GETTING READY FOR THE EU

Budapesti Gazdasági Főiskola KÜLKERESKEDELMI FŐISKOLAI KAR Külgazdasági szak Nappali tagozat Európai Üzleti Tanulmányok szakirány GETTING READY FOR THE EU - SMEs IN THE HUNGARIAN ECONOMY BETWEEN 2002 AND 2004 - Készítette: Szalay Beáta Budapest, 2003 1

Acknowledgements I would like to express my gratitude to the following individuals: To the leader of EIC Budapest Miss Judit Lamperth for her valuable feedback on content and instruction. Without her help this work could not have been carried out. To my dissertation supervisor Mr. Péter Renner for his time, patience and professional insight. To Miss Katalin Major for her valuable assistance. To my colleagues at EIC Budapest; especially Miss Georgina Fojta, Mr. Péter Rohr, Mrs. Judit Rixer, and Mr. László Zentkó for their time and co-operation. To the committed employees of the Hungarian Foundation for Enterprise Promotion, who have helped me a great deal during my research. To Mr. Gábor Szőllősi for his encouragement, wise advice and patience. To Miss Andrea Igazi, for her help in providing me with updated statistical information. To my family for their encouragement and support throughout all these year. Without their help this work could not have been carried out. 2

Abstract Hungary s policy towards small- and medium-sized enterprises has reached a turning point. In light of the accession to the European Union, the role of SMEs in the economic development and the importance of policy implication to strengthen them have been widely recognized. May 1, 2004 will begin a new era, confronting them with serious challenges that they have to be prepared for. The report provides a summary of the (policy) actions and implementation steps towards the promotion and development of SMEs, and to their preparation for the EU accession. Its main aim is to provide an idea about how well SMEs are prepared for the conditions of the Internal Market. Chapter one describes SMEs weight in the Hungarian economy bolstered by a battery of statistics. Chapter two discusses the current situation of SMEs and explores both their opportunities and threats in the mirror of accession. The paper also lists and explains the related policy measures offered by Hungary and the EU. Finally, it gives a detailed analysis of the activities of ITDH Euro Info Centre and evaluates its success. The study concludes that Hungarian entrepreneurs are still sufficiently unaware about the issues would be of utmost importance in light of the imminent accession. Therefore, during the preparation phase, it is necessary to collect and distribute widely information about the role of SMEs and the mechanisms and instruments available for the sector. This motivation of the research was to try and help entrepreneurs and interested readers alike to understand the requirements of the EU, to draw concrete conclusions and also take actions to fulfil them. 3

Table of Contents Title... 1 Acknowledgements... 2 Abstract... 3 Table of Contents... 4 List of Tables and Figures... 6 Introduction...7 1. State of SMEs in Hungary General Overview...9 1.1 Economic Environment... 9 1.2 Definition of SMEs in Hungary and in the EU... 10 1.3 SMEs Weight in the Economy... 12 1.3.1 Number and Composition... 13 1.3.2 Employment Share... 14 1.3.3 Contribution to the Gross Value Added... 15 1.3.4 Contribution to Export Performance... 16 2. Hungarian SMEs in light of the Accession...18 2.1 Strengths and Weaknesses... 19 2.2 Opportunitites and Threats... 21 2.3 Recommendations... 22 3. Hungarian SME policy...23 3.1 Institutional Framework... 23 3.2 Historical Background... 26 3.3 Széchenyi Plan... 28 3.4 Széchenyi Enterprise Promotion Programme... 31 3.4.1 Main Pillars of SZVP... 31 3.4.2 Financing... 32 3.5 Smart Hungary Investment Promotion Programme... 34 3.6 National Development Plan... 35 3.6.1 The Planning Process... 36 3.6.2 NDP Framework... 36 4

3.6.3 Components of NDP... 37 3.6.4 Promotion of Enterprises and Investments... 39 3.7 Public Procurement in Hungary... 40 4. EU Support for SMEs...43 4.1 Pre-Accession Assistance for SMEs... 44 4.2 EU s SME Policy and Hungary... 44 4.2.1 Historical Background... 44 4.2.2 Multiannual Programme for Enterprise and Entrepreneurship (2001-2005)... 46 4.3 Other Funding Opportunities... 48 4.4 Hugarian SMEs in EU Public Procurement Process... 49 5. Activities of ITDH Euro Info Centre...51 5.1 Hungarian Investment and Trade Development Agency... 51 5.2 Euro Info Centre Network... 52 5.3 The Activities of EIC Budapest... 54 5.3.1 Answering Questions... 54 5.3.2 International Projects... 57 5.3.3 Case Study: PAVE project... 58 5.3.5 Seminars... 61 5.3.6 Promotional Activities... 64 5.4 Evaluation... 65 Conclusion...68 Appendices... 70 Bibliography... 76 5

List of Tables & Figures: Table 1.1: Definition of SMEs in Hungary and in the EU Table 1.2: Distribution of Major Indicators Characterising the Situation of Enterprises by Size Category, 2001 Table 1.3: Number and Distribution of All Employed by Enterprise Size, 1999-2001 Table 1.4: Contribution to Gross Value Added by Enterprise Size, 1999-2001 Table 1.5: Distribution of Export Sales by Enterprise Size, 1996-2001 Table 5.1: Answered Questions in Proportion of Total Questions at EIC Budapest, 2002-2003 Figure 1.1: The Proportion of Enterprises in Hungary and in the EU by Employment Category, 2000 Figure 3.1: Public Procurements Won by SMEs by Number, 2002 Figure 3.2: Public Procurements Won by SMEs by Value, 2002 Figure 5.1: Distribution of Questions Answered by Topic, 2003 Figure 5.2: Branch Distribution of Active SMEs in 2001 6

