Váci utca, main shopping district, Budapest
Courtesy Scott Edelman

Shops in Zalaegerszeg
Courtesy John Tarafas

After 1949 Hungary's communist government under Matyas Rakosi applied the Soviet model for economic development (see Postwar Hungary , ch. 1). The government used coercion and brutality to collectivize agriculture, and it squeezed profits from the country's farms to finance rapid expansion of heavy industry, which attracted more than 90 percent of total industrial investment. At first Hungary concentrated on producing primarily the same assortment of goods it had produced before the war, including locomotives and railroad cars. Despite its poor resource base and its favorable opportunities to specialize in other forms of production, Hungary developed new heavy industry in order to bolster further domestic growth and produce exports to pay for raw-material imports (see table 14, Appendix). The Soviet Union became Hungary's principal trade partner, supplying crude oil, iron ore, and much of the capital for Hungary's iron and steel industry. Heavy Soviet demand also led Hungary to develop shipbuilding and textile industries. Trade with the West declined considerably. Soviet pressure, a Western trade embargo, and Hungarian policies favoring domestic and regional autarky combined to reduce the flow of goods between Hungary and the West to a trickle during the Cold War period.

Rakosi's regime also established wage controls and a two-tier price system made up of producer and consumer prices, which the government controlled separately. In the early 1950s, the authorities used these new controls to limit domestic demand and cut relative labor costs by tripling consumer prices and holding back wages. Popular dissatisfaction mounted as the economy suffered from material shortages, export difficulties, and mounting foreign debt. Agricultural growth also stagnated, and the area of cultivated land actually decreased.

During the thaw after Soviet dictator Joseph Stalin died in 1953, Imre Nagy became Hungary's prime minister and, following the Soviet example, implemented an economic policy known as the New Course. Nagy's administration halted the collectivization drive, allowed farmers to leave collective farms, abolished compulsory production quotas, raised procurement prices for farm products, and increased investment in agriculture. Nagy also shifted investment from heavy industry to consumer-goods production. The economic system itself, however, remained unchanged, and plan fulfillment actually worsened after 1953.

Hard-line party members soon undermined Nagy, and Rakosi regained control in 1955. The collectivization drive began anew, and the government redirected investment back to heavy industry before the cataclysm 2000 mic Revolution of 1956 brought the country's economy ÍÍÍÍÍÍÍÍto a standstill. According to official statistics, the economy registered an 11-percent negative growth in 1956. After the revolution, Janos Kadar and others in the new leadership understood that they had to gear their economic policies toward improving the population's living standard, and they recognized that practical considerations had to temper their commitment to the tenets of Marxism-Leninism as defined by the Soviet Union. From 1957 to 1960, consumption grew more rapidly than national income as the government tried to assuage popular discontent. Per capita real income was 54 percent higher in 1960 than it had been in 1950.

In 1959 the Kadar government began a second major collectivization drive. Instead of using coercion, however, the government offered peasants incentives to join cooperative or collective farms. The campaign ended in 1962 after more than 95 percent of agricultural land had come under the socialist sector's control. During the 1960s and 1970s, the Hungarian government made significant investments in agriculture and raised farm prices in an effort to make the sector viable. Agricultural mechanization also expanded by 50 percent.

During the 1960s, the government gave high priority to expanding the industrial sector's engineering and chemical branches. Production of buses, machine tools, precision instruments, and telecommunications equipment received the most attention in the engineering sector. The chemical sector focused on artificial-fertilizer, plastic, and synthetic-fiber production. The Hungarian and Comecon markets were the government's primary targets, and the policies resulted in increased imports of energy, raw materials, and semifinished goods.

By the mid-1960s, the government realized that the policy for industrial expansion it had followed since 1949 was no longer viable. Although the economy was growing steadily and the population's living standard was improving, key factors limited further growth. Returns from mining were diminishing, and Hungary had exhausted untapped manpower reserves. The government recognized that the efficiency of Hungary's industries lagged well behind that of Western industries and that its communication and transportation infrastructures were so inadequate that they retarded further economic growth. The Comecon countries were unable to supply Hungary with sufficient energy, raw materials, and technology to achieve further growth, and Hungary's leaders realized that the country would have to seek these critical inputs from the West. The government introduced the NEM in 1968 in order to improve enterprise efficiency and make its goods more competitive on world markets.

From 1968 to 1972, the NEM and a favorable economic environment contributed to good economic performance. The economy grew steadily, neither unemployment nor inflation was apparent and the country's convertible-currency balance of payments was in equilibrium as exports to Western markets grew more rapidly than its imports. Cooperative farms and factories rapidly increased production of goods and services that were lacking before the reform. By about 1970, Hungary had reached the status of a medium-developed country. Its industry was producing 40 to 50 percent of gross domestic product, while agriculture was contributing less than 20 percent.

