Many countries in similar circumstances have failed to come to grips with these problems, with disastrous results—the paradigm example being Russia’s experience leading up to the crisis of 1998. There, rapid privatization (in the absence of functioning safeguards and market institutions) opened the door to massive self-enrichment by enterprise insiders, and the recycling of funds through a loosely supervised banking system. This led to the rise of oligarchs who bent the system to their will, creating public giveaways and a culture in which lobbying and self-dealing trumped the profit motive.

Hungary saw the beginnings of this in the early 1990s. Its experiments with market socialism had ushered in a complex and murky business environment. Hybrid (state-private) corporate groups, in many cases run by (former) state managers, linked enterprises, banks, and the state in an often collusive mutual embrace. Studies elsewhere have shown the governance failures that arise (with resulting underperformance and vulnerability to crises) where financial institutions are predominantly conglomerate- or state-owned, especially in emerging markets. In these situations, financial flows often depend far more on politics and personal networks than on transparent accounts and legal arrangements.

What could be done about this? Focusing on a direct assault against corruption would likely prove wasteful at best, if not disastrous, in a context where market institutions and the rule of law have only just begun to emerge. This suggests that establishing effective governance in the economy must be among the first priorities for a number of reasons, including the reversal of the wrong incentives. Thus the choices confronting Hungary in the early 1990s were tough, and the stakes high. Should privatization be rapid or gradual? Should market institutional reform be strict and sudden, or slow and accommodating? Should banking reform center on existing institutions or rapid influx of new ones? Hungary escaped the trap of failed transition that would have meant a spiral of distortion, stagnation, and corruption. The main steps in the reform were the implementation and adjustment of a legal reform package known as "legislative shock therapy," a (highly flawed), debt restructuring process, and robust privatization—especially of state holdings in the banking sector. These changes helped create one of the strongest financial sectors in the region along with a competitive and reasonably well-governed market.

These reforms revolutionized ownership incentives and imposed transparency on the system. The influx of foreign owners, together with the growing strength of markets and public sector institutions, brought banks and enterprises under the effective discipline of corporate governance and regulation. This helped create one of the strongest financial sectors in the region, a vibrant economy, and a reasonably well-governed and competitive marketplace. Corruption in the financial system, nearly a way of life in 1991, has become far more episodic and manageable. Having significantly improved both corporate governance and state oversight institutions, and having substantially divested its holdings in the real and financial sectors, Hungary is poised to emerge from its market transition. The disciplines imposed by the applicable international regimes, especially the EU, have played an important role.

The lessons learned from this experience include: