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Defence Industry Consolidation in East Central Europe in the 1990s

Author(s): Yudit Kiss
Source: Europe-Asia Studies, Vol. 53, No. 4 (Jun., 2001), pp. 595-611
Published by: Taylor & Francis, Ltd.
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EUROPE-ASIASTUDIES, Vol. 53, No. 4, 2001, 595-611 3 ,
Defence Industry Consolidation in East

Central Europe in the 1990s
YUDIT KISS
The defence industry in the transformation process
THE DEFENCE INDUSTRY WAS ONE OF THE PILLARS of the command economy system. It
was the centre and quintessentialrepresentationof a classic commandeconomy, with
its rigidity, centralisedcontrol, strong vertical hierarchyand meticulously elaborated,
quantitative,obligatory plans that articulatedpolitical and military-technicalneeds
ratherthan efficiency considerations.Being a specific, closed sector of the economy,
the defence industrymanaged to preserve these basic characteristicspracticallyuntil
the end of the 1980s. Not only in the former Czechoslovakia, but even in reform-
minded Hungary,defence-relatedproductionremainedan almost untouchedresiduum
of the classical command economy.
Defence industrial production peaked in the late 1980s in East Central Europe.
Soon afterwards,however, the sector was hit by an unprecedentedlydeep crisis. The
first majorblow was the sudden end of the WarsawTreatyOrganisation(WTO). The
large-scale and lucrative military marketsand intense military-economiccooperation
networks of the region collapsed. Defence industry enterprises quickly became
insolvent. Their financialdifficulties were aggravatedby the burdensof unsold stocks,
cancelled productionlines and enormous reserves.
The collapse of the WTO military markets took place simultaneously with the
collapse of the civilian markets organised within the Council of Mutual Economic
Assistance (CMEA) system. Defence industryenterprisesin East CentralEuropewere
dual-purpose:in addition to their military-relatedoutput, they exported large quanti-
ties of civilian goods to the Eastern European markets. The disappearanceof the
WTO and CMEA meant the collapse of an extended supply system as well.
Companies could not rely anymore on large and cheap raw material and energy
supplies from the Soviet Union, and lost their stable network of intra-regional
subcontractorsas well. This was anotherfactor that pushed productioncosts upwards
and caused major practical problems in reorganisingthe firms' activities.
Another unexpected blow was the loss of the traditionalThird World markets,
principally in the Arab world. This marketbecame an increasingly importantsource
of hard currencyfor defence industryenterprisesfrom the mid-1970s. The Gulf War
and the subsequent US embargo on Iraq, Libya and Syria froze these business
contacts.
Defence-related enterprises not only lost their markets and major sources of
ISSN 0966-8136 print; ISSN 1465-3427 online/01/040595-17 ? 2001 University of Glasgow
DOI: 10.1080/09668130120052908
596 YUDIT KISS
revenue, but also the backing of the state that previously ensured their privileged
existence. According to the new market-orientedideology, the state was expected to
roll back from direct involvement in economic life. For decades the state had
provided special subsidies, access to investments and credits, tax, export and import
allowances, and specific forms of remunerationfor military-relatedcompanies. Now
all this was to disappear.Owing to radical defence budget cuts, there was a drastic
drop in state orders. This meant the loss of stable and comfortablelocal markets.In
addition,since the nationalarmedforces did not ordernew weapons, the industrywas
deprived of the local army's references and recommendations,something which is
usually a preconditionfor arms exports.
The transformationprocess that was unfolding in all Eastern Europeancountries
added new elements to the defence-relatedfirms' crisis and at the same time made it
extremely difficult for them to tackle it. In addition to the problems stemming from
their specific profile, defence industryenterpriseshad to cope with the challenges of
privatisation,trade liberalisationand new monetaryand fiscal policies like any other
company.
The crisis broughtan 80-90% drop in outputand massive lay-offs and insolvencies
in the military sector throughoutthe region. By the mid-1990s, however, defence-re-
lated productionhad become relatively consolidated in most East CentralEuropean
countries. Output stopped falling and the sector was reorganised following new
guidelines. The way this reorganisationtook place was stronglycountry-specific.The
changes that took place in the defence industryin the 1990s were like a litmus test
manifestingthe natureand depth of the transformationof the East CentralEuropean
economies.
Slovakia and Hungary followed two markedlydifferent paths. Hungary's change
was predominantlyindustry-ledand open to the world economy. The reorganisation
of Slovakia's military-relatedindustrywas principallystate-led and inward-oriented.
In the following section I will briefly describe the crisis and reorganisationof the
defence industryin both countries.Then I will give an evaluationof the restructuring
of the defence industryin the two countries.In the final section the main differences
between the two processes and the most importantfactors determining successful
restructuringwill be outlined.
Two cases of defence industryadjustmentin East Central Europe

Crisis and restructuringof the Hungarian defence industry
The specificfeatures of the Hungariandefence industry.In 1988, the most successful
year of the Hungariandefence industry, approximately40 factories were directly
involved in military-relatedproduction;93% of the country's military output was
providedby 17 enterprises.Defence industryenterpriseswere dual-purpose;the share
of militaryproductionrangedfrom 7.1% up to 82.2% of their total production.There
were five companies at which defence-relatedproductionrepresentedmore than half
of the overall output and one completely military plant.
According to data publishedin 1994, in the peak year of 1988 defence outputwas
Ft21.4 billion,l which represented 2.5% of manufacturingindustry's output (Heti
DEFENCE INDUSTRY CONSOLIDATION 597
Vildggazdasdg,5 November 1994). Defence-relatedactivity reached 6% of the total

