CDIE
          Impact
              Evaluation
                       SAVING ENERGY IN HUNGARY
                                  
USAID has shown that by adopting energy-saving methods and equipment,
Hungarian industry can produce more and pollute less. Now the challenge
                  lies in spreading the technology.
                                  
Since 1990, the Agency has been helping Hungary transit from a centrally planned economy to one
based on market forces. A major problem is energy inefficiency, a legacy of the communist era.
Addressing this, USAID projects have

  Trained a cadre of energy auditors capable of analyzing how a factory uses energy and
   recommending ways to eliminate waste and increase efficiency

  Introduced new ways of thinking about energy-saving technology

  Promoted low-cost, high-payoff energy conservation investments that yielded an average payback
   period of just 2.4 months and a financial rate of return of 485 percent

  As a by-product of improved energy efficiency, helped reduce air pollution at almost no cost
   
The projects were less successful, however, in getting out the message of energy conservation beyond
participating companies. Some reasons:

  Hungary shows no overriding concern for the environmental effects of energy production

  Although the technology clearly works, Hungarian institutions and markets are very weak

  When energy is relatively cheap, little incentive exists to use it efficiently; only when the market
   provides an opportunity to make money will demand for energy conservation become widespread

Author: Joseph Lieberson. Team members: Matthew Addison and Frank Hahn.

PN ABY 511                                               1996, Number 5                                SUMMARY
Until the 1940s Hungary was primarily an agricultural country. After World War II, a Stalinist approach to
planning and an emphasis on heavy industry dramatically reshaped the economy. Central planners gave little
heed to comparative advantage, rarely encouraged efficiency, and failed to recognize real resource costs.
Industry grew rapidly, but eventually there were shortages, stagnating production, and serious imbalances.
Inefficient energy use and high pollution levels harmed productivity and public health.  
  
After the end of communism in 1989, Hungary launched major economic reforms and started to open the
economy to trade and investment with the West. The move to a market-based economy was traumatic,
particularly for industries with old and inefficient equipment. USAID assistance dealt with a number of
problems in the transition from central planning to a free market economy. In particular, if the economy was
ever to be internationally competitive it needed to reduce wasteful energy practices.  Compared with
Western Europe, Hungary needed two and a half times more fuel to produce a dollar of output. If the
Hungarian economy could use energy more efficiently, it could move forward on economic restructuring
and become part of the international economic community.

USAID projects demonstrated that energy conservation works. Factories that made energy investments were
able to pay for their investments on average in just 2.4 months, with the money saved by burning less fuel.
This represents an extremely high financial rate of return of 485 percent.  Even from the perspective of the
national economy the investments generated a high economic rate of return, 165 percent.

Many engineers see energy conservation as a "hardware" problem of installing more efficient burners,
motors, and pumps. In point of fact, even more important is the "software" side of energy management. One
of the most important parts of the USAID projects was the introduction of new ways of thinking about
energy management, finance, production monitoring, and maintenance which can often be more difficult
than just buying a new motor.

Companies where energy is a major share of costs have a strong incentive to make energy efficient
investments. The USAID project targeted those firms, and the strategy paid off. It would have been much
harder to promote adoption in industries where energy is a minor part of production costs. 

While projects succeeded at the eight demonstration factories, and energy auditors trained by the project are
finding new business, the energy conservation message is not spreading rapidly. The technology clearly
works, but Hungarian institutions, markets, and incentives are weak, and much more needs to be done on
dissemination.  

CDIE STUDY

In October 1995 a three-person team from USAID's
Center for Development Information and Evaluation
(CDIE) assessed the Agency's energy conservation
program in Hungary. The assessment covered the
1990 Emergency Energy project, which provided
technical assistance, training, and equipment to
improve energy efficiency; the Regional Energy
Efficiency project; and a 1991 Energy Sector grant,
which addressed energy policy issues.

This was one of six impact assessments on energy
conservation carried out by the CDIE. Other countries in the series were the Czech Republic,
Guatemala, Jamaica, Pakistan, and the Philippines.
Each country evaluation examined the economic and
environmental impact of USAID projects by
exploring the same four evaluation questions:

1.   Policy reform. What has been the impact of
     government energy policy, energy pricing
     decisions, environmental policy, and
     privatization? 

2.   Technology transfer. Was the right technology
     selected, was it adopted, and is it still being
     used?


                  Moving Toward a Market Economy

Hungary is a country in transition nothing new to a land that has seen centuries of war and invasion. Indeed,
Hungary's rocky past is said to give the Hungarian people their distinctive traits at once of pride (in their
survivability) and pessimism (about what the future holds). In 1989 90 Hungary shook off communism to
become a multiparty parliamentary democracy. Today the country is making the difficult transition to a free-market economy that will face global competition.

The 1990 elections that swept the communists from power installed into the new parliament the Hungarian
Democratic Forum and its conservative coalition parties. The coalition, which gained 60 percent of the seats,
had promised wide-ranging economic reform. But reform did not go quite as planned. By the end of 1991,
unemployment had soared into the double digits. The annual inflation rate stood at 34 percent, and production
had declined. Moreover, privatization was going slowly; by the end of 1992, only 8 percent of industry had
shifted from public to private ownership.

