HUNGARY: MAJOR NEW ECONOMIC REFORMS IN PROSPECT

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• Collection: General CIA Records
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• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 17
• Document Creation Date: December 22, 2016
• Document Release Date: August 31, 2010
• Sequence Number: 6
• Publication Date: June 1, 1984
• Content Type: REPORT

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Directorate of (.O
Intelligence
Hungary:
Major New Economic
Reforms in Prospect
EUR 84-10119
June 1984
336
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Intelligence %
Hungary:
Major New Economic
Reforms in Prospect
West Regional Issues Branch, EUR
This paper was prepared byI Office of
European Analysis. Comments and queries are
welcome and may be directed to the Chief, East-
Confidential
EUR 84-10119
June 1984
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(onnaentiai
Hungary:
Major New Economic
Reforms in Prospect
Key Judgments Budapest this year is inaugurating the first major modernization of an
Information available economic reform program that caught worldwide attention 16 years ago
as of 24 May 1984 with its bold breakaway from the Stalinist economic model. New measures,
was used in this report.
long in the drafting and now proposed for gradual introduction during the
period 1984-90, seek even greater decentralization in enterprise manage-
ment, pricing, wages, and in 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. Initially, the
reforms will give a somewhat greater voice to managers and workers in
running their enterprises and-in the case of the most efficient firms-
greater freedom to set prices and wages. Measures to decentralize the
banking system and to restructure the tax system probably will be among
the last adopted. We do not expect decisions by the Central Committee on
the specific scope and pace of reform until sometime next year.
The key question is how far the Kadar regime is willing to go. Certainly
Hungary's leaders have no intention of abandoning their socialist system.
We have seen nothing to suggest 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. Moreover, the regime faces some real obstacles:
? The Hungarian people will have to be won over, since some of the
reforms-at least in the short. run-could lead to a decline in living
standards.
? Budapest will have to contend with resistance from entrenched party and
government bureaucracies.
? And, the reform proposals 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. Other bloc countries are
wary of the demonstration effect of Hungary's higher living standards and
are concerned that its economic reforms may, in the end, lead to significant
political liberalization.
Confidential
EUR 84-10119
June 1984
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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 Council for Economic
Mutual Assistance (CEMA) allies in the common quest for a more efficient
system of economic management. As of now, it appears that the New
Economic Mechanism is headed for a new watershed that promises to keep
it the most innovative model for evolutionary change in Eastern Europe.
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Key Judgments
Introduction
Enterprise Management
2
Capital and Credit Markets
2
Pricing and Enterprise Finance
3
Further Price Reforms
3
Other Related Measures
4
Taxation
5
Timetable and Obstacles
5
Small Enterprises and the "Second Economy"
7
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Milestones in the Evolution of Economic Reforms
Late 1964
1965-67
1 January 1968
1971-76
Party Central Committee appoints high-level government commission to study
reform of the system of economic management.
Debates among specialists are followed by public discussion and some
experimentation.
New Economic Mechanism (NEM) implemented, featuring decentralization of
operational decisionmaking to the enterprise level and some use of market forces.
In the face of soaring trade deficits, excessive investment, and resistance to
greater wage differentiation, Party hardliners succeed in recentralizing some
economic controls.
October 1977 Central Committee, in a watershed decision, calls for reestablishing the original
direction of NEM as a means of promoting enterprise efficiency, modernizing the
economy's structure of production, and improving the balance-of-payments
position.
1978-80 Economic reformers regain influence with policymakers and initiate wideranging
debates over restructuring the system of economic management; initial measures
introduced for greater wage differentiation and "competitive "producer prices
based on world market prices.
Early 1981
June 1982
April 1983
Several subcommittees of experts appointed by Central Committee's Economic
Working Group to draft a comprehensive reform concept.
Central Committee approves reform proposals in principle and orders preparation
of an integrated `economic policy concept "for implementation in 1984-90.
Central Committee reviews 66 page report from the experts entitled Policy
Concepts: Concerning the Further Development of the Economic Management
System.
April 1984 Central Committee makes first public announcement that some proposals have
been agreed upon for implementation starting in 1985 and orders work on other
proposals.
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Hungary:
Major New Economic
Reforms in Prospect F
Introduction
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. Budapest.
recognized the need to revive the 1968 reforms which
had been diluted during the first half of the 1970s.
