in the post-1998 crisis period,Hungary should also start thinking about developing promising sectors - in additionto the traditional sectors that are already doing well - that would drive the countrytowards a new development era for the next several decades. Just as Korea createdfree economic zones in pursuit of its goal to become a Northeast Asian economichub, Hungary, recently affected by the financial crisis in Europe, could also use freeeconomic zones to become an economic hub in Central and Eastern Europe. Unlikeother SEZs, free economic zones help to improve foreigners’ living conditions



through reducing foreigner-specific restrictions that are otherwise difficult to removeon a nationwide basis, or creating necessary facilities. This aspect can make the hostcountry more attractive to foreigners and foreign investors.

Since free economic zones require a greater amount of time and sources thanindustrial complexes and free enterprise zones normally do, at the outset only onepilot free economic zone could be opened in Hungary. If this zone succeeds, thenumber of such zones may be increased in the future.

As selection of an appropriate site has a tremendous impact on the zone’s successor failure, the Hungarian government may weigh at least two locational optionsbelow.

First, the free economic zone could, in principle, be launched in a poor regionwith a view to balancing development across the country. In the light of the currentHungary/EU principles of treating investors in poor regions more favorably thanthose in more advanced regions, the free economic zone would create generousincentives for enterprises. But incentives as such will not be enough to be appealingto investors. Well-developed infrastructure within and around the zone would berequired, among others.

Second, an alternative site for the free economic zone could be an advancedregion. Korea’s case shows that a weak linkage to big cities and the lack of synergyeffects with neighboring regions have impeded foreign investment to Korean freeeconomic zones. Thus, under this second option, the future zone could be openedsomewhere around Hungary’s capital city. Although financial incentives (such assubsidies) here would not be as generous as in poor regions, the closeness toBudapest would make high-quality infrastructure, labor, and market easily availableto economic operators in the zone. In addition, the presence of deregulation benefits(cutting red-tape restrictions) would also compensate the lack of availability of cashgrants and other financial stimuli. It is obvious that here the regional developmentaspect would not be the main point in the designation of the free economic zone -something that would distinguish it from free enterprise zones that already pursuethis regional growth policy.

Either scenario of the free economic zone’s location could well foreseeincorporation of existing industrial parks or foreign enterprise zones into theproposed free economic zone. This may find a parallel with Korea’s case as well. Asmentioned above, Korean industrial complexes may be designated as a SEZ (e.g.foreign investment zone) or become part thereof with SEZ-specific incentivesprovided to resident enterprises.



As is evident from the Korean experience, overlaps among different SEZ-types andsimilar schemes may distract investment activities within individual zones. Therefore,we suggest that Hungary’s free economic zone(s) be more specialized than industrialparks and free enterprise zones. In this respect, it is quite remarkable that Korea’sBasic Plan introduced notable adjustments to free economic zones to highlightpriority sectors as mentioned above. Thus, the Hungarian government could identifya few priority sectors that would be major players in the zone. For instance, one ofsuch possible sectors could be renewable energy and related “green” industries thatwould cover related manufacturing sectors, services and R&D activities. The EU isglobally known as an active player in this field. It provides incentives (grants) forgreen energy that would also be available to related enterprises in the proposed freeeconomic zone. Some “green” projects in the zone could be tied to Hungary’straditional sectors, such as the automotive industry, via contributing to e.g. theproduction of eco-friendly cars.

In addition to the identification of priority sectors, the attraction of anchorenterprises - key players in each respective sector or field (e.g. big multinationals) -would be another strategic task for the government. The presence of such anchorswould draw other investors and related enterprises into the zone.

As noted by the European Commission and the Organisation for Economic Co-operation and Development (OECD), despite some genuine efforts of thegovernment, Hungarian companies - especially SMEs - are not yet properly integratedwithin the international value chain. Spill-over linkages between multinational anddomestic companies are still weak. SMEs seldom engage in R&D or innovativeactivities.67) The European Commission concludes that increasing exports and domesticvalue-added content of exports requires a higher degree of economic spillovers frommultinationals to domestic companies and of innovation. This would, in turn,necessitate greater support for R&D projects, improvement of research infrastructure,enhanced cooperation between businesses and universities, and increased financingfor SMEs.68) To increase linkage between big firms (multinationals) and SMEs,Hungary could, for instance, offer greater access to finance to innovative SMEs thatwould conduct joint R&D projects in the free economic zone. In addition, theprovision of certain benefits and privileges to zone-located multinationals oncondition of their cooperation with SMEs would also encourage SMEs’ role in supplychains.

A recent OECD survey reveals that even with certain government’s reforms,administrative burdens - combined with regulatory instability and uncertainty -


67) See European Commission (2014), supra note 64, pp.26 and 51-56; OECD, OECD Economic Surveys: Hungary

2014, OECD Publishing, 2014, p.53.

68) See European Commission (2014), supra note 64, pp.26 and 51-56.


remain high in Hungary, as shown in [Figure 3-8]. Taxation is quite cumbersomeespecially for SMEs that for complying with tax obligations spend 50% more timethan the OECD average time.69) The services sector, in particular retail andprofessional services, is subject to various restrictive regulations, with barriers tocompetition, especially those restricting entry, being high among OECD countries.70)

We believe the free economic zone could be a promising avenue for further red-tapereforms, and this does not appear to be constrained by EU’s regulatory framework.

With respect to administration, the government agency that is in charge ofindustrial parks and free enterprise zones should also be in charge of the freeeconomic zone. This will ensure their better coordination and consistency in the SEZpolicy.71) Establishing the ombudsman system for both country-wide and zone-specificinvestors - similar to Korea’s system- would also be a worthwhile administrativeattempt to enhance the business climate in Hungary.

While the Korean model of free economic zones can be benchmarked in Hungary,


69) OECD (2014), supra note 67, pp.28-29.

70) Ibid., pp.66-69.

71) It is noteworthy that the right to designate free trade zones and free economic zones in Korea was initially given to

two different ministers - the Minister of Trade, Industry and Energy and the Minister of Strategy and Finance - but,

as seen from Annex 3-1 to this Chapter, since 2008 this right has been united under the Minister of Trade,

Industry and Energy.

[Figure 3-8] Administrative Burdens in OECD Countries

Note: The product market regulation indicator for administrative burdens is composed of the following three elements (equal weights):administrative burdens for corporations, administrative burdens for sole proprietor firms, and sector specific administrativeburdens (road transport and retail distribution).

Source: OECD, OECD Economic Surveys: Hungary 2014, p.57.

Index scale of 0-6 from least to most restrictive


it should appropriately be customized to meet local conditions. Some features of theKorean model may not be acceptable. For instance, Korea’s current practice oftreating foreign companies more favorably than domestic ones within free economiczones will likely not work in Hungary’s case.

Finally, we wish to conclude this study with two recommendations on the bilateralcooperation between Hungary and Korea with respect to SEZs. First, given thecomplexity of the free economic zone project, we suggest that a thorough feasibilitystudy for launching such a zone in Hungary be done. This could well be a new topicfor a future Korea-Hungary Knowledge Sharing Program. The feasibility study couldaddress various questions, including e.g. financial soundness of the project, itspotential socio-economic effects, appropriate location of the zone, promising sectorsto be attracted to the zone as well as comparative advantages of the zone versusother zones in both Hungary and neighboring countries. Consideration of the latterfactor would help the government to identify the ways of making Hungary aneconomic hub in its region. Second, there is a need for a regular government-to-government and private-level dialogue between two countries with a view toexploring and conducting joint projects in each other’s SEZs. We believe that suchSEZ-related cooperation will help both sides to further advance into each other’smarket as well as the respective regional market.


Annex 3-1 Comparison of Korean SEZs (as of 2 March 2010)

Category

Free Trade Zone Free Economic zoneForeign Investment

ZoneComplex type Individual typeIndustrialComplex

Airport, port,logistics hub

Governing law

The Foreign Investment PromotionAct

The Act on Designation andManagement of Free Trade Zones

The Special Act onDesignation andManagement ofFree EconomicZones

Objective

Foreign investment promotion,transfer of advanced technologies,job creation

Foreigninvestmentpromotion, tradepromotion,regionaldevelopment

Foreigninvestmentpromotion,development ofa global logisticsbase

Foreign investmentpromotion,enhancement ofnationalcompetitiveness,balanced regionaldevelopment

Location

Within anindustrialcomplex

No limitation Areas near ports,airports,industrialcomplexes

Ports, airports,distributioncenters, cargoterminals, etc.

Areas nearinternationalairports, ports



Annex 3-1 Continue

Characteristics

Managed asindustrialcomplex for lease

Designated bythe unitof individualbusinessestablishment

Non-tariff district Status of a specialadministrative district(regional cooperative)* 20 mil. - 60 mil.pyeong (Onepyeongequals 3.3 m2)

Designationauthority

Mayors and Governors devise plansThe Foreign Investment

Committee deliberates the plans

The Minister of Trade, Industry&Energy

The Minister ofStrategy and Finance

The Minister ofTrade, Industry &Energy since March2008

Qualificationsfor occupancy

Foreigninvestment ratioof 30% or moreformanufacturing,logistics, etc.Foreigninvestmentamount shall bedouble the landprice within fiveyears sinceconcluding thecontract.

Business sector &FDI requirements* Manufacturing:US$ 30mil. ormore* Tourism: US$20 mil. or more* Logistics: USD10 mil. or more* R&D: at leastUSD 2 mil. ormore (10researchers witha masters’ degreeand experienceof three years ormore)

Domestic or foreign exporterForeign-invested companyWholesale business mainly forexport and importComprehensive logistics business

Foreign-investedcompanyManufacturing,logistics, medicalinstitutions,educationalinstitutions, foreignbroadcasting services,financial institutions,etc.

