19. Memorandum From Nathaniel Davis of the National Security Council Staff to the President’s Special Assistant (Rostow)1


  • East European Economic Reform

At the staff meeting on Wednesday, we talked about the relationship between political stability in Czechoslovakia, Poland and East Germany and the success or failure of reform efforts. You pointed out the crucial role of management incentive and I remarked that the most notable recent step was the Hungarian reform which took effect at the start of this year. Yugoslavia, of course, remains out in front.

Perhaps you would like a bit more information: Rank order, from a market economy at one end to Stalinist planning at the other, might now be the following: Yugoslavia, Hungary, Czechoslovakia, Bulgaria, Poland, East Germany, the Soviet Union, Romania, and finally Albania.

In Yugoslavia they are moving toward free convertibility and share capital. By a system of investment through contract, firms can even use their profits to buy into other firms. Some Yugoslav academicians even advocate factory managers having shares, and there is talk of a stock exchange.

The present period of transition has been painful. The government’s policies have been classically deflationary and economic growth has radically fallen off. There are estimates that urban unemployment is as much as 15 percent.

The Hungarians have an inherent advantage, in not having set up an intermediate network of trusts, cartels or production associations between the ministries and the individual firms (as is the case in most of the other countries in Eastern Europe). In their latest move they have done away with planning for each enterprise. The manager’s salary and bonus do depend on his ability to find customers and satisfy them. If he does not show a profit at all, he pays back a quarter of his base salary.

The Hungarians plan a phased transition from a three-tier pricing system to the virtual abolition of price controls. They plan increased reliance for investment on retained profits (from about 25 percent in 1968 to a larger percentage in each coming year). Another quarter of investment is to be financed with bank credits at 7 to 8 percent. Increasing number of firms will have the right to engage directly in the import and [Page 68] export trade, with foreign currency controlled by duties and surcharges rather than governmental allocation. Apparently at least part of the Hungarians’ motive is to qualify for the GATT.

In Czechoslovakia, economic reform has been hindered by the almost Stalinist conservatism of Novotny and his friends. Tight foreign exchange, continuing scarcities, constant Party interference and the continued incumbency of managers from the earlier era have all served to slow reform. There is no doubt that this was an important element in the recent leadership crisis. Partly because of the genuine socialist tradition in Czechoslovakia, salaries paid managers are much lower as compared with workers’ salaries than in other countries (e.g. East Germany). The manager can increase his earnings by about one-third if he maximizes profits, sales and exports.

Poland is still benefiting from 1956 (including, of course, the de-collectivization of agriculture). There is quite a bit of private trade, and more of the new breed of men than in Czechoslovakia. Quite apart from Oscar Lange, the Poles have some of the best economists of Eastern Europe.

East Germany’s economy benefited for years from the open border with the West. Even now private firms, averaging about 25 employees, produce about 5 percent of gross output. Mixed private/public enterprises produce another 10 percent.

For a few general observations, plans for economic liberalization tend to run afoul of Party control, scarcities, foreign exchange limitations, etc. As for the Party, I am sure not a few big wigs and old aparatchiki have wondered what the Party does if it doesn’t run the economy. Only in Yugoslavia is the manager not hired or fired by the Party/Government. So far, only in Yugoslavia is it the factory manager who has the dinars really free to buy another blast furnace. However, Hungary will be moving in that direction if her most recent reform is really carried out.

One last word. You are probably familiar with the story told by the Czech economist, Sik, which goes as follows: Prague was having worse and worse trouble with traffic congestion and remembered that the British seem to handle things better in London. So they sent a delegation. The delegation reported that the British did seem to handle things better, and the most remarkable difference was that they drove on the left. So the Czech Government decided to shift sides; but, being cautious, they felt they should not take too radical a move—so they decreed that taxicabs drive on the left.

  1. Source: Johnson Library, National Security File, Country File, East Europe. Confidential.