(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00287R001100060001-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 18
• Document Creation Date: January 12, 2017
• Document Release Date: August 23, 2010
• Sequence Number: 1
• Publication Date: April 27, 1984
• Content Type: MEMO

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Central Intelligence Agency
6
Washington. D. C. 20505
DIRECTORATE OF INTELLIGENCE
27 April 1984
HUNGARY: Major New Economic Reforms in Prospect
Summary
Budapest this year is inaugurating the first
major modernization of an economic reform program
that caught world-wide attention 15 years ago with
its bold breakaway from the Stalinist-style
centrally planned economy. New measures, long in
the drafting and now proposed for gradual
introduction in 1984-90, draw on the old ones of
1968 but seek even greater decentralization in
enterprise management, pricing, wages, and the use
of labor, capital, and credit. Although a broad
outline for change has won Party support in
principle, and some initial measures are being
introduced this year, many of the specific and
more path-breaking proposals are still under
debate. Decisions by the Central Committee are
not expected until sometime next year.
This memorandum was prepared by East European Division, Office 25X1
of European Analvsis. Comments and questions are welcome and should be
addressed to Acting Chief East European Division, EURA, 25X1
25X1
( EURM84-10097 ;)
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We have seen two lengthy concept papers
prepared primarily by economic professionals that
outline the general thrust of government proposals
for new reforms. In addition, Budapest's letter
to the IMF last December requesting new standby
credits contained a brief sketch of the proposals,
and a Party plenum in mid-April called for reforms
in "every aspect of management." Because these
documents tend to be vague and elliptical, we
offer here only a preliminary interpretation of
what seem to be the most innovative highlights.
Moreover, even when the Party consolidates its
position, we are unlikely to learn for some time
how much of the government's reform package was
accepted, which specific proposals were rejected
or tabled, or much about the timetable for
implementation over the next several years.
Nevertheless, allowing for some scaling down or
delays, it is clear that Hungary's leaders find
the need for radical changes imperative and are
prepared once again to go much further than their
CEMA allies in the common quest for a more
efficient system of economic management. F__1
The key question is how far the Kadar regime
is willing to go.
-- Some of the reforms could undermine, at
least in the short run, the regime's
commitment to improving living standards.
-- They also are bound to encounter resistance
from entrenched,Par_tv and government
bureaucracies.
The reform proposals also risk negative
reactions from the new Soviet leadership and other
East European regimes. We already have seen signs
that Budapest is fearful that the Western press
will overplay "capitalist" aspects of the new
measures and provoke criticism from Hungary's more
orthodox allies. Indeed, Hungary was clearly the
target of recent Czech and Soviet propaganda
criticizing socialist untries that overestimate
their own "model."
In our judgment, Hungary's leaders have no
intention of abandoning their socialist system.
Nothing we have seen suggests that the state is
willing to relinquish ownership of the means of
production, cede major power to workers over
enterprise management, or embrace political
pluralism at the national level. 0
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Decentralization
Concepts for a "new phase" in economic reform have been
circulating in Hungary's prolific professional think-tanks since
1977 when mounting balance-of-payments difficulties forced Party
leaders to call for a fundamental review of economic strategy.
New rules of the game were needed to make enterprise managers
more profit-oriented and induce them to become entrepreneurial
risk-takers assuming the lead in updating the country's
increasingly outmoded structure of production. Proposals now
under study spring essentially from a consensus that lack of
effective competition for resources is the force holding back
badly needed structural changes:
-- too many large monopolistic enterprises are protected by
vested hierarchial management institutions, restricting
incentives to use resources efficiently; and
-- too many products for export by Hungary's trade-sensitive
economy are not price-competitive in hard-currency
markets.