Requirementsfor taxabatement/exemption

Manufacturingover USD 10 mil.or more Logistics:over USD 5mil. ormore

The same as theaboverequirements fordesignation

The same as the complex-typeforeign investment zone (Article121 of the Restriction of SpecialTaxation Act)

Manufacturing,tourism: USD 10 mil.Or moreLogistics, medicalinstitute: USD 5 mil.or more

Taxes subject toexemption/reduction

Corporate tax,income tax: 5yearsLocal tax: withinthe duration ofup to 15 years

Corporate tax,income tax: for 7yearsLocal tax: withinthe duration ofup to 15 years

Corporate tax, income tax: 5 years(100%for 3 years, 50% for thefollowing 2 years)Local tax: adjusted within 15 yearsin accordance with ordinances

Corporate tax,income tax: 5 years(7years whererequirements forindividual foreigninvestment are met)Local tax: for up to 15years

Corporate tax and income tax are reduced or exempted for 7 years for industry-supportingservice business and business accompanying high technology regardless of regions (100% for 5years, 50% for the following 2 years)



Annex 3-1 Continue

Customs dutiesreduction orexemption

Customs duties are exempted oncapital goods for 3 years

Deferment of customs dutiesCustoms duties areexempted on capitalgoods for 3 years

Rent

About 10/1,000of the land price(Stated in thebasic managementplan)

100%exemption onnational or publicproperties

About 1% of the land price (to bedetermined by managementauthorities after consultation withthe Ministry of Strategy andFinance)

About 1% of the landprice (to be determinedby authorities)

Rentreductionor exemption

Advancedtechnology &USD 1 mil. ormore: 100%Manufacturing &USD 5mil ormore: 75%(Parts/materialrelated complex:100%)

Foreign investment & USD10 mil.,the foreign investment rate of30% & USD 1 mil, businessaccompanying high technology &USD 0.5 mil.: Rent for land areexempted 100%

Authorities determinethe reduction orexemption rate inreference to regionalordinances. (50%-100%)

Share offinancialsupport

Seoul metropolitan area: 40% bythe central governmentOther areas : 75% by the centralgovernment

Decision to be made on thegovernment support ratio at thedesignation phase

Undecided

Note

Unified (on December 31, 2004)- Amendment to the Foreign

Investment Promotion Act※Complex-type foreign investment

zones were“ complexes forforeign-invested companies”under the Industrial ClusterDevelopment and FactoryEstablishment Act before the twotypes were unified.

Unified (on June 23, 2004)- Amendment to the Act onDesignation and Management ofFree Trade Zones (on March 22,2004)

3 free economic zoneswere additionallydesignated (on May 6,2008)

Designatedareas

17 complex-type foreigninvestment zones: Cheonan,Ochang, Inju, Gumi,Pyeongdong, Daebul, Jinsa,Jangan 1 2, Dangdong,Sacheon, Osong, Dalseong,Gumi Parts, Oseong,PohangParts, Iksan Parts36 individual-type foreigninvestment zones: S-LCD, AsahiGlass FineTechno Korea, etc.

8 industrial complexes:Masan,Gunsan, Daebul, Iksan,Donghae,Yulchon, Ulsan,Gimje1 airport: Incheon InternationalAirport5 ports: Incheon, Busan,Gwangyang,Pohang, Dangjin

3 initially designatedfree economiczones: Incheon,Busan (Jinhae),Gwangyang3 newly designatedfree economiczones: Jeonbuk(Saemangeum-Gunsan), Daegu-Gyeongbuk (Gumi,Gyeongsan,Yeongcheon), Yellow Sea(Pyeongtaek,Dangjin)

Source:KOTRA, Doing Business in Korea, 2013, p.60.



References

Act on Designation and Management of Free Trade Zones, Korea.

Anderson, John and Adrian Gonzalez, “Does Doing Business Matter for Foreign Direct

Investment?”, 2013.

http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-

Reports/English/DB13-Chapters/DB13-CS-Doing-Business-matter-for-FDI.pdf

Cho, Hyeyoung, 2011 Modularization of Korea’s Development Experience: Industrial Park

Development Strategy and Management Practices, Ministry of Strategy and Finance,

Korea, 2012.

Choi, Yong-Seok, “Development Strategies for Special Economic Zones in Myanmar”, in KSP

Report, Priority Assignments for Economic Development of Myanmar, Ministry of

Strategy and Finance, Korea, 2012.

Engman, Michael et al., “Export Processing Zones: Past and Future Role in Trade and

Development”, OECD Trade Policy Working Paper No. 53, TD/TC/WP(2006)39/ FINAL (23

May 2007).

European Commission (2014), “Macroeconomic Imbalances: Hungary 2014”, Occasional

Papers 180 (March 2014).

European Commission, “Free Zones”,

http://ec.europa.eu/taxation_customs/customs/procedural_aspects/imports/free_zones/in

dex_en.htm

European Commission, “Free Zones in Existence and in Operation in the Community, as

notified by the Member States to the Commission” (as of 13 August 2013),

http://ec.europa.eu/taxation_customs/resources/documents/customs/procedural_aspects/

imports/free_zones/list_freezones.pdf

FIAS [The Multi-donor Investment Climate Advisory Service of the World Bank Group],

“Special Economic Zones: Performance, Lessons Learned, and Implications for Zone

Development”, 2008.

Foreign Investment Promotion Act

Global Green Growth Institute (GGGI), “GGGI Opens Liaison Office in Songdo”, 4 December

2013, http://gggi.org/gggi-opens-liaison-office-in-songdo

HITA, “Free Enterprise Zones”, 2013.

HITA, Investing Guide Hungary 2014: Why Invest in Hungary?, 2014.

HITA, “The Role of HITA in Investment Promotion”, presentation by Judit Czak?, Budapest,

19 February 2014.

Hungary’s Industrial Park Portal, “Industrial Park Council”,


https://www.ipariparkokmagyarorszag.hu/en/industrial_park_council

ILO, “Good Practices in Labour Inspection in Export Processing Zones”, 2012.

Incheon Free Economic Authority, http://www.ifez.go.kr

Korea Industrial Complex Corporation’s database for the fourth quarter of 2013,

http://www.e-cluster.net/new_app/indust/stat/danji_stat_list.jsp?BOARDNO=10113

Korea’s Free Economic Zone Planning Office, http://www.fez.go.kr

Korea’s Free Economic Zone Planning Office, http://www.fez.go.kr/en/what-is-free-

economic-zone.jsp

KOTRA, Doing Business in Korea, 2013.

Lee, Sang Young, “FDI Site Support & Permit System”, KICOX et al, 2010.

Lee, Sun-young, “Korea Approves First Foreign Casino Operator”, The Korea Herald, 19

March 2014.

Ministry for National Economy of Hungary, “Special Economic Zones in Hungary”,

presentation by ?d?m Nagy (Department for Industry and Construction Economy),

Seoul, 31 March 2014.

Ministry of Trade, Industry and Energy of Korea, “The First Basic Plan for Free Economic

Zones (2013-2022)”, Notification No. 2013-74 (July 2013).

Nicolas, Françoise et al., “Lessons from Investment Policy Reform in Korea”, OECD Working

Papers on International Investment, 2013/02, OECD Publishing

OECD, OECD Economic Surveys: Hungary 2014, OECD Publishing, 2014.

Oh, Wonsun, “Export Processing Zones in the Republic of Korea: Economic Impact and

Social Issues”, ILO Working Paper No 75 (1993).

Shadikhodjaev, Sherzod, “International Regulation of Free Zones: An Analysis of

Multilateral Customs and Trade Rules”, World Trade Review (Cambridge University

Press), Vol. 10, No. 2 (2011).

Special Act on Designation and Management of Free Economic Zones, Korea.

Warr, Peter G., “Korea’s Masan Free Export Zone: Benefits and Costs”, The Developing

Economies, Vol. 22, No. 2 (1984).







Chapter4

KSP_헝가리(영문)_3-4장 2015.2.16 6:28 AM 페이지193 SJ_01

Summary

Hungary has made progress in catching up with high-income OECD countries inmany aspects, equipped with good quality of human capital and a high degree ofopenness of the economy. However, the level of innovation activities andperformance still has room for improvement. The main weaknesses of Hungaryinclude low R&D expenditure and the lack of innovation activities among small- andmedium-size enterprises.

In order to strengthen Hungary’s research, development and innovation (RDI)capabilities, it is necessary to thoroughly analyze the entire innovation system, whichincludes knowledge generating system and industrial system. Among many vitalcomponents to raise RDI capabilities of one country, this report focuses on fosteringinnovative enterprises, an important pillar of national innovation system. Inparticular, the emphasis will be on small- and medium-size enterprises (SMEs) thatwill play a pivotal role in the utilization of R&D results. The report contains the casesof major policies that promote innovative SMEs and their innovation activities toassist their spontaneous growth, accompanying the in-depth discussion regarding thepolicies to strengthen Hungary’s RDI capabilities. Among many policy tools used forthe Korean innovative SME development system, the report focuses on; i) policy fundfinancing system, and ii) fostering venture businesses.

First of all, the Korean government has selectively supported industries withsignificant contribution to the national economy using policy fund financing



Jisun Baek (KDI School of Public Policy and Management)

■ Chapter 04


expecting rapid growth in the targeted industries. However, Hungary should becautious about providing policy funds because it may distort the direction oftechnology progress and may impede restructuring of SMEs, which will hinderupgrading their competitiveness.

The purpose of policy funds should be to strengthen SMEs’ capabilities, not tosolve SMEs’ financial difficulties itself.The direct financial support for SMEs should play only a supplementary role forthe market-friendly financing environment, and the government should makean effort to establish a financing environment that can efficiently allocateresources.The government must establish a monitoring system and an evaluation schemeas policy funds for SMEs’ innovation capabilities can be easily misused due to alarge number of firms.

Another critical concern raised about policy funds is the recipient selectionprocess. A corporate assessment system, which selects recipients for the fund, iscrucial in the policy fund financing system, and thus Hungary should analyze itsassessment system and improve it to be more objective and consistent as well as towell reflect the policy goal.

Since the goal of policy funds is to foster innovative and technology-basedSMEs, it would be desirable for Hungary to elaborate a corporate evaluationsystem, which focuses on company’s technology excellence and businessfeasibility rather than financial history unlike most corporate evaluationsystems, which are based on credit ratings.

In addition to policy fund financing system, the government should implementdiverse and extensive business policies in the early stage of venture businessdevelopment in order to foster venture businesses and to promote venture businessstartups. It is vital to establish a financial system, which provides financial resources tostartup ventures such as venture capital and angel investment in addition to theassistance from policy funds.