Introduction During the past 12 years the Hungarian economy has undergone tremendous changes. With the disintegration of state owned enterprises and the change from planned to market economy, the structure of the Hungarian economy changed considerably in two ways: ownership and size pattern. The changes in the ownership coupled with the increase allowed for private ownership resulted in a significant growth in the proportion and weight of small and medium sized enterprises (SMEs). At the end of 1989 - the eve of the transformation - statistics registered 300, 000 enterprises, while by the end of 1994 the number of the registered enterprises within the Hungarian economy exceeded 1 million. Since then, however, the number has barely increased. Following the period of political changes and economic transformation the Hungarian economy has become stabilized. In the proximity of accession, however, significant changes are underway again. The long-expected ratification of the Accession Treaty took place in Athens, on 16 April 2003, and set the time of accession on 1 May 2004. The biggest ever enlargement of the EU so far - both in terms of diversity and scope - is scheduled to take place when 10 new countries, namely Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, the Slovak Republic and Slovenia will join. EU Members in the Lisbon Economic Reform Agenda identified the strategic objective for Europe by 2010 as follows: to become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic development with more and better jobs and greater social cohesion. As a new member, Hungary must find ways to contribute to this objective. The outcome will ultimately depend on the success of businesses and particularly of SMEs. SMEs are considered to be one of the principal driving forces in economic development, and constitute the vast majority of all business enterprises all over Europe. They play a central role in contribution to the gross domestic product, as well as in increasing economic growth and competitiveness, creating new jobs, providing services, implementing new ideas and progressing innovation. This is due to their private ownership, entrepreneurial spirit and their flexibility, as well as their potential to react to challenges in a changing environment. It is therefore no surprise that the issue of SMEs has demanded special attention and, over the 7

past few years, policies towards SMEs have been considerably developed throughout Europe. I think the reasons, why I chose SMEs as the central theme of my dissertation, are clear. The accession to the European Union means an historic opportunity for Hungary, in which SMEs play a vital role. Success largely depends on the readiness of SMEs; how they can adapt to the changing environment, and how they can exploit the opportunities given by the new, Single Market situation I was also motivated by my experiences throughout my placement at the Euro Info Centre in Budapest, about which I will detail in Chapter 5. It is important to draw people s attention to the importance of collecting and offering information about the European Union and the opportunities offered by now and after the accession. The topic is up-to-date and relevant. There are threats, which have to be avoided, problems, which have to be solved, and opportunities, which have to be exploited - possibly before the accession in order to minimize risks. To reach this aim businesses have to see clearly what the pre- and after-acession context really means. 8

1. State of SMEs in Hungary General overview In order to be able to assess the situation of SMEs first it is necessary to analyse the macroeconomic environment in which they operate at the present. Then I will give the legal definition for SMEs in Hungary, comparing it with the definition given in the EU, and will support my argument concerning the importance of SMEs with a battery of statistics. In the third part of this chapter I will draw the reader s attention of the reader to the opportunities and difficulties arising with the accession. 1.1 Economic Environment According to the ECOSTAT the performance of the Hungarian economy lagged behind the planned and forecasted values in the first half of 2003. The greater depth and length of the recession of the global economy than previously forecasted has significantly reduced the growth potentials of the Hungarian economy. Although the world economy has been exhibiting signs of improvement, there is a time gap before the impact of prosperity can be sensed in Hungary. 1 The growth of the Hungarian economy as in nearly each quarter since 1999 was in harmony with the GDP growth-rate of the Euro-zone. The rate of GDP growth slowed, from 2.7% in the first quarter of 2003, to 2.4%. The low growth rate is also accompanied by a decreasing current account balance and a high fiscal deficit. The budget deficit grew beyond HUF 750 billion in September, already 3/4 of the yearly predictions and is forecasted to reach HUF 850 billion by the year-end. The deficit in the current balance of payments was 2.1 billion. The volume of investments increased by 0.6% in the first half of 2003 although manufacturing investments increased by 4.1% in the first half of the year. The industrial production was rather varied this year; the 8.5% increase in July was followed by 3% decrease in August. Export sales still exceed domestic sales. The increase in household consumption expenditure fall back in the second quarter of 2003 but it is still above the GDP growth. Consumption is still stimulated by the effects of public servants wage increase last year and tax relief on minimum wages. An overall figure for 2003 is calculated to be between 6-7%. 1 http://www.ecostat.hu/print.html/hirlevel/hirlevel37.html - 30 October 2003, 21:15 9

