People often think that politicians want to win elections by any means possible.  This may be true in some cases.  It is also true that such a strategy can sometimes backfire.  Ferenc Gyurcsány could tell you a little more about running large fiscal deficits to pursue popular and populist policies.

Have you seen the images of riots and protests in Budapest over the past several weeks?  People took to the streets to protest when their Prime Minister admitted that he lied on numerous occasions about the state of the economy to remain in power.  The images are troubling indeed -- riot police, cars on fire, broken widows, tear gas, and water cannons. 

The political scandal may be embarrassing for the new member of the European Union.  Yet, what should really sound the alarm bells throughout the region are not the lies themselves, but what Ferenc Gyurcsány was trying to hide.

And what he was trying to hide is the real state of the economy.  The reality in Hungary is that the government is spending freely to appease the electorate beyond what the economy can pay for.  The result?  Projected budget deficit of more than 10% of the GDP.  That is very stark if you keep in mind the EU threshold of 3%.  Debt to GDP ratio in Hungary is also higher than the EU limit.

We call it fiscal populism.  Populist policies financed by any means possible without putting in place measure to ensure sustainability.  It is popular to lower taxes and not popular to raise them.  It is popular to increase funding for and the number of government programs and not popular to cut funding and programs.  But, the lesson of the day is that fiscal populism is not the best choice, even if it seems so in the short term.  Lying about it is even worse.

Interestingly, a recent IMF report released earlier this summer warned about the problem.  In fact, the IMF recognized and clearly stated that the scope of needed fiscal reforms is much larger than authorities are willing to admit.  Other international reports suggest that budgetary problems similar to those of Hungary are beginning to appear in Poland and other Central European countries. 

Solving this fiscal populism is easy on paper.  Cut spending and increase government income through a more powerful economic base and/or higher taxes.  Yet, implementing these measures can be much more difficult than writing up a few policies.

Hungary faces two set of challenges today.  First, it must deal with the short term fallout.  Political crisis may be on the horizon.  The country has already lost over $1 billion from businesses and tourists electing not to come to Budapest.  Negotiations for billions in investment seem to be stalling because of the political uncertainty and economic challenges.  Second, Hungary must implement the necessary measures to resolve the fiscal crisis and, most importantly, realign people’s expectation with the realistic state of the economy.

The good news is that it is not an impossible task.  Getting into the EU may have required a lot of work, but in the process of transition the country developed a set of institutions that built-in democratic ways of solving disputes and economic mechanisms that can be engaged to generate growth.

At the end of the day, it does not matter whether Hungary implements fiscal reforms for the sake of its own people or to meet the requirements of its EU membership.  The difficult task will be convincing people, who easily become accustomed to a good lifestyle, of the necessity of the measures. 

Ten years ago Hungary went through a similar exercise, when Finance Minister Lajos Bokros introduced a reform package that ultimately helped Hungary to become accepted within international markets and paved the way for its entrance into the EU.  The set of reforms was not necessarily popular, but it did put in place the necessary mechanisms for the country to move forward.  Maybe, reformers can reach back into their history and put to use the lessons learned in resolving today’s fiscal crisis.