Dr.

RAM MANOHAR LOHIYA NATIONAL LAW UNIVERSITY 2011-2012

ECONOMICS FINAL DRAFT ON: SOCIALIST ECONOMIC SYSTEM IN HUNGARY

Submitted for the project undertaken in the partial fulfilment of BALLB (Hons.) 5 yrs. Integerated course at Dr.Ram Manohar Lohiya Natinal Law University, Lucknow.

Submitted to:

Submitted by:

Prof. (Dr.) Madhuri Srivastava

Anusha Ramanathan Roll No. 23

ACKNOWLEDGEMENT

I would first like to acknowledge the guidance of my subject teachet, Prof. (Dr.) Madhuri Srivastava, for helping me choose the topic as well as helping me to go about it. I would also like to thank the library as well as the photocopy department , without whose help I would not have made this project. Anusha Ramanathan

CONTENTS

INTRODUCTION.....................................................................................PAGE 1 SOCILAIST ECONOMIC SYSTEM.......................................................PAGE 4 ECONOMICAL BACKGROUND..........................................................PAGE 7 HUNGARIAN ECONOMY: CHALLENGES FACED........................PAGE 10 THE PRESENT AND THE FUTURE.....................................................PAGE 11 CONCLUSION.........................................................................................PAGE 14 BIBLIOGRAPHY.....................................................................................PAGE 15

INTRODUCTION

Economics is defined as the knowledge concerned with the production, consumption and transfer of wealth in the oxford dictionary. It is further defined as a social science concerned with the proper uses and allocation of the resources for the achievement and growth with stability. Noted economist Adam Smith described economics as science of wealth, while Marshall, another economist defined it as study of mans action in ordinary business of life, it enquires how he gets his income and how he spent it. Thus it is on the other and more important side, a part of study of man. Economics is that branch of science which is concerned with the knowledge of production, consumption and transfer of wealth. Economics aims to explain how economics work and how economic agents interact. Economic analysis is applied throughout society, in business, finance and government, but also in crime, education, the family, health, law, politics, religion, social institutions war, and science. At the turn of the 21st century, the expanding domain of economics in the social sciences has been described as economic imperialism. Economics is primarily divided into three major economic systems, one out of the three been followed by the countries all over the world. The economic systems are broadly classified as :

CAPITALIST ECONOMIC SYSTEM MIXED ECONOMIC SYSTEM SOCIALIST ECONOMIC SYSTEM

These three economic systems play an important role in a countrys overall development. A countrys economic development is based on following one of the above systems. One

is easily able to gauge what was the economic history of that country and what is its present state on the basis of the economic system it follows.

CAPITALIST ECONOMIC SYSTEM:

Capitalist economy is also known as the free market or the free enterprise economy. It is an economic system in which the capital and land are private property. In a market capitalist system, enterprises may be formed by individuals who can get access to land and equipment, either because they can own it or rent it and who can hire laborers or employ individuals. In a capitalist economy the production is limited by existing resources, technology and profit. Also known as the Laissez Faire economy it focused more on the individual rights in comparison to state rights.It completely separates economy and state. It is a politicoeconomic system based on the doctrine of the individual rights. This means that capitalism recognizes that each and every individual is the owner of his own life and has the right to live his life in any manner as long as he does not violate the rights of the others. The features of this system include right of private property, consumers sovereignty, competition, price system and entrepreneurs role. The drawbacks of the system were that it led to exploitation of the weak and led to the emergence of class in the society.

MIXED ECONOMIC SYSTEM:

A "mixed" economy is a mix between socialism and capitalism. It is a hodgepodge of freedoms and regulations, constantly changing because of the lack of principles involved. A mixed-economy is a sign of intellectual chaos. It is the attempt to gain the advantages of freedom without government having to give up its power. In this system the freedom in the economic activities are influenced by the Government's regulation and licensing policies. In a mixed type economy, both the private ownership as well as the state takes part in the means of production, distribution and other types of economic activities. The mixed economy allows private participation in the field of production in an environment of competition with an objective of attaining profit. On the contrary following to the socialism features it includes public ownership in production for maximizing social welfare. A mixed-economy is always in flux. The regulations never produce positive results, because they always force people to act against their own interests. When a particular

policy fails, it is propped up by other regulations in the hopes that more control will produce better results. Sometimes the results are so destructive they must either be removed, or the people must be violently oppressed to make them accept it. The merit of this economic system is that there is a coexistence of the private as well the public sector, consumers sovereignty is protected and there is no exploitation of the labour class.