A key problem is that labor and capital stock are in short
supply, yet continue to be misallocated in activities with small
profits or even losses. By contrast, the availability of bank
credit tends to be excessive, and institutions are lacking that
could channel it use into activities yielding the highest
returns. El
Thus, reform proposals aim at establishing an elaborate new
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institutional framework that offers individual enterprises
greater freedom to fix prices and wages while at the same time
providing inducements to use labor, capital, and credit where the
potential payoffs seem greatest. These are not new ideas, even
in Hungary, but experts commissioned by the government now see a
need to reach out in directions that have no precedents. They
seek solutions through a more far-reaching decentralization of
decisionmaking not only to the enterprise level but within the
banking system as well. F-1
Enterprise Management
At the core of the new reform concepts is the notion that
central or middle-level state administrative agencies should
possess only general supervisory authority and should be divested
of their rights to interfere in the operational and investment
decisions of enterprise managers. Implementation of this concept
already was evident in 1980, with the merging of three central
industrial ministries into one with diminished authority, and in
the subsequent breaking up into smaller units of numerous trust
organizations and other very large enterprises enjoying
monopolistic market positions. Organizational decentralization
along these lines is to continue. 25X1
Vetoed, at least for the 1984-90 period, is the creation of
"holding companies," unique types of property management agencies
long advocated by many prominent reform economists. The winning
argument apparently was that holding companies, for all their
potential merits in separating the state from the economy, could
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easily become ministry-like protective organizations that would
serve to restrict rather than promote the development of profit-
oriented entrepreneurial attitudes on the part of their
subordinate enterprises.
Reform proposals envisage a much larger number of medium and
small enterprises with independent rights to decide on their
internal organization, planning, relations with other firms, and
use of materials, labor, and capital. Several new "enterprise
profiles" are suggested, depending on whether the reorganized
firm is owned by the state or by a cooperative. In general, the
reforms seek to create a "system of interests" in which new
representational bodies allow managers and workers alike more
say-so in how their firm is run and who runs it. Central
authorities, however, will apparently retain a veto power over
almost every aspect of management when actions conflict with
their perception of national interest. Even the most ardent
reformers emphasize that their proposals for decentralized
decisionmaking at the enterprise level have little in common with
Yugoslav self-management, which they contend has led to a
spiraling of wages and prices that central authorities have been
unable to contain.
Capital and Credit Markets
Among the most innovative of the new reform proposals are
those directed at making better use of new and existing fixed
assets and decentralizing the credit functions of the central
bank. They may also be among the most politically sensitive
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because they imply closing down chronically unprofitable
enterprises and reallocating not only their capital assets but
also their labor forces to other enterprises--a prospect that
many displaced managers and workers might find traumatic.
Reforms in these two areas are interrelated. They grew out
of experiments begun in 1983 aimed ultimately at developing a
Western-like capital market providing alternative types of
financial assets marketable to both enterprises and the general
public. What is contemplated in the years ahead goes
considerably beyond the sale and trading of equity shares in
domestic corporations and the issuance of government and
enterprise bonds that occurred on a limited scale last year. C
The new proposals would create a network of commercial
banks, subject only to oversight by the central bank, that would
accept and rediscount obligations of enterprises--something
Hungarian bankers describe as a market for "commercial bills."
In line with this, the central bank also would be empowered to
adopt a "flexible interest rate policy" affecting deposits and
loans of both enterprises and the public. The bank would be free
to raise or lower domestic interest rates in line with shifts in
the cost of obtaining foreign credit or in the real interest rate
caused by domestic inflation. As far as we can tell, these
proposals are still on the drawing board and are likely to be
among the last adopted. Officials of the National Bank of
Hungary naturally would like a greater voice in monetary policy,
but they are reluctant to assume responsibility for it without
full backing from the Ministry of Finance to which the Bank is
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Pricing and Enterprise Finance
Many other changes are embodied in the new reform concepts,
mostly involving proposed tax reforms and other revisions in
enterprise financial flows to and from the government budget.
