Guest Article: Hungary’s Reforms: Past and Present

International Monetary Fund. External Relations Dept.
Published Date:
January 1991
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First Deputy President, National Bank of Hungary

The first steps toward policy reforms in Hungary can be traced back to the 1950s. Following two waves of political thaw in 1953 and 1956, Hungarian economists tried to implement their ideas on the transformation of the Soviet-type centrally planned economy. But they succeeded only in mitigating the effects of the most striking distortions. No comprehensive changes could be made because of the subsequent deterioration of the political climate in the Union of Soviet Socialist Republics and, as a result, in Hungary.

The first radical reform was introduced on January 1,1968, after several years of political, academic, and organizational preparation. The reform package included an attempt to combine central planning and market mechanisms, abolition of mandatory plan commands, moves toward enterprise autonomy, and gradual introduction of market prices and profit incentives. But ideological barriers and an unchanged political and institutional framework stood in the way of this effort. The situation was aggravated by attacks by conservative forces within the communist party leadership. As a result, the economic reform process came to a halt by 1972-74.

Despite that, the idea of the 1968 reform could not be totally banished from Hungarian public thought. Gradually, Hungary moved away from the rigid Soviet economic model. This relative freedom allowed Hungarians to enjoy better living conditions and to have a healthier domestic economy than most of their neighbors in Eastern Europe for nearly two decades. But many economic problems remained.

The oil price shock of 1973-74 should have led to further, drastic reordering of economic priorities, but this did not take place. Instead, the government chose to cushion the population against the rise in oil prices and the deterioration of the terms of trade with budgetary subsidies sustained by increased borrowing, without changing the production structure or dampening demand. The country’s standard of living rose in this period, but so did its external debt. By 1978, the leadership realized that the accumulation of debt could not be sustained. But instead of restarting the reform process to revitalize the economy, it cut back on imports from convertible currency areas and encouraged export-led growth mostly by administrative measures. The deterioration of the external balance slowed down, but without the necessary improvement in efficiency and profitability.

A new wave of reform gained momentum by the 1980s, including price reforms (linking domestic prices to those in the world market), a new bankruptcy law for all types of enterprises, a two-tier banking system (i.e., a central bank and commercial banks), and a new company law. But by the second half of the 1980s, the leadership realized that the old system could not be simply improved; it needed to be changed radically. Today, we do not speak of a combination of a planned and a market economy, nor even about a socialist market economy, but about a social market economy, with a high degree of social sensitivity, along the lines of systems prevalent in Western Europe.

Previous reforms

Earlier reforms were partial and half hearted. For a variety of reasons, including political compromises and lack of synchronization between different elements of a reform package, earlier reform efforts failed to improve radically the functioning of the Hungarian economy. For example, the 1968 reform concentrated on building up a market for goods and services, but not for capital, because capital ownership and income from speculation were seen as concepts opposed to the nature of a socialist social and economic order. The central command system—though in a somewhat indirect form—remained predominant for many investments and therefore affected structural development, as did the over-centralized, monopolistic system of enterprise organization. Individual reform measures were not part of a coherent and unified system. All these reforms were never allowed to cross political and ideological boundaries, so that they were often reversed.

The question of ownership—the central element of the market economy—was missing. In the state-owned sector, both the branch ministries and the self-governing bodies of the enterprises proved to be extremely incapable representatives of the state as the owner. In the cooperative sector, the ownership rights of the members were severely restricted by the interference of the political institutions. Earlier reforms did not tackle the issue of ownership directly. They made certain concessions for small-scale private industrial and trading activities and private agricultural production, mostly on the household plots of the cooperative farmers. Of course, many realized that the economic ills of the socialist society stemmed from the weakness of the interest of individuals. But because of the ideological barriers, no solution was found, until very recently, to the question of how to create and foster individual interest at all levels of the economy.

The root of the problem is that egalitarian tendencies have always been extremely strong in socialist countries. Generations grew up on the belief that this approach showed the moral superiority of socialist society over the capitalist one.

Radical reforms could have led to the predominance of private ownership; this, however, would have threatened political power as well. For these reasons, in the past the efficiency and incentives emerging from the creation of self-interest were always sacrificed on the altar of political power.

Another fundamental problem was the selection and behavior of managers of state enterprises in a socialist economic system. Although the executive was, in principle, selected on the basis of his managerial talents, his interests lay more in implementing the directives of his superiors than in following the imperatives of the market. Such a manager—unlike a private owner—is not sufficiently sensitive to demand, or to the future. He is less likely to have an interest in technical development or market research, and more interested in raising wages for the sake of good worker-manager relations, instead of accumulating wealth for the enterprise, or for the economy at large.

The predominance of Comecon trade. The huge captive market of the Comecon countries (also known as the Council for Mutual Economic Assistance) was not as demanding in terms of quality and speed of delivery as Western markets. This made it all very comfortable for the supplier enterprises. As a result, the structure of production in Hungary remained unchanged and the technical gap between Comecon and the Western economic system widened.

Trade with the Comecon countries grew rapidly, and this, for a long time, indirectly impaired the competitiveness and thwarted the export efforts of the Hungarian industry in the Western markets. In the Comecon trade system most of the deals were struck between governments. Once agreements had been reached between governments, companies found that they could bargain for favors from the government. They argued for subsidies, preferential credits, and other types of assistance as preconditions for the fulfillment of obligations made by the governments. This practice essentially removed the possibility of the emergence of market forces in the operation of these enterprises.

The lack of a change in the political system. Perhaps the most important reason behind the failures of the previous reforms was the fact that economic reforms were not linked to political ones. The abolition of the centrally directed system of the command economy put an end to the links with the centralized political system. But the declaration of enterprise autonomy could not produce a breakthrough in economic thinking and productivity because executive appointments continued to be influenced by political factors. Most of the economic policy decisions were based on short-term political considerations, laced with reverence for socialist values.