Korea created public venture funds called the Korea Funds of Funds (KFoF) in2005 and the Angel Matching in 2011 in order to promote investment onventure businesses and companies in the early stage. The Korean governmentalso expanded its deduction on income tax from 10% to 30% to foster angelinvestment from the private sector.The most important infrastructure that Korea established to foster venturebusinesses is the KOSDAQ (Korea Securities Dealers Automated Quotations)market as a trading board of Korea Exchange in 1996. This market is not onlychannel to facilitate SME’s equity financing but also a route for retrieval of

Chapter 4 _ Strengthening R&D Capabilities: By Fostering Innovative SMEs 195


investment in venture capital market. Hungary should take into consideration to establish such kind of market forventure businesses for SMEs’ equity financing and the sustainable growth ofventure capital investment.

Even if there is enough venture capital and financial support from thegovernment, SMEs cannot successfully achieve innovation if they lack their own R&Dcapabilities such as human capital and equipment.

Under such circumstances, it can be more effective to support joint R&D projectswith universities or research institutes, which have R&D human resources andfacilities instead of simply providing funding. Similarly, Hungary should consider introducing a One-stop Clinic Service, whichprovides resolutions to problems SMEs face based on expert analysis ontechnology and management instead of simply providing funding.

The basic premise of policies to stimulate venture capital investment is that thereare enough worthwhile venture businesses that can attract investors and that theypossess strong innovation capabilities. Therefore, Hungary should raise moreprospective entrepreneurs who are ready for a startup company throughentrepreneurship education.

The entrepreneurship education includes programs for teenagers, programs forcollege and graduate students as well as for adults. The education programgenerally teaches knowledge regarding business startup and nourishes theentrepreneurial spirits. Some universities launched a program for Management of Technology (MoT),which is a set of activities related to managing and operating organizations’technology to strengthen its competitiveness. The education program forManagement of Technology not only stimulates students’ interest inentrepreneurship but also raises experts in technology transfer, technologyassessment, and R&D planning.

An additional tool to increase the success rate of business startup is a businessincubator. Business incubators assist the growth of businesses in the early stage,generally providing appropriate support such as management skills, technologicalsupport, manufacturing facilities and equipment, and business mentoring toentrepreneurs.

In order to increase the success rate, a business incubator should providesupport beyond finding available spaces and facilities. It should be able to showthe incubated companies the path to grow and to graduate, and support theevery stage of business startup from business planning to marketing and pilot



production.For example, the Youth Entrepreneur Training Program in Korea provides allthe resources needed for starting a business.

Even with enough venture capital and efficient business incubating system, any ofthose policies will not be able to bear fruit if there are not enough people who haveinnovative ideas. In order to make the policies more effective and connect firms’innovation activities to commercialization, Hungary should first evaluate its ownnational innovation system, maintain infrastructure for innovation activities, andexamine the capabilities of universities and research institutes, which are responsiblefor knowledge generation and diffusion. Furthermore, Hungary should considerintroducing some policy measures to promote business R&D investment such as taxbenefits or other incentives based on the analysis of the potential effects. In addition,Hungary should examine its infrastructure to commercialize the results from basicresearch in which Hungary shows its excellence, and create an appropriateenvironment for R&D commercialization to pursue utilization-oriented R&D.

1. Introduction

Technological progress is an essential source of economic growth, and researchand development (R&D)1) is a vital source of technological progress as manyresearchers confirmed. In particular, technological innovation contributes tosustainable economic growth and job creation as it maintains companies’ competitiveedge in the market. However, investment in R&D is regarded as an area with marketfailure because R&D projects are usually underinvested in the market system.Stakeholders fail to invest in R&D because the outcome of R&D efforts andinvestment is uncertain despite huge amount of investment. In addition, most R&Dprojects do not immediately lead to monetary returns through commercializationeven if the result is success. Moreover, information asymmetries concerning the valueof the investment and the intangibility of the asset that are being created throughthe R&D projects obstruct the socially optimal investment in R&D. Therefore, thegovernment and the related policies play an important role in achieving optimal levelof R&D investment.

With regards to innovation activities, the role of industry is as important asuniversities or research institutes because innovation takes place based on knowledgegenerating activities and firms’ value creating activities. Firms, first, exploitknowledge to create economic values by producing goods. Furthermore, the firmsfind needs for new technology and knowledge during the production process, which


1) According to OECD (2012), research and development (R&D) comprise creative work undertaken on a systematic

basis in order to increase stock knowledge and the use of this knowledge to devise new applications.


may motivate new research projects. (Shin et al., 2012) These activities from theindustry complete the innovation system2), interacting with knowledge generatinginstitutes. Hence, in addition to implementing policies to encourage R&D investment,the government can also contribute to innovation activities by establishing theinstitutions and infrastructure related to universities, research institutes, and firms.

The process of Korea’s economic growth exhibits the significance of technologicalprogress and innovation. In the early stage of growth, Korea imported and absorbednew technologies without creating new technologies. By contrast, at the currentstage, Korea not only can create knowledge for new technologies, but alsocommercialize the outcome from innovation for economic values. Until Koreareached its fully developed stage of technological innovation, the government hasplayed a critical role. For example, in 1962 the Korean government launched the“Science, Technology Promotion Plan“3) to secure experts in technology and toencourage importing advanced technologies from developed countries. Since the late1990s, the government organized science and technology policies for theestablishment of national innovation system through the “Science, Technology andInnovation Plan“ and “Science and Technology Basic Plan.“ In addition to science andtechnology policies, the government has also actively focused on industrial policies tofoster the manufacturing sector and exporting businesses as it understood theimportance of firms in the innovation system.

Hungary has made progress in catching up with high-income OECD countries inmany aspects, equipped with good quality of human capital and a high degree ofeconomic openness. In particular, it emphasizes strengthening the research,development and innovation (RDI) capabilities as it recognizes knowledge-basedcapital as a new source of growth. Hungary has showed strength in science and basicresearch, but it did not succeed largely in commercializing the results from theseresearch acitivities.

In order to strengthen Hungary’s RDI capabilities, it is crucial to thoroughly


2) The term National Innovation System is defined in various studies. OECD (1997) quotes several definitions:

“ .. the network of institutions in the public and private sectors whose activities and interactions initiate, import, modify

and diffuse new technologies.”(Freeman, 1987); “ ..the elements and relationships which interact in the production,

diffusion and use of new, and economically useful, knowledge ... and are either located within or rooted inside the

borders of a nation state.”(Lundvall, 1992); “... a set of institutions whose interactions determine the innovative

performance ... of national firms.”(Nelson, 1993); “ ..the national institutions, their incentive structures and their

competencies, that determine the rate and direction of technological learning (or the volume and composition of

change generating activities) in a country.”(Patel and Pavitt, 1994); “..that set of distinct institutions which jointly and

individually contribute to the development and diffusion of new technologies and which provides the framework

within which governments form and implement policies to influence the innovation process. As such it is a system of

interconnected institutions to create, store and transfer the knowledge, skills and artifacts which define new

technologies.”(Metcalfe, 1995)

3) 1st wave of Science, Technology Promotion Act(1962-1966), 2nd wave of Science, Technology Promotion Act(1967-

1971), 3rd wave of Science, Technology Promotion Act(1972-1976). See (Song, 2005) for detail information.


analyze its entire innovation system, which includes knowledge generating system4)

and industrial system.5) Among many vital components to raise RDI capabilities of onecountry, this report focuses on fostering innovative enterprises, an important pillar ofnational innovation system. In particular, the emphasis will be on small and mediumsize enterprises (SMEs) that will play a pivotal role in the utilization of R&D results.The report contains some major policies that promote innovative SMEs and assisttheir spontaneous growth with an in-depth discussion on policies to strengthenHungary’s RDI capabilities.

The rest of this report is organized into the following sections. Section 2 providesan overview of Hungary’s RDI activities, and Section 3 describes several cases of policyfund financing for SMEs and policies to foster innovative SMEs in Korea. In Section 4,the implications from Korea’s experience will be discussed and recommended policieswill be proposed with some precautions. Section 5 presents concluding remarks andimportant topics that require further investigations and research for strengtheningHungary’s RDI capabilities.

2. Overview of Hungary’s Research, Development and Innovation Activities

Hungary is a central European economy with a strong industry sector in whichforeign investment and technology play a significant role. It has a longstandingtradition in scientific research. In June 2013, the government adopted the Investmentin the Future: National Research and Development and Innovation Strategy (2013-2020), which focuses on key strategic issues.

Hungary has made progress in catching up with high-income OECD countries inmany aspects, equipped with good quality of human capital and a high degree ofeconomic openness. Hungary is classified as a moderate innovator in the level of theEuropean Union. Industries operating within the global value chains such as thepharmaceutical industry, the information technology (IT) sector, and the automotiveindustry along with researchers with international ties significantly strengthen theperformance of the national innovation system. Meanwhile, the research anddevelopment and innovation performance of most Hungarian enterprises lagsbehind that of the enterprises in the more developed EU member states, and still hasroom for improvement.


4) Knowledge generating system implies a dynamic knowledge circulation, including knowledge creation, exchange,

sharing and utilization (Yu & Oh, 2011).

5) Industrial system implies a broadly defined phenomena in which firms enter into and exit from the industry, and

interact with other firms within the market and the value chain.(Shin et al., 2012).


According to OECD (2008b), Hungary’s gross expenditure on R&D (GERD) was1.16% of GDP in 2010 compared to the EU27 average, which was 1.19%, and theOECD average, 2.40% even though Hungary has steadily expanded its expenditureon R&D.6) [Figure 4-1] compares gross domestic expenditure on R&D among OECDcountries.

Moreover, low expenditure on R&D and innovation activity in the private sector isanother reason for the weak innovation performance as [Figure 4-2] illustrates.Despite a recent pick-up - 0.48% of GDP in 2006 and 0.75% of GDP in 2011, businesssector expenditure on R&D is still low. OECD (2008b) points out the heavy concen-tration of R&D activity in a few large firms under foreign ownership as anotherconcern. For instance, only 17% of SMEs participate in product or process innovation7),compared to 34% of the EU average. (European Commission, 2013) [Figure 4-3] alsoexhibits that the propensity to perform product or process innovation is low amongOECD countries. This concern becomes more serious for SMEs.


6) Hungary's GERD has increased to 1.29% in 2012.