SOCILAIST ECONOMIC SYSTEM:

A socialist economy is based on public ownership or independent cooperative ownership of the means of production, wherein production is carried out to directly produce usevalue, usually, but not always, coordinated through economic planning and a system of accounting based on calculation-in-kind or labour. The project would cover the merits and drawbacks of the system as well as the system been used in Hungary. The features of this system are as follows: Ownership by Government: The principal characteristic of a socialist economy is the governmental ownership and nationalization of key production sectors. Though in theory almost all firms and companies should be nationalized, in practice, such a transfer from private to public is almost impossible. Due to this governments are promoted to rely on some private establishments that are largely regulated and managed by governmental laws and officials. Organizations that are involved in production in many cases are co-operative organizations, instead of firms and companies. Progressive Taxation and Wealth Redistribution: Often considered to be a drawback of the socialist economy, taxation system, progressively taxes higher income with higher tax percentages. The collected mammoth tax is then redistributed with the help of several public welfare schemes and policies. Price Control: Another distinct feature of a socialist economy is the technique of price control. Prices of commodities are not fixed by demand and supply analysis, but are fixed by the government, with respect to the necessity and nature of the commodity. Nationalization and Centralization: A socialist economic system is basically operated by a central government. The nationalization and centralization of all avenues of production are handled by one centrally based government that also frames the fiscal policies. The success of a socialist economy is found in such a convention where fiscal policies so implemented are executed by regional and grass root level administration, with an absolute timing and discipline. The economy, as a whole, thus, becomes very, very successful. The GDP shoots up almost instantaneously and poverty is abolished.

SOCIALIST ECONOMIC SYSTEM: MERITS AND DEMERITS

Socialism is a political term applied to an economic system in which property is held in common and not individually, and relationships are governed by a political hierarchy. Common ownership doesn't mean decisions are made collectively, however. Instead, individuals in positions of authority make decisions in the name of the collective group. Regardless of the picture painted of socialism by its proponents, it ultimately removes group decision making in favour of the choices of one all-important individual. Socialism originally involved the replacement of private property with a market exchange, but history has proven this ineffective. Socialism cannot prevent people from competing for what is scarce. Socialism as we know it today, most commonly refers to "market socialism," which involves individual market exchanges organized by collective planning.

The merits of this system are: Efficient use of resources: The resources are utilized efficiently to produce socially useful goods without taking the profit margin into account. Production is increased by avoiding wastes of competition. Economic Stability: Economy is free from business fluctuations. Government plans well and everything is well coordinated to avoid over-production or unemployment. There is stability because the production and consumption of goods and services are well regulated.

Maximisation of Social Welfare: All citizens work for the welfare of the State. Everybody receives his or her remuneration. The State concentrates on the production of basic necessaries instead of luxury goods. The State provides free education, cheap and congenial housing, public health amenities and social security for the people. Absence of Monopoly: The elements of corporation and monopoly are eliminated since there is absence of private ownership. The state is a monopoly but produces quality goods at reasonable price.

Basic needs are met: In socialist economies, like water, education, health, social security, Human development is more in socialist countries.

basic human needs etc, are provided.

 No extreme inequality: As social welfare is the ultimate goal, there are no concentration of wealth. Extreme inequality is prevented in socialist system.

Elimination of Unemployment: - Central planning authority on behalf of state gives boost to employment. It also ensures that all resources are put to their best use. No cyclic Fluctuations: - As socialist economy is planned economy, there is no surplus and deficiency which result in smooth working of the economy. There are no business fluctuations.

No Class struggle: - There is collective ownership of different factors of production which ensures the best utilization of available resources of economy and equal distribution. So there is no gap between haves and have-nots.