General disillusionment with economic reform, coupled with the worldwide recession of the early 1990s,
resulted in a political shift to the left. For most Hungarians, there was a strong sense of having lived better
under socialism. In the 1994 elections, the Socialist party, successor to the Communist party that had
controlled the country for 40 years, was returned to power. 

But Hungary's enthusiasm for socialism has always been tepid at best (Nikita Krushchev dubbed the
Hungarian brand "goulash socialism"). Thus the business community was generally relieved, though not
necessarily surprised, when the new Socialist prime minister, Gyula Horn, reaffirmed his government's
commitment to both democracy and a market economy. At the same time, Horn promised to soften the blow
of radical change by pledging to meet people's basic needs. 

A joke frequently heard during the early 1990s went: "What's worse than communism?" Answer: "Whatever
comes next!" Hungary is making progress, if slowly, toward economic liberalization. (And the country has
attracted significant foreign investment since 1988, more than $13 billion.) For most Hungarians, though,
there is a perception that things will get worse before they begin to get better. They may be right.

3.   Education and awareness. How successful was
     the project at spreading the energy conservation
     message? 

4.   Institution building. Were government and
     private sector institutions strengthened to the
     point were they could promote energy
     conservation after USAID funding ended?

BACKGROUND

Hungary is in the midst of a difficult
transformation from central planning to a
market economy open to investment and trade
with the West. A major problem is energy
inefficiency, which makes many Hungarian
industries uncompetitive in international
markets. Hungary's economy is built on cheap and
abundant energy, with industrial plants that waste
energy and pollute heavily. (While Hungary's
energy use is high, the country is more energy-efficient than the Czech Republic and Poland [See
Figure 1]). Under communism, energy inefficiency
was not regarded as a problem. Now, with the end of
communism and the economy opening to
international trade, much of Hungary's industry is
not competitive with the West. 
In market economies, comparative advantage and
market prices direct production. In Hungary's
centrally planned economy, production, inputs,
location, industrial structure, and technology choice
were not driven by cost, but by other considerations.
Old production processes were not abandoned in
favor of more cost-effective processes. Since
technology was not cost-driven, new factories or
production processes were introduced only when
additional output was required. Companies did not
have to market their products. They concentrated
instead on maximizing output. Energy use was
determined by access to energy and technology not
by international costs. Result: energy inefficiency. 

Project Rationale:
Why Energy Conservation?

With the fall of communism, the new government
elected in 1990 began comprehensive economic
reforms with international support from the
International Monetary Fund, the World Bank, and
USAID. Major energy-price reforms were launched
in 1990 with further plans for 1991.

But in late 1990, just as the reform process was
starting, the economy faced a crisis because of
drastic changes in international energy markets. The
Soviet Union cut back on oil deliveries and
demanded hard currency for oil and natural gas.
With the 1990 91 Gulf oil crisis and the cutoff of
Iraqi and Kuwaiti oil, international oil prices soared
from $13 to $31 a barrel. Most experts assumed oil
prices would move even higher. 
 
The new, democratically elected Hungarian
government was starting to reform and modernize
the economy, but high oil prices and energy
shortages could derail those efforts. In such a
situation, faced with mounting financial and
industrial problems,  pressure might build to return
to the old system of state controls and allocations.
USAID provided assistance to help cushion the
shock and even use the energy crisis as a way to
reform Hungarian industry. 
The rationale for USAID assistance was economic;
if the Hungarian economy could use energy more
efficiently, it could save foreign exchange, maintain
economic momentum, and advance on economic
restructuring. Energy conservation was a means to
help the economy, not an end in itself.

RESULTS

Assistance from the Agency addressed both the
immediate need to reduce energy use and longer
term efforts to restructure the economy and move
toward a modern, efficient energy system. The
assistance centered on efforts to improve industrial
energy efficiency through seminars, factory energy
audits, energy-saving investments, and training of
energy auditors. Energy audits were central to the
program. An energy audit is a technical analysis by
an engineer of how a factory uses energy. It
identifies ways to eliminate waste and increase
efficiency. 

The Regional Energy Efficiency project trained 16
Hungarian energy auditors. Over 6 months they
received 15 days of in-country training, with some
receiving more advanced training in the United
States. Although training covered the engineering/technical side, much of it dealt with management,
marketing, and finance. Of 16 auditors taking the
course, 9 of the best became certified energy
managers. They then went out to factories to
perform energy audits. At the time of this
evaluation, all nine certified energy managers were
operating their own energy service companies and
were actively promoting investments in energy
conservation. 

To build industrial interest in energy efficiency, 10
plants were chosen to receive Agency-sponsored
energy audits. The companies paid for the audits (at
several thousand dollars each) and then received
energy conservation equipment recommended by the
auditor. USAID grant-funded the equipment, and
five USAID-trained energy specialists conducted the
audits. By October 1995, eight of ten plants had
received most of their equipment. 
 