Potentially the most important measure here is the gradual
introduction in much of the economy of what are being billed as
"quasi-free market prices." El
Further Price Reforms: Pricing rules to be introduced on a
limited basis this year but rapidly extended thereafter will
greatly modify the so-called "competitive price system"-1/
implemented in 1980. Domestic producers' prices in the 1980
concept were considered competitive if they were linked to world
markets either directly via exchange-rate conversions of actual
export and import prices or indirectly by exchange-rate
conversions modified by various compensational adjustments such
as tax rebates. New prices based on these formulas were expected
to provide enterprises with incentives to minimize costs of
l/ Since adoption of the New Economic Mechanism in 1968, reformers have
looked on the economy as being composed of two broad sectors--the "competitive
sphere" and the "non-competitive sphere." The competitive sphere consists of
sectors where a potential exists for "self regulation" and includes the
processing industries, the construction industry, and some services branches,
together with domestic and foreign trade in products produced in these
sectors. The concept implies a large number of producers and consumers of
inputs and outputs competing with each other. The non-competitive sphere
includes agriculture and most infrastructure sectors that, in the interest of
social nay and other national considerations, must be managed by the
state.
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production and better adapt their product lines to demand in
volatile export markets. In practice, the system quickly grew
overly complicated, with widespread departures from the original
principles, and it contributed little to cost-sensitivity or
easing the country's current account imbalances. As some critics
describe it:
Our price mechanism presupposes the market mechanism, and
much of our problems are due to this fact or to the situation
that in practice we have a simulated rather than a real
market. We can expect an appropriate solution only if steps
are taken to establish a real market mechanism and
competition. (Emphasis added) 25X1
The new pricing reforms start out cautiously with
applicability confined in 1984 mainly to an informally-designated
"club of elite enterprises" representing the star performers in
the manufacturing sector of industry. Firms eligible for
membership in the club have unprecedented freedom to set their
own prices, the only constraint being that their domestic prices
cannot exceed the equivalent forint price of similar products
imported from convertible currency countries. The firms also
enjoy greater freedom in granting wage increases. Whereas other
enterprises must pay a long-standing and steeply progressive tax
on profits if they increase wages more than this year's 5 percent
limit, the more efficient "club" members are allowed to exceed
substantially the 5 percent ceiling without having to pay the
tax. F7
To be eligible for adopting the freer-pricing procedures,
firms must be major exporters operating at a profit, and the
demand and supply for their products must be subject to
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"adequate" competition in domestic markets. Requirements that
the firms not hold monopolistic positions and that their products
not be in short supply apparently are to forestall unjustified
price hikes.
In 1984, some 60 to 100 enterprises accounting for about a
fourth of sales in manufacturing are expected to adopt the new
pricing formula. But the group of participating enterprises is
expected to expand rapidly, with the freer pricing and wage-
setting scheme to become the general one in 1985 throughout much
of industry, the construction trades, and a large part of the
services sector I. 0
Other Related Measures: A major goal of the 1980 price
reforms carried over in the new proposals is the establishment of
a more rational relationship between producer and consumer
prices. Reducing the former and increasing the latter would
reduce the burden on the state budget of financing enormously
costly price subsidies.
Solutions in this area require, in the first instance, a
more frequent adjustment of the exchange rate based on
fluctuations in international currency markets because producer
prices are based on world market prices. The National Bank of
?/ Domestic prices of fuels and basic industrial materials will continue to
be established according to the rules adopted in 1980; they are linked to the
forint equivalent of import or export prices depending on whether Hungary is
an importer to or exporter from the convertible currency area of the
particular commodity. Prices of most other goods and services will remain
under central determination, including basic consumer supplies, most
agricultural procurement, and major areas of infrastructure such as housing
and public health. F-7
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Hungary already adjusts the exchange rate of the forint on a
weekly basis; the proposal is to make adjustments daily. This,
in conjunction with enterprises' responsibility for making
product mix and prices more competitive, will require that
managers have access to more market-related information. 25X1
No radical changes are contemplated in the determination of
consumer prices, but the government plans to continue selective
increases in prices of consumer goods and services. These
increases will be constrained only by the desire to maintain
present living standards. Elimination of subsidies for certain
essentials has been ruled out even over the longer term as being
an unacceptable policy for a socialist state. 25X1
The goal of reducing producer prices is complicated by the
desire also to rationalize the relative input costs to
enterprises of labor, materials, and capital. This would be
accomplished primarily by increasing the costs to producers of
hoarding labor. To encourage managers to get rid of redundant
labor, enterprise contributions to the social security system
will be increased. In addition, enterprises are to receive
greater tax relief in return for trimming their workforce, with
the savings to be used to raise wages of the remaining workers.
