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

347. Memorandum Prepared in the Central Intelligence Agency¹

EUR M 88–20094

Washington, June 1, 1988

Hungary: New Leadership Struggles to Develop Program [portion marking not declassified]

Summary

Premier Grosz’s stunning rise to General Secretary and the replacement of conservative Old Guard Politburo members by six new members, most of them strong advocates of further reform, leaves Hungary with a leadership that will push harder for economic change. The new leadership was united by its opposition to Kadar’s continued rule and agrees that things must be changed: foreign debt must be reduced, productivity must be increased, government and economic administration must be improved, and “democratization” must be extended. However, it does not have a concrete program for achieving these objectives, and its members disagree over how fast the changes should be made and how radical they should be. Their policy disagreements will be exacerbated by personality conflicts and political infighting, and even after they reach a consensus on policy, they will face the same impediments that Kadar faced, including the risk that major changes could provoke instability and aggravate the country’s precarious financial situation. Major policy changes that go significantly beyond what has already been discussed, such as wage reform and increasing private initiative in the economy are, therefore, unlikely before the end of the year. In discussions with US officials, Budapest may argue that the recent party conference was the most democratic in its history, that significant political and economic reforms are in the offing, and that the US must help turn the economy around if more conservative elements of the party are not to regain the upper hand. [portion marking not declassified]

Intractable Problems

The new leadership inherits an exceedingly difficult economic and social situation. Their most immediate challenge will be to stabilize Hungary’s foreign debt, which has risen nearly $9 billion—to a record $17.7 billion—over the past three years. [portion marking not declassified]

Hungary’s rapid increase in debt is due mainly to the inconsistent implementation of previous economic reforms and to policy errors that have slowed the economy’s adjustment to fluctuating commodity prices and growing competition in world markets. Investment and import restrictions imposed between 1979 and 1985 to cope with recurring balance-of-payments problems held back the establishment of new ventures and the modernization of potentially dynamic enterprises. At the same time, an increasing share of resources was allocated to ailing enterprises in the heavy industry and energy sectors, further undermining the economy’s export potential. [portion marking not declassified]

When Budapest loosened controls on domestic credit, government spending, and imports in 1985, economic performance fell far short of plan and serious payments imbalances reemerged. GNP growth averaged only 0.3 percent annually in 1985–87 while higher than planned growth in investment and consumption—coupled with pent-up demand for Western capital and consumer goods—led to a surge in hard currency imports. The hard currency trade and current account balances subsequently swung into deficit, unleashing the foreign borrowing binge. [portion marking not declassified]

Debt service costs, which we estimate will exceed 50 percent of hard currency export earnings over the next five years, are a severe drain on the economy. They limit Budapest’s ability to devote more resources to updating the country’s increasingly obsolete industrial base, assuring adequate energy supplies, and improving labor productivity. Even if Budapest now meets its austerity program’s targets for reducing the budget and current account deficits, we estimate that it will need to borrow more than $2 billion annually until 1990, and increasing amounts thereafter, topping $3 billion by 1992. If Hungary fails to obtain these funds, it will face the prospect of a debt rescheduling and more severe austerity measures than the current program. [portion marking not declassified]

These economic difficulties have contributed to rising social tension. Workers, already upset with declining living standards and the prospect of unemployment as inefficient enterprises are shut down, are fearful that further reform will lead to even greater hardships. Young people and intellectuals resent regime controls on civil freedoms and are agitating for far-reaching reforms of the political system, which they believe are necessary if further economic reforms are to work. [portion marking not declassified]

New Leaders Divided by Policy Differences, Personal Rivalries

The new leadership, taken as a whole, is more likely to make major changes in the economic and political systems than the Kadar regime, but it may not be able to move as quickly to address the problems as many would like because of potential policy differences and personal rivalries. (See Box on The Balance of Forces in the Politburo.)

• The new leaders formed a coalition because they were united by their opposition to Kadar’s continued rule and by their belief that Hungary needed new policies and stronger actions if it were to avoid a crisis, not because they shared identical views on the solutions to the country’s problems.

• Some members of the Politburo, notably Imre Pozsgay and Rezso Nyers, probably would be willing to permit broad market-oriented economic reforms and almost unlimited political freedoms, while General Secretary Karoly Grosz or recognized conservative Janos Berecz, who is now probably the number two man in the hierarchy, would most likely prefer to stick with less controversial economic policies, such as a stricter austerity program, and fairly limited political reforms that would simply enhance the role of the government in administering economic policy. [portion marking not declassified]

These differences will be aggravated by political infighting as the new leaders jockey for power and prestige.

• The Politburo already has vetoed Grosz’s first three choices for the Premiership—one because he was seen as being Grosz’s “tool”—according to the US Embassy.