This system also had some demerits like: Bureaucratization: - The owners in private enterprises take interest in their work in capitalism. But in socialism government gets all the work done though their people who do not take so much interest and lack enthusiasm as people of private enterprises. Lack of Incentives: - Major disadvantage of socialism is that people do not have incentive for greater work, efficiency and enterprise. People get fixed wages and salaries from government so they lack initiative and incentive.

Red Tapism: - In socialist system the decisions are delayed as files go on moving from one placed to another which results in wastage of time and money also. Concentration of Economic Power in the hands of State: - The power gets concentrated in the hands of government or state, and thus government may not do work according to desires and preferences of the consumers. Economic freedom and Democratic rights of people are endangered because of danger of authoritarism. Promote Corruption: - The government being ultimate authority the government servants often become dishonest and corrupt while doing work of people.

 Misallocation of Resources: - Allocation of resources is not made according to the desire and demands of the consumers since there is no place for price mechanism.

No Consumer Sovereignty: - Wants of consumer are generally not taken into consideration for production of various goods. There is rationing system in distribution of goods as well which is against consumer freedom. Absence of Technology: Work is monotonous and no freedom is given. Any change in the production process will alter the entire plan. Hence any innovation cannot be easily enforced. Everything is rigid and technological changes are limited.

Absence

of

competition

makes

the

system

inefficient.

ECONOMICAL BACKGROUND: HOW HUNGARY WAS CONCIEVED

1918-1921: ECONOMY OF HUNGARY Core Hungary is a fertile plain, in which, in the time of the Dual Monarchy, agriculture dominated. Hungary's industries were centered in the few cities and in the fringe regions of Slovakia and Transylvania, where mining was possible; these regions were now cut off. The Aster Revolution of October 1918 took place in front of a situation marked by a coupon economy no longer capable of supplying the population with basic necessities. Yet the return of large numbers of soldiers, the influx of refugees, the continued economic blockade, the termination of German coal supplies on which the country heavily depended, drastically worsened the situation. The land reform promised by Mihaly Karolyi did not materialize; the Armistice Commission pressured the Hungarian government to make bolder concessions, using the needs of the Hungarian populace as a tool to press home her demands. The Soviet Republic (March-August 1919) energetically pursued measures to address the problems, but the collectivization of the land failed to solve the immediate problems; by the time the next harvest was to be brought in, it was toppled already. The periods of Red Terror and White Terror did not contribute to improving the situation. The Romanian occupation force confiscated goods and shipped them to Romania. The White administration (since August 1919) undid the reforms implemented by the Soviet Republic; yet only the signing of the Treaty of Trianon (June 4th 1920) removed the blockade and thus provided the condition for a gradual economic recovery. An attempt was made to terminate rampant inflation in May 1921, by implementing a currency reform, with limited success.

1921-1941: ECONOMY OF HUNGARY Admiral Horthy's government emerged strengthened from the failed royal coup d'etat. His style of government was patriarchal; communists were regarded as suspect since the days of the Soviet Republic. Strongman Miklos Horthy brought inflation under control. The country slowly returned to economic stability. Hungary's economy, however, depended on large foreign loans, and when these were recalled by U.S. banks after the Wall Street Crash of 1929, the Great Depression set in. In 1933, Gyula Gmbs attempted to establish a fascist corporate state; he failed, but Hungary pursued a foreign policy of being sympathetic to Germany and Italy, but

maintaining political neutrality and striving for regaining some of the areas lost in the Treaty of Trianon. In the Munich Pact of 1938, Czechoslovakia ceded regions with a Hungarian population majority, located in Southern Slovakia, to Hungary. When Germany occupied the remainder of Czechia in March 1939, Hungary annexed Carpatho-Ruthenia.

1939-1944: ECONOMY OF HUNGARY Along with the whole world, Hungary to was involved in the world war and was and like other participating countries was coping to balance its economy with the incoming war. Hungary was sided with Germany in this war.

1944-1948: ECONOMY OF HUNGARY The multiparty coalition government achieved a number of successes, such as getting the inflation, exorbitant in 1946, under control, repairing the country's infrastructure (bridges etc.) and quickly achieving self-sufficiency in food production. A Land Reform dissolved great estates, which were parcelled out and handed out to hitherto landless peasants.