This latter proposal arouses concern, however, that enterprise
managers will resort to the longstanding practice of passing on
any increased costs in the form of higher producer prices. The
freer price-setting scheme and more flexible interest rate policy
being introduced this year should help make the costs of
materials and capital more realistic.
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Taxation
As in any country with a complex legal system, tax reform in
Hungary is highly controversial because of its impact on the
morale and work ethic of all elements of society. Thus, it is
not surprising that reform proposals in this area seem the most
tentative (see box). Their general goal is to lessen the burden
on enterprises subject to heavy profits taxes while broadening
the base of taxes paid by individuals. The issue apparently
turns on the question of whether tax reform should be shaped more
in the direction of the West European system, requiring
introduction of an indirect value-added tax, or the American
system of direct taxes on enterprise and personal incomes. In
either case new tax schedules would be structured so as to
provide greater differentiation in enterprise profits and
individual earnings based on productivity.
Timetable and Obstacles
In essence, the reform proposals aim at considerably
expanded use of market signals by providing more flexible
formation of all price instruments--prices of goods, labor,
capital, and credit. This would not accomplish full-fledged
"market socialism" but it could propel the economic mechanism
substantially further in that direction. Much remains to be
done, however, in working out details and a more specific
timetable for implementation.
Even if government experts succeed in getting a revised
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BOX
Tax Reform
Under existing regulations, most producer enterprises pay a
flat but stiff tax on profits to the state budget and a smaller
one to local governments. They also are subject to a progressive
tax on wage increases above a prescribed limit and a payroll tax
to help fund social security. Trade and other firms that sell
directly to the public pay additional consumer turnover taxes.
The system has been changed several times since 1968, but still
is cumbersome and complex. New proposals, still to be agreed
upon, would reduce enterprise profits taxes by gradually
eliminating the progressive tax and shifting more of the general
incidence of the flat tax from primary and intermediate products
to final goods. Adoption of a value-added tax, it is thought,
would accomplish the latter goal and have the extra benefit of
promoting exports in a way that would be acceptable to GATT and
other international financial institutions. (C)
At present, the only direct tax on personal incomes in
Hungary is paid by private craftsmen and merchants, self-employed
professionals, and persons working private farm plots or renting
out private housing, with different tax schedules for each
group. Employees of state enterprises and cooperatives pay only
a pension contribution to the social security system administered
through the state budget. This lack of uniformity--plus the
growth of "second economy" workers enjoying untaxed incomes from
part-time, after-work jobs, and the recent authorization of
small-scale private and semiprivate enterprises--has led to a
proposal for an integrated progressive tax that applies to all
individual earnings from whatever source. For both technical and
political reasons, however, the proposal is vague and states that
even if a new type of perspmA~ income tax is accepted it can only
be introduced gradually. 25X1
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outline approved by the Central Committee, expected to be
convened for this purpose sometime next year, debates over
details are bound to continue. As the proposals now stand,
relatively small changes are planned for 1984-85, with the
greater part of the package scheduled for introduction by stages
during the next five-year plan (1986-90).
A recent sampling of views among the experts involved
suggests that the major thrust through 1985 will be on reforms in
enterprise management, pricing, and wages but that major changes
in banking and taxation must wait until 1986-90. And, we must
keep in mind that reforms actually implemented down the line may
differ markedly from what is agreed to in the short-run. As of
now, it appears that the New Economic Mechanism is passing
through a new watershed that promises to keep it the most
attractive model for significant evolutionary change in Eastern
Europe.
The key question is how far the Hungarian leadership is
willing to go. For one thing, the proposals we have seen have
the potential for upsetting the Kadar regime's commitment to
improving living standards for the Hungarian people. They also
would force change on entrenched Party and government
bureaucracies. While the leadership believes Hungary must
maintain credit flows from the West, these bureaucracies are
still reluctant to take the kinds of risks essential to making
Hungary competitive in hard currency markets.