machineryproductionand 25-30% in electronics and instrumentproduction(Kovacs,
1994). As much as 76% of the outputwas exported,60% to the formerSoviet Union.
Approximately30 000 people were employed in the defence industry,nearly 2% of
the economically active population (Figyelo, 14 February1991).
In the late 1980s communicationelectronics and precision instrumentsrepresented
75% of the whole militaryoutput.Of the rest, 12%was weapons and ammunition,8%
vehicle and aircraftrepair and 5% other goods like chemical and textile products
(Figyelo, 13 April 1990).
The most important20-25 military-relatedfactories were under strict state supervi-
sion, with managers appointed directly by the Minister of Industry2.All other
ministries connected with military production had a special 'closed department',
whose function was to ensure the needs of military-relatedactivity. These special
departmentshad separatefunds within the respective ministry's budget.
Although some importantcompanies were establishedin the countryside,the bulk
of military-relatedproducerswere concentratedin Budapest. The largest defence-re-
lated company was Videoton, which employed 20 000 people, with approximately
6000 workers in the military-relateddivisions by the late 1980s. The average
workforce of defence industryenterprisesor divisions specialised in military-related
productionwas 2000-3000.
The crisis. After the 1988 production record 1989 brought a drastic reduction of
military orders in Hungary. Both WTO and local demand decreased dramatically.
Between 1988 and 1992 productionpracticallyhalved every second year. Outputkept
falling until 1994. By the end of 1993 the sector was utilising only 20% of its still
existing productioncapacities.
A rapid erosion and disintegrationof the defence-relatedsector accompaniedthe
fall of productionin Hungary.Defence industryenterpriseswere plunged into a chaos
of administrativereorganisations,decentralisationsand changes of legal form. Most
went through several stages of ownership changes, being first commercialised and
then partially or entirely privatised. Companies were reorganised;large-scale enter-
prises were divided into several smaller-scaleunits that became independent.A few
companies went bankruptand were forced to close down, but many survived with a
reduced workforce and output.
Consolidation.In orderto survive, defence industryenterpriseswere forced to launch

majorreorganisationprojects.Most concentratedtheir energies on developing civilian
profiles. In the hope of future military orders, however, they did not liquidate their
defence-related production assets. Some enterprises became exclusively military
contractors;others converted to civilian production.
By the late 1990s the Hungariandefence industryemployed only one-tenth of its
peak workforceand its outputwas approximately10% of its recordproductionlevels
of the late 1980s. By and large the sector shrankto a level at which companies were
able to maintain themselves without large-scale state subsidies. The companies that
managed to survive were the ones which were able to carve out some local orders or
598 YUDIT KISS
TABLE 1
HUNGARIAN
DEFENCE
INDUSTRY 1988-1995
PRODUCTION,
1988 1990 1992 1993 1994 1995
Output 21 9.3 4.7* 6.7 6.3 6.7

(billion Fts)
Workforce 30 000 5600 5600
Companies 40 80* 66* 60 60
Share of 3* Less than
military 1*
production
in GDP (%)
Exports as 75 50 80-90* 21 20
% of output
Note: After a relative opening at the beginning of the 1990s it has again become very difficult to
get reliable data on defence industryproductionin East CentralEurope.In Hungary,owing to the
Law on Secrecy, no official data have been published about the sector since 1995. Approximate
figuresare quotedin interviewswith the protagonistsof the sector. Accordingto Bela Takacs,head
of the departmentof Defence and MilitaryIndustryof the Ministryof Economics, in 1999 output
reachedapproximately$40 million (MagyarNemzet,23 August1999.) Jane's Sentinelquotes a June
2000 interview with Takacs accordingto which sales of Hungariandefence equipmentfell to $40
million annually(Jane's SentinelSecurityAssessment,23 August 2000). The US CommercialGuide
quotes approximately$20-25 million worth arms exports from Hungaryin 1999 (Defense Market
Guide, 1999). Defence-relateddata are often revised retrospectivelyas well. Accordingto a recent
article,the Hungariandefence industryreachedthe bottomin 1995, when outputfell to Ft3.7 billion
and the sector employed 2800 people (Magyar Nemzet, 1 March 2000).
Sources: for columns 1-4: Isaszegi interview, Vilaggazdasag,28 September1994; for columns 1-4,
data markedwith an asterisk:Hegyhati interview,Nepszabadsag, 27 November 1993; for column
3: Heti Vilaggazdasag, 5 November 1994; for column 6: Takacs interview, Nepszabadsag, 18
October 1995; for column 7: Nagy interview, Vilaggazdasag, 4 August 1995.
find export niches. Those which received foreign investments through the privatisa-
tion process also had a chance.
The changes taking place in the Hungarian defence industry were principally
determinedby the recently introducedmarketforces and the enterprises'own survival
efforts. The companies' individual survival efforts turnedout to be a strongershaping
force than higher sectoral or state interest.In addition,after the demise of the Military
IndustrialOffice (MIO, see below) there was no state agency or sectoral organisation
to define and represent these interests efficiently. The sector's size and structure,
which formerly were shaped by external political forces, became principally shaped
by spontaneous,external market demand.
The government'sdefence industrypolicy. The first post-communistgovernmentthat

