The New Economic Mechanism:
Causes and Consequences

by Shauna Mulcahy


  After World War II, Hungary’s communist government applied the Soviet model for economic development to their economy.  This meant that the government used coercion and brutality to collectivize agriculture and the squeezing of profits from the country’s farms to finance rapid expansion of heavy industry.  The principal trading partner of Hungary became the Soviet Union, which supplied Hungary with iron ore, crude oil, and the majority of the capital for their iron and steel industries.1  At this time trade with the West also declined due to a trade embargo and Soviet pressure as a result of the Cold War.

During the early 1950’s the leadership regime in Hungary under Rakosi established wage controls and a two-tier price system made up of producer and consumer prices.  The government was allowed to control these systems separately and therefore use the controls to limit domestic demand and cut relative labor costs by holding back wages and tripling consumer prices.  This caused great suffering in the economy due to export difficulties, foreign debt, material shortages, and the stagnation of agricultural growth.1

After the 1956 Revolution and the implementation of Janos Kadar as the new leader of Hungary, it was viewed most crucial that the economic policies had to be geared toward improving the living standard of the population.  It was also noted by the leadership, however, that the policies had to be geared toward the Marxist doctrine of the Soviet Union due to their presence in the nation of Hungary.  Therefore, during the period from 1956 to 1960, consumption and income grew more rapidly then national income as a result of the government’s policy to appease the population.

During the 1960’s priority in the government was given to expand the industrial sector’s chemical and engineering branches.  “The communist government forced rapid industrialization after the standard Stalinist pattern in an effort to encourage a more self-sufficient economy.”2  The policies enacted by the government resulted in increased imports of raw materials, energy, and semifinished goods.1  By the mid 1960’s however, the government realized that the policy for industrial expansion was in desperate need for change.  The living standard and economy of Hungary were growing but returns from industries were diminishing and they still greatly lagged behind those of the West.  Therefore the government introduced the NEM in 1968 in order to improve enterprise efficiency and make its goods more competitive on world markets. 

 In December 1964, a Central Committee plenum was formed to provide fundamental guidelines for economic reform in Hungary.  In May 1966, the Central Committee approved a reform package called the New Economic Mechanism (NEM), in which many of its elements would be phased in during a preparation period, but its central features required the introduction of a new price system, which was set for January 1, 1968.  “With the NEM, the government sought to overcome the inefficiencies of central planning, to motivate talented and skilled people to work harder and produce more, to make Hungary’s products competitive in foreign markets, especially in the West, and, above all, to create the prosperity that would ensure political stability.”3 

The NEM decentralized decision making and made profit, rather than plan fulfillment, the enterprises’ main goal.  The government introduced “economic regulators” which were indirect financial, fiscal, and price instruments used to influence enterprise activity.  It also introduced a profit tax and allowed enterprises to make their own decisions concerning output, marketing, and sales.  Subsidies were eliminated for most goods except basic raw materials and the government decentralized allocation of capital and supply and partially decentralized foreign trade and investment decision making.  Agricultural collectives also gained the freedom to make their own investment decisions and the economy’s focus moved away from heavy industry to light industry and modernization of the infrastructure.3

The initial results of the NEM were positive.  In the period up to 1970, fulfillment of the plan was successful and the standard of living rose as production and trade increased.  More variety in products were introduced, sales increased faster than production, and the trade balance with both East and West improved.3  The economy also grew with neither unemployment or inflation apparent.  Since the introduction of the New Economic Mechanism in 1968, Hungary moved increasingly to a market-oriented system with less central decision making and more private initiatives.  By 1970, Hungary gained the status of a medium-developed country and its light industry was producing 40 to 50 percent of gross domestic product.1  The focus of the economy finally moved away from heavy industry and to light industry and modernization.

The reform however was not as sweeping as originally planned.  The reform failed to dismantle the highly concentrated industrial structure, which was originally created to facilitate central planning and still inhibited competition under the New Economic Mechanism.1  Therefore the basic flaws of central planning produced economic stagnation.  Another problem was that “enterprises within Hungary continued to bargain with government authorities for resources from central funds and sought preferential treatment.”3  Hence, corruption was still evident in the Hungarian government.

Other problems arose in 1971 when counterreform forces were calling for the return of central controls.  Opposition from government and party bureaucrats was supported by enterprises and workers who perceived the NEM as a threat to their privileged positions.  The income of the large enterprises dropped after the introduction of the NEM and they were also worried about competition for materials and labor from the smaller enterprises.  Within the next few months the opposition got its chance to reverse the reform.  In November 1972, the Central Committee introduced a package of new measures to recentralize part of the economy, but the NEM was not fully abandoned at this time.  New restrictions however were placed on small enterprises, wages rose, prices came under central control, and price supports were introduced. 3

By 1978, the bad economic conditions within Hungary showed that a “reform of the reform” was needed.  The government agreed that it could not continue to shield Hungary from world economic conditions.  A restructuring of the Hungarian economy took place at this time in which the price system was restructured to bring consumer prices in line with world market prices and producer prices were reformed to bring more rational use of energy and raw materials.3   Thus, within 10 years it was shown that although the economy of Hungary benefited greatly from the NEM in the first few years of its implementation, many adjustments would be needed over the years in order to keep the NEM successful and in step with the rest of the world in the future

1 Hungary: Economic Policy and Performance, 1945-85


 2 Background notes: Hungary


 3 Hungary: New Economic Mechanism






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