Consumer price increase was under the targeted figure in August but is expected to rise in the second half mainly due to the increase in food prices. Inflation is expected to reach 4.7% on yearly average. According to a survey by ECOSTAT, the SMEs prosperity index in August, 2003 was 42.7%, which is 2% lower than in July. The business confidence index of the sector has been decreasing since June and it has almost reached its lowest value in the last two years. This deterioration is mainly due to the low performance of the Hungarian economy and the strict fiscal policy expected for next year because of the high budget deficit. 15% of the entrepreneurs expect better performance of the national economy in the following period, 1/3 assume stability, and 55% predict deteriorating conditions. Considering future expectations of their own company they are somewhat more optimistic. More than 1/5 hopes improvement, and 50% of respondents indicate a constant level of performance in turnover. 25% assume slightly and 7% significantly worse performance. 66% forecast no change in export opportunities, while 16% expect better positions. As regards the short-term change in their financial position, 35% predict a deteriorating liquidity. 2 1.2 Definition of SMEs in Hungary and in the EU A common definition of what constitutes an SME is crucial as it is used as the basis for decisions on supporting instruments. This means that the various categories of SMEs have to be defined in an unambiguous and economically fair way, which is legally secure for the enterprises and easy to apply by the state administration. Adoption of a uniform definition is an important part of the harmonization of the SME acquis, as the lack of coherence in this field may cause problems when implementing specific SME-related schemes and programmes. However, the categories offered by the EU are only a recommendation, and are by no means obligatory. Both in the EU and in Hungary SMEs are classified by three criteria: - number of employees - annual turnover or annual balance sheet total - and the so-called criterion of independence. 10

The Commission Recommendation (EC) No 96/280 defines SMEs as enterprises of less than 250 employees, having either a maximum annual turnover of EUR 40 million or an annual balance sheet total not exceeding EUR 27 million. They also have to meet the requirement that 25% or more of the capital or the voting rights may not be owned by either one enterprise, or jointly by several enterprises falling outside the definition of an SME. A micro-enterprise is further distinguished as an enterprise of less than 10 employees. A small enterprise has fewer than 50 employees and reaches either a maximum annual turnover of EUR 7 million or an annual balance sheet total at maximum of EUR 5 million. Medium enterprises are those above the category of small enterprises. 3 Commission Recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises - will replace Commission Recommendation (EC) No 96/280 as of January 1, 2005. Criterion regarding the staff number will be unchanged, while financial indicators will be increased. The new regulation adds to the definition of micro-enterprises the criteria that their annual turnover and/or annual balance sheet total may not exceed EUR 2 million. In the case of small enterprises the annual turnover and/or annual balance sheet total is determined in EUR 10 million. Regarding medium-sized enterprises annual turnover will be increased to EUR 50 million and annual balance sheet total to EUR 43 million. These changes are necessary because of the increase in inflation and productivity since 1996. The European Commission also argues that changes will improve investments, ease access to venture capital, and reduce administrative burdens. 4 According to Act XCV of 1999 on the Small and Medium Sized Enterprises and the Promotion of Their Development, the categories esteblished for the number of employees used in Hungary are the same as in the EU, while considering the annual turnover and the annual balance sheet total the Hungarian limits are lower than recommended. See Table 1.1 for comparison. 2 Konjunktúra-indexek. ECOSTAT Gazdaságelemző és Informatikai Intézet, 28 August 2003, p. 13-19 3 Commission Recommendation (EC) No 96/280 of 3 April 1996 concerning the definition of small and medium-sized enterprises 4 Commission Recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises, C(2002)/1422 11

Table 1.1: Definition of SMEs in Hungary and in the EU 5 Number of employees Annual turnover Annual balance sheet total EU Hungary EU Hungary EU Hungary Micro -10 persons -10 persons Small 10-49 persons 10-49 persons -7 m -700 m HUF 6-5 m -500 m HUF Medium 50-249 persons50-249 persons -40 m -4000 m HUF -27 m -27 m HUF The economic portfolio of Hungary plans to modify the act to comply with EU recommendations. Its draft proposal will probably be discussed in the Parliament in January so that it could become effective before the accession. This change will extend the number of enterprises entitled to subsidies, but at the same time it will decrease the chance of real small and micro enterprises to get resources. The operating capital possessed by Hungarian enterprises is quite small compared to European ones, hence too many enterprises will be considered SMEs. Differences between capital and efficiency would favour enterprises earlier considered as large. In the new situation it will also be difficult to enforce the interest of small enterprises. 1.3 SMEs Weight in the Economy The essential structural features of SMEs have hardly changed recently; their business management is characterized by high labour and low capital intensity. The Hungarian SME sector has a significant role in employment but their GDP contribution is still moderate compared to the EU average. (See Appendix 1 for more comparison.) Their share of exports is also low and is decreasing year by year. The discrepancy is chiefly due to the great number of forced entrepreneurships in Hungary, which is expected to decrease after the accession. 5 A leggyakoribb kérdések a magyar európai uniós csatlakozásról (Frequently Asked Questions about Hungary s Accession to the EU). Magyar Köztársaság Külügyminisztériuma, Budapest, 2002, p. 43 6 Official HNB exchange rate: 1 = 258.07 HUF 14 November 2003 12