took power after the elections in 1990 was led by the centre-right Hungarian
Democratic Forum (MDF). After the 1994 elections the HungarianSocialist Party
(MSZP), the reformed communist party, and its former opposition, the Free
Democrats created a new coalition government.In 1998 the Young Democrats-Hun-
garian Civic Party (FIDESZ-MPP)and the IndependentSmallholders'Party (FKGP)
formed a new centre-rightcoalition.
After the formation of the MDF government, in early 1991, Lajos Fur, the then
Minister of Defence, declared that Hungary needed a modernised arms industry to
supply its armed forces (Heti Vildggazdasdg,20 April 1991). On 1 January 1992 a
Military Industrial Office (MIO) was set up, to coordinate and promote military
productionand related activities in Hungary.This independent,civilian agency was
financeddirectly from the budget of the Prime Minister's Office and its directorhad
the rank of state secretary.
The MIO's major aspirationwas to re-establishclose to pre-crisis productionand
employment levels. To achieve this goal the Office proposed to set up a military
industrialholding company in orderto protectand promotethe core enterprisesof the
Hungariandefence industry. The assets of 10 main military producers were to be
transferredto a state-owned military-industrialholding company under the supervi-
sion of the Military IndustrialOffice. The project was to be financed from the state
budget and other, extra-budgetarysources, like the Fund for Technical Innovation
(Laszlo, 1993).
Owing to internal political struggles, in June 1993 the head of the MIO was
dismissed and the Office ceased to be an independent government agency. Its
functions and some of its personnel were taken over by a departmentof the Ministry
of Industry and Trade. In October 1994 a new project prepared by the Military
IndustrialOffice departmentwas published. According to the document,state-backed
orders,financed (partlyor entirely) from the state budget, could still save the core 59
defence-relatedenterprisesfrom bankruptcy.3The paper called for a major financial
infusion to rescue the sector (Heti Vildggazdasdg,5 November 1994). Less then a
month after the document was published, the Office's director was removed, the
Office was again reorganisedand, sinking a furtherstep downwardin the administrat-
ive hierarchy,became a simple ministry department.
The last reorganisationof the MIO put an end to state-led, large-scale rescue
projects for the Hungariandefence industry.The new official policy concerning the
sector became ratherpragmatic.It emphasised that state agencies were unable and
unwilling to artificiallyrecreatethe defence sector on its former scale. They tried to
assist the companies' struggle for survival, but by and large were resigned to
cooperating with those companies that managed to survive on their own. From the
mid-1990s, when Hungary's invitation to join NATO became plausible, Hungarian
state agencies became more active in promoting the defence industry.They pushed
for increasing defence budgets, specifically those for procurement and technical
development. They assisted the defence-related companies in obtaining quality
certificates, efforts at standardisationand search for foreign contacts.
Even though a large-scale, comprehensive rescue project was not introduced in
Hungary, defence industry enterprises did receive both direct and indirect support
from state agencies on an individual basis. Some companies were bailed out by the
state; some received advantageouscredits for new development projects. In a major
'consolidation' project, announcedby the state in 1993, five military-relatedenter-
prises featured among 13 large-scale state-owned enterprisesthat were selected on
account of their 'crucial macroeconomicimportance'.They received significant state
help, in the form of debt forgiveness and other protective measures. In the spring of
1997 some old bad debts of the defence-related companies, related to pre-1989
investments, were written off. Another indirect way of supportingthe defence sector
was to promote military-relatedR&D (Takacs, 1997a, 1997b).
600 YUDIT KISS
Crisis and stabilisation of the defence industryin Slovakia

The specific features of the Slovak defence industry. In Slovakia, as in the other
backwardeconomies of Eastern Europe after World War II, the establishmentof a
Soviet-style weapons industrywas carriedout in the frameworkof a forced industri-
alisation programme. The Slovak arms industry specialised in large-scale heavy
weaponry production, principally under Soviet licences. Most defence industry
enterpriseswere green-field investments.
Military productionreached its peak, Kcs 19.3bn4,in 1988. Slovakia contributed
more than 60% of the whole Czechoslovak defence output, while its population
representedonly 33% of the country.Military-relatedproductionwas concentratedin
the heavy engineering and electronic industries.In 1988 arms manufacturingrepre-
sented 24% of the total output of these two branchesin Slovakia (Droppa, 1993, p.
7).
All militaryenterpriseswere dual-purposefactories.In 1988 56% of the companies
had a higher than 20% share of defence-relatedproduction.Between 1980 and 1990
60% to 90% of all investments carried out in these enterpriseswere dedicated to
military purposes. The average employmentin the Slovak firms was 12 000-14 000
people. At its peak the Slovak defence industrydirectly employed approximately80
000 people (Outrata,1993, pp. 84-85). The largest Slovak military enterprise,ZTS
TEES Martin,was 60% military-relatedand employed approximately15 000 people.
Another characteristic of the Slovak defence industry was its high regional
concentration.In the late 1980s there were more than 30 000 workers involved in
defence-relatedproductionin the so-called 'military triangle' of Martin, Detva and
Dubnica in North-CentralSlovakia. Other regions' defence dependence was also
strong:in several provincialcities like Martin,Dubnica,Detva and Povazska Bystrica
military-relatedproductionwas the main, sometimes the only employmentpossibility.
The bulk of defence-related enterprises were under the control of the special
departmentof the Ministry of Economy. The rest of the companies, principallythe
ones specialised in repair,belonged to the Ministry of Defence.
The crisis. Between 1988 and 1991 defence industryoutputfell from Kcs 19 billion
to Kcs3.5 billion. By 1992 outputwas a mere Kcsl.8 billion. This represented9.3%
of the 1988 peak productionlevel. The crisis caused the loss of 30 000 jobs in the
sector (Droppa, 1994). Arms exports suffered a similar decrease. Between 1976 and
1988 the average yearly sales reached about Kcs7 billion, whilst in 1991 and 1992
they were only Kcs3.7 billion (Outrata,1993, pp. 88-89).
In the early 1990s the bulk of the Slovak defence-relatedenterpriseswere on the
edge of bankruptcyand faced dim future prospects. They had lost their traditional
marketsand had difficulties in finding new ones. They lacked resourcesto modernise
military production,follow up conversion projects or maintain existing production
levels. They were also in the midst of political and institutionalinsecuritythat made
their situationeven worse. In early 1994 defence industryoutputreachedSK2 billion,
approximately10% of the peak in 1988. At least half of the previously employed
workforce was made redundant,causing about 30% unemploymentin some heavily
affected areas.
TABLE 2
DEFENCE
SLOVAK INDUSTRY 1988-1997
PRODUCTION,
1988 1992 1994 1997
Output (CSK billion)

