TCS Daily

Who Is Failing .hu?

By Meelis Kitsing - July 21, 2003 12:00 AM

Driving through central Budapest last autumn, my fellow passenger, a top Hungarian politician, pointed out the car window at a massive shopping mall with pride. He explained that the owner of the Mammut mall made his fortune in Silicon Valley and plans to set up a technology park near Budapest, where all the brightest minds can come to work -- a sort of Silicon Valley of "New Europe."

Indeed, Budapest's shopping malls are impressive in size and real estate developers from all over the former Eastern Bloc take the trip to learn from them their example. Hungary has been the first to develop US-style mega-malls in Central and Eastern Europe. However, even if malls like Mammut have brought the "American dream" closer to Magyars, Hungary is a long way from transforming this achievement into the digital world.

A look at hard data indicates that Hungary has actually been slow in advancing the "Information Society." According to the International Telecommunications Union (ITU), the per capita Internet penetration in Hungary for 2002 was 16 percent. Croatia and Slovakia had similar Internet penetration rates despite the fact that war in the former and an authoritarian premier (Vladimir Meciar) in the latter significantly slowed their respective reform processes. At the same time, Estonia and Slovenia outperform Hungary by 2.5 times. In Hungary's case it is particularly worrisome that the penetration rate increased by only one percentage point, up from 15 percent in 2001, after having doubled in the previous year.

Why is this country losing out in the Internet game? After all, Hungary started flirting with markets as far back as the 1980s and -- boasting the highest Foreign Direct Investment (FDI) to gross domestic product (GDP) ratio in Central and Eastern Europe -- was a darling of foreign investors throughout the1990s. In addition to early economic reforms and rapid inflow of FDI, many multinational companies have established their CEE headquarters in Budapest. Hungary was the first country to start offering mobile phone services and among the first in the CEE to privatize its incumbent telecom company. Many preconditions for the successful take off of the Internet are in place.

An April 2001 ITU paper titled "Internet in a transition economy: Hungary Case Study" offers a variety of reasons ranging from impact of export control regime of the Cold War era to low personal computer penetration, and from the Socialist era inheritance of poor infrastructure to duties on computer hardware exports. When comparing Hungary with other transition economies and considering the national income level and high elasticity of the demand for Internet access, then everything comes down to prices. The high costs of fixed line telephony that make Internet connectivity overly expensive are also highlighted by the study mentioned above. Another report, this by the European Commission and candidate countries "eEurope+ 2003 Progress Report" (July 2002), offers further evidence of high prices by pointing out that Hungary had among the highest Internet access costs of EU candidate countries in 2001.

Nonetheless, the formal reasoning that high Internet access costs distort Internet diffusion is of no help if the causes for the high access costs are not explored. At first glance, Hungary seems to be a model pupil in the restructuring of the telecom sector and expanding the telephone infrastructure. One-third of the national telecom company Matav was already privatized back in 1993. Government effectively separated control from ownership by completing the sale of all its shares in 1999, keeping the "golden share." Strategic investor Deutsche Telekom became the largest shareholder. Parallel to privatization, the number of main telephone lines per 100 inhabitants increased from 10 lines in 1990 to 36 lines in 2002, and most telephone lines were digitized.

However, significant barriers for competition in the telecom sector allowed the incumbent to collect monopoly rents thereby slowing Internet diffusion. As in most other EU applicant countries of the CEE, the incumbent was able to preserve its monopoly over voice telephony until 2002. The degree of "regulatory capture" seems to be higher in Hungary than in many other CEE countries.

The extent of regulatory capture is reflected in the ability of the incumbent to charge consumers (as was indicated above) and other telecom businesses higher prices. In the 1990s interconnection fees that are charged by different operators for connecting to the network controlled by monopoly was not based on objective criteria and costs. The planned move to the more objective cost-based pricing was constantly delayed in the second half of the 1990s. This is a major barrier for market entry because interconnection charges may account for anywhere from one-third to half of the total costs incurred by new entrants. Furthermore, slow progress in adopting laws that would have forced the incumbent to un-bundle the local loop created additional obstacles.

Evidence of regulatory capture is supported by a report on the regulatory reform in the telecommunications industry of Hungary, prepared by the Organisation for Economic Cooperation and Development (OECD) in 2000. The report questions the independence and accountability of the telecom regulator in Hungary. In the 1990s, important decisions were made by politicians in spite of the existence of the formally independent regulator. Political authorities constantly broke their promise of not intervening in setting prices for the various telecom services, and the outcome was often a result of last minute political interference. Personal ties between regulators and the incumbent complicated matters yet further. In 1999, a former employee of the incumbent telecom operator became the head of the regulatory agency.

Such an outcome has led to questioning the merits of privatization in the telecom sector. A top government official in Slovenia (a former socialist country that has been reluctant to privatize its state-owned telecom company) is cynical when Hungary is given as an example, asking "whether privatization has done any good for the country."

The book Privatization, politics and economic performance in Hungary (Cambridge University Press, 1998) by Zoltan Antal-Mokos of Budapest University of Economic Sciences, points out that political bargaining in the process of privatization works against the expected goal of improved efficiency. A vast variety of case studies in the book demonstrate that privatization "is more about politics than performance."

However, the ills of the Hungarian telecom sector are hardly a demonstration of failures of privatization and the market. It is the government who has failed ".hu" by doing the work in the telecom privatization only half-heartedly. More specifically, the government has not allowed for a truly independent regulatory agency, it has not avoided political interventions, and has not kept the incumbent telecom company accountable. In the transition from monopoly conditions in the market to the open market, the role of independent regulator is crucial in the telecommunications sector.

At the same time, it would be an exaggeration to say that Hungary has completely failed to advance Internet diffusion. The last two years brought the adoption of new legislation governing the opening of the telecom market. These improvements have yet to be reflected in the tariffs and Internet penetration rate. New laws and regulations alone give no cause for being overly optimistic. As the evidence suggested above, formal rules do not always stop politicians. Last year's launch of a government-subsidized Internet access packages, aimed at increasing use of the Internet, failed to live up to expectations, according to the Budapest Business Journal (October 21, 2002). Again, instead of focusing on the more important issues in ensuring competitive environment, politicians thought an easy fix to the problem would be accomplished by simply throwing taxpayers' money at it.

In summary, if Hungarian politicians muster the political will to tackle all the market participants in a non-discriminatory and transparent manner and concurrently reduce the power of vested interests, the probability for rapid Internet diffusion will increase significantly. Otherwise, "e-Mammut" will appear exclusively in their dreams.

TCS Daily Archives