II Framework for Reform Since 1968

János Somogyi, and Anthony Boote
Published Date:
March 1991
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Central planning was introduced in Hungary in the late 1940s. It laid the basis for managing the economy after the authorities established the social ownership of the means of production through broad nationalization and, in agriculture, through widespread collectivization. Based on macroeconomic plans formulated at the center, basic production inputs were allocated directly and enterprises were fitted into the chain of command of central planning and management through specific and detailed directives concerning production, investment, employment, and the setting of wages and prices. The priority objective of rapid industrialization was pursued by imposing tight quantitative growth targets and forced saving, in an environment more or less insulated from the world economy. Rapid output growth was recorded as long as reserves of manpower, capital, and natural resources could be exploited. The process, however, involved high costs and major economic disequilibria, especially shortages of consumer goods.

The Government saw a need for major modifications at an early stage and took steps toward decentralization, accompanied by a relaxation of tight planning, a reduction in the number of compulsory plan indices, and wider latitude for prices in resource allocation. This process was interspersed with efforts to restore the dominant role of central planning and to suppress market elements. The authorities eventually came to recognize that the succession of partial measures had failed to resolve the problems with growth, the balance of payments in convertible currencies, and living standards. Against this background, in 1965, the Central Committee of the Hungarian Socialist Workers’ Party commissioned a group of expert committees to draw up guidelines for a comprehensive reform. The leadership approved the recommendations in mid-1966, and the experts prepared the detailed decrees and regulations necessary to adopt the New Economic Mechanism (NEM) on January 1, 1968.

The New Economic Mechanism

The blueprint of the NEM outlined in the resolution of the Central Committee of the Party of May 7, 1966, represented a reform model aimed at modifying certain basic features of traditional central planning without overstepping the limits of the established social-political system. The objective was not to reform socialism but rather to improve the methods of “building socialism.” The NEM blueprint preserved the basic principles of the system, including the dominance of social ownership of the means of production, the ideological postulates of socialism, and the central role of the national economic plan in the allocation of resources. The reform sought to bring about a more efficient implementation of the plan through market-based, decentralized decision making. It hoped to achieve consistency between the plan and market processes by replacing plan directives with indirect control via financial instruments. The reform blueprint also provided safeguards to protect the socialist character of the economy and to avoid “unhealthy excesses” of competition and “market anarchy.”

The most important characteristic of the NEM was its elimination of directives and commands from the center. Correspondingly, it abolished the central allocation of the means of production and inputs and authorized trading among enterprises. The NEM recognized, however, the mixed nature of the economy. It envisioned a dominant role for the state sector, moderate scope for the private sector, and encouraged the expansion of the cooperative sector. Autonomous enterprises were to be responsible for microeconomic decision making subject to a uniformly applied system of economic regulations; the interests of employees were represented in the decision-making process of enterprises. Finally, the NEM plan envisaged a closer direct relationship between the domestic economy and foreign markets by introducing a unified exchange rate, a closer connection between domestic and foreign prices, and by licensing enterprises to engage directly in foreign trade.

The decentralization of decision making and the increase in enterprise autonomy were to be accompanied by a greater role for enterprise profits to guide production and marketing decisions, with more flexible prices intended to reflect the effects of supply and demand. The role of prices and wages in allocating resources was hampered by, among other things, a complex tax-subsidy structure that limited the effects of the reform on enterprise profitability. Moreover, price liberalization was introduced only gradually and the authorities did not foresee a significantly enhanced role for the exchange rate and interest rates as economic policy instruments. The banking system and various other aspects of the institutional system, such as the role of the government ministries, remained essentially unaffected by the reform.

The NEM was never intended to replace planning by the market but rather to implement the planner’s priorities through market-based incentives. The substantial prerogatives remaining with the planners were frequently used to subvert the market’s influence. The result was a set of conflicting signals that precluded fundamental economic change. Enterprises switched from bargaining with the center about the plan to bargaining about regulations.

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