(SK billion) 19.3 1.8 2 2
Employed 80 000 50 000 40 000 30 000
Enterprises 25 25 25 25
Share of military production 30-65 0-10 n.a. n.a.
in their output (%)
Share in heavy engineering 24 n.a. n.a. n.a.
and electronic industry(%)
Note: I could find no more recent figuresthen the ones I was given in my 1997 interview
with Dudak.The latest Jane's assessmenton the Slovak defence industryquotes 1994-95
data. According to the article, the value of arms exports fell from $178 million in 1994
to $29 million in 1995 (Jane's SentinelSecurityAssessment,3 April 2000). Accordingto
the 2000 Conversion Survey, in 1998 in Hungary 2200 people were employed in the
defence industry, in Slovakia 35 000 (Bonn International Center for Conversion,
Conversion Survey. Global disarmament,demilitarizationand demobilization (Oxford
University Press, 2000)).
Sources: Droppa, 1993 and 1994b; Stanek, 1993; Dudak et al. 1997.
Stabilisation. According to official sources, in 1997 the Slovak defence industry's

output was one-tenth of its peak productionlevels reached at the end of the 1980s.
The sector was utilising 20-30% of its productioncapacity. The bulk of production
was repair and production of spare parts. Local demand covered 5% of defence
industry output (Dudak et al., 1997).
According to independentexperts, defence industryoutput grew considerablyafter
the nadir of 1992-93. Smith claims a 40% increase in 1995 and 13%in 1996 (Smith,
1997, p. 67). Blaha states that defence-related production accounted for 7-8% of
manufacturingindustry's outputin 1996. He quotes J. Brhel, secretaryof state at the
Ministry of Economy, stating that this share could well increase to 30% by 2000
(Blaha, 1997, p. 75). According to New Europe, by mid-1997 the workforce in the
whole sector was reduced to 18 000 people (New Europe, 13-19 July 1997).
By late 1999 the bulk of the current or former defence-related companies in
Slovakia were still strugglingwith serious economic and financialproblems.They had
very high levels of debt, unresolvedinternalstructuralproblems,insufficientdomestic
and foreign orders and, despite several waves of redundancies, still significant
overemployment.The 1999 OECD Report on Slovakia assessed the situation of the
currentor former defence-relatedcompanies rathercritically (OCDE, 1999).
The government'sdefence industrialpolicy. After the Velvet Revolution the introduc-

tion of market-orientedeconomic reforms and political liberalisationtook place more
slowly in Slovakia then in the rest of the formerCzechoslovakia.The break-upof the
country in 1993 made the problems worse. The 'transitioncrisis' was prolonged and
political uncertaintieswere magnified by Prime Minister Meciar's impulsive style of
running the government.In the spring of 1994 the Meciar cabinet was ousted and a
new government,led by Josef Moravcik, was formed. In November 1994, when the
interim government's mandate was over, Meciar and his allies won back power. In
602 YUDIT KISS
1998 a wide coalition of anti-Meciarforces managedto form a new government,led

by the Slovak DemocraticCoalition (SDK) of Prime MinisterMikulas Dzurinda.The
new cabinet launchedmajor economic reconstructionand political reforms. Unfortu-
nately, the governing coalition is rather unstable and economic difficulties are
mounting, which might threatenthe government's position.
After the break-upof Czechoslovakia, the new Slovak Prime Minister, Vladimir
Meciar promised that 'the Slovak army will have enough means to guarantee its
efficiency, even if these means have to be provided at the expense of other budget
items' (Lidove noviny, 5 January1993). The governmentintendedto consolidate the
military sector with both new institutional arrangementsand renewed financial
support.
In 1995 the Ministry of Economy, the Fund of National Propertyand some other
ministries,enterprisesand banks founded the DMD holding company in Trencin.The
aim of the holding company was to coordinateand facilitate the member defence-re-
lated companies' exports,R&D and technologicalinnovation.It was expected to push
its companies to restructureand assist them in obtaining externalresources for their
projects.By the late 1990s 20 companiesbelonged to the holding company,including
some key defence-relatedenterprises.
The Slovak governmentsprovided direct financial support for the crisis-stricken
enterprisesof the military sector as well. In 1993 SK500 million were scheduledfor
ongoing conversion projects.5By the end of the year, as an emergency step, the
government provided SK2 billion to write off the military enterprises' bad debts
(Droppa, 1994; Pravda, 31 January1994). In 1994 the Moravcikgovernmentdecided
to allocate anotherSK245mn for conversionprojects (Lidovenoviny, 18 April 1994).
In June 1994 a decision was taken to help about 30 companies with anotherSK300
million to resolve the problem of their bad debts (Lidove noviny, 22 June 1994).
Under different headings ailing defence-related companies received important
financial infusions practically every year.
In 1997 the Slovak government introduced Act 211/1997, on revitalisation of
enterprises.Since the bulk of Slovak enterpriseshad serious financial problems, the
law envisaged assisting these companiesto clean their balance sheets and launchnew
restructuringprojects. Companies had to present a business plan that promised to
increase the efficiency of production,improve the employmentsituationand/orboost
the regional economy. All defence-relatedcompaniespresentedtheir projects.Even if
they were not accepted, the participationin the programmeprotected them from
bankruptcyand helped them to postpone crucialrestructuring.In 1998 one of the first
steps of the in-coming governmentwas to cancel the revitalisationprogramme,which
had proved to be utterly counterproductive.
The principalmeans to preservethe government'sdirect influence over military-re-
lated firms was maintained state ownership. Under the first Meciar government
privatisationslowed down and the privatisationof defence industryenterpriseswas
blocked. The Moravcikcabinet intendedto carry out a radical and rapidprivatisation
but did not succeed. During Meciar's second term a controversial privatisation
process was carriedout. Voucher privatisationwas halted and the sale of state-owned
enterpriseswas carried out on a case-by-case basis, principallythroughdirect sales.
The Fund of National Property(FNP, the state privatisationagency) sold companies
directly to invited buyers, without public tenders.6 The result of this lop-sided
privatisationprocess was a complicated system of cross-ownership,in which the real
owners of the military-relatedenterprisesbecame predominantlystate-ownedbanks,
companies and other state institutions.
As of 1 May 1997 all defence industry enterprisesthat had not been previously
privatised became 100% state-owned shareholders'companies. The state as founder
and owner was represented by different state organisations, like the Ministry of
Economics, Ministryof Defence and the Fund of National Property.Defence industry
enterpriseswere included in a group of strategic companies that were scheduled not
to be privatised.
Following a new policy turn,in 1997-98 several majorcompanies (including some
of the 'strategic' ones) were sold to groups close to the Meciar government. In
November 1998, one day before the new governmentheld its inauguralsession, the
Fund of National Propertysold the majorityshares of the DMD holding company to
a group of Meciar allies (Slovak Spectator, 9-15 November 1998). After the new
governmenttook office, it changed the entire leadershipof the FNP and promised to
review the most importantprivatisationdeals of the Meciar period. The state regained
control over several companies thathad been sold in opaque deals, among othersZTS
TEES Martin.
Evaluation
Defence industry consolidation in Hungary and Slovakia can be evaluated both at
company and at macro level. At company level successful restructuringwould mean
increased efficiency, productivityand profitability,economic and financial stability,
output and sales growth, promising future prospects and stable external contacts.
Using these criteria,thereis only a handfulcompanies,like Videoton, Orion,Fegarmy
and TKI in Hungaryand Slovenske Lodenice, MartinDiesel and HrinovskeStrojarne
in Slovakia that can be considered successful.7
It can often be misleading to employ standardeconomic performanceindicatorsin
the context of defence industryin East CentralEurope. Usually it would be illusory
to expect profitability,major output growth or sound financial situation as a success
indicator, for example. Most enterpriseshave serious financial difficulties and have
limited marketopenings. Specifically in Slovakia, even those companiesthatmanaged
to carry out successful restructuringand have promisingfuture prospects are saddled
with accumulated debts and have very limited resources for further development.
When assessing the results of company-level adjustmentefforts it is often more
illuminating to look for more qualitative indicators, for example the way internal
production and management systems were reorganised or managerial attitudes
changed. Companies that put an emphasis on development and investment (even
though owing to their poor financial situation it was often postponed), carried out
in-depth restructuringof productionand management,made efforts to obtain quality
certificates and pursued active marketingare possible candidates for future success
stories.
In general the companies that became successful were those which were able to
turntheir defence industryheritageinto a developmentasset. They capitalisedon their
604 YUDIT KISS
higher than average technological and infrastructurallevel, highly skilled and