Table 1.2: Distribution of major indicators characterising the situation of enterprises by size category, 2001 7 (%) Micro Ent. 1-9 without employee Small Medium SME total Large Total employee Number 64.3 32.0 3.0 0.6 99.9 0.1 100 Number of employees 11.6 26.9 13.8 15.1 67.4 32.6 100 Net turnover 1.6 11.7 7.9 17.8 39.0 61.0 100 Gross value added 1.2 9.3 8.7 16.5 35.7 64.3 100 Capital 1.3 4.2 3.0 9.0 17.5 82.5 100 Exports 0.3 2.7 2.6 11.0 16.6 83.4 100 1.3.1 Number and Composition Focusing solely on the number of registered enterprises in Hungary, one may conclude that it is high - even compared to the EU average. This fact, however, is quite misleading since the majority of operational enterprises have fewer than 10 employees and thus belong to the micro-business sector. Statistical surveys first revealed the number of active enterprises within the registered group in 1995. Then the rate of active enterprises was 57.5%, which has reached 74.6% by 2002. 8 This clearly manifests that although the proportion of non-active, so-called forced entrepreneurships is decreasing, but it is still very high. They are established under the pressure of the founder s earlier or current employer, mainly for cost accounting reasons. Greater attention must be paid to the self-employed as their role in employment must be reinforced. 7 State of Small and Medium Sized Business in Hungary Annual Report 2002. Hungarian Institute for Economic Analysis 2002, p. 2 8 Calculated by the author after statistics of the Hungarian Institute for Economic Analysis, http://kfi.matav.hu/kfi5/statistics.htm - 10 October 2003, 12:03 13

Figure 1.1: The proportion of enterprises in Hungary and in the EU by employment category, 2001 70% 60% 50% 40% 30% 20% 10% 0% 64.0% 49.0% Sole proprietors 32.0% 44.1% 1-9 employees 5.9% 3.2% 0.6% 0.8% 10-49 employees 50-249 employees Hungary EU Number of Employees The table indicates that the proportion of micro-enterprises in Hungary is much higher then in the EU, but at the same time the proportion of small- and medium enterprises is significantly lower. For this reason in Hungary the economic importance and the development-forcing role of the entrepreneurial sector is not as high as in the industrially more advanced countries. The increasing number of micro-enterprises is still typical while the number of the most productive medium-sized ones is stagnant or slightly decreasing even. Thus to improve their significance and profitability is of vital importance. 1.3.2 Employment Share Since the aggregate proportion of micro and small enterprises is slightly under 100% they have an outstanding role in employment. Table 1.4 shows below the overall employment effect of enterprises (ratios refer exclusively to the competitive sector, and do not cover public sector employees). 14

Table 1.3: Number and Distribution of All Employed by Enterprise Size, 1999-2001 9 Employed (person) Distribution (%) 1999 2000 2001 1999 2000 2001 Enterprise without employee 332 107 325 799 346 370 11.2 11.0 11.6 Micro 745 230 774 245 803 599 25.0 26.2 26.9 Small 419 332 414 227 411 501 14.1 14.0 13.8 Medium 545 288 459 293 452 151 18.3 15.5 15.1 SME total 2 041 957 1 973 564 2 013 621 68.6 66.7 67.4 Large 948 209 981 821 976 149 31.8 33.2 32.6 Total 2 977 736 2 955 385 2 989 769 100.0 100.0 100.0 Source: Computation based on tax returns The data in the table indicates that nearly 70% of the people are employed by SMEs and only 30% by large enterprises. Within the SME sector a significant proportion is represented by micro-enterprises. The 67% share of SMEs in the entrepreneurial employment sector is slightly above the EU- 19 10 average. The average meanwhile embraces significant differences between member countries. This rate is significantly under the EU-average, for example, in Ireland (49%), but much in excess of the average in, for example, Italy (80%). Looking at the three groups of SMEs separately, the differences among EU members are even greater, changing from 18% (Ireland, Luxemburg) to 48% (Italy). Hungary s 36% figure is close to the average (34%). 11 1.3.3 Contribution to the Gross Value Added The contribution of the different-sized enterprise categories to the gross value added is defined on the basis of the difference between their respective production inputs and outputs. This figure, together with the balance on product taxes and subsidies, is equivalent to the GDP. When assessing the performance of the Hungarian economy, changes in the gross value added deserves special attention. It is very important to know what factors determine the 9 State of Small and Medium Sized Business in Hungary Annual Report 2002. Hungarian Institute for Economic Analysis: 2002, p. 88 10 EU-19: the 15 countries of the EU, plus Iceland, Liechtenstein, Norway and Switzerland 11 http://europa.eu.int/comm/eurostat - 25 October 2003, 14:19 15