The eight energy audits under the Emergency
Energy project were a bakery, a metal works, a
chemical works, a glass factory, an alumina plant, a
district heating plant, a paperboard factory, and a
yeast and alcohol plant. Relatively low-cost but
high-payoff energy conservation investments were
completed at each plant. Except for the district
heating plant, the average payback period (when
cost savings equaled investment costs) was about
one month a very quick return on investment. The
district heating plant had a much longer payback
period, 28 months, but still had a high financial rate
of return.

PROGRAM ELEMENTS

The USAID program sought to improve energy
efficiency in Hungary through the four
complementary areas of policy reform, technology
transfer, education and awareness, and institution
building. 

Policy Reform

Energy Price Reform

Although it is important to get energy policies
right, the technical side is relatively simple
compared with the political issues. From 1990
through 1992 Hungary made great strides in moving
energy prices toward world market levels. The
government also scaled back non-energy subsidies
to bring prices in other areas of the economy in line
with real costs. Those were heady times; with the
end of communism, Hungary was eager for reform. 

In the last few years, though, policy reform has
slowed, and energy price increases are starting to lag
behind inflation. For many Hungarians the rapid
pace of economic change throughout the economy
was too much too soon. One indication of "reform
weariness" is that the free-market reform
government was voted out of office in 1994, and the
Socialists (of the former Communist party) are now
back in power. Still, by 1995, most energy prices in
commerce and industry are close to the cost of
production. The only major remaining subsides are
on energy for the households. 

Hungary demonstrates that polices that raise energy
prices increase the desire of factory managers to
invest in energy efficiency. But it also demonstrates
that positive economic impacts can be offset by
weakening political will. 
Privatization 

The status of firms with respect to privatization
affects how they react to opportunities to
improve energy efficiency. In Hungary, success
with energy conservation often depends on where a
factory is in the privatization process. Plants still
owned by the state or by local management lack
capital, tend to have a limited view of the future, and
are reluctant to make investments. Inflation, the high
cost of capital, and subsidized energy make the
situation worse.  

The best hope lies with privatized firms that have a
foreign partner or owner. Foreign firms bring in
technology, management, finance, and marketing
skills. They are concerned with cost controls, and
they take a strong interest in energy conservation.
They have access to needed funds and are willing to
make energy conservation investments that have a
longer payback. 

The government moved relatively quickly to
privatize non-energy industries, but it has been
slower to privatize the electric and gas utilities and
state-owned petroleum company. Nonetheless,
progress has been made. By December 1955 six
electricity distribution companies and two power
plants were privatized.The Hungarian Energy
Office, which has received USAID support, has
worked to establish the necessary industrial structure
for utility privatization and to draw up a regulatory
framework. It is also responsible for pricing policy
under the gas law and for advising the Ministry of
Industry and Trade on energy prices until other
mechanisms are in place. What is still needed is a
regulatory mechanism, such as the U.S. system, in
which state public utility commissions set rate and
service standards.

Environmental Policy Reform 

If energy efficiency is to make economic sense,
prices must reflect the true cost to society of
producing and consuming energy. Not only
should prices reflect financial costs, but they should
also reflect nonfinancial, nonmarket costs such as
environmental damage. In late 1994, the Ministry of
Environment published the "National Environmental
and Nature Conservation Policy Concept Paper"
covering the period up to the year 2020. The gas and
electricity laws of 1994 promise that prices will
cover financial costs by the end of 1996 but do not
include environmental damage as a cost. 

Rather than stressing energy laws, enforcement of
environmental regulations may be the best way to
improve energy efficiency. In the Czech Republic,
for example the need to meet pollution standards has
provided impetus for energy efficiency, even when
energy prices did not provide adequate incentives.
But that is not the case in Hungary. Although the
environment is of interest, it is not a major public
concern or national priority. Moreover, energy and
its associated environmental problems are not
priority fields under environmental programs. The
Ministry of Environment has been active in
publishing comprehensive guidelines, principles,
and policy recommendations. Standards are tough,
but enforcement is not, and little has resulted from
these efforts.

Technology 

The USAID projects effectively trained
Hungarian energy auditors in all phases of
energy technology, and the auditors then helped
factories use the new technology. The project
trained a cadre of private sector engineers who took
on the task of convincing industry and lending
institutions that investments in energy efficiency can
be profitable. 

A big problem in introducing new technology is old
ways of thinking. The mentality of socialist central
planning concentrating on production targets and
output and not necessarily costs is the norm in all
too many firms. A straight engineering solution to a
production problem may have been enough in the
past, but in a world of higher energy prices and
market competition, companies need to consider
costs and cost reduction in their plans along with
marketing, finance, and energy conservation. The
USAID projects have helped to change attitudes
carried over from the days of central planning. 

USAID-trained energy auditors offered factories a
wide spectrum of energy-related services, including
energy audits, identification of financing sources,
recommending equipment and training, and
reviewing organizational and management
impediments to energy savings. In addition, the
Agency introduced energy performance contracting.
This practice ties an energy auditor's compensation
directly to energy savings the firm achieves. 

