Hardening the budget constraint: Institutional reform in the financial management of Hungarian local governments

Tamás Vasvári

doi:10.1556/032.2020.00037

Abstract

AbstractKornai (2014) described the problems of municipal indebtedness in Hungary and analysed the process of bailout carried out between 2011 and 2014. In the same period, the central government also reformed the local government system, which included serious limitations of their financial independence. This study re-examines the state of the soft budget constraint (SBC) of Hungarian local governments. To start, the general theoretical framework of SBC is introduced. Then, the budget constraint on the Hungarian local governments before the bailout is described briefly, followed by an assessment of the corresponding measures which were expected to offset the negative messages of the completed bailout and to harden the budget constraint. The study concludes that the central government decided to harden the budget constraint through the introduction of new hierarchical mechanisms, while the development of fiscal discipline stopped. On the one hand, this resulted in the consolidation of municipal budgets, but on the other, it was accompanied by a serious limitation of local autonomy, projects and borrowing in general, while the central government employs specific administrative tools to show favour to some settlements according to its (political) interests.

Highlights

The financial management of local governments in Hungary was ripe for a large-scale reform by the beginning of the 2010s
This resulted in the consolidation of municipal budgets, but on the other, it was accompanied by a serious limitation of local autonomy, projects and borrowing in general, while the central government employs specific administrative tools to show favour to some settlements according to its interests
The central government had to act in order to harden the budget constraint and to consolidate the financial management of local governments in order to avoid the reproduction of outstanding debt

Summary

Introduction

The financial management of local governments in Hungary was ripe for a large-scale reform by the beginning of the 2010s. The relief valve of the overpressure brought about by the simultaneously appearing operating deficit and the expansion drive was the high degree of freedom of local governments on money and capital markets even by the Western European standards. The fundamentals of fiscal discipline were missing, including the fact that local governments and later the banks believed (in spite of the relevant clear legal rule) that the central government will never release the hands of large local governments. It happened: simultaneously with the transformation of the statutory foundations of the sector, the central government set about assuming municipal debt and deleting the memento of the guilty past. The central government planned to achieve this goal by introducing administrative controls into the financial management of the local governments instead of promoting fiscal discipline and strengthening the corresponding institutions (e.g. the municipal debt settlement procedure)

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Conclusion