versatile workforce, strong enterprisenetworks,large-scale reserves and large usable
land holdings. The bulk of the current or former defence-related companies,
however, were stuck with the negative elements of their defence industrialheritage.
They were unable to change the hierarchical dependency and rigid management
patterns-the whole company rationale that correspondedto military technological
and securityrequirementsratherthan economic efficiency. They have deep structural
problems, serious financial burdens and insecure future prospects.
It is also an open questionwhetherexit from the sector can be considereda success.
In some of the most successful adjustmentcases an in-depth enterpriserestructuring
was carriedout simultaneouslywith a radical productionprofile change. The Slovak
Martin Diesel and Slovenske Lodenice or the HungarianSiemens-Telefongyarand
Bakony Works became prosperousby leaving the defence-relatedsector and entering
a civilian productionbranch with more development potential.
Restructuringefforts can be evaluated from a different perspective, horizontally
at regional level and vertically at sectoral level as well. Seen at a sectoral level,
the defence industry in both countries was practically decimated as far as output
and employment are concerned. It is clear that military-relatedproduction was
oversized in the individual WTO countries in the past, since it was designed to
meet the needs of the whole military alliance. The drastic reduction of the scale
of the defence industry can be interpreted as a quantitative adjustment of the
individual countries' defence sectors to their actual defence needs.
A further,crucial question when assessing defence industry adjustmentefforts at
sectoral or regional level is what happenedto the productionassets formerly tied to
defence-relatedproduction.The creative reallocation of these assets diminishes the
losses caused by the restructuringand provides at least some returnson the major
investments that were channeled exclusively to the defence industry in the past
decades.
Here again there were some successful cases, but often outside the boundariesof
the sector or region. The high-quality, versatile workforce trained in the defence
industry,for example, was absorbedby the civilian car componentor telecommunica-
tion industries in both countries. Czech companies close to the newly created
Czech-Slovak border established a specific long-term, long-distance commuting
system that absorbedthe cream of the well-trainedworkforce released by the ailing
Slovak defence companies. Former defence industry skills, premises and some
technology were reused by newly set-up SMEs in the Slovak Dubnica and Hrinica
and the HungarianSzekesfehervarand Ajka.
Comparisons
In the following section I will present the major factors that were decisive in the
success or failure of defence industryadjustmentand comparetheir impact in the two
countries.
Macroeconomic elements
The general state of the economy. In the early 1990s Hungary's macroeconomic
transformationproject suffered serious delays and distortions, due to political and
economic difficulties. The transition crisis became unexpectedly long. Output and
investment continued to fall, while the budget deficit, foreign trade deficit, external
and internalindebtedness,unemploymentand inflation kept increasing.In the spring
of 1995 a severe economic stabilisation programme was launched in order to
restructuremacroeconomicbalances. Among others,the measuresincluded a one-step
devaluation of the national currency, an import surcharge and radical cuts in real
wages and social security expenditures. The package had serious negative conse-
quences on welfare, but had a stabilising impact on the economy that led on to
recovery. From 1996 the Hungarianeconomic situationhas been improvingconsider-
ably. Even though by 1999-2000 major balance problems appeared again and
economic growth has slowed down, the economy was clearly expanding and had
promising future prospects.
In Slovakia the velvet revolution and the break-up of Czechoslovakia were
followed by a deep recession. GDP and industrial production decreased, while
inflation,unemployment,tradeand budget deficits kept climbing. The economy began
to recover from 1994. Between 1995 and 1998 the Slovak economy manifested
impressive GDP growth and the lowest inflation rate in East Central Europe.
Economic growth, industrial production and investment began to soar, as well as
exports and privateconsumption.At the same time inflation,the budget deficit and the
trade balance were under control.
From 1997, however, the economy's deep structuralproblems became manifest.
The deficit on the currentaccount reached 10% and that of the state budget mounted
to 5% of the GDP. The increase in exports was principally due to massive sales of
raw materials or low value added products that showed clear signs of exhaustion.
Despite its positive economic indicators in the mid-1990s Slovakia attractedvery
limited foreign direct investment (FDI), principally due to its unstable political
climate. Heavy externalborrowingfinancedthe investment and consumptionupsurge
experienced during the 1990s, which led to a swift increase in foreign indebtedness.
Since the Meciar governmenttried to hide the worseningproblemsof the economy,
it was the new government's difficult task to redress the economic situation. At the
end of May 1999 the governmentapproveda 'rehabilitationprogramme'that focused
on cutting expenditureand improving the efficiency of public budgets, streamlining
state administrationand reforming social welfare systems. Thanks to the macroeco-
nomic stabilisationmeasures the twin deficits were relatively well under control by
the end of 1999. At the same time unemployment,inflation and foreign indebtedness
reached alarminglyhigh levels. The proposed restructuringand adjustmentmeasures
were expected to depress living standardsfurther(MESA, 1999; IMF, 1999).
In principle, the better shape the economy is in, the better the prospects of a
successful industrial restructuringare. By and large both countries confirmed this
point. The possibilities of a successful defence industryconsolidationhave improved
simultaneouslywith the general economic recovery. Beyond this general picture, at
the same time, there were some other correlations.In the early 1990s the transition
606 YUDIT KISS
recession and the state authorities'relative indifferencepushed the bulk of Hungarian