New rules of the game were needed to make enter-
prise managers more profit oriented and induce them
to become entrepreneurial risk-takers in assuming the
lead in updating the country's increasingly outmoded
structure of production.
While Hungary has cautiously introduced some limit-
ed reforms in recent years, the country's financial
crisis has focused economic policy largely on stabiliza-
tion measures. Budapest has slashed investment and
slowed the growth of consumption in an effort to run
current account surpluses. Hungarian economists and
leaders, however, recognize that these measures are
only short-term fixes
Proposals now under study spring essentially from a
consensus that bolder action is needed to correct
problems with efficiency and competitiveness if Hun-
gary is to enjoy economic growth and external equilib-
rium over the long term. In particular, the regime
feels it is imperative to tackle the problems of:
? Too many large monopolistic enterprises that are
protected by vested hierarchial management institu-
tions, restricting incentives to use resources
efficiently.
? Too many export products that are not price
competitive in hard.currency markets.
? Labor and capital that are in short supply, yet
continue to be misallocated in activities with small
profits or even losses.
? The easy availability of bank credit and the lack of
institutions to channel it into activities yielding the
highest returns.
Thus, reform proposals aim at establishing an elabo-
rate new institutional framework that offers individ-
ual enterprises greater freedom to set prices and
Figure 1. Austerity-Brief Briefing: Don't bother to sit down,
comrades. This is just to let you know what our current
economic situation permits!
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 in
Hungary, but experts commissioned by the govern-
ment 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.
The general thrust of government proposals for new
reforms is contained in two lengthy concept papers
prepared primarily by economic professionals. In ad-
dition, Budapest's letter to the International Mone-
tary Fund (IMF) last December requesting new stand-
by credits contained a brief sketch of the proposals,
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Figure 2. Investment squeeze-Government support lasted up to
the 11th floor!
and a party plenum in mid-April called for reforms in
"every aspect of management." Because these docu-
ments tend to be vague and elliptical, we offer here
only a preliminary interpretation of what seem to be
the most innovative highlights.
Enterprise Management
At the core of the new reform concepts is the notion
that central or middle-level state administrative agen-
cies 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 was al-
ready 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.
Vetoed, at least for the 1984-90 period, is the creation
of "holding companies," unique types of property
management agencies long advocated by many promi-
nent reform economists. The winning argument ap-
parently was that holding companies, for all their
potential merits in separating the state from the.
economy, could easily become ministry-like protective
organizations that would serve to restrict rather than
promote the development of profit-oriented entrepre-
neurial 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, plan-
ning, 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 propos-
als 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
' A program for expanding the number of small enterprises is
already well under way as part of an effort to legalize and tax much
of Hungary's huge "second economy." See the appendix
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among the most politically sensitive because they
imply closing down chronically unprofitable enter-
prises and reallocating not only their capital assets but
also their labor forces to other enterprises-a prospect
that many displaced managers and workers would
find traumatic
Reforms in these two areas are interrelated. They
grew out of experiments begun in 1983 aimed ulti-
mately at developing a Western-like capital market
providing alternative types of financial assets market-
able 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.
The new proposals would create a network of com-
mercial 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 acted upon. 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 subordinate.
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 of
so-called. quasi-free market prices into much of the
economy.
Further Price Reforms. Pricing rules to be introduced
on a limited basis this year but rapidly extended
thereafter will greatly modify the so-called competi-
tive price system Z implemented in 1980. Domestic
producer 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-25X1
rate conversions modified by various compensational
adjustments such as tax rebates and subsidies. New
prices based on these formulas were expected to
provide enterprises with incentives to minimize costs
of production and better adapt their product lines to
demand in volatile export markets. In practice, the
system quickly grew overly complicated, with wide-
spread 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 the25X1
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 competi-
tion."3 (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 coun-
tries. The firms also enjoy greater freedom in granting
I Since adoption of the New Economic Mechanism in 1968, reform-
ers have looked on the economy as being composed of two broad
sectors-the "competitive sphere" and the "noncompetitive
sphere." The competitive sphere consists of sectors where a poten-
tial exists for "self-regulation" and includes the processing indus-'
tries, the construction industry, and some services branches, togeth-
er 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
noncompetitive sphere includes agriculture and most infrastructure
sectors that, in the interest of social policy and other national
considerations, must be managed by the state. Agriculture in
Hungary, despite substantial private activity, is largely under
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collective management and heavily subsidized by the state; subsi-
dies keep the costs of production and retail prices of farm products
' Jozsef Berenyi and Mrs. Sandor Hole, "Experiences With the
Price Mechanism," Figyelo, Budapest, 18 November 1981, p. 4
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wage increases. Whereas other enterprises must pay a
longstanding and steeply progressive tax on profits if
they increase wages more than the 1984 5-percent
limit, the more efficient "club" members are allowed
to exceed substantially the 5-percent ceiling without
having to pay the tax.
