Csaba Lentner - East of Europe, west of Asia

harmattan

Csaba Lentner

EAST OF EUROPE, WEST OF ASIA

Historical development

of Hungarian public finances from the age

of dualism to the present

Translated from the Hungarian by

Anikó Béltekiné Gál

Translation revision:

Prof. Dr. Csaba Lentner

Paris – Budapest, 2020


This book has been published by the generous support

of the Pallas Athéné Domus Animae Foundation.

Peer-reviewed by:

Prof. Dr. Ernő Huszti honorary professor, Doctor of the Hungarian Academy of Sciences

Dr. Pál Péter Kolozsi PhD, associate professor at the Corvinus University and the National

University of Public Service, head of department in the National Bank of Hungary

English language translation © 2020 by L’Harmattan Publishing House

Originally published in Hungary by L’Harmattan Publishing House, Budapest.

Copyright © 2019, Prof. Dr. Csaba Lentner and L’Harmattan Publishing House.

ISBN 978-2-343-18706-8

© Éditions L’Harmattan, 2020

© L’Harmattan Könyvkiadó, 2020

© Prof. Dr. Csaba Lentner, 2020

All rights reserved. The work and its parts are copyrighted. Any use beyond what is permitted

by law is subject to the prior written consent of the publisher.

Copy editor: Tamás Tiszóczi

Cover design: László Kára

Page-setting: Krisztina Csernák

Printing:

Leader in charge:


TABLE OF CONTENS

Chapter 1: Theme and Purpose of the Book, a Short Historical Arc

of its Subject . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

1.1 The historical-interpretation framework of Hungarian public finances . 9

1.2 The structure of the book, its theoretical foundation . . . . . . . . . . . 12

Chapter 2: State-controlled Economy in the Era of Dualism

(1867–1918) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

2.1 The Austro-Hungarian Compromise of 1867 and its outline history . . . 19

2.1.1 The Hungarian Reform Era as a preparation for capitalist

development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

2.1.2 Economic measures of the government of the Revolution

and War of Independence 1848–1849 – The beginning

of independent economic administration . . . . . . . . . . . . . . . 22

2.1.3 The pre-compromise period after the War of Independence:

the age of neo-absolutism as the “main test” of post-compromise

economic governance . . . . . . . . . . . . . . . . . . . . . . . . . . 26

2.2 Economic aspects and effects of the Austro-Hungarian Compromise

of 1867 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

2.2.1 Direct economic and political interests leading to the Compromise

of 1867 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

2.2.2 The essence of the state treaty, the framework of economic

administration, budgetary processes . . . . . . . . . . . . . . . . . 30

2.2.3 Regulatory background and results of industrial development . . 35

2.2.4 Monetary and credit policy and central bank relations

in the age of dualism . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Chapter 3: Economic Administration of the Period Between

the Two World Wars, with Particular Regard to István Bethlen’s

Politics of Consolidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

3.1 Political consolidation after the armed fights (world war, First Hungarian

People’s Republic) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

3.2 Economic consolidation . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

3.3 The role of the independent central bank and the development

of the financial area . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

3.4 The economic aspect of the 1938 Győr Armament Program . . . . . . . 62


6 | Table of Contens

Chapter 4: The Main Features of Public Finance and Economic

Administration in the Planned Economy . . . . . . . . . . . . . . . . . . 67

4.1 Post-World War II economic administration (1944-1947) . . . . . . . . . 67

4.2 Structure of the planned economy system, its regulatory environment . . 71

4.2.1 Socialist industrial policy until the New Economic Mechanism . . 71

4.2.2 Agriculture: from the first violent collectivization wave

to the Hungarian Revolution of 1956 . . . . . . . . . . . . . . . . . 76

4.3 The New Economic Mechanism of 1968 and its forerunner,

the Regulatory Reform in 1955/1956 . . . . . . . . . . . . . . . . . . . . . 79

4.3.1 Economic measures of 1955/1956 . . . . . . . . . . . . . . . . . . . 79

4.3.2 The New Economic Mechanism . . . . . . . . . . . . . . . . . . . . 81

4.3.3 The beneficial effects of the New Economic Mechanism:

development in agriculture . . . . . . . . . . . . . . . . . . . . . . 87

4.4 The banking system of the socialist planned economy . . . . . . . . . . . 91

4.5 The decline of the planned economy system . . . . . . . . . . . . . . . . . 98

4.5.1 The period after the reform of 1968 . . . . . . . . . . . . . . . . . . 98

4.5.2 Economic decline and fallback in the living standard . . . . . . . 100

Chapter 5: Economic Conditions of Transitioning to a Market

Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

5.1 Regime changing conditions, regime changing laws, regime changing

“opportunities” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

5.1.1 “Resumption of the market economy" . . . . . . . . . . . . . . . . 105

5.1.2 On EU accession . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

5.2 The main contents of the principles, regulation and impact of privatization 113

5.2.1 Industrial sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

5.2.2 Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

5.3 Banking system during the transition towards the market economy

until 2013 – until the change of the central banking system . . . . . . . 124

5.3.1 The beginnings of a renewedly two-tier banking system . . . . . . 124

5.3.2 The post-millennial period . . . . . . . . . . . . . . . . . . . . . . 127

5.4 Public finances: budget, public debt, global economic crisis of 2007-2008 130

5.4.1 “The flowers of deterioration” . . . . . . . . . . . . . . . . . . . . . 130