Political, economic, and social processes have their own logic, their own dynamics, and necessities. Thus, reforms were often viewed by the authorities as an admission of weakness; hence they tried to restrict such efforts to a minimum. It became clear that so long as decisions on economic matters and the appointment of executives remained a political issue, economic efficiency could not fully become a reality. This state of affairs concentrated substantial informal powers in the hands of the state and party bureaucrats, many of whom were unfamiliar with particular economic issues or industries.

Along with “true values” of socialism, such as free health care and education, security of being, and full employment, socialism also produced pseudo-values, such as artificially low prices of certain basic foodstuffs and services, and cheap rents. These led to shortages of commodities and of housing, and to the neglect and deterioration of the existing housing facilities. The transition to a true market economy requires overcoming the ideological taboos—for instance, that only physical and intellectual work is ethical, trade or entrepreneurship is dubious at best, and income from capital is immoral—that have taken such deep roots in public thinking in the course of the past 40 years.

Will this reform succeed?

What factors make it likely that the current transformation will continue and be successful?

The change toward a market economy is so major an undertaking that it could not be accomplished without accompanying political changes. The most important domestic political changes have already taken place. By mutual consent of those in power and those in opposition, multiparty parliamentary elections were held this spring, similar to those of the Western democracies. These changes occurred not through a coup, but as a matter of political evolution. Although Hungarian political life is characterized by keen debates, these have been contained within the parliamentary framework.

Following change in the political system of the country and as a result of the changes taking place in the Comecon countries, the international environment has also become supportive of reforms. Thus, the opportunity is now there for the establishment of the institutional system necessary for a market economy and for the introduction of privatization.

Further, the Hungarian reforms are not isolated this time. All of Eastern Europe and, what is of particular importance, even the Soviet Union, is undergoing an enormous change. Each of these countries is seeking to find the political and economic solutions best suited to its own situation.

The rearrangement of relations between them is also in progress. This implies the development of frameworks within which standardized political and economic solutions associated with Comecon are not needed any more. Moreover, it will be possible to build up economic ties, closer than before, with various organizations in the advanced market economies. The other important factor in this rearrangement of relations is that the former Comecon countries will, from January 1,1991, settle their trade accounts without obligatory interstate agreements, based on world market prices, and with payments in convertible currencies. Although this shift will put a major financial burden on Hungary, in addition to a number of other problems, it is also expected to do away with the undesirable effects of the earlier transferable rouble trade that hindered technical development, competition, and renewal in the past.

As a result of successive reform efforts over the past two decades, and particularly in the past two years, the basis for the establishment of a market economy has emerged in Hungary. With the command plan abolished more than 20 years ago, and the other forms of centralized direction of enterprises gradually reduced, the autonomy of the enterprises is, by now, virtually complete. Most managers have obtained the skills needed to operate in a market economy; partnerships and joint ventures are sprouting; various forms of modern financial instruments have appeared; and a taxation system, in line with those in Western Europe, has been established. Foreign trade, prices, and wages have been greatly liberalized; good progress has been attained in making the national currency convertible.

The settlement of ownership issues is important. The decision on the sale of state-owned assets has already been made. The parliament adopted the necessary legal framework and the process of large-scale privatization unfolded in the last two years. Many state-owned enterprises have established joint ventures with foreign firms and the government has launched a massive privatization program. Privatization is partly led, partly controlled by the State Property Agency. Privatization can be initiated by this Agency, by the enterprises concerned, or by prospective buyers. Privatization is a market-based process and is helped by favorable credits.

One of the most important tasks ahead is to improve the performance of state enterprises. A part of the solution is to privatize as many enterprises as possible. This, however, will take time and has certain limits. Therefore, the reform of the state enterprise sector is un-avoidable and cannot be bypassed by privatization. The reform may have different forms but some basic principles should be observed: the state-owned enterprises should be run by autonomous and accountable managers like private firms and conglomerates; they should be subjected to real market forces and should be supervised by professional, business-oriented bodies, whose sole responsibility is to assure high profitability within the framework of legal regulations and business ethics.

The establishment of new private enterprises, including from the beginning of 1991 foreign trade activities and joint ventures, is completely free and requires no specific licence. At the same time more than 90 percent of imports and domestic prices will be liberalized. Special laws and a broad range of measures will ensure fair trade practices and counter monopolistic tendencies.

The state will decrease its participation in the economy: it will decrease subsidies radically and will not make any investment in the competitive segment of the economy. The financing of health, education, and housing sectors will be reformed radically.

The prospects of the political and economic changes in Hungary have been improved by the strengthening of links to Western market economies. Hungary’s exports to these markets have already reached $7 billion per annum, or about a quarter of its GDP. The barriers in the way of the movement of capital and commodities are being demolished on both sides, while the transfer of technology has become easier. Hungary is seeking an early association agreement with the European Community, as a prelude to full membership. It will continue to count on the support of the international financial community and multilateral organizations in its move toward a fully functioning and successful market economy.

The most comprehensive assessment of the Soviet economy to date


Describes the current state of the Soviet economy, including economic development under perestroika

Recommends reforms to halt the deceleration of economic growth, fall in output, and growing unemployment

Outlines how Western economic assistance can support these reforms

The study was undertaken in response to a request by the leaders of the seven principal industrial countries and the Commission of the European Communities at the Houston Economic Summit in July 1990.

Prepared jointly by the International Monetary Fund, the World Bank, the Organisation for Economic Co-operation and Development, and the European Bank for Reconstruction and Development.

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