To be eligible for adopting the freer-pricing proce-
dures, firms must be major exporters operating at a
profit, and the demand and supply for their products
must be subject to "adequate" competition in domes-
tic markets. Requirements that the firms not hold
monopolistic positions and that their products not be
in short supply apparently are intended to forestall
In 1984, the authorities expect some 60 to 100
enterprises, accounting for about a fourth of total
sales in manufacturing, to adopt the new pricing
formula. But the group of participating enterprises
probably will expand rapidly, and the freer-pricing
and wage-setting scheme is scheduled to become
general in 1985 througllout much of industry, the
construction trades, and a large part of the services
' 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 determina-
tion, including basic consumer supplies, most agricultural procure-
ment, and major areas of infrastructure such as housing and public
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
Solutions in this area require, in the first instance, a
more frequent adjustment of the exchange rate based
on fluctuations in international currency markets,
since producer prices are based on world market
prices. The National Bank of Hungary already ad-
justs the exchange rate of the forint on a weekly basis;
the proposal is to make adjustments daily. This, in
conjunction with enterprises' responsibility for mak-
ing product mix and prices more competitive, will
require that managers have access to more market-
related information.
No radical changes are contemplated in the determi-
nation of consumer prices, but the government plans
to continue selective increases in prices of consumer
goods and services. These increases will be con-
strained by the desire to maintain present living
standards. Elimination of subsidies for certain essen-
tials has been ruled out even over the longer term as
being an unacceptable policy for a socialist state.F_
The goal of reducing producer prices is complicated
by the desire also to rationalize the relative input costs
of labor, materials, and capital to enterprises. This
goal 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 great-
er tax relief in return for trimming their work force,
with the savings to be used to raise wages of the
remaining workers. This latter proposal arouses con-
cern, 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
Tax reform, because of its direct impact on both
managerial and individual incentives, has posed a
dilemma for the authorities right from the start of the
New Economic Mechanism. On the one hand, reform-
ers want to restructure the tax schedule so as to
provide greater differentiation in enterprise profits
and individual earnings based on productivity. The
most productive enterprises and workers need to be
rewarded for their efficiency and not see their earn-
ings skimmed away to support laggards elsewhere in
the economy. Yet, these earnings are the principal
source of revenue needed to finance state expendi-
tures
Because of the conflicting objectives, proposals for tax
reform seem the most tentative. 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 of an
indirect value-added tax or the American system of
direct taxes on enterprise and personal incomes. We
believe the Hungarians will make progress in this
area, but the results most likely will not be evident
before the end of this decade.
Figure 5. Bankruptcy-The weeping man represents a successful
enterprise whose profits are being siphoned off to sustain
another firm operating at a loss.
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 outline approved by the Central Committee,
which we expect will 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 25X1
part of the package scheduled for introduction by
stages during the next five-year plan (1986-90).
A recent sampling of views among the Hungarian 25X1
experts involved suggests that the major thrust
through 1985 will be on reforms in enterprise man-
agement, pricing, and wages but that major changes
in banking and taxation must wait until 1986-90.
Reforms actually implemented down the line, further-
more, 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 wa-
tershed that promises to keep it the most attractive
model for significant evolutionary change in Eastern
Europe.
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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 turn-
,over taxes. The system has been changed several
times since 1968, but still is cumbersome and com-
plex. New proposals, still to be agreed upon, would
reduce enterprise profits taxes by gradually eliminat-
ing 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
At present, the only direct tax on personal incomes in
Hungary is paid by private crgftsmen.and merchants,
self-employed professionals, and persons working pri-
vate 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 adminis-
tered through the state budget. This lack of uniformi-
ty-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 ap-
plies 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
personal income tax is accepted it can only be
introduced.gradually.
