In 1990, General Electric acquired Tungsram Ltd., a Hungarian light bulb manufacturer. Hungary’s inflation rate was 28% in 1990 and 35% in 1991, while the forint (Hungary’s currency) was devalued 5% and 15%, respectively, during those years. Corresponding inflation for the U.S. was 6.1% in 1990 and 3.1% in 1991.
- What has happened to the competitiveness of GE’s Hungarian operations during 1990 and 1991? Explain.
- In early 1992, GE announced that it would cut back its capital investment in Tungsram. What might have been the purpose of GE’s publicly announced cutback?
- What has happened to the competitiveness of GE’s Hungarian operations during 1990 and 1991? Explain.
Answer. Since forint devaluations haven’t kept pace with Hungary’s roaring inflation, we know that the forint’s real exchange rate has risen. Specifically, if the nominal exchange rate (dollar value of the forint) at the start of 1990 was e0, the forint’s real value at the end of 1991 was:
0.95 x 0.85e0 x (1.28)(1.35)/[(1.061)(1.031)] = 1.276e0
This equation reflects the fact that if the nominal exchange rate (dollar value of the forint) at the start of 1990 was e0, then the 5% devaluation during 1990 left it at 0.95e0 by the end of 1990. A further 15% devaluation during 1991 would have left the nominal rate equal to 0.95 x 0.85e0 by the end of 1991.
Based on this equation, we can see that the real exchange rate increased by 27.6% during this two-year period. The sharp appreciation in the real value of the forint reduced the cost competitiveness of GE’s Hungarian operations.
- In early 1992, GE announced that it would cut back its capital investment in Tungsram. What might have been the purpose of GE’s publicly announced cutback?
Answer. GE was trying to put pressure on the Hungarian government to devalue further the forint and thereby improve the cost competitiveness of its Tungsram manufacturing facilities. In effect, GE was telling the Hungarian government that it was in business to make a profit and that if it couldn’t make a profit in Hungary because of the high forint and the resulting sharp jump in its costs, it was not going to invest there in the future.