companiesto struggle seriously for survival.They had no other externallifesavers on
the horizon. By the time the economy began to recover and the authoritiesstartedto
reconsiderthe official promotionof the sector again, most companies were over the
worst of their crisis and could make better use of whatever state help they were
offered.
The relative macroeconomic success of the Slovak economy, and the major,
state-financedinvestment projects that provided some civilian orders until the late
1990s, at the same time kept Slovak defence-relatedcompanies above water. They
were not really forced to restructure,since they knew that, if the worst came to the
worst, the state had the means and political will to bail them out. Only the most
far-sightedcompany managersrealised that this was a short-termstrategyand tried to
carry through major transformations.
Economicpolicy. Several elements of economic policy, like wage, price and employ-
ment policy, bankruptcyregulations or privatisationhad a fundamentalimpact on
enterpriserestructuringefforts. Privatisationplayed a specifically importantrole.
At the beginning of the transformationprocess in East CentralEuropethere seemed
to be a wide consensus that privatisationwas going to resolve the problemsof ailing
state-owned enterprises.Owing to their political and strategic importance,however,
the privatisationof the defence industryenterpriseswas more contested than in the
case of other companies, both in Slovakia and Hungary.
By the end of the 1990s most Hungariandefence industry enterprises were in
private hands. There was a restricted group of companies that were scheduled to
remain under long-term state control. The bulk of Slovak companies were formally
privatisedbut de facto were under the control of state-ownedbanks, institutionsor
companies. The evidence of case studies suggests that the change of ownershiphelps
to resolve the deep-rootedproblems of defence companies only if it creates genuine
owners with a long-termperspectiveand ability to mobilise capital for the inevitable
restructuringof the firms. A genuine change of managerialattitudeis indispensable
both at private and state-owned companies.
The bankruptcy law and its implementation had a major role in enterprise
restructuringefforts. In the early 1990s in Hungary there was a massive wave of
bankruptciesthat made it clear to defence industry enterprisesthat they were not
consideredan economic exemption any longer. Several became insolvent or bankrupt
and were forced either to change profile or find external resources to avoid liqui-
dation. In Slovakia, despite an existing law, bankruptcyproceduresin practice were
not implemented.The threatof failure remainedrathertheoreticalfor most company
managements.
Employmentpolicy was not a crucial element in enterprise-leveldefence industry
restructuringin Hungary.Specialised state employmentagencies or regional authori-
ties addressed the consequences of sometimes massive redundancies.Employment
policy, at the same time, had a major role in preservingdefence industrycompanies
in Slovakia. Since most were large-scale employers and regional economic centres,
consecutive governmentsinsisted on helping them out, fearing massive redundancies
would have provoked a regional crisis. Defence-related companies were forced to
reduce their staff in order to reduce overhead productioncosts, but usually they did
it gradually and taking into consideration social criteria (for example the family
situation of the employees). To keep their core workforce they also had recourse to
ratherunusual practices; ZTS TEES Martin, for example, 'lent' a group of its best
qualified workers to the Volkswagen Bratislava company.
Industrial policy-defence industrial policy. In Hungary, after the first attempts to