Auditors looked closely at the "hard" technologies
of production process equipment and production
process monitoring, as well as the "soft"
technologies of energy management. They
recommended both low-cost and higher cost
improvements. Generally low-cost improvements
were adopted by the firms and funded by USAID.
Higher cost measures, such as new burners and
correctly sized motors and pumps, were to be funded
by the firms but were usually not carried out.
Managers cited uncertainty about market prospects
and a lack of investment capital as reasons for not
changing over. 

The experience of one of the audited plants
illustrates the process. The formerly state-owned
fiberboard factory at Mohacs was built in 1957.
Equipment was largely of pre World War II design
and not energy-efficient. Engineers have kept the
plant operational, but at only 55 percent of rated
output. With rising energy prices and competition
from abroad, the employees (now partial owners) are
interested in solving their problems. A USAID-trained specialist completed an energy audit that
identified steps to reduce energy
consumption and improve production.
He prepared a detailed business and
financial plan to show management the
benefits of recommended
improvements. 

The recommendations were accepted
and equipment installation began in
1994. A Honeywell computerized
process control and monitoring system
was installed on one of four production
lines along with other energy-saving
equipment. Even using existing
production equipment based on a 50-year-old design, the results were
dramatic. Peak electrical demand dropped 24
percent, bringing a significant saving on electricity
charges. The factory now uses less steam,
production is more reliable, and the product is more
uniform and of higher quality. 

Through these steps the plant has offset energy price
increases, remained competitive internationally, and
increased annual output from 55 percent to more
than 70 percent of rated capacity. Because the audit
also identified other energy-saving opportunities and
only one production line has been improved, the
energy auditor and plant managers are actively
seeking more money for these improvements. Here
is a clear case in which exposure to the latest
management techniques and technology paid off. 

District heating companies provide another example
of how knowledge of technology and information
fosters the spread of energy conservation
investments. In Hungary 103 towns have large
groups of apartment blocks heated by central steam
plants. Often several thousand apartments are heated
by one central heating plant. Unmetered heat is
provided to each apartment, and temperature
regulation is accomplished by a simple technology:
opening and closing windows. As a result, heating
costs are high and heat distribution in buildings is
uneven. 

With cheap energy few incentives existed to make
improvements. Now the situation is changing. A
USAID-sponsored energy audit demonstrated that
heating companies could realize significant cost
savings and improve heat distribution by installing
on off valves, thermostats, and meters in individual
apartments. 

USAID spread the energy conservation message
with presentations to the Hungarian District Heating
Association. At the same time, Agency-trained
energy auditors and engineering professors at the
Technical University of Budapest also promoted
conservation. To test the spread of the message, the
evaluation team examined a recent (non-USAID)
energy demonstration project at the Eger District
heating system. New valves that control and monitor
heat distribution to individual buildings are being
installed in steam substations, and one
demonstration building has been retrofitted with
thermostats and meters. Another district heating
company is installing 540 valves in its steam
substations. 

More efficient production-line technology was an
important part of USAID projects. Efforts were not
limited to equipment; energy auditors were also
given training in management methods that use the
latest computer-based control techniques and
standard business and financial management
analysis. They learned about sources of funding and
how to approach lending institution and equipment
manufacturers for favorable financing terms. Energy
auditors have a vested interest in the financial
success of an energy conservation project, since
typically their compensation depends directly on the
value of energy saved. Therefore, they choose
projects with care and continue to be involved over
several years. 

Education and Awareness

Training, seminars, and other promotional
activities are all well and good, but success
depends more on having in place realistic energy
prices and incentives, and factory owners
interested in making a profit. 

USAID education and awareness efforts
concentrated on training energy auditors. The
auditors have established a network among
themselves (the Hungarian chapter of the
Association of Energy Engineers), with government
energy agencies, district heating systems, the
academic community, equipment suppliers, and the
electric utility. Through these contacts they remain
up to date and maintain their technical capabilities.
Most tend to be aggressive, entrepreneurial, and
creative in marketing energy services.
Other actors include the government's Energy
Center, which has prepared pamphlets and
information for the general public and energy
conservation professionals. District heating
occupants have also been targeted. This is an area
where more attention must be given if the public is
to support conservation. The national electricity
company has set electricity rates that reflect time-of-day pricing and peak-usage pricing to encourage
conservation. The Technical University of Budapest
offers courses in energy conservation, and
nongovernmental organizations (NGOs) such as the
Hungarian Energy Association and the Energy Club
provide technical networks. 

But the public is accustomed to subsidized,
unmetered heat and electricity, and there seems to be
little public awareness or concern about energy
conservation or energy-related pollution. Energy
providers face a strong lobby from the elderly and
households that want cheap power. Public awareness
and education programs directed to the general
public have been few. Some district heating
companies have started pilot programs to inform the
public, but this effort is limited. 

The government recognizes the need to improve
energy efficiency, but action has been limited. As
noted elsewhere, government energy pricing
provides large subsidies to households, a policy that
deters conservation. The government has not yet
stood up to political pressure to provide cheap
energy to households. Raising prices closer to actual
costs will be the real measure of the government's
commitment to energy conservation. 

