Economic development in Hungary: the transition years--1989 to 1998.

• Author: Buss, Terry F.

Abstract

This paper reviews Hungary's progress in transitioning from a centrally-planned, Communist state to a market economy in a democratic society over the decade of the 1990s. Hungary employed a gradualist approach in its transition, experiencing many wrong turns along the way. As of 1998, though, Hungary has, arguably, been the most successful former Soviet Bloc country. With its impending acceptance into NATO and the European Union, its transition will be nearly complete.

Introduction

In 1989, Hungary and neighboring countries in the Soviet Bloc, threw off the shackles of Communist Party dictatorship to pursue the difficult road to a market economy and a democratic government (Bartlett, 1997). This paper is a general assessment of how well Hungarians have done in their quest over the past decade.

Hungary itself is interesting for two reasons: (1) Not only did it have to reinvent its economy and government from scratch, but as a small country--land area the size of Indiana and a population as large as Ohio--it has to compete with much more powerful western nations. (2) In contrast to Poland which chose rapid shock transformation from one system to another, Hungary represents a successful more gradualist approach (World Bank, 1997).

Background

Hungarians undertook economic development in the 1990s on the legacy of a failed Communist economic/political system.

Central Planning

Central planning guided economic development under Communist rule in Hungary (Kornai, 1992). Planners in Budapest, the capitol, allocated resources--including everything from sewer and water services through highways to industrial plants and buildings, not to mention education, health and social services--across the country. The Communist Party decided which regions and communities would benefit. Government decision-makers, functionaries, and technocrats, then implemented Party orders.

Two important ministries were economic planning--controlling all aspects of production, and construction--creating the built environment. County/regional governments managed economic development locally according to the plan, with city governments and local party organizations playing a subservient role. Defense, mining, agriculture, gas/oil/electric, and other ministries controlled industries related to their function.

Hungarian industries were large conglomerates, supporting not only worker needs for day care, schools, recreation areas, cafeterias, health care and so on, but also providing necessary infrastructure--including buildings, housing, roads, bridges, utilities and a host of other amenities--to support industry itself.

Occasionally, higher and lower Party organizations, ministries, and industries disagreed with policy, but not often. Generally, elites settled disagreements in private, with subordinates going along to get along. Security forces kept everyone in line.

Communist economics valued mass production, not individual consumption. Industrial production targeted capital goods (e.g., machinery, equipment, tools) and basic steel for use by other industries in production. Hungary used cheap Soviet raw materials and energy resources to produce goods traded back to Russia and other Soviet Bloc countries, as part of a comprehensive plan--Council for Mutual Economic Assistance--coordinating production across the Soviet empire.

Some industries produced for foreign markets either to obtain "hard currency" to pay off foreign debt from borrowing or importing, or to further Soviet foreign policy objectives--propping up Cuba's, Angola's, or Viet Nam's economy, for example.

Communists did not lavish benefits on the population. Consumer goods, including food and clothing, were of poor quality and often in short supply, but usually inexpensive. Picture housing complexes of 50,000 inhabitants with no grocery store or restaurant within walking distance, no paved road or sidewalks, no department stores. Even so, Hungary probably enjoyed more foreign consumer goods than other Soviet Bloc countries.

Black markets flourished, and for many Hungarians were an important source of goods and services they could otherwise not obtain. People met at flea markets on weekends to barter goods. No one hired a construction company to build a house. Houses were built with materials pilfered from state-owned enterprises and by builders moonlighting from state employers. Bribery took care of building permits.

Much of the goods traded on the black market, ironically, were made in state-owned factories. Workers either stole products from factories for resale off the books, or used factory equipment to produce other goods not made at the factory.

Black markets co-existed along side the official market, because Communist Party members were also forced to obtain goods and services from the underground economy. Black marketeers charge high prices, because products are scarce and in demand. As such, black markets rationed goods, benefiting the rich and penalizing the poor.

Industries, not driven by market competition, but by often clueless planners, were highly inefficient. As long as they produced according to plan, no one cared. Industries were managed by Communist Party hacks, appointed for their loyalty to the Party, rather than their competency in management. Industries employed too many people, making very shoddy goods no one really wanted. Workers were poorly paid with little incentive to work, leading to low productivity, absenteeism, alcoholism, theft, and occasionally sabotage. A popular saying among workers sums things up: "They pretend to pay us, we pretend to work." Industries were social entities: it was common to hear managers say to Westerners: "Our unemployment is inside the factory, yours is outside."

This economic system performed well at first. Workers, believing in Communism, were willing to make great sacrifices for the cause. Those unwilling to voluntarily sacrifice did so anyway through coercion. Foreign trade in weapons and natural resources brought in hard currency, in Hungary's case, to import consumer goods, in short supply.

As the system became more inefficient, planners robbed productive industries to prop up unproductive ones. When central bank funding was insufficient, firms began borrowing from one another, trading in kind, or delaying payments. Hungary's Communist government borrowed from other Eastern European countries and the Soviet Union--usually in credits, but also from Western banks--always in dollars. Debt soared. Central bankers responded by inflating currency to cover foreign debt. Eventually the system crashed.

Fall of Communism

The Soviet Union, central to economies of its satellite nations, could not sustain the system and consequently was unable to enforce its will on Hungary and other Bloc countries. In 1989, Communism fell across Eastern Europe, with Hungarians playing a decisive role. East Germans tested Soviet weakness by visiting Hungary ostensibly as tourists, then fleeing across the Austrian border, without Hungarian border guards lifting a finger (EIU, 1997: p. 19). The Berlin Wall fell, allowing East Germans to move freely to West Berlin. In June 1989, Hungarians held a public funeral and re-burial for the leader of the 1956 Revolution, Imre Nagy, executed by the Russians after invading Hungary. Both acts openly defied Russian hegemony in the region.

Economic Development Context

How does this tie into economic development? First, government totally controlled the economy; now a market economy is required. Prices and currency exchange must be liberalized, budget deficits must be reduced, taxation and legal systems must be established, social needs must be met, populations must be re-educated. Black market economies must be eliminated and rule of law established.

Second, Hungary, like other Eastern European countries, organized production by inefficient and outmoded state enterprises. New industries must be developed, and existing ones either retooled or shutdown. Industries must become competitive, especially with European trading partners. A market-based banking system must be developed to drive the economy. Foreign investment is key in a country lacking capital.

Third, communities existed to benefit industry under Communism. With many industries redundant, communities became redundant as well. Communities must redevelop: housing and retail stores are critical to appease the public, while industries reorganize in a market economy.

Fourth, Communists banned private property. For development to proceed, private ownership must be established and guaranteed, then state property must be transferred to private actors. Property, illegally seized, must be returned or compensated for.

Fifth, Communism persisted through credit provided by others. Foreign debt must be repaid, as must bad debt of state enterprises in arrears and public funds--pensions and health care--essentially bankrupt.

Sixth, Communist governments are notoriously corrupt, tending to be populated with opportunists. Those taking advantage under the Old Regime are likely to do so under reformed ones. Corruption must be minimized.

This paper addresses Hungary's progress in meeting these economic development challenges in...