5.4.2 From crisis to crisis, from adjustment to adjustment . . . . . . . . 134

Chapter 6: The Economic Administration and Constituents

of the Active State Operations after 2010 . . . . . . . . . . . . . . . . . 141

6.1 Main administrative steps and legal cadastre of the post-2010 period . . 141

6.1.1 The forced path . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

6.1.2 The targeted direction of the economic administration after 2010

and the dynamics of applied legislation – Constitution, Stability Act,

other fundamental and public finance laws 6.2 Changes

in fiscal policy space . . . . . . . . . . . . . . . . . . . . . . . . . . 142

6.2 Changes in fiscal policy space . . . . . . . . . . . . . . . . . . . . . . . . 147

6.2.1 Tax structure changes . . . . . . . . . . . . . . . . . . . . . . . . . 147

6.2.2 Budget, public debt and national wealth . . . . . . . . . . . . . . . 152

6.2.3 Financial relations between Hungary and the European Union . . 155


Table of Contens | 7

6.3 Changes in central bank policy: the turn in monetary policy . . . . . . 156

6.3.1 New trends in leading central bank policy after the crisis . . . . . 157

6.3.2 Turn in the monetary policy of the National Bank of Hungary . . 158

6.3.3 Turn in monetary policy and recovery of lending . . . . . . . . . 159

6.3.4 Turn in monetary policy and decrease in external vulnerability . . 163

6.4 Being on the verge of an era? Economic balance of active state operation

over the past 8 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

6.4.1 The Hungarian model as a successful crisis management . . . . . 169

6.4.2 The Hungarian model as the policy of wage catch-up, reduction

in public utility charges as well as the expansion of family and

home foundation support . . . . . . . . . . . . . . . . . . . . . . . 172

6.4.3 Hungarian model and sustainability: conditions for a competitive

turn in Hungary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176

Chapter 7: Theoretical, Systematic “Summary” . . . . . . . . . . . . . . 185

7.1 On classical economic principles, general requirements, optimal way

of state operation - in connection with state influence . . . . . . . . . . 185

7.1.1 From Adam Smith to John M. Keynes . . . . . . . . . . . . . . . . 185

7.1.2 On contemporary Hungarian relations in the age of dualism,

the construction of the state economy . . . . . . . . . . . . . . . . 189

7.2 On the importance of budgetary discipline and a “good tax system”

ornamented with international classics and the theoretical standards

of dualism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

7.2.1 On the framework of the state finances in the era of dualism

providing a foundation that remains to this day . . . . . . . . . . 193

7.2.2 Unique historical excerpts on taxation . . . . . . . . . . . . . . . . 197

7.2.3 On the organization of a good state administration and tax policy

– with reference to the era of dualism . . . . . . . . . . . . . . . . 199

7.2.4 On the Smithian and old-new dimensions of disciplinedconstructive

taxation . . . . . . . . . . . . . . . . . . . . . . . . . . 203

7.3 New forms of post-crisis central banking policies, the renaissance

of institutional thinking . . . . . . . . . . . . . . . . . . . . . . . . . . . 210

7.3.1 Crises compelling changes . . . . . . . . . . . . . . . . . . . . . . . 210

7.3.2 Revitalizing institutional thinking and appreciating the role

of the central bank . . . . . . . . . . . . . . . . . . . . . . . . . . . 213

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221

Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284

Macroeconomic data from the age of dualism to the present: focusing

on external economy, inflation, public debt and national production data . . . 284

A Short Summary of the Book (in Hungarian and in English) . . . . . . . . . 302

The Author’s Brief Curriculum Vitae (in Hungarian and in English) . . . . . . 303



Chapter 1: Theme and Purpose of the Book,

a Short Historical Arc of its Subject

1.1 THE HISTORICAL-INTERPRETATION FRAMEWORK

OF HUNGARIAN PUBLIC FINANCES

Drafting of the historical development of Hungarian public finances assuredly

seems to be a shorter, more modest task compared to similar works of Western

European countries and nations. But if we take a look at the past one and

a half centuries of the evolution of the Hungarian public finances, which is

the aim of this work, it is rather a dense, yet swiftly changing series of events

of hectic nature, including crises, reforms, renewals, and fallbacks again, together

with the connected “cavalcade” of economic theory, that may emerge.

The arrival of the Hungarian tribes into the Carpathian Basin, the Conquest,

happened at the end of the 9 th century A.D. – in case we ignore the

theory of double conquest 1 . At this time, the nations populating the western

part of Europe have already been forming states for centuries, having public

administration and an army. What’s more, four hundred years have passed

since the fall of the Western Roman Empire with a developed state apparatus.

2 In the areas of Egypt, Greece, China and Persia, systems with advanced

administration have been operating for thousands of years. After the Hungarian

Conquest, the development of the Hungarian tribal alliance as a state

organization took place around the first millennium, under the direction of

King Stephen. “Our first King, St. Stephen, by taking up Christian faith and

building the Christian state, has created the opportunity for the Hungarians

to survive for centuries. The state incarnating Christendom, as a protagonist

of Western culture and as a will of Europe, has contributed through thousand

years to the preservation of the structural identity of the Occident and

its undisturbed development being influential until the present.” 3

“From the age of the settlement of the Magyars in Hungary up to the beginning

of the 18 th century the country was almost exclusively a primary

producer state, insofar all of its produce, industrial activity, trade, tax system

and government budget was based actually on agriculture and related ways of

business” 4 – wrote Gyula Kautz in the second half of the 19 th century. Therefore,

he says, “in the Hungarian economy, the Middle Ages lasted until the

18 th century. The natural economic character of our national economy, along

with all its shortcomings and provincialism, the immobility and stagnation

of industrial life, the underdevelopment of capital and credit business, the

passivity of trading, the lack of taxability, and so on, until the present century,

stayed almost unchanged. For that very reason, compared to other countries,


10 | Chapter 1: Theme and Purpose of the Book, a Short Historical Arc of its Subject

we have to admit that, apart from some glaring but short periods in which

national power has been more productive and our economy has stepped up,

we can show a few states only in which the progress of the national economy

would have been so slow and difficult as it was in Hungary”. 5 Our backward

conditions occupying peripheral positions beside the major global economic

trends and centres have set back the quality of our economic administration

and the sciences based on them throughout centuries. However, it is important

to divide up this longer, eight century long period of time.

From the founding of the state even up to the second half of the 19 th century

many changes and contradictions featured our conjuncture. Following

a five-and-a-half-century-long de facto existence, the Kingdom of Hungary,

which was accounted a determinative secondary power 6 in the region,

after having almost hundred years of successful fighting against the Ottoman

Empire, finally practicably ceased to exist after losing the battle at Mohács in

1526: the country, split into three parts, lacked the features of independent

statehood and separate economic administration. The western and northern

part of the country came under Habsburg rule, ruled from Vienna and Bratislava,

but still retained its own constitutional relations. 7 The central part of

the country became the occupation and administrative unit of the Ottoman

Empire, while under significant Ottoman influence, the Transylvanian principality

tried to walk the path of independence with more or less success.

The disintegration of the former state organization, the emergence of occupation

zones and strong areas of interest set back the Hungarian economic

conditions, and made the foundations of the functioning of an independent

state impossible.

The “late founding of the state”, the delay in the development of the state

organization have fundamentally left their marks on our administrative

conditions. Although as we may know it from the memorials of Leo VI, the

Wise, the Hungarian tribes, living among tribal circumstances and marching

(“spanning”) constantly towards the Carpathian Basin, in addition to

“valuing conquest gifts, noble ores very high, they possessed an excellent

military organization supported already by a kind of financial and administrative

system”. Contemporary sources verify that “finances were managed

by a separate officer in chief and the national treasury had a specific income.