increase of the gross value added, and to what extent. Between the period of 1996 and 2001 these factors were as follows: 5.3-5.5% increase in the number of employees 46.2-46.8% rise of the capital asset of enterprises 48.3% improvements in work- and capital intensity. 12 Table 1.4: Contribution to Gross Value Added by Enterprise Size, 1999-2001 13 (%) 1999 2000 2001 Enterprise without employee 1.2 1.1 1.2 Micro 8.3 8.7 9.3 Small 8.9 8.7 8.7 Medium 17.0 17.0 16.5 Large 64.5 64.5 64.3 Total 100.0 100.0 100.0 Source: Computation based on tax returns It appears that the proportion of the contribution of different-sized enterprise categories to the gross value added did not change significantly between 1999 and 2001. The table also indicates that the enterprises having the biggest chunk in the sector (enterprises without employee) contribute least to the gross value added. At the same time, the contribution of medium-sized enterprises to the gross value added is greater than their number would justify, which shows that they are more efficient. The difference between the size structure of enterprises in Hungary and in the EU is also reflected in the sector s GDP contribution. The SMEs contribution to the GDP in the EU is about 60% while in Hungary it is slightly above 50%. 1.3.4 Contribution to Export Performance As for the distribution of export sales, the contribution of large enterprises has increased markedly since 1999 and is now 83%. This number indicates how moderate the contribution of the SME sector to export sales is in Hungary. Moreover, their share has declined in every size category. Most small enterprises sell their products and services on the domestic 12 Tamás Mészáros, Zoltán Pitti: A vállalkozási szerkezet módosulása, különös tekintettel a középvállalkozásokra és az EU-sajátosságokra, Európai Tükör 2003/1, p. 60 13 State of Small and Medium Sized Business in Hungary Annual Report 2002. Hungarian Institute for Economic Analysis, 2002, p. 94 16

market; only a total of 7.5% of their revenues are generated by export. 14 Small and mediumsized enterprises could simply not retain their exportability. The small enterprises export to the markets of the developed countries under the average, the large ones over the average, whilst the export-range of medium-sized enterprises lies in between the two. This obviously shows the difference in their export potentials. Table 1.5: Distribution of Export Sales by Enterprise Size, 1996-2001 15 (%) 1996 1997 1998 1999 2000 2001 Enterprise without employee 3.9 1.3 1.1 0.4 0.4 0.3 Micro 9.3 9.3 7.8 3.5 3.2 2.7 Small 10.8 8.9 9.7 3.4 3.0 2.6 Medium 22.2 17.3 16.5 12.3 11.9 11.0 Large 53.7 63.1 64.9 80.4 81.6 83.4 Total 100.0 100.0 100.0 100.0 100.0 100.0 Source: Computation based on tax returns 14 http://www.ecostat.hu - 2 November 2003, 16:27 15 State of Small and Medium Sized Business in Hungary Annual Report 2002. Hungarian Institute for Economic Analysis, 2002, p. 98 17

2. Hungarian SMEs in light of the Accession This part of my dissertation deals with the present situation of SMEs, examines the opportunities and threats presented by the EU accession, and outlines a few recommendations about how to minimize the risks associated with next May. The examples of earlier EU enlargements have clearly shown that for existing member states the accession represents a great opportunity to further improve. Managing the effects of accession has caused problems of different nature and gravity to the variuos countries, depending largely on the country s level of readiness and the extent to which it was prepared to adapt to community guidelines. Benefits are expected from both ends. The addition of more than 100 million people, all from rapidly growing economies, to the EU market of 370 million will certainly boost economic growth and create jobs in both old and new member states. At the same time European citizens standard of living is likely to improve, as the new members will further adopt compulsory EU policies as regards environmental protection, the fight against crime, drugs and illegal immigration. Enlargement will also strengthen the Union s role in world affairs in foreign and security policy, trade policy, and the other fields of global governance. With the enlargement the EU will have become the world s largest exporter having an almost 20% share in global exports. Trade within the EU will also increase by an additional 9%. 16 Hungary s economy, as that of a new member state is expected to develop faster because of integration. Accession will further strengthen the predictability and stability of the economic environment and will considerably increase the efficiency of European companies investing in Hungary. Other impacts include the elimination of internal frontiers, which people will observe immediately after the accession. A common regulatory framework provided by the Single Market will increase the overall efficiency of the economy by improving the allocation of resources, increasing the degree of specialisation and enhancing competition. Non-member countries will also benefit from an enlarged Union. A single set of trade rules and administrative procedures will apply across the Single Market of the enlarged Union. 16 Enlargement What can Enterprises in the New Member States Expect? Enterprise Publications, European Commission, 2003, p. 7 18

This will simplify dealings for all firms within Europe and improve conditions for investment and trade, bringing benefits not only to the EU but also to its trading partners all across the world. The SMEs, which form the basis of the economy, are particularly exposed to the numerous changes in the business environment, induced by economic restructuring and preparations for accession. In the following sections I will explore the impact of accession on the Hungarian SMEs, in line with the main theme of my dissertation. 2.1 Strengths and Weaknesses The primary strengths of Hungarian SMEs are their flexibility, innovative capabilities and creativity. The key to their success lies in their organizational structure and flexibility to external shocks. The small number of employees, the absence of a bureaucratic structure and the ease of re-engineering their production capacity makes them particularly strong in times of crisis. They are likely to innovate via the introduction of new organizational approaches to enhance productivity, or the development of new techniques to expand sales. Their inventiveness is shown by their swift reactions. The quick and efficient production changes, along with the simultaneous engagement in several lines of operation are traditional values of SMEs and form the key to their competitiveness. The frequent alterations in the legislation have forced entrepreneurs to adapt quickly to the modified requirements. The majority of enterprises have a long experience in business. In the past few years multinational companies had a strong presence in Hungary and have selected their suppliers on a competitive basis. Many enterprises became suppliers of these multinationals and thus learnt to adapt to international requirements and standards. Weaknesses include technological backwardness caused by the lack of capital. The absence of advanced technologies causes shortcomings in quality and speed. According to a recent survey concerning the application of information technologies in SMEs, 72.4% of entrepreneurs have computers, and among these, 53.7% use the Internet. These numbers are significant and show quite an improvement. On the other hand however, almost half of those (47.2%) possessing computers have only one, 23.6% have two and 29.2% have three or more computers. Among those with Internet connection 3/4 have only one computer 19

