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

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

6535.

Budapest, July 11, 1987, 0536Z

SUBJECT

• Hungary’s New Program on the Economy: Tensions Between Long and Short-Term Adjustment.

REF

• Budapest 2972.²

Summary:

1. The recent party and government personnel changes in Hungary, followed by the Central Committee communique of July 2, which announced a new program for economic and social consolidation, underscore the Hungarian leadership’s growing concern about the country’s deteriorating economic situation. The most significant aspect of the communique is the distinction between the need for both short-term adjustment to the country’s immediate balance of payments problems and long-term structural adjustment.

2. The two approaches are not necessarily compatible and, at least initially, can be expected to act in opposite directions. What is more, the restrictive characteristics of a short-term adjustment program are quite likely to be more in line with the abilities of the new Prime Minister, Karoly Grosz, than the more liberal characteristics needed for decentralizing and restructuring the economy. Radical economic reformers sense this and, therefore, fear that long-range economic reform will suffer or, at a minimum, be subverted by still powerful bureaucratic and political interests.

3. Central Committee staffers, however, stress that the situation is now truly different. They feel that there is widespread recognition of the seriousness of the country’s economic situation and a broad consensus that without restructuring, sustained growth in the future will be impossible. Another factor forcing the party’s hand at this point is money, or the lack thereof to continue to bail out loss-making industries or support expensive social programs. Thus, whether or not real changes will come about remains to be seen. It is now up to the government to bring forth the details of an economic program this fall, which will provide a clearer picture of the prospects for systemic economic reforms. Much will depend on how the program is implemented, and real changes may take years to emerge.

End summary.

4. The Central Committee communique clears the way for additional short-term adjustment measures beyond the reductions in producer and consumer subsidies and the tightening of credit introduced in April and May (reftel). The taboo against an official inflation rate in the double-digits has apparently been lifted, which will permit some needed policy changes. Further price increases can thus be anticipated as additional subsidies are cut to try to bring down the budget deficit. As a result, real incomes will fall, perhaps as much as 15 percent over three years, according to an economist in the Finance Ministry (or 20 percent according to Politburo member Berecz per septel.)³ Given the planned introduction of a steeply progressive personal income tax in January, the incomes of entrepreneurs and moonlighters who work in the private sector are likely to be particularly hard hit. Finally, import restrictions of some sort will be introduced, although they will not necessarily be as drastic as those implemented in 1982, when GATT rules were waived temporarily.

5. All these measures require a firm hand, which most agree Grosz has, and an economic sense, which insiders agree fits new CC Economic Secretary Miklos Nemeth. The implementation of more decisive short-term adjustment measures is, therefore, fairly certain, but not 100 percent guaranteed because political interests could interfere. Time is also of the essence, so the planning office intends to issue the annual indicators (national income, consumption, investment, inflation, and average wage growth rates) early—October or November—so that enterprises can adjust their behavior from the beginning of the year.

6. For the general populace it will be belt tightening all the way. The labor force will have to become more disciplined as well as more mobile and adaptable. As Central Committee staffers have told us, the country simply cannot afford expensive welfare programs, so some displaced workers will have to make great sacrifices to secure new employment by moving or commuting long distances. This creates a certain sense of foreboding by the public at large. A tight adjustment policy forced on the public will not be popular, but could probably bring the current account nearly into balance by 1991. The leadership can probably sell such a policy for at least two years.

Long Term Adjustment

7. The future of the longer range adjustment program is more fuzzy as well as much more important to the economic well being of the country. Reform economists, never optimistic about the prospects of reform measures, are more pessimistic about the impact of Grosz’s appointment in this area. One radical reform economist did, however, find the Central Committee communique of July 2 a more promising document than the one issued after the November plenum. He is encouraged by references to the need for some systemic changes, favorable comments on the expansion of private sector activities, a call for more glasnost, and the expressed desire for more balanced trade with the Soviet Union. (Hungary is currently under pressure to run a ruble trade surplus with the Soviet Union to pay back its accumulated ruble debt.) Still a clear admission that basic systemic changes are necessary, that more market competition is indispensible, and that investment should be shifted from heavy industry to smaller, more dynamic, export-oriented industries, are lacking in the communique. There are numerous potential pitfalls that could undermine the implementation of longer range reforms even through the party and government may currently intend to follow through with them.

— One hazard is that tighter central controls on imports and domestic demand needed to address the country’s immediate balance-of-payments problems run counter to the decentralization and increased market orientation needed to make industry and agricultural cooperatives more responsive to shifts of demand in export markets.

— The need to emphasize greater scientific and technical cooperation within CEMA means Hungarian enterprises will still face a dual market and probably continue to produce separately items destined for the East and for the West. This hampers efforts to improve efficiency and become more competitive in Western markets.

— Rhetoric aside, there is no firm sign the leadership will allow the degree of political liberalization needed to underpin a more market-oriented economic system. Instead political intervention and clout appear to remain as the main arbitrators of economic forces. As one mainstream economist noted, if everything is negotiable, nothing will get done. Ironically, the leadership may find itself in the position of giving in the face of rising social tensions, for example, by keeping open a loss-making enterprise, just so people don’t turn off of reform entirely.

8. There is also naturally a general uneasiness about the implementation and impact of such laws as the bankruptcy act, tax reform, and the futher liberalization of enterprise management, which would ultimately entail the lifting of price, wage, and import controls. Efforts to proceed in these areas could easily be subverted by vested interests. What was said in the communique of July 2 is not strong enough to bolster any of these elements against vested interests.

9. Laszlo Mohat, Deputy Head of the Central Committee’s Economic Department assured DCM and EconOff that this time the situation is different. He acknowledged that over the past few years the party has been reluctant to face the negative consequences of both short and long term adjustment, but now the economic situation is so serious, the leadership must act on its rhetoric. He added that the party can no longer let firms appeal for special tax exemptions and subsidies in view of the pressing need to reduce the government budget deficit.

Details of Adjustment Still Awaited

10. Unmentioned in the communique are key provisions of tax and wage policy, investment priorities, the need for import and price controls, and the degree to which real incomes will be allowed to fall. It is too much to expect that a Central Committee document would go into such detail. And many of these aspects should rightly be filled in by the government program and regulations. Reportedly Miklos Nemeth’s speech given at the Central Committee plenum was a bit more comprehensive and will be appearing in a future issue of “Tarsadalmi Szemle.”

11. The population does not appear to be holding his breath, although here is a growing unease about the potential for unemployment. The general attitude among workers and the intelligentsia appears to be that the communique was not worded forcefully enough or the personnel changes were not convincing enough to provide adequate proof that real changes are in the making. In the meantime, the uncertainty regarding he potential changes means that many enterprises are not operating with strategic long-term considerations in mind.

12. Whether or not major changes occur remains to be seen with the program the government is supposed to present in September, and more specifically in how that program is implemented. Given the delicate situation of Hungary’s external balance, the implementation of more systemic reforms and a turnabout in performance is likely to be slow. The party is envisoning a 3–4 year period of consolidation as well as further personnel changes this year, probably on the government side, to carry the program through.

Palmer

1. Source: Reagan Library, Nelson Ledsky Files, Subject File, Hungary: [1987 Memos—Letters/1987 Cables/1988 Cables/1987–1988 Intel Reports, Press Articles, Research/Bios] (2 of 2). Confidential. Sent for information to the Department of Commerce, Eastern European posts, Vienna, Geneva, USIA, and Moscow.
2. Telegram 2972 from Budapest, April 1, reported the implications of the recent credit crunch in Hungary. (Department of State, Central Foreign Policy File, D8770252–0530)
3. Not found.