Foreign Relations of the United States, 1981–1988, Volume X, Eastern Europe

335. Telegram From the Embassy in Hungary to the Department of State¹

6346.

Budapest, July 4, 1987, 0905Z

SUBJECT

• Meeting With Prime Minister Grosz on US-Hungarian Trade and Hungarian Economic Policy.

1. Confidential—Entire text.

2. I met with Prime Minister Grosz on July 3rd to inform him that the USG had decided to license sale of Boeing 737s and McDonnell Douglas MD80s to Hungary, and to encourage Hungary to purchase one of these American aircraft. I said I wanted to get his first week in office off to a good start in terms of US-Hungarian trade. I also wanted to point out other signals of U.S. seriousness in increasing trade: U.S. Chamber of Commerce President Lesher, Commerce Department Assistant Secretary Freedenberg, and the Chairman of Guardian Industries all will be in Budapest the week of July 6–12. (I also gave Grosz a cowboy hat and some other U.S. products from our July 3rd reception and he immediately put the hat on.)

3. Grosz expressed pleasure at the news about the aircraft and about the visits. He said that he and I were “lobbyists” in common for these projects and he wants a more active economic relationship with the United States despite the differences in our size and Hungary’s central European location.

4. Grosz then volunteered some comments on the Central Committee session of July 2nd. He said the basic lines of external and internal policy will remain the same, but serious problems must be solved. Poor balance had continued for the first five months of 1987. The government will develop a program by September 1987 based on the document from the Central Committee (only released to the public July 4th—see below). A decision had been taken by the CC to initiate VAT and income taxes in January, 1988. A second step would be action on a new social policy including pensions in the course of 1988. Third they would institute a new wages policy by the end of 1988.

5. Grosz said they want to introduce two basic changes: more use of private capital and increased competition. He noted that a decision has been taken on which sectors of the economy to stimulate, which were the most promising. But debate continued about which sectors to cut back.

6. A decision also had been taken to raise prices this month. This would not be popular but it must be done. There would be some decrease in the standard of living.

7. Finally, Grosz noted that there will be personnel and substantive consequences as a result of a new policy effort to get the party out of micro-management of the economy. The government will assume a larger role.

8. The actual communique released on the evening of July 3rd and read in detail on evening news program contains no great surprises but comes across as solid endorsement at highest levels of restructuring program and planned tax reform. CC communique notes continued growth of budget deficits at a time of increased consumption and the need to take measures to bring production and consumption into balance. In the short run, this can be taken only with a reduction of expenditures while over the long term there must be an increase in the country’s income producing capacity. The document urges that decisive steps be taken to reduce subsidies and bring an end to the situation here by which successful enterprises finance inefficient and loss-producing activities.

9. On taxes the CC document gives a green light to the introduction of a Value Added Tax (VAT) and income tax while calling for a reduction of direct taxes on production. The VAT is foreseen as helping to promote a situation where prices will reflect real costs, however, it is recognized that this will also lead to substantial increase in consumer price levels. The need for wage reform is also cited with a call for wages to reflect the social usefulness of work. The CC recognizes that such a policy will result in a greater degree of wage differentiation. An income tax will be introduced “after appropriate preparation.” The tax will be progressive but not to such an extent as to take away worker incentive.

10. The communique also emphasizes the need to commit resources for worker retraining and encourage a situation where the labor force will be ready to change jobs. An improvement in the country’s education system and the need to develop more skilled workers is also emphasized.

11. As is generally the case with CC communiques this document tends to be long on generalities and rather short on specifics. Nevertheless, at first reading it does appear to provide the new Prime Minister with the authority to proceed with most of the key elements of the restructuring program particularly tax reform and phase-out of unprofitable enterprises. The inclusion of the reference for a need to increase the role of the fledgling securities market will also provide an opportunity for further innovation in this area. While no time table is set out for these changes to be put into effect, we have little doubt that Grosz will attempt to move as briskly as possible. Whether or not he will be able to overcome well-entrenched vested interests and wide-spread skepticism remains the major open question.

Thus far the urgency of Hungary’s economic situation, reflected in both the CC communique and a government statement on the economy earlier this week, do not seem to be disrupting our contacts’ vacation plans.

Palmer

1. Source: Reagan Library, Rudolph Perina Files, Hungary—Substance 1987 (3). Confidential; Immediate. Sent for information to Eastern European posts.