• Berecz was thwarted in his effort to be named Deputy General Secretary, but he is likely to continue scheming against Grosz and other members of the Politburo in order to increase his influence. If he is stymied by the other leaders, he may in desperation try to arrange for Kadar to attend Politburo meetings in return for the “old man’s” support on leadership matters.

• Pozsgay and Berecz have been feuding openly for the past year about the former’s association with dissidents, and they are likely to continue to clash over this issue in the Politburo. [portion marking not declassified]

* * *

Box: The Balance of Forces in the Politburo

New General Secretary Grosz probably will need some time to consolidate his power in the Politburo—and over the Central Committee. Embassy reporting suggests that although Grosz was instrumental in convincing Kadar to step down at the conference, many of the other personnel changes were not directed by him but were instead the result of an unprecedented demonstration of authority by conference delegates and the newly-elected Central Committee. Thus the new Politburo members may not feel beholden to Grosz for their power and may not hesitate to oppose him. Moreover, Grosz is more likely to have to respect the wishes of the reinvigorated Central Committee than Kadar needed to for most of his career, making it even more difficult for him to dominate policy making. [portion marking not declassified]

At least initially, the Politburo is not likely to vote along set factional lines. The pragmatic technocrats in the leadership are likely to decide their positions on the basis of facts rather than ideology or the views of the General Secretary, and a fluid voting pattern in which the majority changes from issue to issue may result. The most likely tendencies are these:

• Conservative Orientation. Support for meaningful reforms limited by ideological considerations, fear of setting loose uncontrollable forces for change. Only Janos Berecz falls in this category.

• Pragmatists. A basic acceptance of the need for changes, but stance linked to the issue at hand. Most likely to be more comfortable with economic than political reform, but probably would support small steps in the latter area. Karoly Grosz, Janos Lukacs, Csaba Hamori, Judit Csehak, Istvan Szabo fall into this category.

• Radical Reformers. Advocate sweeping reforms that verge on social democracy. Imre Pozsgay, Rezso Nyers, and Miklos Nemeth probably fall into this group.

• Unknown. Preferences cannot be determined on the basis of available information. Pal Ivanyi and Ilona Tatai are political unknowns. Tatai, head of Taurus Industrial Rubber Company, probably has an open mind on reform issues; Taurus has concluded several business deals with American companies and is a test case for employee stockholding. [portion marking not declassified]

* * *

Continuity in Economic Policy Likely in the Short Term

Budapest remains committed to pursuing such economic reforms as expanding the influence of the market, increasing private initiatives, and facilitating foreign investment. The recent party conference, however, avoided dealing with the country’s serious economic problems and merely recommended that the Central Committee set up a working group to explore the possibilities for further reform. It may be several months before this committee arrives at a conclusion and reports back to the leadership, which would then probably put the recommendations before the Central Committee before acting on them. Even after the party adopts a new program, however, bureaucratic footdragging by officials whose power or perquisites will be diminished by the reforms is sure to slow its implementation. [portion marking not declassified]

Moreover, the new leadership faces the same obstacles to faster reform that stymied the Kadar regime. The introduction of more sweeping changes, such as market pricing or the implementation of stricter austerity policies, such as the closing of insolvent firms, would lead to higher inflation—which has already topped 18 percent—and unemployment, either of which could threaten stability. Austerity policies needed to deal with the country’s financial problems also make it difficult to carry out long overdue structural reforms. For example, tighter central control of imports and investment to reduce the trade deficit run counter to the decentralization and greater market orientation needed to make Hungarian industry more efficient and competitive. In addition, structural change requires a more flexible labor force, but a host of factors—among them, the oversupply of unskilled laborers, an undersupply of skilled workers, and housing shortages—-will continue to impede labor mobility. [portion marking not declassified]

Economic performance during the first quarter of this year underscores the difficulties of trying to balance austerity and reform. Industrial output grew by only 0.9 percent compared with the same period in 1987, despite a much milder winter. Confusion over the major tax reform introduced in January and a too sudden tightening of credit by the National Bank, which is trying to function more like a Western central bank, appear to have created supply bottlenecks that slowed overall industrial growth. [portion marking not declassified]

Little progress, moreover, has been made in shifting resources from heavy industry to more competitive sectors. Output in the energy intensive and inefficient metallurgy sector increased 4.4 percent, and despite a reduction in subsidies to Hungary’s ailing steel works, these firms are continuing to receive more indirect support: the government is allowing them to sell their hard currency earnings to other enterprises at a subsidized rate. In contrast to the moderate growth in metallurgy, output in machine building, important to modernizing Hungary’s industrial base, declined 1.6 percent, while performance has continued to lag in potentially dynamic export sectors, such as food processing and light industry. [portion marking not declassified]

Political Reform More Divisive. . .