available for using the Internet. More than half of the entrepreneurs interviewed spent less than 200 000 HUF (~ EUR 775) on computer technology. This means that SMEs IT infrastructure does not keep pace with the rapid development of technology. 17 Proper tools and using information technology are required to ensure quick and flexible communication with clients and partner organizations, and to meet changing demands. SMEs should develop in this respect, both in terms of equipment and knowledge. SMEs often lack the necessary financial and marketing knowledge; they prefer to concentrate on technical skills. A great number of SMEs are experts in their own products and/or services, but lack considerable managerial skills such as marketing, innovation and financial planning. Neither can they afford to employ personnel familiar with these issues. The also lack information and knowledge about the EU market conditions. The majority of SMEs are unclear about the advantages and disadvantages of the accession. Several surveys have revealed that only multinationals are fully ready for EU accession. With reference to the CAPE Survey 2002 18, only 53% of companies are fully (10%) and partly (43%) informed; while 28% claim having no information. 55% admit they do not sufficiently exploit the available information, while 25% describe the situation only slightly better than in 2002. The most significant obstacle to growth is the lack of capital and the uneasy access to financial resources. Early stages of growth are marked by uncertainty both in production and marketing. Smaller, innovative firms operate in environments of high complexity and rapid change and rely heavily on intangible assets. SMEs often have trouble obtaining financing, because banks and traditional lending institutes are averse to risky ventures. SMEs frequently suffer from cash flow problems, often caused by late payment of their customers. Many SMEs have problems in following legal regulations. Legislation is a necessary regulator to protect the business environment, to ensure employees health and safety and to lay down the respective social security rules. At the same time, however, it hampers 17 Katalin Kiss: Tanácsadás a kis- és középvállalatok esetében az EU csatlakozással kapcsolatban, (Consulting among SMEs in accordance with EU Accession), Humánpolitikai Szemle, XIV. évf., 2003/7-8, p. 44-45 18 http://www.signform.be/cape/survey2003.pdf - 3 November 2003, 9:24 20

business by imposing additional costs and administrative barriers. Large companies may assign a portion of their staff to deal exclusively with studying new regulations and ensuring the compliance of company operations. For SMEs, this would be a high cost, given the size of their businesses. SMEs often bear a disproportionate burden in complying with too many regulations and procedures, especially in the start-up phase. Such pressure of regulatory requirements can be a setback in one of their strengths - namely flexibility - and can lead to business failure. 2.2 Opportunities and Threats Becoming a member of the Union will bring new opportunities for actors of the business environment. In order to take advantages of the changes it is essential that SMEs consider accession as an opportunity to develop and reform. They need to adapt to the changed environment, capitalizing on the new situation. The elimination of internal frontiers and the free movement of goods will significantly facilitate and speed up transportation between and distribution among the member states and will therefore make these operations less expensive. This new situation will pose a risk but it will also offer an opportunity for Hungarian SMEs to go global and improve their competitiveness. In a larger market production levels will increase, and that will lead to higher productivity and economies of scale. SMEs, however, will have to face increased competition in the Single Market. In such a competitive environment quality, reliability, speed and environmental protection are the key values. Improving these factors, however, presumes innovation and capacity. Thus, in this competitive environment, the smallest enterprises are most likely to be damaged, due to capital shortage, limited modernization opportunities, and almost non-existent chances of starting a new business outside the micro-region. Increasing competition among financial institutions as a result of the free flow of financial services across borders will hopefully improve the level of their services and moderate their profit margins. Loans will possibly be offered with easier access and better conditions and they will be a basis for enhancing competitiveness. 21

The usual tools of small companies to gain price advantage such as the minimum wage employment, the so-called virtual companies and the bypassing regulations - will disappear in the Union. In certain cases complying with regulations may result in higher costs, which needs to be offset by increased efficiency and productivity. Safety at work and compliance with safety regulations will also be more important issues in the European Union. 2.3 Recommendations Globalisation of competition requires successful and forward-looking company management systems that are based on strategy and focused on business. In the light of today s business environment all SMEs have to ask themselves some questions, even if they want to go on with their local strategy and if business outside their traditional region has no strategic logic: Could co-operation with international partners/suppliers enable us to provide added value to our customers? Would such cooperation improve our profitability? Is there a chance that an international competitor able to offer the same personalized service by employing new IT and sophisticated logistics solutions enters our local market? If the organization expects such a situation, it should quickly start to develop a suitable strategy that offers a solution to these new environmental conditions. Most of all they should consider exporting as a strategic option. Small firm networks, clusters and syndicates may be the most expeditious path to a dynamic SME sector. Grouped in local systems of production, SMEs can often be more flexible and responsive to customer needs than large, integrated firms. They can pool resources and share the costs of training, research and marketing. Clustering facilitates exchange of personnel and the transfer of technology, also creates new possibilities for efficiency gains. From a company s view-point to be prepared for membership means the adoption of the EU legislation, the acquis communautaire, understanding the EU market and being ready for market competition. 22