preserve the state-guaranteedprivileges of the defence industry in the early 1990s,
official policy became by and large 'laissez faire'. Changes of governmentdid not
bring major changes in defence industrialpolicy. By 1995-96 the Hungariandefence
sector's size and structurebecame shapedprincipallyby spontaneousexternalmarket
forces. The state played a mostly facilitating role, providing indirect assistance and
some, limited subsidies to the defence industrialcompanies.
State interventionbecame more active again from the mid-1990s, with Hungary's
invitationto join NATO. State agencies found a new role redistributingthe increased
defence and procurementbudgets and mediatingin offset deals that accompaniedthe
modernisationprojects of the national defence forces. The defence industrybegan to
play a key mediatorrole in the country's Europeanand Atlantic integration.
In Slovakia, in contrast, the state retained its direct control over the companies,
through ownership, direct regulation and state subsidies. According to the official
guidelines, the defence industry had to be preserved because it was an industrial
flagship with significant export potential and a major source of employment. The
defence industrywas presentedas a symbol of nationalsovereigntyalreadyduringthe
break-upof Czechoslovakia.This role continuedinto the late 1990s, when, according
to the new official arguments,it had to be rescued and promoted to cater for the
modernised Slovak armed forces that eventually aspired to NATO accession. The
defence-relatedheavy industry also provided an indispensablepolitical supportbase
for Meciar and his HZDS Party. In Slovakia politically articulated local needs
determinedboth the sector's size and structure.Multiple direct governmentinterven-
tions aimed at both avoiding a furthercollapse and a genuine transformationof the
sector.
When the Dzurindagovernmenttook office in 1998 the sector's crisis was already
so deep that the new cabinet could not leave defence companies to their fate. Intense
governmentinterventionhelped the companies to obtain local and foreign orders and
foreign cooperation contracts. 'We just did what the company management was
supposed to do a long time ago', said Ludovit Cerak, Minister of Economics, after
announcingthat his ministryhad won a contractfor ZTS TEES Martinto export 800
tanks to Peru and 50 tanks to India (Slovak Spectator, 8-14 February1999).
Microeconomic elements
General conditions of enterpriseactivity. Beyond the general health of the economy,
the in-depth structuralchanges had a majorimpact on defence industryconsolidation
in East CentralEurope. The development of the economic environment,the level of
liberalisation, the state of the banking system, infrastructure,inter-enterprisenet-
608 YUDIT KISS
works, the state of factor markets and the like all had a major significance for
enterpriserestructuringefforts.
Despite the relatively better macroeconomic shape of the Slovak economy until
1996-97, Slovak defence firms had to struggle with serious difficulties stemming
from the rigidity of the economic structures.It was very difficult to find new jobs for
the redundantworkforce, to replace former subcontractorswith new ones or to get
credit for developmentprojects, either from the state or local banks. The rigidity of
the flat market,for example, became a majorobstacle to structuraladjustmentefforts
by the late 1990s. The general underdevelopmentof the economic texture made the
introductionof enterpriselevel reforms very difficult.
In Hungary, in contrast, micro-level economic development was more advanced
than in Slovakia. This provided more tools and flexibility for companies when they
addressedtheir bottlenecks.
Sectoral specifics. The natureand structureof the defence sector was a key factor in
adjustmentefforts. The Slovak defence industry had a large-scale, energy and raw
material-intensive,highly concentratedheavy industrialbase that constituted nearly
mono-culturalregional clusters. It was strongly dependent on Soviet licences, raw
materials and spare parts. All these characteristicsmade restructuringextremely
complicated and costly.
The Hungariandefence industrywas smaller-scale,more varied and more flexible
to begin with. Militaryelectronics, precision instrumentor small weapons production
is easier to convert than heavy industrialbranches.Hungarianmilitaryproductionhad
a relatively high input of local R&D and from the mid-1970s was engaged in
important export activities outside the WTO framework. These elements made
adjustmentssignificantly easier than in Slovakia.
Management.Macroeconomicpolicy concerning the defence industryevidently had

a majorimpact on enterpriselevel managerialbehaviour.However, since the systemic
changes began, the management's attitude and decisions taken at company level
gained a lot of importance.
In Slovakia the general attitudeof the companies' managementwas that in the end
it was the state's responsibility to keep them going. This, both real and assumed,
dependence inevitably restricted enterprisingspirits at company level. There were,
however, several company managementsthat took initiatives and tried to implement
changes, even within the limitations of state regulations.In the early 1990s at ZTS
Dubnica and Vahom, for example, an in-house accounting system was introduced,
with the aim of increasingthe branchcompanies' efficiency and accountability.The
management of Martin Diesel and ZTS Hrinovske Strojare implemented serious
internal restructuringand productivity-enhancingmeasures, despite the lassitude of
the general economic environment.
In Hungary at the beginning of the transformationdefence industry managers
manifested a strong bitterness vis-a-vis the state that had 'let the defence sector
down'. Later, however, the bulk of company managementscame to terms with the
situation and tried to make the best of it. Several defence-relatedcompanies carried
out successful restructuringprojects,principallythanksto their dynamicmanagement.
Regionalfactors. Evidence from case studies shows that the regional dimensionplays
an increasingly importantelement in enterpriserestructuring.Enterpriseand regional
level adjustmentefforts became much more interrelatedthan in the past. In the period
of state socialism the regions' well-being was directlyrelatedto the prosperityof their
dominant enterprises, over which they had a very limited, if any, influence. Now
regional authoritieshave more freedom to make use of their regional endowmentsand
create joint development projects with their major companies.
Similarly, the immediate economic environmenthas gained an increasing role in
enterpriselevel restructuringefforts. The regional dimension offers companies a new
forum at which problems of adjustmentthat are difficult to resolve at company level
can be addressed. The problems of redundantworkforce, empty company premises
and other unused productionfacilities were successfully resolved by joint company-
region efforts in the case of the Videoton company in the Hungarian town of
Szekesfehervar.Several industrialparks and SMEs were set up using the production
assets released by the reductionin defence-relatedproduction.A main source of hope
for the ZTS TEES Martincompany and the whole depressedMartinregion appeared
with the recent establishmentof the US company Johnson Controlsthat will produce
car seats, absorbingsome of the redundantworkforce and using the infrastructureof
the region.
Externalfactors
The defence industrywas shapedby externalpolitical factors duringthe WTO period.
After the political changes the traditionaldefence marketscollapsed and cooperation
networkswere broken. A period of inwardlooking developmentfollowed, when both
Hungaryand Slovakia tried to redefinetheir nationalsecurity concepts, defence needs
and the place of the defence industryin their economy. From 1994, when the sector's
slow recovery began, both at company and official level the emphasis was put on the
development of external trade and cooperation relations. Exports, FDI and foreign
cooperationwere seen as a key element of the survival of the defence industryboth
in Hungary and Slovakia. Both countries' companies and state authoritiestook part
actively in the search for new trading and cooperationpartners.
The undertakingwas ratherdifficult, because there is fierce competition between
Eastern European and Asian countries on the restricted markets for traditional
weapons. Political restrictionson arms tradeare much stricterthan in the past as well.
In addition, specifically in Slovakia, there was a significant lack of marketing
experience. The major arms trade company, Omnipol, with most of its specialised
experts, remainedin Prague after the break-upof the country.It took a long time and
considerable difficulties to create a new infrastructurefor arms trade. From 1994,
however, both countries concluded some new export deals.
By the mid-1990s the Hungarian defence sector had again become principally
geared towardsexports. Hungariandefence firms found new marketniches in Russia,
Turkey or the USA or revived contacts with their former Third World tradepartners
like India. Exports provided a vital source of cash for struggling defence industry
companies in Slovakia. The Slovak defence industrybecame active in African, Asian
and Latin American markets.
610 YUDIT KISS
As far as foreign cooperation and FDI were concerned, in Hungary several