The key question is how far the Hungarian leadership
is willing to go. For one thing, the proposals we have
seen have the potential, at least in the short run, for
upsetting the Kadar regime's commitment to improv-
ing living standards for the Hungarian people. While
the typical Hungarian consumer remains better off .
than most of his counterparts throughout the Bloc, the
regime, nonetheless, knows there are limits to the
amount of austerity consumers will tolerate. The
reforms also would force change on entrenched Party
and government bureaucracies. Some bureaucrats al-
most certainly feel threatened by job losses resulting
from an extensive decentralization. Others doubtless
are reluctant to take the kinds of risks essential to
making Hungary competitive in hard currency mar-
kets.
Finally, the reform proposals risk negative reactions
not only from the new Soviet leadership but also from
other East 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 pre-
lude to more fundamental changes. Budapest's eco-
nomic proposals have been worked on not only by
economists but also by sociologists, jurists, and histo-
rians who believe that an efficiently functioning mar-
ket-oriented economy cannot succeed without signifi-
cant political liberalization. Thinly veiled criticism of
Hungary has already surfaced in Czechoslovak 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.
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
is willing to relinquish ownership of the means of
production, to cede real power to workers over enter-
prise management, or to embrace political pluralism
at the national level.
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Appendix
Small Enterprises and
the "Second Economy" s
Hungary has long tolerated private enterprise in
agriculture and, to a lesser extent, in retail trade and
consumer services. Since 1981 the Kadar regime has
further legitimized and thereby spurred an increasing-
ly wide range of activities in Hungary's huge "second
economy" in a bid to ease some of the country's
economic ills. We believe the Hungarian regime has
come to appreciate that private market activity pro-
vides essential goods and services, supplements per-
sonal incomes, during a period of austerity, and pro-
motes a risk-taking entrepreneurial spirit lacking in
the large, monopolistic, and grossly inefficient state
and cooperative enterprises. Budapest has concluded
that some enlargement of the legal private sector need
not undermine its socialist principles and that legal-
ization should strengthen its ability to record and tax
the vast volume of economic activity going on outside
The Second Economy. Estimates by Hungarian re-
searchers of the size of the second economy of legal,
semilegal, and illegal private activities show:
? Three families in four in Hungary's population of
10.7 million enjoy a "secondary" income in addition
to that received from state or cooperative services.
? Roughly half the population, including urbanites,
cultivate private plots full or part time, making
agriculture the largest employer in the private sec-
tor; for some food items-pork, eggs, potatoes,
vegetables, and fruit-private agriculture is the
primary supplier.
? The second economy also supplies the bulk of
workers in housing construction, maintenance, re-
pair, and other consumer services.
Small Enterprises. Partial statistics indicate that by
mid-1983 some 13,400 new small enterprises had
been established, primarily in the industrial, construc-
tion, and service trades (see table). Employment in
these ventures totaled only about 81,000 persons,
partly because the regulations limit the permissible
number of entrepreneurs and employees per enter-
prise. If legally licensed private craftsmen and retail
merchants are added, the number of persons working
full or part time in small enterprises comes to
243,000, or roughly 5 percent of the labor force.
the socialized sectors.
The Image of Capitalism
The regulations expanding the scope of authorized
private enterprise unleashed a flurry of reports in the
Western media that Hungary was "going capitalist"
and probably raised some doubts among Budapest's
more orthodox CEMA partners. In 1983 party Chief
Janos Kadar stressed that the new measures had
nothing to do with capitalist methods and emphasized
that 98 percent of the means of production in Hunga-
ry remains socialized property. Kadar also stated that,
whereas private activity accounted for 14 percent of
agricultural production in 1982, it contributed only 1
percent in industry. Although Kadar's numbers
roughly portrayed the situation in 1982, they do not
fully reflect the importance of the second economy in
delivering some key goods and services nor the mo-
mentum of the small enterprise program.
Some examples illustrate the kind of sanctioned activ-
ity allowing private entrepreneurs to seek out opportu-
nities complementing-and, in some cases, competing
iary of a state-owned corporation and designed to 25X1
serve the needs of private entrepreneurs.
with-the much larger state and cooperative
enterprises:
? A small advertising agency operating as a subsid-
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Hungary: Estimated Number of Units
and Employees in New Small Ventures
as of Mid-1983 a
70 NA
155 NA
Business partnerships within 5,862 52,831
socialist enterprises
Specialized work units within
cooperatives:
absorbed by the new small enterprise program. We
suspect, however, that the bulk of unlicensed private
entrepreneurs have adopted a wary, wait-and-see atti-
tude.