3. Hungarian SME Policy The basic rationale why governments support SMEs is that they, on the one hand, lack the competitive edge needed to secure financing. There is also the relatively higher administrative cost involved in complying with government regulations, including tax legislation. On the other hand, there is the argument that such companies are much more flexible and dynamic and thus contribute to overall economic growth. 3.1 Institutional Framework This section presents organisations and networks promoting the development of Hungarian SMEs, without aiming at completeness. The institutional framework of enterprise promotion is very complex and is composed of several elements, including public administration organisations, the system of chambers of commerce, the network of enterprise development centres, organisations supporting technical and trade development, as well as interest representation groups, associations and foundations. Enterprise Development Council (VT) Although it was already established in 1995, its main role and structure has only been set in the Act on the Development of Small and Medium-Sized Enterprises and the Promotion of Their Development of 1999 (see details in the next section). According to the Act the VT makes recommendations for and expresses its opinion on the programmes and measures serving the basis of the SME strategy. It makes an assessment of the effectiveness of ministry programmes and enterprise-promotion organisations that are financed from the national budget, and evaluates the distribution of the budget appropriation for SMEs. According to the Act, members of the VT are the Ministers for Economy, Agriculture and Rural Development, Environmental Protection, Education, Finance, Social and Family Affairs, the minister in charge of co-ordinating PHARE programmes, a representative of the Prime Minister s Office, the chairmen of national chambers, and five representatives of the national organizations that represent the interests of SMEs. The VT meets at least four times annually. 19 19 Act XCV of 1999 on the Small and Medium Sized Enterprises and the Promotion of Their Development 23

Hungarian Enterprise Promotion Public Benefit Company (MVF) In 1999 it was established with the objective of promoting the sector of SMEs in its development. Since 2001 its only proprietor is the Hungarian government. The MVF works as the operational background organization of the Ministry of Economy and Transport (GKM) in carrying out its strategic functions. Its main objective is to carry out effectively the tender application process and operate the state support programmes to promote the realization of the national economic development objectives. It plays an important role at all levels of tender applications, including initial publication and provision of information to potential bidders, reception and evaluation of tenders, conclusion of contracts, financing and monitoring. It also contributes to the continuous improvement of the application system. It operates in partnership with the GKM, and other local, regional and national organizations of enterprise promotion, including the Hungarian Foundation for Enterprise Promotion (MVA), and the Regional Development Holding Company (RFH). Hungarian Foundation for Enterprise Promotion (MVA) and Local Entrepreneurial Agencies (HVKs) The MVA/HVK was established in 1990 by the government in order to support the establishment and development of Hungarian SMEs. In 1990, the Commission of the European Union appointed MVA to implement PHARE s SME Development Programme. HVKs were established under the MVA to serve as an implementation body operating in each county, totalling 140 to date. However, each HVK operates as an independent entityr, with the MVA supervising the programmes implemented by them and coordinating between the EU, the Hungarian government and HVKs. Since 1990 to the present day, the EU s PHARE programme has seen to the promotion of SMEs, which meant over EUR 80 million financing, supplemented by the GKM as co-financier. 20 The MVA manages the Micro Credit Programme (see details in Section 3.4.2), organizes enterprise development, consulting and training programmes, and other international programmes, such as businessmen s meetings. 20 http://www.mva.hu/z_alapitv/a_tortenet.html - 2 November 2003, 14:54 24

Regional Development Holding Company (RFH) and Regional Development Companies (RFTs) The RFH was established in April 2000, with a working capital of HUF 500 million, to promote the development of enterprises and regions, the enhance employment and strengthen both inter-company and cross-border economic relationships. The RFT was originally established as an affiliate of the Hungarian Development Bank. Between 2000 and 2002 RFH participated in the development programmes of the Széchenyi Plan, as a key organization with executing tasks and managing calls for proposals. In 2002, when RFH s subscribed capital was increased to HUF 8.5 billion, RFH purchased the RFTs and established additional companies involved in regional and entrepreneurial development. Since 2002 the main objective is to create an EU-compliant organization that is involved in regional and small area development and is in line with the EU funding mechanisms. Such an organization is capable of receiving EU development funds. Hungarian Investment and Trade Development Agency (ITDH) and Euro Info Centre (EIC) The ITDH was established in 1993 as a background organization of the GKM and the Ministry of Foreign Affairs, under the support of the PHARE programme. Its activities focus on investment promotion and trade development, including primarily improvement of export capabilities, increase of international competitiveness and subcontracting potential of Hungarian SMEs, as well as preparation of the Hungarian corporate sector for accession to the European Union. Euro Info Centre, operated within the framework of ITDH, has been designed to assist SMEs in their preparation for the accession to the EU, and to mediate the enterprise policy of the EU for Hungarian SMEs through consultation, seminars, information stands, publications and business partner exchange. For details, see Chapter 5. Hungarian Chamber of Commerce and Industry (MKIK) The MKIK, with a long history behind, is now a special entity established under the law. In the past, all enterprises have been required to register with the MKIK, but mandatory registration was abolished in November 2000. 25