1948-1953: ECONOMY OF HUNGARY With Hungary becoming a people's republic, the border to Austria was sealed off (Iron Curtain); following Tito's break with Stalin, the border to Yugoslavia similarly was sealed off. Enterprises employing more than 100 employees were nationalized in 1948, the collectivization of farmland was begun, a socialist economy imposed. A first three-yearplan (1947-1949) was succeeded by a five-year-plan 1949-1954. Investment was to increase multifold in order to develop and expand industries. There were difficulties when it came to attracting a workforce for newly created factories. Police was empowered to stop citizens in the streets and ask them about their employment. The economic policy of trying to enforce the collectivization of farmland and rapid industrialization resulted in a severe economic crisis; the production level did not reach the numbers planned for, another problem was the products' often inferior quality, a lack of consumer goods on the market and a drop in incomes.

1953-1956: ECONOMY OF HUNGARY In 1953, Hungary produced 2.18 million metric tons of wheat, in 1955 2.13 million (IHS p.278).

1956-1973: ECONOMY OF HUNGARY First Five Year Plan 1956-1960, Second Five Years Plan 1961-1965, Third Five Years Plan 1966-1970, Fourth Five Years Plan 1971-1975. In 1957, Hungary produced 1.95 million metric tons of wheat, in 1973 4.50 million (IHS p.278). In regard to economic policy, Kadar was willing to experiment. A new attempt to cultivate farmland was made, this time by offering the farmers incentives rather than apply force; it succeeded. In 1964 a New Economic Policy was proclaimed, implementing deregulation. Market mechanisms were permitted to work within a set frame. The Hungarian economy grew. Hungary's economic policy was referred to as Goulash Communism.

1973-1990: ECONOMY OF HUNGARY Fourth Five Year Plan 1971-1975, Fifth Five Year Plam 1976-1980, Sixth Five Year Plan 1981-1985, Seventh Five Year Plan 1986-1990. In 1973, Hungary produced 4.50 million metric tons of wheat, in 1988 7.0 million (IHS pp.278-279). Janos Kadar's Goulash Communism had been relatively successful in the 1960es and early 1970es. The Oil Crisis of 1973 hit Hungary hard, for the country had no oil sources and depended on imports from the Soviet Union or elsewhere. Hungary soon accumulated foreign debt, and another economic reform was necessary. A new economic policy was implemented in 1979. Industrial monopolies were broken up, consumer prices of many products raised to world market level (hitherto, most prices were state-subsidized). Yet the success of these measures did not satisfy expectation. In 1985, Hungary openly discussed bold plans such as making the Hungarian currency convertible.

HUNGARY SINCE 1990: A policy of fast-pace economic liberalization (1990-1994) resulted in high unemployment and huge foreign debt; the next administration pursued a policy of austerity (from 1995), emphasizing exports and privatizing state-owned enterprises. Hungary's GDP shrunk until 1993 grew at a slow pace until 1996, from when economic growth picked up. The Hungarian Stock Market was opened in 1990. The Hungarian Forint was made freely convertible in 1995.

HUNGARIAN ECONOMY: CHALLENGES FACED

Like any other economic system, the Hungarian economy also faced challenges due to the various going ons in the global market. Due to the recession which recently rocked the whole world, and nearly toppled over the most developed economic systems, also had a devastating impact on the Hungarian economy. Now post recession, the economy is facing various hurdles which have to be overcome by it to stabilize the country.

The post crisis world permanently requires less resilience on external financing. Hungary needs a new growth model, which rely on domestic savings. Robust and continuous government debt reduction has to be in the focus of macroeconomic strategy. To preserve real convergence in the post crisis world we need tight and credible fiscal policy. Fiscal consolidation has to rely on long lasting structural measures on the expenditure side. To enhance long term growth potential structural weaknesses has to be addressed as well: tax and social transfer reform, which support increasing labor force participation, improvement of the quality of primary and secondary education to strength employability, strengthening technological transfer among multinational and small/medium size businesses, to eliminate the dual structure of our economy. Stability of the regulatory environment, strengthening the rule of law, respect of contracts and market based coordination. Anchored inflation expectations.