The outlook for political reform is clouded because it will be a contentious issue within the leadership and between the leadership and elements in the party’s Central Committee. In the past, Pozsgay has gone so far as to admit the worth of dissidence and multiple political parties, while Grosz and Berecz are strongly opposed to such radical ideas. Grosz insists that the party’s leading role is not negotiable and that independent trade unions and youth groups outside the officially recognized union and youth structures cannot be permitted. His speech to the party conference emphasized the themes of increasing social discipline and maintaining order, and he also has defended publicly the decision taken earlier this year to expel four prominent members of the party for associating with dissidents. At the same time, the regime is likely to be faced with numerous calls for radical political reforms from intellectuals within the party who have been emboldened by Kadar’s ouster, and its credibility will be quickly destroyed if it ignores these calls. [portion marking not declassified]

. . .And Political Stability Uncertain

Grosz is not popular with workers, and his failure to include a well-liked trade union official in the Politburo may exacerbate his difficulties in selling an austerity program. When Grosz tried to address a workers’ meeting late last year, he was shouted down, and more recently workers in Grosz’s home county painted the slogan “Bread for all—String up Grosz” on a train going to Budapest. Workers could be quick to vent their anger in open demonstrations if he pushes ahead with plans to close bankrupt enterprises or lay off workers from unprofitable factories. [portion marking not declassified]

Outlook

The regime probably will be tied up with turf disputes, as individual leaders vie for predominant influence in various policy areas, and with making further personnel changes, particularly in the government, for the next several months. The new leadership is likely to want to put its own team in charge of key ministries, such as the Ministry of Industry, and it may also want to restructure the government in order to improve its administrative efficiency. [portion marking not declassified]

The new Politburo members have not made any policy statements since their appointment, but with younger, better educated leaders now in power, we expect the regime to develop more imaginative steps for dealing with Hungary’s pressing economic problems. Miklos Nemeth, for example, in his address to the party conference, advocated the conversion of foreign debt into shares that foreign companies could hold in Hungarian enterprises. [portion marking not declassified]

For now, the regime will probably stick with the austerity and reform program for 1988–90 developed by the Grosz-led government last fall and endorsed by the party conference. The economy is still trying to adapt to the measures introduced at the beginning of the year, and the main goals of the austerity program have been incorporated into Hungary’s $365 million standby arrangement with the IMF. The leadership may try to toughen the austerity measures, however, because some key targets, such as the size of the budget deficit, are already being overshot. In addition, they will almost certainly push ahead with reforms already envisaged, especially the economic association law, which will permit the conversion of state enterprises into joint stock companies. The new law may even broaden stockholding rights to Hungarian citizens and foreign companies in view of the economy’s shortage of investment funds. Wage reform is also on their agenda, but Grosz recently acknowledged in the Soviet press that it is going to take a long time to plan and implement. [portion marking not declassified]

The regime probably will heed calls made at the party conference for improving internal party democracy by increasing the influence of lower-level party bodies in the formation of policy. Budapest also is likely to give the government more autonomy to fill in the details of the economic plan and to permit the National Assembly greater leeway to debate policy proposals, but a meaningful reduction of ultimate party control over the actions of these bodies does not appear likely at this time. Nor is the new leadership likely to change the existing policy of opposition to dissidence unless Politburo liberals, with the support of reformers in the Central Committee, can convince Grosz, Berecz, and their allies that a traditional hardline approach in this area will be counterproductive to the development of a new social consensus. [portion marking not declassified]

Implications for the US

Budapest’s objectives in dealing with US policymakers are not likely to have changed much, but regime members probably will be better salesmen for Hungarian policy. Most of the new Hungarian leaders are better educated, more sophisticated, and more open to contacts with the West than their predecessors—8 of the 11 Politburo members have visited the US, for example. They are likely to still focus on multi-year Most-Favored-Nation trade status, a reevaluation of Cocom restrictions, more bilateral trade, and more joint ventures, but they may argue that the recent leadership changes are indicative of the development of a new era of democracy and market-oriented economic reform and that the US must help Hungary turn its economy around if more conservative forces are not to regain power. With a number of high level US visits to Hungary planned for June, as well as the upcoming visits of Nemeth and Grosz, Washington may have a unique chance to affect Budapest’s thinking before the regime has time to fully develop its domestic and foreign policy agenda. [portion marking not declassified]

1. Source: Central Intelligence Agency, Office of Support Services (DI), Job 90T00100R: Intelligence Publications Files, Box 3, Folder 260: EUR M 88–20094: Hungary: New Leadership Struggles to Develop Program. Confidential; [handling restriction not declassified]. Prepared in the Office of European Analysis. A distribution list is ibid.