The government provides financial support for the implementation of MKIK s priority tasks, such as accelerate the development of SMEs, prepare them for EU accession and further improve Chamber services. The organization helps to mediate and popularize the objectives of the enterprise promotion programmes, and to acquaint entrepreneurs with the announced tenders. MKIK also elaborates ethical rules on decent market conduct with the involvement of economic interest representation groups. It co-ordinates the provision of economic information and the promotion work of the regional chambers that operate in the capital, both at the county seats (19) and in three other cities. At present the economic chambers have more than 45,000 voluntary members. 21 Interest representation organizations of enterprises play a crucial role in shaping the business environment. They participate in the activities of the National Interest Conciliation Council, the Enterprise Promotion Council and other councils of national competence. These organisations present to the government economic policy proposals aiming to affect the group represented by them; they co-operate in working out the laws, communicate the views of entrepreneurs and negotiate with the government in their interest. The most important of these organisations are the following: National Association of Craftsmen s Corporation (IPOSZ) Hungarian Industrial Association (OKISZ) National Association of Entrepreneurs and Employers (VOSZ) Confederation of Hungarian Employers and Industrialists (MGYOSZ) National Association of General Consumer Co-operatives (ÁFEOSZ) National Federation of Traders and Caterers (KISOSZ) 3.2 Historical Background In the late 1980s, when the economy has stagnated and the needs for economic liberalization have risen significantly, the government decided to launch drastic reforms in May 1988 by stepping up the ongoing initiative to move toward a market economy and transform the entire economic structure. The legal system was subordinated to supporting reforms, including the taxation system, the introduction of a new pricing mechanism and the 21 http://www.mkik.hu/ - 5 October 2003, 22:03 26

amendment of the Foreign Investment Act, followed by the Company Act of 1989 - to liberalize the foundation of private firms and the privatisation of state enterprises. Then the new administration, born out of the 1990 general election, embarked on extensive economic reforms toward a full market economy. As a result, SMEs of varying size and nature have emerged. In the 1990s, the need arose for SMEs promotion, so as to absorb the people who have lost their jobs as a result of the structural reform of the industry. Various laws and programmes were introduced to lay the foundations of fostering SME development. Nevertheless, the reforms are not considered a full-fledged SME promotion policy and programme. Here is a list of SME policies and programmes implemented in the 1990s, along with the established organizations: 1989 Enactment of the Company Act 1990 Enactment of the Solo Proprietorship Act 1990 Establishment of the Institute for Small Business Development 1990 Establishment of the Hungarian Small Business Association 1990 Establishment of the Hungarian Foundation for Enterprise Promotion (MVA) 1994 Issuance of Government Decree 2040/1994. on the Government Conception of the Development of Small and Medium-Sized Enterprises 1995 Establishment of Enterprise Development Council (VT) 1997 Establishment of the Small Enterprise Department in the Ministry of Industry, Trade and Tourism it was later reorganized to the SME Promotion Department of the Ministry of Economic Affairs. It was the first administrative body responsible for SME policy. 1998 Formulation of the Hungarian Government s Strategy for Supporting Small and Medium-Sized Enterprises the strategy sets forth the following 9 policy agendas for SME promotion toward 2000. 1) Improvement of the business environment; 2) Expansion of financial access; 3) Strengthening of innovation capabilities; 4) Development of business information systems; 5) Creation of the entrepreneurship culture; 6) Preparation for the EU integration; 27

7) Upgrading of institutions and systems; 8) Enactment of the SME Promotion Act; 9) Coordination of SME support programs. 1998 Formulation of the Subcontracting Program designed to foster SME domestic parts suppliers, promote their productivity improvement and activate growth of the supplier base. 1999 Enactment of the Act on the Development of Small and Medium-Sized Enterprises and the Promotion of Their Development (entered into force in January 2000) 22 The SME promotion act has been drafted and discussed by the VT. The bill was submitted to the parliament in October 1997, but it was not passed until November 1999, partly due to the change of government. The act sets forth the basic principles on SME promotion. It consists of 4 chapters and 19 articles, including the definition of SMEs and budgetary allocation, as well as the fields and forms of support. The VT was re-codified: its role, operating procedures, organizational structure and members were determined. The Act also emphasizes that in the long term Hungarian enterprises need to catch up with the demands of the European Union. The Act established the SME Budget Appropriation (KKC) stressing that it is not their only available option for support, and other legislations may also grant access to tax and contribution benefits. 23 The Ministry of Economic Affairs became responsible for managing the appropriation. SME promotion policies and programmes in Hungary were developed to a structured and systematic form in 2000. They are strongly affected by the EU industrial policy guidelines. 3.3 Széchenyi Plan On March 29, 2000, a medium-term development plan - the so-called Széchenyi Plan - was announced by the previous government for the period of 2001-2006. The priorities of the plan matched closely the development plans prepared to receive resources available under the Structural Funds of the European Union. The seven priorities set in the Plan were as follows: motorway construction; research, development and innovation; housing construction, travel development, supplier programme, SME development and regional economic development. The Plan projected a total of HUF 434 billion for 2001-2002 to 22 Zoltán Román: A kis- és középvállalatok az EU-csatlakozás tükrében (The SMEs and the EU Accession in Hungary). Európai Tükör 51., Miniszterelnöki Hivatal Integrációs Stratégiai Munkacsoport, 1999, p. 83-90 23 Act XCV of 1999 on the Small and Medium Sized Enterprises and the Promotion of Their Development 28