Energy awareness is very low in state-owned
factories and most privatized local companies. The
most success is with privatized firms that have a
foreign partner with deep pockets and a commitment
to compete in the international marketplace.  How
can energy awareness be raised for other firms? 

Probably the most important step to raise interest in
energy conservation is on the policy side: Energy
prices need to be raised. Subsidized energy for
households needs to be cut sharply and narrowly
targeted. Privatization needs to go forward. And the
energy investment climate needs to be improved.
Until those steps are taken, education and awareness
programs will have only minimal success.  

Institution Building

Government and private environmental agencies
and institutions are weak and just beginning to
take shape. In Hungary there is no overriding
concern for the environmental effects of energy
production and use and no clear public mandate for
NGOs in this area. To be sure, several NGOs, such
as the Energy Club and the Clean Air Action
Committee, are active in energy and the
environment. However, they often deal with
issues nuclear energy, automobile pollution,
regulatory accounting procedures only
peripherally related to USAID projects. In some
instances, they take a populist position of opposing
profits in energy production and actually propose
rolling back energy prices. 

The Hungarian Association of Energy Engineers
carries on discussions with the government on
energy policy and serves as a de facto energy
conservation trade association. In the industrial
sector the Hungarian Energy Association speaks for
industry and equipment suppliers. Large industrial
energy users have the Association of Hungarian
Energy Consumers. District heating companies have
formed an association to share technical information
and experiences, and hospital energy managers have
their own association. These associations are the
principal pathway to share knowledge of new energy
equipment, technology, projects, and funding
sources. 

The government's Hungarian Energy Office is
responsible for regulating and pricing energy,
overseeing conservation, providing public education,
and approving construction of new power plants.
But the office has been functioning for only a little
more than a year, and many of its responsibilities
still need to be established. 

In a similar energy conservation program in the
Czech Republic, USAID helped establish an NGO
that then provided seminars, training, and other
work in the energy field. The NGO (known by its
Czech acronym, SEVEn) helped raise energy
awareness and developed energy auditors and
energy service companies. The Agency's program in
Hungary took a different tack. It was not designed to
develop an institution like SEVEn, but aimed
instead at direct training of energy auditors and
direct support for energy service companies. To
some degree this may have been necessitated by the
lack of strong, environmental or energy NGOs and
a low level of public concern. Though USAID
projects did much to improve energy efficiency, they
did not leave behind strong institutions to continue
the effort. 

PROGRAM IMPACT

Financial and Economic Impact

The USAID project components dealing with
energy audits and equipment installation have
extremely high rates of return a financial rate
of return of 485 percent and an economic rate of
return of 165 percent (table 1). Rates of return are
calculated by first taking all program investments,
next valuing the flow of benefits, and finally
comparing costs with benefits. The flow of benefits
occurs for a number of years, and that flow, less all
costs, yields the net annual benefit. As a simplified
example, if a $100 investment generates net annual
benefits of $40, the rate of return is 40 percent.

One can look at rates of return in two ways: first,
from the perspective of the individual firm and,
second, from the perspective of the entire country.
Economic analysis examines costs and benefits to
the country, including externalities such as
pollution. In contrast, a company looks only at its
own financial rate of return. For example, the price
a plant pays for coal does not include the damage
coal smoke causes, such as increased health
problems or ruined house paint. Although pollution
affects society as a whole, it is of no cost or benefit
to the plant The company is interested only in the
cash it takes in and pays out. It receives no cash
benefit from less pollution. 

From the viewpoint of the firms, benefits include
energy savings equivalent to 4,431 metric tons of oil
a year, or $1,020,300. In addition, by better
production scheduling, firms are able to avoid peak
electricity charges of $547,400 a year. Together
these benefits amount to a first year pretax savings
of $1,567,700 for the eight factories. But firms do
not keep all of these savings, since they pay
increased income taxes on their new profits, which
reduces annual financial benefits to $1,019,005. 

The financial analysis proceeds as if firms had
purchased the equipment and therefore includes both
equipment costs (paid by USAID) and energy audit
and installation costs (paid by the factories).
Equipment costs totaled $168,300, and installation
costs were estimated at $35,000, yielding a total
investment cost of $203,300. These costs compare
with energy savings of $1,019,005 in the first year.
Energy savings cover investment costs in just 2.4
months a very quick payback. Projected into the
future, even with 10 percent yearly depreciation and
assumed closure of some factories in the first few
years, the financial rate of return is very high at 485
percent. 

The financial rate of return is converted to an
economic rate of return by adjusting
costs excluding income taxes and peak energy
charges and adding in USAID project management
costs. A major difference between benefits to the
firm and society is the reductions in pollution and
electricity demand charges. Reduced pollution has
an estimated economic benefit of $551,950 (see
table 2 and the environmental impact section below
for a discussion of how pollution benefits are
determined). Since electricity demand charges are
simply a transfer of money from the utility to the
energy-using company with no change in real
resource use, they are not an economic benefit. The
same is true of income taxes: they are merely a
transfer from the firm to the government. 