defence-related companies established contacts with foreign partners.In the early
1990s foreign capital participated principally in privatisation, creation of joint
ventures and enterprise restructuringprojects. Foreign cooperation ranged from
simple assembly productionto joint researchprojects, and foreign partnersincluded
small-scale family-based companies as well as major TNCs like Siemens, IBM or
Sony. The military dimension was generally an attractivefactor, but there were no
specific military-relatedprojects carriedout with foreign cooperation.
From the mid-1990s, when Hungary's NATO membership became reality, it
became clear that defence budgets would be increased and the Hungarianarmed
forces modernised. This means a possible increase in local demand, and a new
opening for defence-relatedfirms throughoffset deals and intensifiedparticipationin
foreign militarycooperation.Hungariancompanies have alreadybecome involved in
specifically defence-related cooperation, like Dunai Repulogepgyar Rt with the
Swedish SAAB, and several, even civilian companies were listed as potential
cooperationpartnersin offset deals. NATO-relatedforeign contact building became
a major driving force for the Hungariandefence industry.
In Slovakia, owing to political insecurities and the very modest FDI, foreign
ventures and cooperation contacts were ratherlimited. There were, however, some
cases of cooperationwith Westerncompaniesin specific military-relatedprojects.The
most importantprogrammewas the modernisationof T72 tanks at ZTS TEES Martin
and ZTS Dubnica and Vahom, with the participationof the Belgian Sabca company,
two Frenchenterprisesand the British GEC Marconi.There was foreign cooperation
in the completion of the Zuzana automaticgun system at ZTS Dubnica and Vahom
as well. After the change of government and the confirmationthat Slovakia wants
furtherintegrationwith the Europeanand Atlantic institutionalsystems, defence-re-
lated contacts are likely to intensify.
As a result of the crisis and partial restructuring,the Hungariandefence industry
became leanerbut more efficient and productivethan in the past. Despite the slowness
of the changes, the defence industry has been learning a hard lesson of economic
adjustmentin Slovakia as well. In both countries the changes were achieved with
enormousmaterialand humanlosses. Active state interventionand financialcontribu-
tions in Slovakia do not seem to have diminishedthese losses significantly.It is still
an open question whether the defence industry will continue absorbing scarce
development resources or whether the latest measures by the new governmentwill
help to put the sector on a self-sustainingtrack.It is also a question whetherthe new
pull-effect of the NATO-relateddemand in Hungarywill boost the defence industry
beyond the country's economic possibilities.
Geneva
This article was originally presented at the 6th EACES Conference, Barcelona, Spain, 7-9
September 2000.
1
Exchange rates: 1988: 70 HungarianForint (Ft) = 1$; 1993; lOOFt= 1$; 1997:200 Ft = 1$; 1998;
240Ft = 1$; 2000; 290Ft = 1$.
2
Except the 100% military-related company that belonged to the Ministry of Defence.
3 Most
companies were created from the vestiges of former large-scale defence industry firms that
split into smaller units.
4Exchangerates:1989: 1$ = 30CSK (CzechoslovakCrown):1992: 1$ = 28CSK;at the end of

1993; 1$ = 33 Slovak Crown (SK); 1997: 1$ = 34SK; 1999: 1$ = 36SK: 2000: 1$ = 47SK.
5 Between1990 and 1993the Czechoslovak
governmentlauncheda major,state-backedinitiative
to convert defence industryenterprisesinto civilian producers.Financialsubsidies for ongoing
military-relatedproductionandsales werecurtailed,while conversionprogrammes whereencouraged
andfinanced.
6 The selectednew ownerswereoftenclose to government circlesandwereexpectedto createthe
'new Slovakcapitalistclass'. In mostcasesthey paida fractionof the sale price,the restwas forgiven
in exchangefor promisesof furtherdevelopmentandinvestments.
7
The case studiesreferredto in this articlewere carriedout by the author.Detaileddescriptions
arein Kiss (1997, 1999aand 1999b).
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Defence Industry Consolidation in East Central Europe in the 1990s

Defence Industry Consolidation in East

The defence industry in the transformation process

Two cases of defence industryadjustmentin East Central Europe

Vildggazdasdg,5 November 1994). Defence-relatedactivity reached 6% of the total

Consolidation.In orderto survive, defence industryenterpriseswere forced to launch

1988 1990 1992 1993 1994 1995

Output 21 9.3 4.7* 6.7 6.3 6.7

The government'sdefence industrypolicy. The first post-communistgovernmentthat

Crisis and stabilisation of the defence industryin Slovakia

1988 1992 1994 1997

Output (CSK billion)

Stabilisation. According to official sources, in 1997 the Slovak defence industry's

The government'sdefence industrialpolicy. After the Velvet Revolution the introduc-

1998 a wide coalition of anti-Meciarforces managedto form a new government,led

higher than average technological and infrastructurallevel, highly skilled and

recession and the state authorities'relative indifferencepushed the bulk of Hungarian

Industrial policy-defence industrial policy. In Hungary, after the first attempts to

Management.Macroeconomicpolicy concerning the defence industryevidently had

As far as foreign cooperation and FDI were concerned, in Hungary several

4Exchangerates:1989: 1$ = 30CSK (CzechoslovakCrown):1992: 1$ = 28CSK;at the end of

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