Keep financial intermediation active and motivated to provide appropriate level of financing future business activities.

HUNGARIAN ECONOMY:THE PRESENT AND THE FUTURE

Prior to World War II, the Hungarian economy was primarily oriented toward agriculture and small-scale manufacturing. Hungary's strategic position in Europe and its relative lack of natural resources dictated a traditional reliance on foreign trade. In the early 1950s, the communist government forced rapid industrialization following the standard Stalinist pattern in an effort to encourage a more self-sufficient economy. Most economic activity was conducted by state farms and state-owned enterprises or cooperatives. In 1968, Stalinist self-sufficiency was replaced by the "New Economic Mechanism," which gave limited freedom to the workings of the market, reopened Hungary to foreign trade, and allowed a limited number of small businesses to operate in the services sector. Although Hungary enjoyed one of the most liberal and economically advanced economies of the former Eastern Bloc, both agriculture and industry began to suffer from a lack of investment in the 1970s. Belated reaction to the economic crisis of the early 1970s and deteriorating terms of trade resulted in increasing indebtedness. In response, the Hungarian Government launched a restrictive economic policy in the late 1970s and early 1980s, followed by the Dynamization Program of 1985, which increased consumer subsidies and investments--mainly in unprofitable state enterprises--eventually leading to a doubling of foreign debt levels. By 1993, Hungary's net foreign debt rose significantly-from $1 billion in 1973 to $15 billion. Liberalization of the economy continued, however, and in 1988-89 Hungary passed a joint venture law, adopted tax legislation, and joined the International Monetary Fund (IMF) and the World Bank. By 1988, Hungary developed a two-tier banking system and enacted significant corporate legislation which paved the way for the ambitious market-oriented reforms of the post-communist years. The Antall government of 1990-94 began market reforms with price and trade liberation measures, a revamped tax system, and a nascent market-based banking system. As a result of the collapse of Eastern markets and the inability of state-owned companies to compete with foreign competitors, industrial production fell by 50% between 1989 and 1994, and the country faced high unemployment and inflation rates, as well as a deteriorating trade balance. By 1994, the costs of government overspending and hesitant privatization had become clearly visible. In 1996, austerity measures referred to as the Bokros package (for then-Finance Minister Lajos Bokros) improved both the fiscal and external balance situation, and increased investor confidence. Simplified and accelerated privatization led to significant inflow of foreign capital in industry, energy, and telecommunications sectors, and a number of greenfield investments were launched. Hungary's early openness to foreign direct investment (FDI) led to a sustained period of high growth and made Hungary a magnet for FDI in the late 1990s and early parts of this century.

In 1995, Hungary's currency--the forint (HUF)--became convertible for all current account transactions, and subsequent to Organization for Economic Cooperation and Development (OECD) membership in 1996, for almost all capital account transactions as well. In 2001, the Orban government lifted remaining currency controls and broadened the band around the exchange rate, allowing the forint to appreciate by more than 12% in a year. Trade with European Union (EU) and OECD countries now comprises over 75% and 85% of Hungary's total trade, respectively. Germany is Hungary's most important trading partner, followed by Italy and France. The United States has become Hungary's sixth-largest export market, while Hungary is ranked as the 72nd-largest export market for the United States. Bilateral trade between the two countries has increased to more than $1 billion per year. With more than $60 billion in FDI since 1989, Hungary has been a leading destination for FDI in central and eastern Europe, although this level is beginning to decline. The largest U.S. investors include GE, Alcoa, General Motors, Coca-Cola, Ford, IBM, and PepsiCo, with the overall level of direct U.S. investment estimated at $9 billion. As a result of extensive and continuing liberalization, the private sector produces about 80% of Hungarys output. Close relationship with the economies of the EU helped pave the way for Hungary's EU accession in 2004. As part of its EU membership agreement, Hungary agreed to meet the economic criteria necessary to adopt the euro. In 2005 and 2006, however, it became clear that not only was a high budget deficit hurting the economy (nearly surpassing 10% of GDP in 2006), but that Hungary was moving away from meeting euro entry requirements, and would be subject to EU excessive deficit procedures. Against this backdrop, in fall 2006, Prime Minister Gyurcsany launched a program of fiscal consolidation by raising taxes, decreasing subsidies, and streamlining the public sector. Businesses complained, however, that increased taxes, particularly on labor, decreased Hungary's economic competitiveness compared to other countries in the region. Greater fiscal discipline allowed the government to reduce its deficit to 3.4% of GDP by 2008, but decreasing government spending during this period also reduced domestic consumption and contributed to a decrease in Hungary's GDP growth. In October 2008, the effects of the global financial crisis spilled into Hungary. Despite its success in reducing its fiscal deficit, years of high budget deficits and Hungarys high external debt levels fueled investor risk aversion, and negatively affected the foreign exchange, government securities, and equity markets in Hungary. The country was hit hard by global de-leveraging, and weak demand for government bonds. A sharp decline in the share of non-resident investors in the government securities market raised concerns that Hungary would be unable to meet its external financing requirements. In order to increase investor confidence and ensure liquidity in domestic financial markets, Hungary concluded a $25 billion financial stabilization package with the IMF, EU, and World Bank in November 2008.