When all adjustments are made, the result is an
estimated economic rate of return of 165 percent. 

Environmental Impact 

Through improved energy efficiency, air
pollution was reduced at almost no cost. Energy
efficiency and positive environmental effects go
hand in hand. When factories use less electricity or
burn less coal, less pollution goes up the
smokestack. The Agency's energy conservation
projects helped reduce energy consumption, which
in turn reduced air pollution. 

Pollution is harmful, but it is difficult to place a
dollar value on cleaner air. Since long-term health
costs and aesthetic values are hard to determine,
environmentalists often use alternative ways of
valuing cleaner air. 

One approach is to look at abatement costs how
much it costs to reduce pollution by installing
pollution-control devices at the factory. If new
burners and stack scrubbers remove a ton of sulfur
dioxide pollution from the air, and the burners and
scrubbers cost $800, then that is a good proxy for
the value of reducing air pollution. It costs $800 to
eliminate one ton of pollution.

Another way to place a value on cleaner air is to
count the abatement cost avoided. If a factory
reduces sulfur dioxide pollution by one ton by
burning less fuel or by burning fuel more efficiently,
it avoids the costs of new burners and stack
scrubbers. The value of reduced pollution is counted
as the money saved by not having to invest in
pollution-control devices in this case, the same
$800. 

Abatement costs avoided in Hungary are estimated
at half of abatement costs in the United States. This
lower amount reflects two factors: the difference in
income levels and the technical stage of pollution
control. U.S. incomes are higher than Hungarian,
and compared with Hungary, the United States is
willing to pay more to reduce pollution. On the
technical side, Hungary has high pollution levels,
and measures to reduce pollution are much cheaper
than in the United States, where easy and low-cost
early measures have already been completed.

Table 2 shows the pollution reduction resulting
from USAID energy audits and equipment
installed at eight factories. It is useful to link these
pollution benefits to energy savings and equipment
costs. The annual value $551,951 of reducing
annual emissions needs to be compared with the
one-time investment costs of $203,300 (financial
costs to the firm) or $883,300 (economic costs to the
economy). But in one sense equipment costs are not
really an environmental cost. Pollution benefits are
a gift, since energy conservation equipment was
installed by factory managers as a way to save on
their fuel bill; the financial rate of return on the
energy-saving investment is 485 percent. From the
manager's perspective, the equipment pays for itself
in fuel savings, and the country receives the bonus
of reduced air pollution for free. This is one of the
most powerful justifications for energy efficiency:
cost-effective energy efficiency investments yield
surplus environmental benefits to the country.

Sustainability and Replicability

Energy conservation investments were sustained
at the demonstration plants, but the spread to
other plants was limited. A foreign aid project
transfers resources and provides benefits, which is
all well and good. However, of equal interest is what
happens after a project ends. Have project benefits
been sustained? Have they spread beyond the
original demonstration sites? And what were the
factors affecting sustainability and replication?

Sustainability deals with whether program benefits
continue after the USAID project ends. Will new
technology and practices introduced by the project
continue? Evidence of sustainability is the continued
use of energy-saving equipment and institutions
years after a project ends. 

The Emergency Energy project was implemented
during 1991 93, so it was possible to go back in
1995 and make a preliminary judgment whether
benefits had been sustained and were replicable.

Table 2. Estimated Annual Reduction in Air Pollution
As a Result of USAID Projects

Metric tons
Cost per
ton
Value if in U.S. 
Value in
Hungary

Carbon monoxide
Carbon dioxide
Sulfur dioxide
Nitrous oxides
Particulates
Total

117.9
28,300.00
329.9
52.1
84.6
28,884.5
$56
$25
$865
$1,980
$15
$6,602
$707,500
$285,363
$103,158
$1,277
$1,103,901
$3,301
$353,750
$142,682
$51,579
$638
$551,950

Under the second project, Regional Energy
Efficiency, equipment is still arriving and activities
are not fully completed. Still, it is possible to make
some preliminary assessments. 

A 1994 USAID-funded evaluation found that eight
plants receiving energy conservation equipment
under the Emergency Energy project were using the
equipment effectively, and all investments were
generating a high rate of return. From the CDIE
evaluation team's on-site visits and discussions with
those familiar with the plants, it appears the plants
are continuing to use the energy conservation
investments. In many cases they are expanding their
energy conservation efforts.

Another way to measure sustainability is through
activities of energy auditors trained under the
project. Are they still in business, and has demand
for their services increased? The evaluation team
conducted in-depth interviews with nine USAID-trained energy auditors to determine if they were
still in that line of work and if business was
growing. All trainees were still in the energy
business; all had received follow-on energy
contracts and related engineering jobs. They were
also able to identify new energy investments that
resulted from the USAID program. 

Replication relates to the demonstration or spread
effect of information and technology between plants
and industries. To test for actual spread effects, the
team interviewed a broad range of engineers, factory
managers, equipment providers, and government
officials. There were cases in which companies were
making energy conservation investments, but the
numbers were small, in relation both to the size of
the industrial base and to existing high levels of
energy inefficiency. One of the more promising
signs was the Eger District Heating System, in
which an energy conservation project was out for
bids. Of energy auditors bidding on the project, half
had been trained by the USAID project. Another
USAID trainee was serving as technical consultant
to the District Heating System. 