7) "Product innovation: the introduction of a good or service that is new or significantly improved with respect to its

characteristics or intended uses. This includes significant improvements in technical specifications, components and

materials, incorporated software, user-friendliness or other functional characteristics." (OECD,2008b)

"Process innovation: the implementation of a new or significantly improved production or delivery method. This

includes significant changes in techniques, equipment and/or software." (OECD,2008b

[Figure 4-1] Gross Domestic Expenditure on R&D, compared to GDP

Source: OECD (2012).


Recognizing the importance of RDI capabilities, which significantly affect theentire economy including employment and growth rate, Hungary builds new RDIstrategies based on the best practice of countries with similar conditions. Hungarypursues a goal in which to reach the EU’s average innovation performance by 2020.


[Figure 4-2] Business R&D Intensity 2011

Source: OECD(2013b).

[Figure 4-3] Product of Process Innovators in 2008-2010

Source: OECD Innovation Statistics published by OECD.


Although the gross domestic expenditure on R&D increased to 1.29% in 2012, itshighest value in the last two decades, it is still far below the 2% average of theEuropean Union. To reach the goal, the Hungarian government plans to expand itsGERD to 1.8% by 2020 and seeks to promote innovative SMEs and foster startupcompanies as these innovative enterprises will play an essential role in the nationalinnovation system.

During the seven years until 2020, Hungary plan to create: More than 30 large research and technological development groups will jointhe “world’s elite”,More than 30 R&D research centers of large global companies will beestablished and strengthened,More than 30 R&D-intensive macro-regional, medium-sized enterprises willproduce and provide services,More than 300 RDI and growth-oriented small enterprises (the so-called“gazelles”) will find their place in the global market,More than 1,000 innovative startups will get the funding required for startingtheir activities, and Many innovative supplier companies with national decision-making centers willprovide services to the global large companies that have already beenestablished or will be established in Hungary.

In particular, Hungary has provided policy loans and subsidies to innovativeenterprises using the EU’s Structural Funds Operative Programmes and the Hungary’sResearch and Technological Innovation Fund (RTIF). The priority of the provision is oncompetitiveness enhancement, knowledge-based economy, physical and culturalresources, financial tools and services, and information and communicationtechnology (ICT) according to the 2014-2020 Economic Development and InnovationOperative Programme (EDIOP). For example, the “Start-up 13” funded by the RTIF isa two-stage plan that supports startup companies, especially technology-basedcompanies, which exploit the results from research and development. In the firststage of the plan, technology incubators will be accredited. In the second stage, theaccredited technology incubators will discover startup companies with potential andsupport them by providing guidance regarding business startup, management andtheir growth. The “Mentor Club” program has also been successfully initiated andoperating to assist startup companies to realize their innovative ideas. This programassigns an expert as a mentor to a startup company that lacks experience.

In addition to startup support programs such as the Start-up 13 and Mentor Club,Hungary also strives to build infrastructure for SMEs’ innovative activities. To bespecific, the Hungarian government has run Jeremie Programmes and provides policyloan credit guarantees to SMEs. Furthermore, venture capital has improved greatlydue to the Fund of Funds and Co-investment from Jeremie Programmes and venture



capital investment all worth 0.66% of GDP in 2012.

However, SME’s access to finance in Hungary is well below EU average, anddomestic SMEs still claim that access to finance is one of the most serious difficultiesdespite the government’s recent efforts. (European Commission, 2013) In order tostrengthen Hungary’s RDI capabilities, Hungary should strive to solve this problem.Moreover, the government must keep in mind that the ultimate goal for providingfinancial resources is innovation activities of SMEs, thus those financial resources canassist establishing a system in which innovative SMEs can be developed and growspontaneously.


[Figure 4-4] Venture Capital Investment, compared to GDP

Source: OECD(2013a).

Table 4-1 Venture and Growth Capital Financing in Hungary, 2007-2011

YearSeed, start-up, early stage

(million HUF)

Later stage expansion

(million HUF)Total1)

20072008200920102011

494479420

5,01311,168

3,45513,303

3001,969140

3,94913,782

7206,98211,308

Source: OECD(2013b).Note: 1. The total excludes buyouts.


As an OECD and EU member country, Hungary must be treated in a different wayfrom other countries participating in the Knowledge Sharing Program (KSP). Inaddition, the standard for assessment and policy recommendations must also bedifferent from other KSP participants because Hungary’s concerns and goals aredifferent from other participants. In this sense, Korea’s experience from the1960s~1980s is not very helpful unlike in other KSP cases. However, Korea’s rapideconomic development experience can comprehensively illustrate the stages ofdevelopment regarding innovation system and economic development, which havetaken a long time for other developed countries. Moreover, Korea has had the sameconcerns as Hungary. Korea has grappled with the solutions, having made greatefforts for the transition to knowledge-based economy. These experiences forstrengthening RDI capabilities and fostering innovation activities of enterprises canhelp Hungary in completing its national innovation system. This does not imply thatpolicies and efforts, which Korea had tried, were all successful. Some policies led toproblems, especially from a distributional standpoint. Some policies may be too earlyto evaluate its success. Therefore, Hungary should not overlook at the problems thatKorea experienced but should observe the lessons that Korea has learned from itsexperience to avoid errors.

3. Korea’s Experience

It should be noted from <Table 4-2> the importance of SMEs in the Koreaneconomy, which represents 99.9% of the whole enterprises in Korea, and those SMEshired 12 million workers in 2011. Particularly, the SMEs proved their importance inthe Korean economy during the financial crisis in the late 1990s. In those days, someof the large conglomerates went bankrupt, and many others underwentrestructuring. However, some innovative SMEs including venture businesses createdjobs and added value while large conglomerates underwent a large-scalerestructuring and layoffs. Furthermore, SMEs accounted for 79.2% of the net increasein employment from 2008 to 2011 according to SBMA (2013). This statistics provedthat SMEs led in job creation during the era of jobless growth, reflecting theimportance of SMEs in employment.

Despite the importance of SMES in the national economy, the SME promotionpolicies carried out in the 1960s and 1970s were actually concentrated on largeconglomerates because of the unbalanced growth strategy. Thus, the Koreangovernment implemented some SME policies from the early 1960s such asestablishing the Industrial Bank of Korea (IBK) in 1961 and the Korea Trade-Investment Promotion Agency (KOTRA) in 1962, but most SME policies were not fullyinitiated until the mid-1970s. As the proportion of subcontracting SMEs and suppliersto large conglomerates increased, the government set them as the policy targets and



initiated support measures such as implementing the Subcontracting SystemPromotion Act in 1975 and establishing the Korea Credit Guarantee Fund in 1976.8)

Although the government underlined the importance of strengthening SMEs’technical competence especially in the parts and materials industry in the 1980s andthe early 1990s, it did not pay much attention to SME’s innovation activities.However, this policy stance has changed since the late 1990s, and the governmentput more emphasis on SMEs’ innovation capabilities rather than the simple technicalcompetence. As a result, the government initiated various policies to strengthenSMEs’ innovation capabilities including the Venture Business Promotion Act.

Korea has grown rapidly based on export-oriented industrialization. While Koreanproducts were competing against products from many countries in the world market,Korean companies and the government recognized the importance of technologicalprogress and innovation through research and development activities. The awarenesson the importance led to the investment on R&D and the policies to encourageinnovation activities. Figure 4-5 shows the gross domestic expenditure on R&D(GERD). Although the expenditure from the private sector has been the main drivingforce of the increase in GERD, R&D expenditure from the government has alsoincreased for the last 30 years.


Table 4-2 Distribution of Firms 2008-2011

Year

Number of firms (thousands)Number of employees

(thousands)

TotalLarge

firmsSMEs Total

Large

firmsSMEs

20083,047 3

(0.1)3,044(99.9)

13,070 1,603(12.3)

11,468(87.7)

20093,069 3

(0.1)3,066(99.9)

13,398 1,647(12.3)

11,751(87.7)

20103,125 3

(0.1)3,122(99.9)

14,135 1,873(13.2)

12,263(86.8)

20113,235 3

(0.1)3,232(99.9)

14,534 1,907(13.1)

12,627(86.9)

Source: The Small and Medium Business Administration.Note 1: The numbers in the parentheses are the proportion (%). Note 2: Data on for-profit businesses (individual, company, and corporation) on the basis of national businesses survey according to SME

basic law. Includes non-employer firms and excludes financial firms.

8) See Park (2013) for Korean SME promotion policy history in detail.


As mentioned earlier, this report focuses on innovative activities in enterprisesamong many vital components to raise RDI capabilities of one country, particularlythose in SMEs. To be specific, in this section, I will briefly describe policy fundfinancing system in Korea, and will also discuss how Korea has taken advantage ofthis system in order to enhance innovation capabilities of SMEs. In addition, I will alsopresent some policies to promote venture businesses9) and how those policies affectthe growth of innovative SMEs. It would be beneficial for Hungary to observe Korea’sexperience in the areas of policy fund financing system and venture businesspromotion policies because; i) one of the main problems regarding innovationactivities that Hungary is facing is low R&D expenditure, especially low business R&Dinvestment, ii) “Access to Finance” is perceived as SME’s main difficulty (EuropeanCommission, 2013), and iii) Korea has adopted various policy measures to financiallysupport SMEs and their innovation activities, and iv) Hungary considers innovativeSMEs as a solution to economic growth as Korea did in the late 1990s. The relatedpolicies are mainly administered by a government department, the Small andMedium Business Administration (SMBA). The Small and Medium BusinessCorporation (SBC), a non-profit, government-funded organization, implementgovernment policies and programs for SMEs such as policy funds, training andconsulting. In addition to the SMBA and SBC, the Korea Credit Guarantee Fund


[Figure 4-5] Gross Domestic Expenditure on R&D

Source: Korea Statistical Information Service, KOSIS.

9) According to Kim & Kim (2013), "A venture business is a SME pioneering a new market on the basis of

independent technology and idea." Currently, Korea has three criteria for venture certification; i) companies invested

by venture capital companies, ii) companies involved in advanced technology level, and iii) companies performing

active R&D activities.


(KODIT), Korea Technology Finance Corporation (KOTEC) and Korea VentureInvestment Corporation (KVIC) also play important roles in promoting SMEs and theirinnovative activities.