Under the agreement, Hungary committed to further fiscal consolidation, financial sector reforms, and enacting banking sector support measures. Terms also included periodic assessment of macroeconomic and fiscal targets. Taking into consideration the worsening global economic and financial crisis, the IMF and the EU revised their projections of Hungarys GDP decline in 2009 to minus 6.7%, and agreed to increase the 2.9% deficit target to 3.9% for 2009. Public debt was expected to increase to 83% of GDP in 2009 before returning to more sustainable levels through fiscal tightening. To respond to the crisis, the Bajnai government in 2009 enacted a series of economic reforms and spending cuts intended to reduce the tax burden on labor, encourage employment, improve Hungary's economic competitiveness, and offset lost government revenue due to the deeper-than-expected recession. These measures included reforms to the pension and entitlement systems, as well as tax changes to shift the tax burden from labor to wealth and consumption. In addition to cuts in taxes for businesses and employees, tax changes included raising the value added tax (VAT), and a proposal for the introduction of a property tax. In 2009 GDP declined by 6.3%, and the Hungarian Government was able to meet the 3.9% deficit target. The Orban government elected in 2010 has pledged to meet the 3.8% budget deficit target and launched a 29-point economic program designed to promote growth by reducing administrative burdens on businesses and lowering the tax burdens on small businesses. The plan also includes strict control of budgetary expenditures, and a tax on the financial sector of HUF 200 billion (about $850 million), which would remain in effect for 2 years.

THE FUTURE: The future looks positive for Hungary's economy, given the trend since the end of the communist system. Growth has been steadily increasing, inflation has been declining, and unemployment has stabilized. Relative to other countries in the region, Hungary's economic conditions have proved quite favourable. The key economic event in the near future affecting Hungary will be accession to the European Union, something Hungary hopes will happen between 2004 and 2008. This event will bring about a significant restructuring of trade, employment, agriculture, and financial services. Hungary has already begun to introduce major fiscal and financial changes in preparation for accession, following the detailed guidelines issued by the European Union. Among other changes that accession would bring, Hungary intends to join the euro states adopting a single European currency. Doing so would link Hungary's inflation and interest rates to the European Central Bank in Frankfurt and remove the independence currently enjoyed by the Hungarian National Bank.

Hungary's main challenges for the future will be to manage its workforce, including some structural sectors where unemployment remains significantly high. There are also regions, especially in the eastern portion of the country, where unemployment and poverty remain significantly higher than the national average. In addition, Hungary in 2000 and 2001 has experienced problems with flooding that have caused significant disruption to people and to agriculture. These problems and more will have to managed in the future to enable Hungary's economy to grow and develop further.

CONCLUSION

The Hungarian economy is probably the most successful and sufficient communist economy in the world. Although it is a socialist planned economy, market elements, profit motivation, and a new concept of planning was introduced. The recent induction of Hungary into EU has also helped this country to bounce back from the devastating effects of the recession.

BIBLIOGRAPHY

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