In contrast to USAID programs in other countries,
no attempt was made to create an energy
conservation institution. The project relied on a
cadre of energy auditors to establish successful
examples that could be replicated by other plants.
The test is the degree to which project-supported
changes have spread to other companies. 

Existing institutions are weak.  The Energy Center
has a program, but its role is limited; it could never
service the whole country. Hospitals and district
heating systems have their own technical
associations, but the flow of information on energy
conservation is uneven. Little information appears to
flow among industrial firms: most plants are isolated
and unfamiliar with what others are doing in energy
conservation. Several managers spoke wistfully of
the "good old days" of central planning, when
technical directives and instructions came out
regularly from the government or industrial trusts.
Now they receive little guidance. 

The project relied on a cadre of energy auditors to
establish successful examples that could be
replicated by other plants. However, project-supported efforts have not spread widely.
Replication within an industry or even within a
geographic region is limited. Hungary lacks the
institutions that disseminate information in the
West: trade associations, technical societies,
industry newsletters, industry seminars, and, in
particular, private sector equipment salesmen. As in
the West, private sector and commercial providers
are needed to spread the message.

PROGRAM EFFECTIVENESS

The program was effective at reaching target groups,
and benefits have continued. But continuing
effectiveness depends on the willingness of firms to
make energy-saving investments, and that depends
on several factors. First is the business climate. As
Hungarian industry goes through economic
restructuring, individual firms face major problems.
They realize they should improve their energy
efficiency, but other tasks finding working capital,
maintaining production, finding markets seem
more immediate and threatening to the firm than
investments to improve energy efficiency. When a
company concentrates only on the short term, there
is little interest in trimming costs. Right now, most
firms are thinking short-term. 

The second factor is availability of capital.
Government capital needs are great, and the
government has crowded private borrowers out of
the marketplace. The small amount of credit
available to private companies is offered on very
stiff terms. Most firms find it impossible to borrow
from financial institutions. Thus they depend on
their own resources and are usually reluctant to
make investments. Even when they do have the
money, energy-saving investments often rank very
low.

The third factor is energy prices. Until recently,
energy was cheap; many Hungarian businessmen
still have a mind-set toward cheap energy and
operate factories with machinery and production
processes so designed. Even though the government
expects to have energy prices fully cover costs by
the end of 1996, most factory managers are reluctant
to junk energy-inefficient equipment. 

The final factor is a factory's energy intensity.
Companies for which energy is a major share of
costs have a strong incentive to make energy-efficient investments. The USAID project targeted
those firms, and the strategy paid off. It would have
been much harder to win adoption in industries for
which energy is a minor part of production costs. 

LESSONS LEARNED

1. Energy conservation measures are first and
foremost business investments. The type and level
of investment a firm is willing to make depends
on the business climate and the attitudes of
business managers. 


                   It Takes Money to Save Money
At the Mohacs Fiberboard Factory, equipment is 40 years old and technology is at least 50 years old.
Management sees the need to modernize and figures it would take $3 million to buy the necessary
equipment. With new equipment, product quality would improve, labor costs would drop, energy
costs would fall sharply, and output could increase by 50 percent or more. The equipment could pay
for itself in three to five years. However, the company is unable to find domestic financing. It will
continues to operate outdated equipment, and its future is bleak. 

With the end of Hungary's socialist economy, many
firms find they are using obsolete manufacturing
equipment to produce goods  that are difficult to sell
in a competitive market. Although managers would
like to lower costs, most efforts are directed at short-term, low-cost measures to increase production and
sales. 

Because of high inflation and the government's
insatiable demand for credit, private industrial
companies find it difficult to find capital for energy-saving investments. Most firms must self-finance
energy conservation measures. A large part of the
problem is macroeconomic; as long as inflation is
high and government borrowing demands are large,
little credit will be available for private investors. 

The key is how business managers react to this
climate. Some have a can-do entrepreneurial
attitude, whereas others continue the passive
caretaker approach they followed under
communism. 

2. When energy is cheap, little incentive exists to
use it efficiently. So long as the government
provides major energy subsidies, broad-based
energy conservation is difficult. 

Under socialism, cheap energy encouraged energy-intensive investments that now make many
Hungarian firms uncompetitive. In the last few years
the government has raised energy prices, but
recently, with high inflation, real energy prices have
fallen. In most cases, industry pays energy prices
reasonably close to real costs, but household energy
users are heavily subsidized. (The government has
pledged that by 1997 it will bring all energy prices
to the point where they equal real costs.) 

3. Without adequate incentives it is difficult to
find capital to fund energy-saving investments. 

Experience in the United States shows funding for
energy conservation will be provided only when the
market provides an opportunity to make money. In
the United States, starting in the mid-1970s, energy
prices rose sharply and the states and federal
government established incentives to make energy
investments attractive. These included insurance, tax
incentives, loan guarantees, free audits, and free
equipment. In addition, mandatory energy-efficiency
standards for buildings and appliances were phased
in. These incentives and higher energy prices created
a market for energy-efficient equipment and
materials. Hungarian government policies are too
weak to stimulate such a market. 