3.1. Policy Fund Financing System

Policy funds are financial tools to support enterprises to implement public policies.Policy funds support the areas in which the market system is likely to fail such asinvestment on SMEs, young startup companies, and research and development. Policyfunds also provide support for investment on long-term facility and direct loans toSMEs with low collateral but with growth potential. As these areas are likely to beunderinvested due to information asymmetry and time-lag of return on investment,the government intervenes in the market by providing financial resources to fosterblue chip companies.

In particular, Korea’s policy fund financing system intensively supports theindustries, which contribute to national production and employment significantly,providing policy loans and subsidies for long-term facility and R&D activities. TheKorean system makes use of policy loans, credit guarantees, subsidies and investmenton venture capital, depending on the purpose of the funds. In 2012, creditguarantees accounted for 65% and policy loans, subsidies, and investment onventure capital accounted for 16%, 12% and 7%, respectively. (European


[Figure 4-6] The Role of Policy Funds

Source: Lee(2012).


Commission, 2012) However, the current policy stream emphasizes efficient andmarket-friendly financing environment as the Korean economy develops. Therefore,the direct financing will play only a supplementary role as the government builds asystem, which efficiently allocates resources across policy fund recipients.

In addition to the aforementioned organizations such as the SMBA, SBC, KODIT,KOTEC, and KVIC, Korea Finance Corporation (KoFC), Korea Development Bank(KDB), and the Industrial Bank of Korea (IBK) are also involved in providing policyfunds. Each of these organizations delivers policy funds in different ways withdifferent purposes in order to differentiate itself with other organizations. Forexample, KODIT and KOTEC provide credit guarantees to SMEs with low collateralwhile the KoFC focuses on long-term facility investment. The SBC provides policyfunds to SMEs using various methods such as agency loans via commercial banks,direct loans, and invest on Korea fund of funds.

This subsection describes some programs of policy fund provided by the SBC whichuses various methods of support, and discusses how these programs help to fosterinnovative SMEs and their innovation activities. Moreover, it will present an exampleof corporate assessment scheme for the selection of policy fund recipients followedby the importance of selecting recipients.


[Figure 4-7] Policy Fund Support System in Korea

Source: Lee(2012).


3.1.1. SBC’s Policy Funds

The Small and medium Business Corporation (SBC) was founded in 1979 as a non-profit, government-funded organization to deliver policies and programs for thedevelopment of SMEs as the SME policies became more diverse although thesepolicies were not well-structured then. The main functions of the SBC includeproviding policy funds, training, consulting, and export support.10) Among thesefunctions, policy fund financing will be highlighted in this subsection.

The SBC selects SMEs that possess technologies with commercial potential, andprovides financing to expand operations, develop new products and streamlinebusiness structure. Depending on the purpose of the fund, the SBC operates severaldifferent types of policy funds, and their priority is to strategically develop suchindustries that are related to green growth and new growth engine, parts andmaterials industry, knowledge-based service industry, cultural industry, and bioindustry.


10) See Table 4-3 for the programs that the SBC currently runs.

11) The SBC's Youth Entrepreneurship Training Program will be discussed in Section 3.2.C.

Table 4-3 Main Functions of SBC

Programs Description

Policy FundsSelects SMEs that possess technologies with commercial potential and providesfinancing to expand operations, develop new products and streamline businessstructure

ConsultingTechnology

Development

SME One-stop Clinic Service: After expert analysis on the technology andmanagement of benefit recipients, the solution to the problem such as financing,marketing, or training support will follow based on the diagnosis report. Consulting: Provides business consultation to SMEs to assist in their sustainably andto secure a competitive edge in the global market. Technology Development: Assists in product design and producing a prototype toturn creative ideas into real products at low cost

Global Cooperation &Marketing

Arranges exhibition overseas and provides export marketing assistance to promoteSME’s export and global cooperationExplores overseas market opportunities

Training

SME CEO and Employee Training: Provides a training program to employees or CEOof SMEs regarding production technology, automation, IT, business administration,and product quality enhancement.Youth Entrepreneurship Training Program11): One-stop training center to nurtureyoung CEOs by providing prospective entrepreneurs with all their resource needs forstarting a business.

Source: The Small and Medium Business Corporation.


<Table 4-4> summarizes various policy fund programs that the SBC provides in

2014 by agency loans, direct loans, and hybrid financing. The current support system

emphasizes to promote commercialization of R&D results and performance in inno-


Table 4-4 SBC’s Policy Funds

Type of Policy

FundsDescription

2014

Budget*

Venture Startup Fund

Provides financial assistance for startup businesses, young entrepreneursand those who restart their own business to build new facilities and startnew ventures during initial growth stagesLaunched in 1998 and steadily increased the budget (620 billion KRW in 2007).

1,300

Commercialization ofR&D Results

Offers financing toward the commercialization of R&D results to fostertechnology-based innovative SMEsOffers financing for SMEs who wish to commercialize the technologiesdeveloped from public R&D projectsIncreased the budget as R&D and technology development areemphasized (100 billion KRW in 2007) 350

350

New Growth Fund

Offers financing for innovative SMEs in high-tech industries to improvethe productivity and to increase the product quality. Provides financing for the cases in which three or more SMEs cooperateto enhance their competitive edge

835

Business ConversionFund

Improves the competitive edge of business by encouraging restructuringand business conversion

160.5

Trade Conciliation FundSupport for the SMEs who experience losses due to FTA by offeringfinancing for facility or R&D in order to recover from the crisis

9.5

Stabilization FundOffers short-term financing for the stabilization of business operations tothe SMEs who experience temporary difficulties but are highly likely to berecovered.

25

Export Support FundOffers short-term financing for exporting SMEs who cannot usecommercial trade finance due to a short export history and low collateral

75

Small Merchant &Industrialist Fund

Promotes startups and creates jobs by fostering economic vitality andsupporting manufacturing firms

300

Hybrid Financing12)

Mezzanine financing (A hybrid of debt and equity financing) for aspiringSMEs with technologies and potential in the marketplaceAcquires convertible bonds (CB) issued by SMEs and then shares theSME’s future profits

150

Total Amount 3,205

Source: The Small and Medium Business Corporation.Note*: Billion KRW, approximately equals to million USD

12) Hybrid financing was introduced in 2008 in order to meet the financing needs of SMEs and to diversify SBC's fundingschemes. First, the SBC acquires the convertible bonds of selected recipients, and then evaluates the potential benefitsof sharing recipient's growth during the assistance. Then, the SBC determines whether to exercise the conversionrights. If the CBs are not converted into stocks, the CBs are repaid in installments at the maturity rate. Another type ofhybrid financing reduces the burden of a fixed interest rate and collects income-linked interest payments. (Lee, 2012)


vation activities. As the SBC assigns more than one-third of its budget to the Venture

Startup Fund, it intends to promote business startups, especially companies based on

technology. Other one-third of the budget is allocated to encourage SMEs’

innovation activities through the Commercialization of R&D Results and New Growth

Fund. Moreover, the SBC has expanded the loans on security of companies’ patents

since 2014. Acquiring information regarding the evaluation of R&D projects from the

Korea Evaluation Institute of Industrial Technology (KEIT) and the Korea Technology

and Information Promotion Agency for SMEs (TIPA), the SBC offers loans in

connection with R&D subsidies to the participants of successful R&D projects.

In addition to simply offering policy funds to SMEs, the SBC provides some policy

funds under the “SME One-stop Clinic Service” program, which is a complete package

to solve problems that SMEs face. This program dispatches a group of experts who

are trained in management and technology to the benefit recipients to analyze the

company’s technology and management first. Based on the analysis and diagnosis

report, the problems of recipients are identified and the solutions are proposed. The

SBC assists the recipients to solve the problems by providing financing, marketing or

training support. The SBC expects to increase the efficiency of policy funds through

this program as well as to continue upgrading the efficiency of policy funds.

3.1.2. Corporate Evaluation System

Considering the limited financial resources, the selection of outstanding recipientsis no less important than programs because selecting high quality recipients not onlyincreases the efficiency of the funds but also lowers the risk in the loss of funds.Therefore, building a corporate assessment system that selects appropriate recipientsis as important as offering good policy fund programs.

The corporate assessment system for policy funds should be different from thesystem that commercial banks apply because most SMEs do not have a good financialstatement, which significantly affects an ordinary corporate rating scheme. Inparticular, it is essential to reflect technical feasibility and commercial viability as thegoal of policy funds in order to foster innovative and technology-based SMEs withgrowth potential. Thus, the corporate assessment system for policy funds should takeinto account of non-financial components that can measure prospects for futuregrowth besides companies’ financial statement or financial history.

The SBC established its corporate rating system as it launched a direct loanprogram in 1998, and continuously improved the system. The system introduced in1998 yielded a score based on the selection criteria of the program and it did notprovide much information regarding companies’ credit risk. Thus, it adopted the



current rating system in 2004 in order to improve the previous system. Unlike theprevious system, the new system enabled the SBC to conduct follow-up, reflectingboth financial and non-financial components for the evaluation. In particular, thetechnology evaluation rating was also established to supplement the technology sideof their evaluations. The evaluation consisted of market potential, technology level,management skills, marketability and financial evaluation. In 2007, the rating modelwas revised to include 13 classes in accordance with corporate size, industry and otherfactors. The model has been improved in 2009, taking into account of the direction ofgovernment’s SME funding policy and external voices. After an additional revision in2010, the current system, as illustrated in [Figure 4-8], first reflects the rating fromtechnology evaluation, and the score based on financial components, which affectcompany’s credit is used to make a fine adjustment in the rating. In addition, thePolicy Consistency Index, which incorporates policy consistency with the programsand the effects of the program on national economy into the decision, is created andconsidered during the selection process.

As the SBC develops its own corporate evaluation system each of theorganizations, which provide policy funds develops its own corporate evaluationsystem as well to secure the stability of the funds and to differentiate it from otherorganizations. For example, KOTEC develops its technology appraisal system, KTRS,which differs from an ordinary credit rating system as it focuses on companies’technology excellence and business feasibility rather than financial history.


[Figure 4-8] Corporate Evaluation Rating Process as of 2011

Source: Lee(2012).


Most corporate evaluation systems are based on credit rating system. However,SMEs, especially startup companies, are not able to acquire a good evaluation in themarket due to their lack of collateral and a short financial history even if they haveinnovative and commercially viable ideas and technology. Their ideas andtechnologies cannot be appreciated in the market due to information asymmetry.Therefore, KOTEC, which provides financing for technology-based SMEs primarilythrough credit guarantee scheme, develops its own appraisal system, KTRS, excludingfinancial components from the evaluation process.