Finally, the reform proposals risk negative reactions not
only from the new Soviet leadership but also from other East
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European governments, which are already wary of the demonstration
effect of Hungary's higher living standards and are concerned
that Hungary is moving too much on its own to improve relations
with the West. Perhaps most worrisome for Hungary's CEMA
partners is the fact that in the minds of many Hungarians the
economic reforms are only the prelude to more fundamental
changes. Budapest's economic proposals have been worked on not
only by economists but also by sociologists, jurists, and
historians who believe that an efficiently functioning market-
oriented economy cannot succeed without significant political
liberalization. Thinly veiled criticism of Hungary has already
surfaced in Czech and Soviet news media chastising socialist
countries that overestimate their own "model" and seek unilateral
advantages from the West. Possibly in reaction to this kind of
criticism, a Hungarian banker claiming to speak for Party and
government leaders has stressed to US Embassy officials the hope
that Western officials and press commentary will not overplay the
new reforms. Indeed, we would not be surprised if Budapest
becomes very cautious in publicizing the details simply to avoid
the problems with its Bloc neighbors that the Western press has
helped create. El
In our judgment, Hungary is not going and does not intend to
"go capitalist," as the Western media like to suggest. This
would imply that the Communist Party is willing to abdicate its
control over economic policy, enterprise behavior, and public
welfare. Despite the novel and evolutionary nature of Hungary's
economic policies, nothing we have seen suggests that the state
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is willing to relinquish ownership of the means of production, to
cede real power to workers over enterprise management, or to
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Distribution List: Hungary: Major New Economic Reforms in
Prospect
Internal
1 D D-1-
1. ADDI
1. DDI Registry
1. Ex. Director
1. NIO for Economics
1. NIO for Soviet Union and Eastern Europe
1. D/EURA
1. DD/EURA
1. C/EURA/EE
1. DC/EUR kj~ E
1. EURA/EE/EW
5. EURA/EE/EW branch files
2. EURA production (Maria)
4. CPAS
External
Dept of Commerce
1. The Hon Lionel Olmer:
1. Mr. Frank Vargo:
1. Dr. Susanne Lotarski:
1. The Hon Allen Lenz:
Under Sec/ADDI
0/IL Room 3850
Department of Commerce
Deputy Assist/Policy
Planning & Analysis
0/IL Room 2036
Department of Commerce
Director, Office of USSR/EE;
International Trade Admin.
Room 3414
Department of Commerce
Director, Office of Trade
& Investment Room 4816
Department of Commerce
DIA
1. Mr. Ronald Davis:
1. Mr. Christian Foster
NSC
1. Mr. James Matlock Jr.
1. Mr. Peter Summer
Chief, Communist Economy
Section; Resources Division
Defense Intelligence Agency
Attn: DB4E
Pentagon, Washington D.C. 20301
DB-4E1
"A" building Rm. 2805
Arlington Hall Station
Senior Director for European
& Soviet Affairs
Rm 368, NSC
Director of European &
Soviet Affairs, Room 368
NSC
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1. Col. Tyrus Cobb
1. Ms. Paula Dobriansky
State
1. Mr. Mark Palmer
1. Mr. Hugh Montgomery
1. Mr. John Danylyk
1. Richard Combs
1. Mary Ann Peters
European & Soviet Affairs
Room 368 NSC
DD/European & Soviet Affairs
Room 368 NSC
Deputy Asst Secy
Bureau of European Affairs
Room 6219 State
Director of INR
Room 6531 State
INR/REC
Room 8662 State
Director, Office of East
European & Yugoslavia Affairs
Room 5220 State
Economic/Commercial Officer
Office of East European &
Yugoslav Affairs
State
1 each to the following embassies
Budapest
Prague
Moscow
Warsaw
East Berlin
Sofia
Bucharest
Belgrade
Treasury
1. Harvey Shapiro
Deputy Director/Office of E/W
Trade Room 4450
Department of Treasury
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