In 1973 and 1974, in the midst of the Fourth Five-Year Plan (1971-75) world oil prices skyrocketed. Hungary's terms of trade, that is, the ratio of the prices Hungary received for its exports to the prices it had to pay for its imports, deteriorated considerably. The leadership responded to the new conditions with several major policy errors, which reversed the changes that had taken place under NEM. First, policy makers assumed world oil prices would soon return to earlier levels and concluded that the economy could be shielded from the capitalist world's crisis. The government did this shielding by subsidizing enterprises hard hit by rising energy costs and taxing the profits of enterprises that benefited from the high world prices. Second, the authorities chose to accelerate economic growth to deal with Hungary's deteriorating terms of trade. The Fifth Five-Year Plan (1976-80) emphasized industrial expansion and modernization and provided for a significant increase in investment. The share of gross investment in gross domestic product climbed from 34 percent in 1970 to 41 percent in 1978. Third, the government used pre-1974 price and demand figures to justify launching major projects that the economy at that time could not carry out efficiently. Finally, planners earmarked significant investment resources to increase the country's capacity to produce energy, basic materials, and simple semifinished goods in order to meet domestic demand and increase exports to the Comecon markets. However, Hungary's investments did not spawn a modern manufacturing capacity, which is the kind of industrial capacity needed to produce output for sale on the convertible-currency market.

Decision makers discovered to their chagrin that they could not protect the economy from the world price increases. Because the economy depended on energy and raw-material imports, accelerated economic growth required increased imports of raw materials and energy that Hungary could not obtain from the Comecon countries. Thus, Hungary had to turn to the convertible-currency market to obtain a greater proportion of its inputs. In the 1970s, Hungary's spending on consumption and investment outstripped what its economy produced by an annual average of 2.2 percent in 1978 alone it spent 5 percent more. The export earnings did not cover the cost of imports, convertible-currency trade deficits quickly piled up, and the government used foreign credits to finance the deficits. In addition, the government's efforts to shield the country's enterprises from Western price increases backfired as Hungary's structure of production and investment never adjusted to world demand. Antireform politicians and managers of large enterprises won partial reinstatement of the command economy by the mid- 1970s. This recentralization exacerbated Hungary's economic woes by further isolating Hungary's enterprises from market forces and prompting managers to show inadequate concern for efficiency, waste, and the competitiveness of their products on world markets.

Hungary's economic policy makers realized by 1978 that if the economy continued to run trade deficits, the country would soon be unable to honor its debt obligations. In 1978 the HSWP decided to revive the NEM. A year later, the government implemented a stabilization program aimed at, among other things, redirecting the economy away from heavy industry, improving the convertible-currency trade balance, and shrinking the country's foreign debt. The program's architects planned to maintain current levels of material consumption for several years in order to maximize convertible-currency exports at the same time, they planned to cut spending by reducing investment.

New external shock waves rocked the economy in the late 1970s, further eroding Hungary's terms of trade and undercutting the country's creditworthiness despite the reduction in investment. Oil prices rose dramatically and precipitated a world recession. Soon interest rates rose, and Western banks reduced the flow of credits to the East European countries in 1982 as a result of Poland's debt moratorium, Romania's insolvency, and the economic sanctions levied by the United States against Poland after the declaration of martial law in December 1981. The interest-rate increases helped to increase Hungary's hard- currency debt (see table 15, Appendix). Before the rates rose, Hungary relied heavily on floating-rate, short-term loans whose maturities were poorly staggered. In 1981 more than 80 percent of Hungary's US$8.7 billion convertible-currency debt was due within five years, and debt-servicing costs consumed about 33 percent of Hungary's convertible-currency earnings. In 1982 a liquidity crisis in in Hungary shook the confidence of Western bankers, and for several months the country was unable to negotiate new credits from the West.

Eager to avoid debt rescheduling, Hungary joined the IMF and the World Bank in 1982 and received from them about US$2 billion in loans. In addition, Hungary introduced a stricter stabilization program and obtained bridge financing from the Bank for International Settlements. The leadership also renewed its support for economic reforms, which creditors viewed as a positive step toward more efficient use of resources and improvement of the country's balance of payments.

Under the new stabilization program, spending on investment and consumption, which had outstripped the amount the economy had produced by 6.9 percent from 1974 to 1978, fell to 1 percent less than production from 1979 to 1983. By 1985 Hungary had slashed its investment spending to about US$5.2 billion, 21.8 percent less than in 1981. The government also increased prices steeply. Hungary's Sixth Five-Year Plan (1981-85) called for greater austerity, efficiency, and profitability, and it forecast growth of 14 percent to 17 percent over the previous plan period. The economy, however, grew by only 7 percent. Industrial production rose only 12 percent, far below the planned growth of 19 to 22 percent. Agricultural output rose 12 percent over the previous plan period, while the Hungarians' real per capita income increased 7 to 8 percent. Planners targeted exports to increase by 37 to 39 percent and imports by 18 to 19 percent exports, however, rose only 27 percent, while imports increased merely 6 percent.

Data as of September 1989