As illustrated in [Figure 4-9], the KTRS provides a technology rating grade derivedfrom a quantitative analysis of company’s business prospects based on risk andtechnology levels. There are 33 indicators for technology level13), which can reflectcompetence, technical feasibility, marketability, business feasibility and profitability.In addition to the indicators for technology level, the model contains indicators forcompany’s own internal risk such as years in operation since incorporation, industrycategory, number of regular employees, and indicators for external risk from marketsuch as the SME Production Index, Composite Stock Index, Leading Composite Index,and Exchange rate.


13) KTRS-SM, a modified KTRS model for startup companies with less than 5-year history, has 23 indicators. KTRS-

BM, a modified model for small businesses with sales less than 1 billion KRW, contains 18 indicators.

[Figure 4-9] Rating Process of KTRS

Source: KOTEC, www.kibo.or.kr


The indicators that the KTRS adopts were selected based on the cases from othercountries and expert opinions. In addition, the selection of indicators also reflectedthe five-year history of evaluation results from the Technology Appraisal Model,which were developed by KOTEC and SMBA in 1999. Because some indicators areinevitably qualitative and assessed by evaluators, KOTEC also developed the “KTRSFeedback system” in order to secure consistency and objectivity. Since the model issimple and comprehensive, this rating system can be easily modified for differentsectors. As of 2014, there are three KTRS models - KTRS, KTRS-SM for startupcompanies with less than 5-year history, and KTRS-BM for small businesses with salesless than 1 billion KRW. The rating grades from the system can be used not only forloan guarantees but also technology transfers and assessment of technologydevelopment projects.

In accordance with other SME policies, policy funds can help foster SMEs andenhance their competitiveness. On one hand, one can expect rapid growth, providingpolicy funds with other non-financial support to SMEs in targeted industries. On theother hand, policy funds may distort the direction of technology progress. Moreover,policy funds, especially for SMEs without competitive edge, will impede liquidation ofsuch firms and restructuring for improvement. Therefore, ultimately, the directfinancial support for SMEs should play only a supplementary role for the market-friendly financing environment, and the government should make a great amount ofeffort to establish a system, which efficiently allocates resources. At the same time,every organization, which delivers policy funds, must collect data from policy fundrecipients and applicants and take advantage to increase the efficiency of policyfunds. It must also strive to build a transparent and objective corporate assessmentsystem in evaluating recipients’ performance.

3.2. Support for Venture Businesses

Although the government emphasized the importance of SME’s technicalcompetence in the 1980s and early 1990s, most policies focused on the simpletechnical competence in the parts and material industry.14) As some of the largeconglomerates went bankrupt and many others underwent restructuring during thefinancial crisis in the late 1990s, the Korean government started paying attention toventure businesses. Because some innovative SMEs including venture businesses notonly created jobs and added value but also adapted to new business environmentunlike large conglomerates, they were considered as a new growth engine in


14) The government started implementing some policies to support SMEs and startup businesses in the late 1980s -

for example, the Support for Small and Medium Enterprises Establishment Act and the Support for New

Technology Project Financing Act in 1986- as it realized the importance of innovation capabilities of SMEs.

However, venture businesses were not successful until the mid-1990s due to the lack of supportive policies and

institutional framework. (Yun, 2002) The Act on Special Measures for the Promotion of Venture Businesses enacted

in 1997 was the pivotal legal infrastructure for venture businesses. (Kim & Kim, 2013)


overcoming the crisis.

To foster venture businesses and to promote venture business startups, thegovernment implemented diverse and extensive business policies in the early stage ofventure business development. For example, the government expanded investmenton venture businesses and offered tax benefits for the rapid growth of venturebusinesses. Moreover, the government pushed forward establishing the KOSDAQmarket for venture businesses to easily access equity finance.15) However, excessivebenefits and the government’s heavy involvement were highly responsible for theventure bubble in the early 2000 and hindered the growth of private markets. Afterthe venture bubble, the direction of venture business policies is to create anenvironment in which venture businesses spontaneously grow. Thus, venture businesspolices have focused on removing moral hazard among venture business managers,stimulating investment on venture business from private sectors, and providingbusiness incubators and startup training rather than a direct financial support.

3.2.1. Stimulating Venture Investment

As explained in <Table 4-4>, the largest portion of SBC’s policy funds is offered toinnovative technology-based SMEs including venture businesses with difficulties inaccessing finance through the “Venture Startup Fund.” The purpose of this programis to encourage business startups with innovative ideas. Although this program offersfinancial assistance to people with innovative ideas to start a new business (duringthe initial growth stage), most policy funds including the Venture Startup Fund areprovided in the form of loans. Therefore, it may be too risky or burdensome for anindividual person to take the whole risk of starting a new business. Even if anindividual is willing to take the risk, it is difficult to endure the time before he/sherealizes profit or return. Considering the high risk of success and a substantial amountof time spent before any return can be realized from the initial startup stage, policyfunds, in a form of loan, will not be enough to encourage and foster venturebusinesses. In order to maintain the system in which venture businesses start up andspontaneously grow, it is vital to establish a financial system, which provides financialresources to startup ventures such as venture capital investment and angelinvestment in addition to the assistance from policy funds.

However, it is difficult for venture businesses, especially ones in the startup stageto find investment due to their high risk, information asymmetry and time lagbetween investment and first return. The underinvestment for these reasons willimpede venture business startup and growth despite their contribution to thenational economy such as leading innovation and creating jobs. A public venturefund has been proposed as a solution for the underinvestment as it can lower the risk


15) See Kim & Kim (2013) for the policies implemented between 1997 and 2012 in detail.


by creating venture funds and investing in venture capital jointly with the privatesector.

Korea created a public venture fund in July 2005 for the purpose of a “Korea Fundof Funds (KFoF)” with investment from the SBC, Ministry of Culture, Sports andTourism (MCST), Korea Intellectual Property Office (KIPO), Korea Film Council (KOFIC),Korea Communications Commission (KCC), and Ministry of Employment and Labor(MOEL) to encourage private venture capital investments in SMEs. The KFoF providesa stable capital source for venture investment and reinvest returns during its fundduration.

As [Figure 4-10] illustrates, the SMBA oversees the KFoF, and Korea VentureInvestment Corporation (KVIC), a government agency, manages the funds. KVICprovides finance to venture capital firms that invest in SMEs and venture companies.KVIC invests up to 40% of partnership funds with some exceptions, and the restshould be invested by other investors from the private sector. The raised partnershipfunds will be invested on outstanding SMEs and venture businesses, which meet thepurpose of raised funds. The KFoF shares some of the risk with private investorsthrough this joint investment, and revitalizes the venture capital market.

Starting with KRW 170.1 billion that the SBC invested, the KFoF gathered KRW 1.6trillion as of December 2013. The amount retrieved by the fund of funds is KRW 183billion in 2013, and the accumulated amount by 2013 is KRW 707 billion.16) Theretrieved amount is not distributed to investors as dividend, but it is reinvested for 30years, the fund duration. The Korean venture capital investment compared to GDP is


Table 4-5 Yearly Progress of Fund Sources

Fund Source 2005 2006 2004 2008 2009 2010 2012 2013

SBC 170.1 110 90 80 285 100 34.5 72.5

MCST 50 100 120 52 40

KOFIC 10 10

KCC 11 6 5

KIPO 55 55 33

Total 170.1 215 245 80 438 121 92.5 117.5

Total FundAccumulated

170.1 385.1 630.1 710.1 1148.1 1269.1 1361.6 1479.1

Source: SMBA (2013).Note: As of late June 2012, in billion KRW.

16) The Korea Venture Investment Corporation, www.k-vic.co.kr.


0.11%, but it has steadily increased in recent years as Figure 9 presents. (SMBA, 2013)

Since investment on the early stage start-ups involves particularly high risk, it iseven more difficult for startup companies to find investors than companies in thetake-off stage. While angel investment for business startup accounts for 70% of


[Figure 4-10] Operation Structure of KFoF

Source: Korea Venture Investment Corporation, www.k-vic.co.kr

[Figure 4-11] Trend of New Investment on Venture Business

Source: Venture Capital Statistics published by Korean Venture Capital Association, KVCA


investment on venture businesses in the U.S., it accounts for only 3% in Korea.(SMBA, 2013) Due to little investment on startup companies, the founders of startupcompanies have no choice but to rely on loans along with the burden of failure. Thehigh risk is one of the main obstacles for startups.

In order to vitalize angel investment, the government makes a constant effort tocreate a virtuous cycle in the venture investment system. First, the “Angel MatchingFund” has been created in 2011 based on the KFoF and investment from universitiesand research centers. The Angel Matching Fund is a fund that specializes on the earlystages of start-ups by making joint investment on companies with angel investors.Unlike the ordinary partnership funds of KFoF, the KFoF can invest this matchingfund up to 70% to significantly reduce the risk. In addition to creating the “AngelMatching Fund”, the government also expanded a deduction on income tax from10% to 30% to foster angel investment from the private sector.

3.2.2. KOSDAQ Market

The most important infrastructure that Korea established to foster venturebusinesses is the KOSDAQ (Korea Securities Dealers Automated Quotations) market, atrading board of the Korea Exchange (KRX). The KOSDAQ market was established in1996 to facilitate SMEs’ equity financing based on the “Measure to Establish a StockTrading Market for Small and Medium Enterprises” in 1986. It has been operating asa SME market division of the KRX, but currently listed companies are mostlyknowledge-based and IT businesses regardless of their size. As <Table 4-6> compares,the KOSDAQ market lowers listing requirements to facilitate SMEs’ financing through


[Figure 4-12] Operational Structure of Angel Matching Fund

Source: Korea Venture Investment Corporation, www.k-vic.co.kr


publicly traded shares. The KOSDAQ market has grown rapidly with thegovernment’s venture business policies and the development of IT industry in Korea.