Climate for Expansion
The regime has been gradually reducing obstacles to
rapid expansion of the small enterprise program.
These impediments-excessively high taxes, limited
provision for loan capital, and cumbersome legal
restrictions-were probably introduced deliberately at
the outset to gain policy consensus, especially among
ideological hardliners suspicious of any "private"
inroads into the socialist system. As the program has
unfolded, official policies toward these constraints
have eased.
Official thinking seems ambiguous on how far legal-
ized semiprivate and private activities should be
pushed. Prospects for the program are difficult to
Private business partnerships 3,481 NA C discern. Little information exists on how many sec-
Civil law partnerships 409 NA ond-economy entrepreneurs have converted to legal
a Our grouping of the units into socialist, semiprivate, and private status and the extent to which roadblocks are being
sectors is provisional. Small ventures in the "semiprivate" sector are created by large state and cooperative enterprises who
hybrids that seem to be neither purely socialist nor purely
rivate
p
enterprises. view the changes as threatening.
b In agricultural producer cooperatives and state farms.
c Although documentation is lacking, press commentary makes it
clear that private business partnerships are the second-largest
employers among small ventures.
? Eight small cooperatives and 33 semiprivate busi-
ness partnerships in a large state automotive enter-
prise that handle tool design, toolmaking, machin-
ery design, and some transport tasks.
? A private business partnership of professional
mountain guides, called Sub-Alps, doing high rise
repair work on state hotels.
? A two-person automotive repair service, named
Non-Stop, which operates during the hours when
state facilities are closed.
? Private taxi services, which for a fee can use state
garage and service facilities and the VHF radio
system.
? A private partnership producing small computers
for hospitals.
We have not seen any figures suggesting the volume
of previously semilegal or illegal activity that has been
There are good reasons why second-economy entre-
preneurs appear to have made no headlong rush to
register as legal enterprises. Apart from the high
taxes they face when successful, these people are
being invited to exchange the risk of arrest for the risk
of policy shifts that might destroy their business. Only
a consistent attitude by the authorities will gradually
dispel such fears and suspicions.
Since there are limits beyond which the government
does not want small semiprivate and private ventures
to grow, the large enterprises have little to fear. in
terms of serious competition for either. labor or mar-
ket shares. Nonetheless, these small ventures still
could prove troublesome in other ways. In the case of
labor, complaints have been voiced that young work-
ers with above-average talent will switch their careers
from state to higher paying jobs in the small ven-
tures-threatening a "brain drain" from state enter-
prises. Perhaps even more unpleasant is the prospect
that the small ventures, in their search for gaps in the
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market and under pressure to excel because of com-
petitive risks, will further demonstrate the inefficiency
of many large enterprises
The program is vulnerable to criticism for contribut-
ing to a more unequal distribution of income and is
arousing resentment among those unable or unwilling
to become private entrepreneurs. Workers in a steel
mill, for example, even if they could acquire the
necessary capital, generally have neither the educa-
tion nor skills in demand for legalized moonlighting.
In the first half of last year, the purchasing power of a
worker earning only regular wages declined more
than 5 percent, whereas incomes for participants in-
the second economy continued to far outpace the
country's 8.5-percent rate of inflation.
Expansion of legalized private activity may also be
complicating the economic stabilization program Bu-
dapest worked out with the International Monetary
Fund to help it through its financial difficulties. In its
assessment of the 1983 program, the Fund noted that
the rapid expansion of income in the private sector
was a major factor preventing the reduction in domes-
tic demand needed to improve Hungary's current
account balance. While the IMF probably sees merit
in legalizing second-economy activity as a means of
helping to prevent a serious decline in living stan-
dards, it apparently has been pressing the regime to
further boost-rather than reduce-taxes on large
incomes.
At this stage, we believe the regime still sees more
benefits than drawbacks to broadening the scope of
legalized private enterprise. Thus, we expect a steady
but measured evolution of the small venture program.
If the government sticks with it over the next decade,
Hungary will stand in even sharper contrast to its less
imaginative, hidebound CEMA partners. A "social-
ist" economy with ownership shared among state,
cooperative, semiprivate, and private enterprises
would constitute a challenging model for emulation-
particularly if it succeeds in promoting the efficiency
that has eluded centrally planned economies and
avoids creating pressures for parallel political reform.
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