4. Privatization can bring in new capital, new
management, and an interest in energy
conservation, but is most successful when it
brings in a foreign company with deep pockets
and a commitment to compete in the
international marketplace. 

State-owned firms are carrying on much as before.
With a secure market and government subsidies or
guaranteed prices, they stress production rather than
efficiency or costs. Many so-called privatized firms
are still majority owned by the national government
or by a municipality; they are not really privatized.
Energy conservation is of minor interest.

Hungary has started to privatize  its economy, and
many newly privatized firms have a strong interest
in energy conservation. But much depends on the
type of privatization that takes place. 

Companies awaiting privatization or those that have
been privatized by turning the factory over to
previous managers and workers are often as
uninterested in saving energy as state-owned firms.
These companies need to worry about markets and
costs, but they lack capital resources to invest in
equipment modernization and energy efficiency.
They can pursue no-cost and low-cost energy
investments but cannot afford major investments. 

The most responsive companies are likely to be
privatized firms with a foreign partner to bring in
technology, management, finance, and marketing
skills. They also are concerned with cost controls
and take a strong interest in energy conservation.
They have the money and are willing to make
energy conservation investments with a longer
payback. 

5. So long as the public and business fail to see
energy and pollution as urgent issues, NGOs and
special-interest groups will have a limited role,
and the government and legislature will be slow
to act. 
Since energy and pollution are not viewed as serious
problems, energy and environmental NGOs and
special-interest groups play a small role in a limited
public debate. On the question of energy
conservation, the government, industry, and NGOs
all agree on the solution: prices must rise and energy
subsidies to households must be sharply limited and
targeted to those most in need. The problem is when
and how to make politically difficult changes. 

Public education programs must be developed and
coordinated by the government and NGOs.
Awareness of the links between energy production,
energy prices, and pollution take a long time to
instill. Such programs are entirely lacking now.

6. Energy conservation is more than "hardware"
(equipment and machinery). Even more
important is "software" (management, finance,
and marketing) and the United States has much
to offer on the software side. 
Under socialism, production and output were
supreme. Business planning, marketing, finance, and
energy conservation were not needed. Now they are.

Hungarian engineers are good technicians, but they
need to learn a new way of approaching problems.
The most important part of the USAID projects was
the introduction of new ways of thinking for
example, the total practice of energy management,
energy operations and maintenance approaches,
financial analysis and marketing.  

7. Long-term energy conservation requires an
independent regulatory body (a public utility
commission) that supports economic prices,
minimizes cross-subsidization, has a framework
for public participation, and develops rate
structures that support conservation. 

Hungary is well ahead of other Eastern European
countries on energy management, having set up in
1994 the Hungarian Energy Office to regulate
wholesale and retail prices and to define the
responsibilities and relationships among energy
companies. But  rules and procedures are not fully in
place, and the Ministry of Industry and Trade and
municipal governments still determine most energy
prices often on a political rather than an economic
basis. Uneconomic prices and subsidies continue to
send the wrong signals to energy users and
providers. Energy regulations for electricity and gas
producers and distributors must be well defined. In
Hungary they are not yet in place. 

8. Good energy conservation technology is not
enough; effective and continuing dissemination is
needed. 

During the USAID energy project a number of
energy conferences and training sessions covered
practical industrial problems. But since the end of
major USAID involvement, few seminars have been
few conducted. There are organizations for
government operations (such as the Hospital
Managers Association and District Heating
Managers Association and for broader technical
audiences, but little such support exists for industrial
energy managers. In the West a panoply of
consultants, newsletters, equipment salesmen, trade
associations, and other sources of technical
interchange keeps managers abreast of technological
developments. In Hungary those information sources
barely exist. When USAID designs a project, it
should also consider a longer term dissemination
strategy that relies mainly on the private sector. 

9. Pollution controls do more than just cut down
on pollution; they can discourage wasteful and
inefficient energy consumption, but only if the
government takes a strong initiative. 

As the Czech Republic demonstrated, pollution
control may be one of the most effective ways both
to cut harmful emissions and to improve energy
efficiency (see Impact Evaluation PN ABS 546,
Saving Energy in the Czech Republic). But it has not
been important in Hungary. The government has
talked about the importance of pollution control and
has strong measures on the books, but it has done
little to enforce laws or change practices. Neither the
government nor the public is seized with the issue.

10. If the objective is to cut back on energy
consumption, efforts directed at heavy energy
users may be the best approach.  

If energy is a major cost of production and fuel costs
are "expensive," major energy conservation
measures will be adopted. Ore smelting, district
heating, and some heavy industries are major energy
users. By contrast, for most manufacturing and
processing companies, energy is a minor part of
production costs and thus these enterprises are not
ideal candidates for energy conservation activities.
The USAID program achieved high financial and
economic rates of return by concentrating on firms
that were moderate to large energy users. 

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