The KOSDAQ market is not only a channel to facilitate SMEs’ equity financing butalso a route for retrieval of investment. Because it takes long time for the return tobe realized from the investment, a route for retrieval is important for venturecapitalists and their investment decision. Even if a public venture fund reduces therisk associated with investment, investment on venture businesses will not besustainable without appropriate exit markets. In general, there are two major exitmarkets, the IPO (Initial Public Offering) market and the M&A (Mergers andAcquisitions) market. Because of the KOSDAQ market, 92.6% of venture capitalinvestment is retrieved by the IPO in Korea while 70.8% is retrieved by the M&A inthe U.S. (SMBA, 2013) In particular, the KOSDAQ market plays a pivotal role as achannel for retrieval in venture capital market because Korea still lacks infrastructurefor M&A of SMEs.

3.2.3. Entrepreneurship Education and Business Incubators

The basic premise of all the aforementioned policies to vitalize venture capital


Table 4-6 Example of Listing Requirements17)

Criteria KOSPI

KOSDAQ

General Venture

Growth

Technical

Companies18)

Years in Operation since incorporation At least 3 years At least 3 years -

Business size ( or )19)

Equity capitalAt least 30billion KRW

At least 3 billionKRW

At least 1.5 billion KRW

Base marketcapitalization

- At least 9 billion KRW

No. of shares to be listedAt least 1million

-

Source: The Korea Exchange.

17) This table presents only a part of the requirements. More detail information regarding listing requirements can be

found in the KRX website.

18) Growth Technical Company: The company that has received the higher than A grade in the assessment of

technology capability by professional appraisal agency.

19) To be list in the KOSDAQ market, ① or ② must be met. However, to be listed in the KOSPI market, there are

additional requirements regarding total sales in addition to equity capital.


investment is that there are enough venture businesses with a competitive edge,which can attract investment. For a successful business startup, non-financialelements such as CEO’s entrepreneurship and management skills are also important.“Entrepreneurship education” is an educational program for students andentrepreneurs in entrepreneurship and general understanding of businessadministration. (Lee, 2012) The education program generally teaches knowledge onbusiness startups including economics, laws, business administration, accounting,public administration, trade and technology as well as positive attitudes ofentrepreneurs. It also nourishes the entrepreneurial spirits. (Kim & Kim, 2013) As someof the existing literature (Lee, 2010; Yun & Hwang, 2007; Koh et al., 2003) pointedout, the important factors of entrepreneurship for the success of venture businessesare CEO’s management experience, ability to utilize information from markets, andmanagement skills as they have great impact on on company’s performance. Since alack of CEO’s management capabilities was suspected as the main culprit to venturebusiness failures, the importance of entrepreneurship has been widely recognized inKorea.

The entrepreneurship education includes programs for teenagers, college andgraduate students, and adults. The programs for teenagers intend to cultivateentrepreneurship among youths and to change their perspectives on economics andvalue creation. (Kim & Kim, 2013) For entrepreneurship education, colleges offerclasses teaching knowledge on business and entrepreneurial attitudes to enhancebusiness management capabilities. Some universities launched a program for theManagement of Technology (MoT), which is a set of activities related to managingand operating organizations’ technology to strengthen its competitiveness. Theeducation program for the Management of Technology not only stimulates students’interest in entrepreneurship, but also raises experts in technology transfer,technology assessment and R&D planning.

The Korea Advanced Institute of Science and Technology (KAIST) recognized theimportance early, and founded the KAIST Techno MBA in 1995. The KAIST TechnoMBA has provided an educational program, which integrates technology andbusiness administration. Large conglomerates such as Samsung and LG haverecognized the importance of entrepreneurship education and encouraged theiremployees in the R&D division enroll in the KAIST’s program. In 2008, KAIST foundedthe Graduate School of Innovation and Technology Management. The programfocuses on skills for entrepreneurs, commercialization and problem solving, targetingpeople with prior working experience in industries. The courses in the curriculuminclude theoretical courses such as Innovation Management, Entrepreneurship andBusiness Management, and practical courses such as Technology CommercializationPractice, Public R&D Planning, Formation and Implementation of EntrepreneurialVentures.



In addition to entrepreneurship education, business incubators can be helpful toincrease the success rate of business startups. Business incubators assist the growth ofbusinesses in the early stage, generally providing appropriate support such asmanagement skills, technological support, manufacturing facilities and equipment,and business mentoring to entrepreneurs.

Business incubating system in Korea is under the control of SMBA withadministrative support from the Korea Institute of Startup EntrepreneurshipDevelopment (KISED). The government provides space and experts to startupcompanies and prospective entrepreneurs that have innovative ideas andoutstanding technology but lacks experience. As <Table 4-7> shows, there are 280incubators as of 2011 and 75% of the incubators are located in universities. As theassigned budget and the number of incubators increased, the number of firmsincubated also increased as <Table 4-8> shows. As incubated firms grow and stand ontheir own feet, new firms can enter into the incubators.

The Youth Entrepreneurship Training Program is a good example of supportprogram, which integrates business incubator and entrepreneurship education. Thisprogram is one of the training programs that the SBC provides in order to fosterbusiness startups among youths and nurture young CEOs. The program providesstartup training entrepreneurship education in connection with other types ofsupport such as consulting and policy funds to maximize its effectiveness of thepolicy. To be specific, the program selects young prospective entrepreneurs who wantto start their own businesses based on technology and innovative ideas, and provides


Table 4-8 Budget and Number of Supported Business Incubators

2009 2010 2011 2012

Firms incubated 4,770 4,818 4,764 5,123

Sales (billion KRW) 2,538.2 2,480.7 2,005.5 1,659.2

New Jobs Created 22,017 21,113 18,078 17,276

Source: The Small & Medium Business Administration.

Table 4-7 Performance of Business Incubators

2005 2006 2007 2008 2009 2010 2011

Business Incubators 275 265 269 281 279 286 280

Budget (billion KRW) 16.3 18.3 16.8 18.9 30.6 35.3 38.0

Source: The Small & Medium Business Administration.


them with startup training as well as business space. Moreover, the program assignsexperts with experience to participants as mentors who can guide them in every stepof the startup process such as planning, R&D support, prototype production, andmarketing. The program consists of three stages with evaluation. In the first stage,participants submit their business and product planning. In the second stage,participants develop their product and produce a prototype. In the last stage, theybegin pilot production, rolling out marketing strategies before they graduate. Aftereach stage, participants go through an evaluation based on their work. Theparticipants who earn the highest grade from the evaluation will receive startuploans from the SBC after graduation.

4. Implications and Policy Recommendations

In order to strengthen research, development and innovation capabilities, it isimportant to examine the entire innovation system of the nation including bothknowledge generation and exploitation of knowledge because innovation takesplace based on knowledge generating activities as well as firms’ value creatingactivities. In particular, firms not only exploit knowledge to create economic valuesbut also motivate new research projects by finding a need for new technology.Among many vital components to raise RDI capabilities of one country, this reportfocuses on fostering innovative enterprises, an important pillar of nationalinnovation system.

Korea has also recognized the importance of firms’ innovation activities and hasstrived to secure experts in technology and promote innovative enterprises and theirinnovation activities. Korea’s experience from the 1960s~1980s is not very helpful


Table 4-9 SBC’s Youth Entrepreneurship Training Program

Type of Support Description

Startup Space Offers a space for startup at the training center

Coaching Experts and successful entrepreneurs are assigned as a mentor

Startup Training Provides practical knowledge on technology commercialization and business startup

TechnologyDevelopment

Provides assistance including equipment from the stage of product design toprototype production

Financial SupportCovers expenses for technology development, prototype production, pilotproduction, registration of intellectual property rights, and marketing

Startup Loans afterGraduation

The participants who earn the highest grade from the evaluation will receive startuploans from the SBC after graduation.

Source: The Small and Medium Business Corporation.


unlike in other KSP cases because Hungary’s concerns and goals are different fromother KSP participants. However, Korea has had similar concerns as Hungary, andKorea has made great efforts in the transition to knowledge-based economy.Observing Korea’s recent efforts for the transition can help Hungary to reduce itserrors in policies to strengthen its RDI capabilities.

In this section, the implications from Korea’s experience will be discussed and I willpropose the recommended policies to help strengthening Hungary’s RDI capabilitieswith some precautions. The main weaknesses include the low R&D expenditure,particularly from business R&D investment and the lack of innovation activitiesamong SMEs. Thus, the policy recommendations proposed in this section aim topromote innovation activities among SMEs and foster innovative startup companies,which are the basis of utilization-oriented RDI activities.

Hungary already has a strong foundation in basic research and shows a goodperformance in some areas such as physics, mathematics, biology, chemistry, clinicalmedicine and engineering. (OECD, 2008a) Moreover, Hungary is already equippedwith the basis for policy implementation and good policies. Thus, the policyrecommendation for Hungary in this report focuses on some policy tools andprecautions rather than policies for fundamental changes.

4.1. Policy Fund Financing System

Policy funds are financial tools to support enterprises to implement public policies.Policy funds intend to foster blue chip companies by providing financing to the areas,which are likely to be underinvested due to market failure. The Korean governmenthas selectively supported industries with significant contribution to the nationaleconomy using policy fund financing, expecting rapid growth in the targetedindustries. However, policy funds may distort the direction of technology progress.Moreover, policy funds, especially for SMEs without competitive edge, will impedeliquidation of such firms and restructuring for improvement. Thus, policy fundfinancing is helpful in resolving SMEs’ financial difficulties in the short-run, but it maynot be helpful in fostering competitive SMEs in the long-run. Therefore, the purposeof policy funds should be to strengthen SMEs capabilities, and ultimately, the directfinancial support for SMEs should play only a supplementary role for the market-friendly financing environment. Furthermore, policy funds provided for R&D activitiesor long-term facilities can be easily misused and wasted as operating expensesbecause it is not easy to closely monitor every recipient due to a large number offirms. The government must establish the monitoring system and the evaluationscheme when it offers policy fund financing for SMEs’ innovation capabilities.



4.1.1. Corporate Evaluation System

In light of Korea’s experience, the important factors that determine the success of

policy funds include the selection of recipient and the ex-post evaluation. Without a

doubt, offering policy funds to companies with higher growth potential can increase

the efficiency of policy funds. Thus, the screening process for recipients must be

selective, objective, and transparent. In addition, the screening process must be in line

with the government’s policy direction in order to maximize the effect of the policies.

Furthermore, an ex-post evaluation must be set in place to be reflected for the future

screening process and the planning of policy funds. Therefore, the selection criteria

for recipients and the evaluation process must also be discussed while policy fund

financing system is established.

Since each of policy fund programs may have different purposes, targets and

policy goals, the evaluation system should take those into account. If the goal of the

program is to promote innovative SMEs and their innovation activities, the emphasis

must be on companies’ innovation capabilities rather than simply on the financial

statement. As already discussed in Section 3.1.B, the KOTEC’s KTRS is one of the

examples that shows the effort to establish a unique system to evaluate a company

based on its technology level. It does not necessarily imply that the KTRS is an

appropriate system for Hungary. As KOTEC developed KTRS to lower the default rate

by selecting outstanding recipients and additionally introduced the KTRS Feedback

System for the consistency of assessment results, Hungary should analyze its

assessment system and make an improvement for better outcomes with the same

amount of financial resources.

After selecting recipients and providing policy funds, the organizations who run

the policy fund program should continue to monitor recipients and conduct an ex-

post evaluation. Their performance is important not only for their own benefits in

the future but also for the future policy direction. Therefore, the organizations

should track the performance of recipients and applicants, if possible, because the

collected data can be used for future policies to increase the overall efficiency of

policy funds.

The necessary condition for establishing a corporate evaluation system based on

companies’ technology is to secure experts who can analyze and evaluate companies’

technology level and performance, objectively. Even if the system quantitatively

assesses companies, some indicators are inevitably qualitative and assessed by

evaluators. In particular, assessing companies’ technology level, technical feasibility

and growth potential require special and professional skills, and thus the system

would be useless without experts who are capable of analyzing those components.



The experts in assessing companies’ technology level can also make a plan and

implement national R&D projects. Therefore, Hungary should foster experts who are

competent in analyzing companies’ technology level while developing a corporate

evaluation system especially based on companies’ technology level.

4.1.2. Policy Funds in Connection with R&D Projects

As European Commission (2013) pointed out, Hungary exhibits a comparatively

low propensity for innovators. If SMEs lack their own R&D capabilities such as human

capital and equipment, it is unlikely that policy funds can induce SMEs’ product or

process innovation. To promote SMEs’ innovation activities and raise the success rate,

financial support like policy funds will not be enough, but SMEs need tangible and

practical assistances such as planning and managing research and development

projects, highly educated human resources and specialized equipment and facilities.

For example, the SMBA selects new technology development plans submitted by

SMEs, and organizes a task-force team for each qualified project with experts in

planning R&D projects from the Korea Institute of Science and Technology

Information (KISTI) and Korea Technology Finance Corporation (KOTEC) and the

employees in R&D division of the SME. The task-force team analyzes technical

feasibility and commercial viability, and provides the strategy for technology

development and commercialization. In connection with this program, the SMBA

provides policy funds to the outstanding R&D projects.

For SMEs, which lack human resources in research and research facilities, the

SMBA supports SME’s partnership with universities and research institutes. To be

specific, an enterprise with an idea for new technology forms a team with universities

and research institutes, which have R&D human resources and facilities, and the team

jointly develops new technology based on SMEs’ needs. The SMBA financially support

the joint R&D projects. As SMEs participate in the joint R&D projects, they not only

realize their ideas into technology but also enhance their R&D capabilities by

learning-by-doing. This joint R&D project support program started in 1993, and the

SMBA provided KRW 712.5 billion to 34,133 firms as of 2012. On average,

approximately 250 universities or research institutes participate in the joint R&D

projects in the recent five years. (SMBA, 2013)

4.2. Policies to Foster Innovative SMEs and Business Startups

Hungary is striving to foster innovative SMEs and business startups. In addition tothe startup support programs such as the “Start-up 13” and “Mentor Club,” Hungaryhas established the Fund of Funds and Co-investment program based on Jeremie



Programmes, and venture capital has improved greatly in recent years. However, tosustain venture capital in the long-run, Hungary has to start preparing an exitstrategy for venture capital investment. Because investors need to retrieve theirinvestment, it is important to set up a system for investment retrieval or gain returnsfor investors. Even if a public venture fund reduces the risk associated withinvestment, investment on venture businesses will not be sustainable without exitmarkets. Therefore, for sustainable growth of venture capital investment, Hungaryshould start establishing infrastructures such as M&A or IPO mechanism specializedfor SMEs in order to facilitate retrieval of venture capital investment.

The basic premise of policies to stimulate venture capital investment is that thereare number of good venture businesses, which can attract investors and thecompanies have strong innovation capabilities. Even if there is enough venturecapital and the government provides extensive support, the investment willeventually lose vigor and the effect of the policies will be trivial without competitivecompanies and their capabilities. Therefore, the government should raise moreprospective entrepreneurs who are ready for startups through entrepreneurshipeducation while striving to vitalize investment on innovative companies and theirinnovation activities. At the same time, the education program for startup training,business management and technology management should be offered in order toincrease the success rate.

The entrepreneurship education includes programs for teenagers, college andgraduate students and adults. In particular, entrepreneurship education in collegescan be provided in a form of general education, which intends to cultivateentrepreneurial spirits and enhance business management capabilities. In addition,colleges can offer an educational program for the Management of Technology inorder to stimulate students’ interest in entrepreneurship and to foster prospectiveyoung CEOs. However, entrepreneurship education offered in colleges has its limit.The targeted group of people who can participate in the program is limited, and thedevelopment of good curriculum and faculty recruitment are the expecteddifficulties. Alternatively, entrepreneurship education can be offered to people whowish to start their own business in the near future as a short-term training program,supported by the government or relevant organizations. The curriculum may coverpractical knowledge for business startups such as business management, patentapplication, financing, and accounting.

An additional tool to increase the success rate of business startups is a businessincubator. Business incubators assist the growth of businesses in the early stage,generally providing appropriate support such as management skills, technologicalsupport, manufacturing facilities and equipment, and business mentoring toentrepreneurs. In order to increase the success rate, a business incubator should



provide support beyond spaces and facilities. It should be able to show the incubatedcompanies the path to grow and to graduate, and support the every stage ofbusiness startup from business planning to marketing and pilot production. TheYouth Entrepreneurship Training Program of the SBC discussed in Section 3.2.C. is agood example to provide all the resources needed for starting a business. Consideringlimited resources, the selection process for incubated companies is important.However, a more important factor is the evaluation on a regular basis. The goal ofbusiness incubators is to incubate companies to grow and graduate. Thus, businessincubators should check incubated companies for progress and assist them to growfaster so that new companies can move in to the business incubator.

In summary, Hungary should be cautious about providing policy funds asproviding policy funds on targeted industries have pros and cons. It may help therapid growth, but it may impede restructuring for competitiveness. Therefore, thepurpose of policy funds should be to strengthen SMEs’ capabilities, not to solve SMEs’financial difficulties itself. Ultimately, the direct financial support for SMEs shouldplay only a supplementary role for the market-friendly financing environment, andthe government should make an effort to establish a financing environment, whichcan efficiently allocate resources.

Hungary may want to consider providing policy funds in connection with R&Dprojects. Since SMEs usually lack their own R&D capabilities, they might not be ableto participate in innovation activities even if they have enough funding. Instead ofsimply providing funding, it can be more effective to support joint R&D projects withuniversities or research institutes, which have R&D human resources and facilities.Furthermore, the government must establish a monitoring system and an evaluationscheme as policy funds for SMEs’ innovation capabilities can be easily misused due toa large number of firms. Moreover, Hungary should analyze its assessment systemand improve it to be more objective and consistent and to well reflect the policygoals as the process to select recipients is critical in increasing the efficiency of policyfunds and to maximize the effect of policies.

As venture capital in Hungary improves, Hungary should start establishinginfrastructures for M&A or an IPO mechanism specialized for SMEs in order tofacilitate retrieval of venture capital investment. As the retrieval is facilitated,investors can receive returns, which can be reinvested into other or the same venturebusinesses. Furthermore, for sustainable growth of venture capital investment, theremust be enough number of innovative and competitive companies, which can attractventure investment. Thus, the government should foster more prospectiveentrepreneurs who are ready for startup and increase their success rate throughentrepreneurship education.



In addition to the policies to promote SME’s innovation activities usinggovernment support, Hungary may want to consider encouraging large enterprisesto support innovation activities of their suppliers. In 2011, “Shared Growth” amonglarge conglomerates and SMEs was one of the most discussed economic issues inKorea, and as such building related policies and infrastructure are in progress.Although there are not enough achievements yet, some large enterprises, such asSamsung Electronics, expand their support programs for their outstanding first-tiersuppliers to enhance their competitiveness. These kinds of program can be mutuallybeneficial between large enterprises and their suppliers because large enterprises canreceive higher quality components from competitive suppliers. Hungary can exploitits strategic partnership with large enterprises by encourage them to expandprograms on “Shared Growth” with SMEs.

5. Conclusion and Further Study

Innovation and Technological progress is crucial from an economic-wideviewpoint, and innovation activities including research and development contributeto sustainable economic growth and job creation as it maintains companies’competitive edge in the market. However, investment in R&D is regarded as an areawith market failure because of high risk and information asymmetry. Therefore, thegovernment and the related policies play an important role to achieve optimal levelof R&D investment and innovation activities.

This report focuses on the policy tools to foster innovative SMEs and to promotetheir innovation activities. However, the basic premise for the success of these policiesincludes the importance of the entire national innovation system includinginfrastructure for knowledge creation and diffusion, and science and technologycapabilities. In particular, knowledge creation and diffusion become more importantas the society experiences the transition to the knowledge-based economy. (Shin etal., 2012) Even with enough venture capital and efficient business incubating system,any of those policies will not be able to bear fruit if there are not enough peoplewho have innovative ideas. The policies that Korea has implemented to supportinnovative enterprises would not have been successful if there were no infrastructurefor science and technology and active research and development activities since the1970s.

In order to make the policies more effective and connect firms’ innovationactivities to commercialization, Hungary should first evaluate its own nationalinnovation system, maintain infrastructure for innovation activities, and examine thecapabilities of universities and research institutes, which are responsible forknowledge generation and dissemination. Furthermore, Hungary should consider



introducing some policy measures to promote business R&D investment such as taxbenefits or other incentives based on the analysis of the potential effects. In addition,Hungary should examine its infrastructure to commercialize the results from basicresearch in which Hungary shows its excellence and create an appropriateenvironment for R&D commercialization to pursue utilization-oriented R&D.




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