Military taxes and indemnities as well as princes’ and state revenues and

possessions were distinguished sharply […]. This allows us to conclude that

they were convinced of the separate financial necessities and interests of an

orderly state”. 8

Following the founding of the state, in the conjuncture of a five-and-ahalf-century-long

period 9 of independent statehood, the implementation

of an economic administration at contemporary level has led to a relatively

effective functioning of the state, resulting in a strengthened defence of the

country as well as economic development. Subsequently, the independent

Hungarian statehood was not favoured by either the disruption of the coun-


1.1 The historical-interpretation framework of Hungarian public finances | 11

try into three parts, nor the Habsburg dependence that came along after this

one-and-a-half-century-long period with the eradication of the Ottoman

subjection and what especially intensified after 1686 (extended by then to

the whole of the country). The failure of Rákóczi’s War of Independence between

1703 and 1711, then the boom of reforms featuring the first decades

of the 19 th century, the “intellectual drive” for trading and lending and industrial

development, and then the Revolution and War of Independence

of 1848-1849 aimed at changing the Habsburg dependence, targeting also

economic reforms, as well as the decades following its counterinsurgency

have finally led to the Compromise with the House of Habsburg. This, ultimately,

advanced the country’s economic development and public finances.

The relative economic success in the age of dualism was cut short by World

War I. Afterwards, the intention of compensating the military, economic,

territorial and social losses became the most significant political feature of

the Horty Era. The results of the similarly relatively successful economic stabilization

have sunk definitively after World War II. Then, after a two-year

transition period, it was the forced political and economic integration into

the Soviet sphere of influence and the planned economy that determined the

economic administration and policy in Hungary.

Planned economy, having been sustained, though with an ever decreasing

efficiency, for four decades, as well as the inherent state and party control

was not a homogenous era either, as a wide range of instruments of economic

policy was applied. The intent on changing constraints was embodied in

the events of 1955-56, and later in the New Economic Mechanism beginning

in 1967-68. The endeavour to release the voluntarist approach – represented

mostly in the industry – to forced armament following the Second World War

characterized all the time our domestic relations. As a result of this, the Hungarian

planned economic system was more “market-oriented” than that of

other socialist countries. It is especially true if we take into account the early

entrepreneurial forms used in agriculture (backyard farm, allowance plot).

The miscarriage of reforms, the gradual depletion of the system’s internal

resources, the indebtedness of the country and the inherent economic vulnerability

has led partly to the dependence on western loans and partly to the

“licensing” of domestic entrepreneurship prevailing under market conditions.

As a result, instead of developing a transition based on internal (endogenous)

factors, the contours of a rough, neoliberal market economy system

evolved in Hungary. The “intensifying” course since the late 1980s was characterized

by the suppression of state regulation and control, and the creation

of private property by means of legal instruments replacing state and cooperative

property in the production and service sectors. A market economy has

developed in Hungary, but not through the expansion of internal resources

that have been gathering momentum on the market based intention to do

business and looking for breakout points for decades, but with the effect of

western capital on dynamic development.


12 | Chapter 1: Theme and Purpose of the Book, a Short Historical Arc of its Subject

Weaknesses of the transition to a market economy, its ineffective implementation,

the overspending state budget, the asymmetric taxing structure

led to a further deterioration of the path of public debt that has resulted in its

unsustainability by the time of the crisis in 2007-2008. The state’s economic

influence, the marginalization of regulation to an extent more than justified,

and the intensification of the deficit of the central budget and the municipal

public finance subsystem, the over-indebtedness of family households predetermined

the inability of the state to operate.

In a new political and economic course reinforced by the new social empowerment

and legal provisions launched in 2010, Hungary implements

an active model of the state’s economic influence. Budgetary discipline, tax

discipline, and the regulation of the operation of financial institutions have

been strengthened. As a result of the above listed and the new type of tax

regulation, the problems of the state budget have eased, the public debt to

GDP ratio has decreased and the conditions of economic growth have been

created. Furthermore, following a “self-consolidation” of the state budget,

municipal governments, social security and households indebted in foreign

currency have gone through a procedure of financial consolidation and task

centralization coordinated by the state. State administration, and within that

economic administration, are characterized by centralization and the dismantling

of parallel public service capacities, as well as the pursuit of efficiency,

to which the monetary policy of the central bank supporting the governance

“has been associated” since 2013.

1.2 THE STRUCTURE OF THE BOOK,

ITS THEORETICAL FOUNDATION

The dissertation embraces five subsequent courses of economic administration

that may differ occasionally regarding the applied survey method and available

resources. Their common feature is a more markedly displayed presence

of statehood with the – sometimes relative – legalized nature of its legal

framework compared to that in the three-hundred-year period preceding

the 19 th century. In each case, economic development, the determination

of falling into line with Western European standards is at the forefront.

Accordingly, the starting point in the case of each state administration

course is the intention to achieve a more modern statehood and economic

level. Béla Máriássy [10] made his statement in the age of dualism exemplary

for all the five investigated eras that “the basic conditions for statehood

are self-dependence of the state, material wealth, personal and property

security and intelligentsia. Only a financially orderly sate possesses these four

prerequisites, as material wealth means substantial and valuable production,

and production is impossible without state subsidy, while ensuring selfdependence,

personal and property security as well as intelligentsia requires


1.2 The structure of the book, its theoretical foundation | 13

large expenditures. Thus, these expenditures can be covered only by a state the

production of which is large and valuable enough. Therefore, its citizens have

a surplus beyond their actual needs, and this surplus allows them to constantly

contribute to the state expenditures without offending their wealth”. Máriássy

expects the self-dependent state, i.e. the most successful institution, possibly

originally of a legal nature, to aid the hurt, undeveloped economy. It means

– through well organized budgetary procedures – the support of business

life, interference into market conditions – as the classical example of Smith

shows – possibly until the market requires that, and until market elements

recover and culminate again. 11

For the reason of the “delayed settlement” of the Hungarians, the “underdevelopment”

and the “hindrance” (Turkish wars, Habsburg suppression,

Soviet sphere of influence, the non-autonomous and ineffective economic

policy during the transition to a market economy), respectively, a pursuit

“beyond power” for catching up in economic development can be observed

in each investigated era, where the state played mostly a catalysing role. In

other words, except the transition to a neoliberal market economy, the contours

of a “state-organized” and state-built market or planned economy

structures have evolved. In the neoliberal market economy system the state

also has a central role; however, it mainly cuts back state property and “sets

back” state regulation and control. It can also be stated in advance that, to

the contrary of international examples that had a lot of time for preparation

and implementation in course of the establishment of state autonomy, the

economic administration of Hungary aiming at the development of economic

conjuncture was relatively rapid. This “forced” administration tried – as

a “background actor” – to achieve catching up and attain full growth of the

functioning of the state. It is also evident that unsuccessful attempts to catch

up with the economy and their accumulation have led to a more active regulatory

environment. 12 Our economic administration in the studied terms

– due to a failure at the final points experienced in the above mentioned

courses – has become increasingly intense, because it has always targeted

the developed countries and wanted to make up lost ground regarding the

catching up attempts. The formation of legal norms regulating the behaviour

of economic operators was therefore characterized by rapid dynamism.

The aim of the book is:

– to describe and draw a parallel among the main features of the five eras’

economic administration such as the measures of state authority affecting

economy and to analyze the effectiveness and efficiency of these economic

management systems;

– to investigate what effect the fiscal policy (the government) and the operation

of the central bank have on each other;

– to search for and systematize the major theories of political science and

public finance determining the given eras;

– to reveal and systematize the effect of the state on the actors of economy.


14 | Chapter 1: Theme and Purpose of the Book, a Short Historical Arc of its Subject

The research behind this book tried to reveal and evaluate the institution

of the state’s economic influence in the last one and a half centuries on the

implementation of independent state organization or, respectively, on the

activity in pursuit of its acquisition or catching up and modernization. It

also aimed at mapping the role taken by the state’s economic policy, as well

as its efficiency and quality, among the Hungarian conditions characterized

by delay and lagging behind.

Thus the book intends to create a new scientific value by means of investigating

the historical track of economic administration, the efficiency analysis

of economic data and conditions and systemizing the imprint of political

science of the studied economic courses. It must be added though, that due

to spatial limitations and researcher’s humility this cannot be done in full

depth, therefore it focuses only on the significant points of major economic

processes and intellectual flows of ideas. 13

The five investigated courses are: 1) the half-a-century-long period of

dualistic policy and economic arrangement being formed after the Compromise

with the House of Habsburg in 1867; 2) the reconstruction between

the two world wars, the economic policy of a state preparing principally to

territorial revision; 3) economic conditions of the planned economy operating

under a strong state and party influence; 4) the nearly three decades

of the transition to a market economy started in the 1980s; 14 5) the new era

of active state influence beginning in 2010. So it is about five distinct periods

of history in the centre of which is the research of the state’s role and its

regulatory activity. Four courses were characterized by active state influence

while one was featured by the reduction of state ownership and regulation.

Both the previous and present public finance conditions in Hungary have

differed from those featuring developed market economies belonging mostly

to the Anglo-Saxon cultures. Similarly, our planned economy was also different

from the Soviet practice. Therefore, in addition to our geographically

“centred position”, a kind of intermediate Hungarian practice can be observed

in the field of public finance, as well, which is also expressed in the

title of this book.

Regarding the “genre” of the book, it belongs to the field of political science.

During the past decade, in many of my studies, I tried to define the

subject and category of public finance within the political science to put its

status fulfilled in the different ages into a historical and international context.

15 After the years of the crisis of 2007–2008 the state’s role increased, its

regulatory and controlling activity became stronger 16 , that is the effect public

finance made on the actors of the economy has been intensified. 17 This provides

a good opportunity for an interdisciplinary field of science to be formed

in Hungary, as well, 18 between the “descriptive” jurisprudence and the now

business-oriented economic science focusing more on the functioning of the

state, the intrinsic conditions of which were established by the age of dualism

19 and the period between the two world wars. 20


1.2 The structure of the book, its theoretical foundation | 15

“Administration science means the direction of research called public administration

by Zoltán Magyary, so it is not necessary to squeeze the approach

applied by jurisprudence into that. For that reason, unlike the contemporary

repugnance, we can call Zoltán Magyary without reservation the classic

of Hungarian public administration science.” 21 According to Barna Mezey,

“public administration, that is, the administration of the state for the fulfilment

of state power and public needs as a public task, is one of the most

complicated activities of social life” 22 . In my opinion, this “complicated activity”

involves fiscal regulation, tax administration and control of the public

finance system as well as monetary policy, regulation and supervision within

the central bank branch. Indeed, since it is the satisfaction of public needs,

the stability of value of the money paid for them, i.e. the “potential acquisition”

of public needs “fixed in values” these state institutions are responsible

for. Historical examples show that during the crisis the state is the implementer

of consolidation-reorganization, the creator of stabilization, but the

philosophy of intervention may be reassessed and its intensity may decrease

in terms of later state operation. Ten years after the crisis, we are in this stage.

László Csaba’s philosophy propagating the raison d’etre of “methodological

pluralism” 23 that was phrased out at the peak of the crisis and what is still valid

today and gave direction to the way of discussion of this book, is encouraging.

As he states, parallel with the renewal in economics started about a decade ago,

“justice for methodological pluralism, and within that historical, institutional

and comparative economic approaches have been bestowed, while solutions

that bring to the fore unilateral mathematical formalization tend to confine.” 24

It is a much better way – in terms of this approach – to examine the development

of Hungarian economy and public finance together with the related legal

regulations. 25 These reorganizations of science cannot neglect the proven scientific

results; the new approach aims at only to increase the depth of science.

However, it seems as if besides the mainstream mathematical economics 26 the

lore of interpreters approaching the functioning of the sate in historical and

institutional 27 framework “have matured”, and they receive more attention.

The purpose of the book is therefore to discuss the operation of public economy,

along with the legal relevance, with historical and international outlook,

creating a chronology of one and a half centuries, drawing conclusions from

the events and contemporary theories. It can also be found that the crisis has

somewhat weakened the dogmas of the economics that had come into view

along with the decline of the (Bretton Woods) gold standard system, the beliefs

that mathematical planning was stable 28 , and even more the confidence

in them 29 . Thus new approaches sprawl 30 or old ones are rediscovered 31 , i.e.

the reflection on theoretical ideas has come to the fore. 32

According to Mária Ormos 33 , an economic crisis is due to several reasons

and factors. Namely, market laws can be neglected by market players, and

political spheres, intellectuals, contemporary mentalists or external impulses

can also make an influence, as the crisis can also alleviate with the combined


16 | Chapter 1: Theme and Purpose of the Book, a Short Historical Arc of its Subject

involvement of these actors and factors. The solution is therefore not a “duty”

only of the state, but a widespread contribution is needed in correcting the

hampered mechanism. “The solution to the crisis can only be expected in

the foreseeable future, and it can only be relatively durable if, in addition to

the financial and economic issues of the state, solving formulas take into account

other – social, political and intellectual – elements.”

With reference to the “intellectual elements” of dualism that may be considered

the cradle of Hungarian capitalism, some criticism can gain ground.

According to the criticised, inappropriate approach, following the collapse of

the planned economy in Hungary, the policy of the central bank has moved

too far from the government’s fiscal policy, basically by means of the relatively

fast withering of refinancing functions that supported the real economy

and by limiting the operations that assisted the financing of public debt. As

a result of this, monetary policy actually got out of the territory of economic

policy (economic administration, public finances). Its effects on the level

of macroeconomics and on social context decreased, which has ultimately

led to an unsustainable debt path at retail and corporate level as well as at

the level of state budget.

Similarly, the period of dualism featured by a state budgetary activity can

give a good foundation for the interpretation and management of politics

(public administration) and public finance as a separate field, particularly

in the period of state-controlled, “new” capitalism. 34 Ágoston Karvassy 35 , in

the middle of the 19 th century, treated on money in details as a basic monetary

asset, as well as on bank and loan, which belong to the “status” of the

state, to the discipline of political science. 36 He defined “financial lore” that,

in his opinion, had lain waste for such a long time, as a synopsis of the theories

needed for “the status” (the state) to collect, manage and use financial

means the simplest way in order to achieve its objectives.” 37 The institution of

the central bank, on the other hand, serves the purposes of the “status” with

its refinancing and rediscounting policy, its direct or indirect operations for

“easing” public debt. Due to the characteristics of the institution, its means

differ from that of fiscal policy. However, its ultimate goal cannot be else than

that of the government policy, i.e. to make state operations more effective and

improve the society’s living standard. Therefore, in the field of political sciences,

and within that public finance, it is justified to manage fiscal discipline

and bank note issuing together. 38 Especially in the period after the outbreak

of a crisis has it been justified that a stimulus of the central bank independent

from the government can be definitely supportive, particularly during crisis

recovery (e.g. István Bethlen and the Politics of Consolidation, the term after

the crisis of 2007-2008 in an international space), and also while stepping

up from a former stage of development (e.g. from the stage of transition to a

market economy to an active sate model managing crisis efficiently). It is inappropriate

to favour a central bank with unlimited independence from the

government in an exclusively anti-inflationary monetary policy status in a


1.2 The structure of the book, its theoretical foundation | 17

fiscal policy environment of the government with no curbs, counterweights,

i.e. constitutional control (e.g. during the transitional period of the Hungarian

market economy). The reason for that is that the strictness of the central

bank (the restraint of central bank instruments supporting fiscal policy 39 )

restricts the undisciplined, overspending government in its “guilty actions”

only modestly. It is (was) not advisable to make reference to the roles of a

central bank “more advanced by orders of magnitude” and formed through

a much longer, organic way than the one in the country. Neither is it recommended

to import these functions into the Hungarian context without any

adaptation, nor to “tolerate” the behaviour of a central bank “watching the

crisis remotely”. The central bank does not generate public money (it is not

part of the state budget, see the Act on Public Finances), although it manages

a treasury single account, and if necessary, expects the government to

make an equalization reserve. Its registered capital, which altogether takes

up ca. 1 % of its balance sheet total, 40 is owned by the state, but it is also legally

independent, and at the same time, it plays a cardinal role from the

point of view of the economic operation of the state, so it is the institutional

actor of public finances.

In the current Hungarian conditions, therefore, public finance can hardly

be “forced into” the field of economics or jurisprudence. Instead, it is advisable

to build the parts of the state economy that develop, we can say urgently,

due to the constraints of the crisis, but maybe still organically, on (taking into

account the western culture) a thousand-year-old basis of political science.

This way, in an interdisciplinary field of economics and law, an exact field of

political science can strengthen. It would incorporate the legal, economic,

sociological and political elements of the operation of the state, although it

always remains close to law and economics, as the interdisciplinary cooperation

– generating synergy – cannot be lost. Political science is therefore a field

of science focusing on the functioning of the state. At the same time, public

finance, as a part of it, encompasses the elements of the fiscal operations of

the state (such as taxes, control, subsidies, nationally owned enterprises) and

those connected to monetary regulation (like micro- and macro-prudential

elements, banking supervision 41 ).

Our book born along this intellectual cadastre, an overview of the one-anda-half-century-long

operation of the Hungarian public finance institutions

and the history of their “superimposed antecedents”, can hopefully provide

a comprehensive picture of the hectic changing Hungarian conditions including

their international environment and “imprints” in the disciplines.

Budapest, January 2020

Csaba Lentner

Professor of Public Finance

National University of Public Service



Chapter 2: State-controlled economy

in the era of dualism (1867–1918)

After the end of the independent Hungarian statehood in 1526, until the end

of the Turkish wars, and in the centuries following the Habsburg occupation,

no separate Hungarian public finance system could develop. The intellectual

achievements of the Hungarian Reform Era evolving from the beginning of

the 19 th century, the economic administration measures of the Revolution and

War of Independence of 1848-1849, even if wrecked, were followed by the decades

of neo-absolutism: the tax administration innovations carried out in this

period under the imperial framework have matured after the Compromise

of 1867, and founded the basis of separate Hungarian economic administration.

The lessons drawn from the dualist Hungarian state operations is how a

highly independent and effective public finance practice can be built up from

underdeveloped, backward economic conditions and state finances lacking

independence, and what are its aspect of economic management and administration.

In other words, how, from a late stage of development, with what

administrative measures can we move on to the path of stable state operations?

2.1 THE AUSTRO-HUNGARIAN COMPROMISE

OF 1867 AND ITS OUTLINE HISTORY

2.1.1 The Hungarian Reform Era as a preparation

for capitalist development

Due to late development, theories aiming at improving Hungary’s economy

and general conditions burst into the surface with elemental force in

the 1820s. From among contemporary intellectual leaders, with no doubt,

István Széchenyi was the most significant, 42 it was his ideas, which had a

decisive influence on the conditions of the country. Széchenyi “has resolved

many Hungarian problems, but has raised even more issues”. 43 Conditions

restraining development like “poverty, lack of capital, the complex issue of

serfdom (peasants), aviticity, fiscalitas, burden sharing, the issue of customs

duty and related problems of foreign trade, the problems of the industry in

connection with the society for the promotion of domestic economy and

industry [Védegylet], trade and credit issues”. 44 Széchenyi investigated the


20 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

constraints of opportunities and was seeking solutions for them. “In Hungary,

the amount and expanse of fertile land is so large that even a non-exploited

part of it would make another nation rich …” 45 He formulated the restraints

of contemporary economic conditions the more plastically in the lack of

loan capital: “… I see the lack of loan as one of the major causes of all moral

depravation and spiritual degradation.” 46 “The reason for the lack of loan

is that no one can improve his lands to the extent as it should normally be

possible.” 47 However, the institutional system and disbursement of credit as

a catalyzer of economy could not be established due to a number of limiting

factors. Owing to the law of aviticity, the non-negotiable nature of seigneury,

at the same time, the underdevelopment of the credit channels hindered

the formation of capital and income, which appeared at a moderate level of

internal solvent demand. “The majority forgets about internal consumption,

although this forms the basis of the economy of nations. England itself consumes

the three quarters of its manufactured products, and only a quarter

of them makes up its so called world trade. Therefore, the more people live

in a more ornate house, eat better food, wear nice garments somewhere, etc.,

that is, the bigger the internal consumption is, the richer I will consider that

country. And the more people want and can get all the good things of life

for themselves, the greater will be the labour and strive to make these goods

out.” 48 István Széchenyi expected the rise of Hungary from the freedom of

trade, to which the elimination of the guilds and the law of aviticity was essential.

A boom in trade and industry was expected to bring forth fulfilment of

prosperity, internal consumption and human freedom. “The goal is therefore

more consumption, greater prosperity, human freedom and dignity. Most

of these remain just goals for the time being, but our tools at that time have

become an end in itself.” 49

The epochal significance of Széchenyi 50 is shown as it follows. “The majority

of the works published on economy in the last decades of the 18 th and the

first ones of the 19 th century – due to underdeveloped market conditions and

opportunities, especially in the internal market – considered the economic

rise of Hungary dependent on the development of foreign trade.” 51 Széchenyi,

however, “saw the reason of the country’s fundamental backwardness

in the existing feudal system, which hinders economic activity in all fields,

including production, turnover or the financial sphere”, 52 i.e. he considered

the backward, unsustainable nature of the system as the core problem. “The

error is in our system; lo and behold, this is the philosophy of the issue.” 53

The “clogging effect on agricultural production” 54 of feudal conditions still

prevailing in the first decades of the 19 th century and the guilds that “throttle

down diligence in the industry” 55 were both such restraining factors that

hindered the country to be launched on the way of civic development. Thus,

there was no chance for a credit business adequate to contemporary standards

to evolve. “Széchenyi built his reform scheme aiming at the renewal of

the Hungarians on the solution of the credit issue. Credit was the base of all


2.1 The Austro-Hungarian Compromise of 1867 and its outline history | 21

his reform system, credit was the issue he discussed most frequently in his

works and that caused him the biggest problem.” 56

Antal Mátyás, summing up István Széchenyi’s resentful thoughts, states

that “because of the insecure nature of our financial conditions foreign capital

does not dare to come into the country. At home, on the other hand,

moneylender’s capital can endure, while loan capital is not able”. 57 Partly to

overcome this, and partly to create a modern financial institution, he poses the

question of creating a National Bank. “So money is what we need most, and

today this is the motive what could result in jobs and, in turn, more money

over time. If we were to set up a well-ordered national bank, it would be just

as if some of the capital that foreigners brought into our country would be

borrowed at an interest rate of 5 or 6% at the most, we would not be afraid

of being called, and after having derived a smart profit of that we would earn

9 or 10%, would slowly pay our debt again, and the latter profit would stay

in our pocket. And is it not clear that it would be much less dangerous if we

were owing to ourselves than to strangers?” 58 An independent financial institute

organized according to national interests, reinforced loaning, and the

idea of internal clearing as the way to avoid resource outflows are listed in

Széchenyi’s concept which has – technically – detached the feudal Hungary

of the age from the developed western world. “So Széchenyi has considered

credit as the instrument for mobilizing and increasing economy and wealth

through which it was to advance business life and economic growth.” 59 The

absence of this, i.e. “the lack of conditions for financial management have

thus raised thousands of issues that affected unfavourably the industry, agriculture

and trade, as well, making fast development impossible”. 60

István Széchenyi thus defined the lack of credit, as the tip of the iceberg, as

the key problem of the transition from feudalism to the new economic era.

This comprised the non-existence of the institutions providing the disbursement,

and the inefficiency of the material (admissible) collateral guarantee

for the loan, i.e. the legal circumstance that hindered lending. Its concept

was based primarily on boosting Hungarian agriculture. “Széchenyi was of

the opinion that the credit concept he proclaimed would boost Hungarian

agriculture and, through this, the whole country would be refreshed.” 61 “No

matter how hard Széchenyi criticized the existing, obsolete feudal conditions,

as a landlord he could not reject the feudal system as clearly as its civic

critics.” 62 He believed that – in the absence of bourgeoisie – nobility is to be

entrusted by making the changes. Széchenyi urged widening the sharing of

public burdens. He saw that “the civilian production mode requires advanced

infrastructure, modern roads, canals, regulated rivers, and, Széchenyi says, it

is not possible that the cost of these is charged only on the serfs: the nobility

should take part in them.” 63 Based on his personal example (supporting the

establishment of the Chain Bridge, the Hungarian Academy of Sciences, 64

the development of the agricultural 65 , financial 66 and transport sectors 67 ), he

considered the institution of public donations as a partial solution. So the


22 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

creation of the conditions of crediting, the strengthening of the burden sharing

nature of the tax system, the widening of public donations are the most

important elements of Széchenyi’s concept, which was to be implemented

by the noble class, the main beneficiary of the feudal order (“at that time”),

which, however, had a significant lack in recognizing interests in its own

age matured for reforms. Without exaggerating the significance of Széchenyi

marking the era, Virgil Koltai writes: “… in the given circumstances,

making the nation awakened of consciousness of self was the right way and

tool chosen by Széchenyi. Not only did he proclaim ideas, but he also created

institutions… But he also showed that if we want to live, we must die for

the past and reborn in the great ideas and feelings of human progress… ” 68

From the 1840s onwards, instead of the theoretical concept of organic development

of the economy, open aspirations to gain political independence

were intensified. Then in the spring of 1848, the processes began to turn into a

constitutional revolution, and a few weeks later, into a series of armed events

of freedom fighting against the House of Habsburg. The realization of ideological

recognition – among others – was incarnated in Acts Nr. XV /1848

and XIV/1848 of the April Laws. The first law provided for the abolition of

aviticity and the second for the establishment of the credit institution, which

was adopted still by the last (National Assembly of the estates of Hungary) /

Hungarian Diet (1847-1848) and ordained by King Ferdinand V (Austrian

Emperor) on 11 th April 1848.

2.1.2 Economic measures of the government of the Revolution

and War of Independence 1848–1849 – The beginning of

independent economic administration

Evaluating the historical antecedents, the laws made in April 1848 can be

considered as the end of the reform era. The package created a new public

law situation in the Habsburg Empire, which aimed at the development of the

Hungarian part. By the April Laws, Hungary became a parliamentary state,

a constitutional monarchy from a feudal state, and feudalism was virtually

eliminated, but no national bank was set up.

The prelude of the April Laws was that, to the effect of the outbreak of

the Paris Revolution, on March 3, 1848, Lajos Kossuth 69 submitted a petition

proposal at the lower house. It included the abolition of serfdom, the

introduction of sharing public burdens and the set up of an independent national

government. The revolution broke out on 13 th March 1848 in Vienna,

and on 15 th March in Pest, which events have accelerated political and economic

change. In this process was a catalyst the phrasing of the 12 points by

those who urged a radical and fast move, listing burden sharing in point 6,

the abolition of the villein socage relations in point 7, and the setting up of

a National Bank in point 9, which latter was omitted from the April Laws.


2.1 The Austro-Hungarian Compromise of 1867 and its outline history | 23

István Széchenyi’s thoughts appreciating Kossuth who was taking the lead

in the rapid changes express the essence of the process: “My friend, we live

mighty works […] The first act was beautiful! I am full of the most beautiful

hopes […] My policy was sure, but slow. Kossuth has staked one’s all upon

a single cast and until now has won at least as much for my country as my

politics could not have produced in 20 years.” 70

Legislation breaking down the legal institutions of the feudal state, introduction

of burden sharing (Act VIII), the abolition of the villein socage

(Act IX), regulation of the settlement of disputes on common land (Act IX),

the abolition of the court-baron (Act XI), the ecclesiastical tithing (Act XI)

and aviticity (Act XV) on the whole served to promote the economic development,

for which Act III (establishing a responsible Hungarian ministry

and regulating the operation of executive power) provided the administrative

framework.

Due to Act VIII the tax exemption of the nobility terminated, and thus,

on the one hand, the state – though mostly only in principle – acquired a

new source of income. On the other hand, one of the cornerstones of noble

privileges has been abolished, helping to reduce social differences. The act

provided for the imposition of a new tax based on burden sharing by November

1848. At the same time, the Parliament invalidated the relevant

provisions of the Golden Bull and the laws referring to it. “By examining the

19 th century taxation, we have to state that the three principles of modern

taxation – generality, equality and proportionality – were laid down in the

Batthyány tax laws.” 71 By declaring the burden sharing “all the inhabitants

of Hungary and its affiliates bear public burdens equally and proportionally

without distinction.” 72

The abolition of villein socage (Act IX) meant the immediate liquidation

of the due services of a serf to his landlord and, at the same time, put an end

to the institution of court-baron. The law promised the landowners concerned

state compensation and temporary protection against the creditors

until a decision was made on compensation. The transition period was helped

by a credit institution established in terms of Act XIV that has provided a

temporary loan to the noble estate until the settlement of the compensation.

73 Act XV disposed on the abolishment of aviticity introduced in 1351.

It also enabled the ungentle to acquire land, furthermore to sell noble land,

to borrow money for nobles, so that the land could also be used as collaterals.

The abolition of feudal judgment is declared in Act XI. In this way, the

landlord’s court was dissolved, replaced by the sheriff-deputes and county

authorities. By these laws, the feudal socio-economic order has been shaken

to its foundation.

The April Laws passed by Ferdinand V. can be regarded as a constitutional

revolution, a constitutional change, on which the revolutionary events of

Pest on March 15, 1848 had a catalytic effect on the one hand, while, on the

other hand, regarding the future, they provided a political background for


24 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

their actual maintenance. This was a great necessity because the Vienna court,

along with the counterinsurgency of the Vienna revolution and the decline

of the revolutionary atmosphere in Europe, took steps towards reorganization

and temporization. Moreover, under the leadership of the Croatian ban

Jellasics, the court sent an army against the Hungarian government, causing

the events turning to a war of independence. Thus the laws made under

the ‘constitutional revolution’, the changes they brought about, were in fact

even more acute, with the emphasis on securing the financial cover of the

war of independence, and the economic administration took a backseat accordingly.

“The Hungarian self-defence struggle was not the result of the

emergence of individual interests, but of the rotting of the entire body of

the country condemned to economic exploitation and all the organs of its

administration.” 74 The situation was aggravated by the fact that the transposition

of laws demolishing the feudal system into practice (burden sharing,

compensation, setting up a credit institution, etc.) was difficult due to war

events, so the amount of government revenue was significantly lower than

it had been expected.

The Parliament’s right to establish the annual budget for the first time in

Hungary is set out in Act III of 1848 on the formation of the first independent

responsible ministry: “Section 37: The Ministry is obliged to present

annually the revenue and necessities of the country, and the account of the

managed revenue in respect of the past, to the lower house in order to have

it examined and approved by the Parliament.” 75 Lajos Kossuth, who has undertaken

the lead of the first responsible Ministry of Finance appointed in

accordance with Act III in the spring of 1848, received an unreasonably

difficult task”. 76

The most important task of the new Hungarian government was to provide

the economic funds, which were based on two pillars, the creation of

the budget and the institution of independent banknote issuance. 77 Depending

on the war situation, the preparation and approval of the budget for 1848

and 1849, the creation of financing conditions, the provision of budget revenue,

the setting up of economic administration and the establishment of

the national currency became indispensable. Although the ruler signed the

April Laws, he was not interested in their implementation, 78 since it would

have made possible for Hungarian independence and economic separation

to be fulfilled. Thus, the importance of creating an independent financial life,

which has become urgent from the point of view of defence, has been “appreciated”.

Hungary did not have its own currency, its financial administration,

which could have been inherited. From the beginning of the Habsburg’s

jurisdiction, the finances were run by the Vienna Court Chamber and, in

particular, the Hungarian Chamber of Finance. In the spring of 1848, the

Batthyány government faced financial turmoil and lack of financial administration,

despite the acceptance of the legal foundations of a modern tax

system by the monarch’s approval of the April Laws. On 18 July 1848, Kos-


2.1 The Austro-Hungarian Compromise of 1867 and its outline history | 25

suth submitted a detailed report to the Parliament entitled “On the country’s

finances and budgetary plan for the second half of 1848 and for 1849”. The

proposal included the budget for the period between 11 April and 30 June

1848, separately for the second half of 1848, and a more generous budgetary

plan for the year 1849. The proposals were presented on a balance sheet

basis, together with the amount of deficit and method of financing. In addition,

budget appropriations, major items and relationships were presented

by ministries with separate calculations and with detailed explanations. Kossuth

has presented a bill on the levying of taxes, such as “about the taxation

in the current half a year of formerly tax-free classes of the country, the extraordinary

income tax, the extraordinary brandy tax”. In order to cover the

country’s public needs in the current half a year, a decision was also taken

on credit (up to 16,000,000 pfrt), ad hoc taxes and “direct” taxes. 79 The establishment

of the financial management of the independent Hungarian state,

making money and even the “measures taken to eliminate and overcome the

difficulties of currency exchange”, 80 “the negotiations with the management

of the Hungarian Commercial Bank” 81 on the issue of banknotes – covered

by the sacrifice of the nation – the bridging of the deficit by credit 82 reveals

a wide range of tasks.

In addition to the creation and approval of a separate budget another fundamental

issue of financial autonomy was the independent banknote issuance.

To this end, Kossuth started negotiations with the Hungarian Commercial

Bank of Pest. At first, he attempted to create the collateral security of the

new banknotes for precious metal ores by subscribing a loan. On May 23,

1848, Kossuth called on the nation to subscribe for interest-bearing treasury

vouchers with a denomination of 50 and 100 forints, with a maturity

of 3, 6, 9, and 12 months, and promised a 5 percent interest. The vouchers,

getting into the circulation of money, were later used also as banknotes, but

the results expected at the time of issuance were not achieved: returns have

reached only one third of the projected amount. 83

The banknote issuance agreement with the Hungarian Commercial Bank

of Pest was concluded on 17 th June 1848. Under the contract, the Ministry of

Finance would have deposited 5 million forints in gold and silver as collateral

security, and in return the bank would have issued banknotes in a value

of 12 and a half million forints. The Ministry of Finance was able to raise

only a part of the collaterals – roughly it was equivalent to 1.8 million forints

– thus the issuance of banknotes was also proportional. 84 The conclusion

of the contract was of even more overriding importance, as the Hungarian

Commercial Bank of Pest has this way been transformed into a bank for

issuing banknotes thus creating an independent Hungarian central bank.

The forint was also used in the medieval Kingdom of Hungary, it was successful,

and later became a generally known currency of Austria-Hungary.

The name of the new, independent currency is therefore linked to historical

precedents, which sought to strengthen confidence in new money, because


26 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

the forint’s economic background was rather uncertain. Despite the protest

of the courtyard, it became an independent Hungarian currency (called

Kossuth Banknote), which was used in the areas under Hungarian control

until the end of the War of Independence. After vindicating the right for

a budget (approval of the Budget Act), the independent national currency

meant the establishment of an independent statehood.

In order to issue additional money, Kossuth asked for a vote of two hundred

thousand conscriptees and a credit of 42 million forints in a parliamentary

speech on July 11, 1848, which was voted by the members of parliament

shouting “given, given”. Because of the unfavourable economic and political

conditions, Kossuth could only rely on the nation’s self-sacrificing power:

“The nation cannot trust other than its own power. For this purpose, it is

necessary to raise the army to 200 000, and for its armament 42 million forints

are needed” 85 asked Kossuth the members of the Parliament opened in

early July 1848. On August 13, 1848, the central bank launched the Kossuth

banknotes, thus creating the money issuance monopoly of sovereign state operations.

The failure of the War of Independence was caused by the economic

power behind the military superiority of the imperial and Tsarist Empire,

despite the fact that within one and a half years the Hungarian budgetary

and financial administration system has been established.

2.1.3 The pre-compromise period after the War

of Independence: the age of neo-absolutism as the “main test”

of post-compromise economic governance

After the counterinsurgency of the war of independence Batthyány’s tax regulations

were again introduced by the order of Emperor Franz Joseph I, that is

landlords also had to pay tax. The emperor established the tax office, the institutional

framework of collecting state revenues. 86 After 1849, the management

of public debt was raised because the war expenditures became a priority for

the empire’s financial administration. In order to cover the deficit, government

bonds bearing interest on a wide scale have been issued. Tax system

was unified throughout the empire’s territory, which was “accompanied by”

the constant increase of revenues and strict tax collection. Direct taxes such

as land tax, house tax, tax on earnings and, respectively, income tax, which

was a kind of supplement to the tax on earnings, appeared. Tax return was

based on an income estimate. In addition to direct taxes, consumption taxes

were also applied to salt, sugar and spirits, and dues were also part of the tax

system, and a significant amount of government revenue came from tobacco

excise. Franz Joseph forced Hungarians to provide revenues corresponding

to the goals of public finances – on the Austrian model – with statutory rules

and decrees. After the fallen war of independence, Kossuth bank notes were,

of course, withdrawn from the market. Following the events of 1848-49, the


2.1 The Austro-Hungarian Compromise of 1867 and its outline history | 27

Austrian tax administration also took place in the territory of the Kingdom

of Hungary, i.e. a homogenous tax administration system covering the whole

territory of the empire was established. As a result of the regulated, efficient

tax administration, despite the valiant act out of bravado, direct taxes and

excise duties grew dynamically.

Tax revenues in Hungary between 1850 and 1864 87

1850 1857 1864

Direct taxes 11 076 768 17 427 654 28 305 000

Excise duties 12 273 865 37 473 302 47 164 000

Total 23 350 633 54 900 956 75 469 000

(Data calculated in Austrian forint)

While the pre-revolutionary tax burden had risen by just the eighth by 1850,

by 1857 it increased by nearly two-and-three-quarter times and by 1864 by

more than three-and-a-half times. Consumption was taxed more heavily than

income. However, the average per capita consumption – due to economic

underdevelopment and lack of solvent demand – remained below that of

the total empire in the Hungarian provinces. Despite this, at the beginning

of the 1860s, the tax burden in Hungary in respect of direct taxes, on an

average, exceeded the average of the entire empire by more than 4% and by

more than 8% in Croatia. 88

After the events of 1848–1849, the refocused regulation on the abolition

of serfdom, the extension of tax administration to Hungary, the binding of

voting rights to a certain amount of tax paid (tax census), the partial, then

later full elimination of customs lines have lead to the establishment of an

imperial economic unity. New, more marketable conditions have been created

for the economy of Hungary within the unified, indivisible constitutional

framework of the Austrian Empire, guaranteed by the Oltmütz Constitution

(4 th March 1849). Within this regulated framework, the extraction of industrial

raw materials, the production of basic industrial commodities, and the

processing of agricultural products into sugar, spirits and grain mill products

were the most powerful. Nonetheless, the development of industrial

production was much less dynamic than that of agriculture. However, there

was also a gradual growth and transformation, featured by a partial development

of the base of the industrial revolution focusing on certain fields of

industry. Industrial production in Hungary, which was barely above the level

of the home industry, accounted for about a fifth or sixth of the total imperial

production. In parallel with the modernization of economic administration,

the development of financial institutions has also started. However, in terms

of the final effects of this process on state budget, Hungary’s share was only

17 per cent in the tax on earnings in the early 1860s, although – as already

mentioned – the rate of direct taxes in Hungary was four percent higher


28 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

than the imperial average. Between 1861 and 1863 state expenditures overdid

revenues by more than one-sixth. This happened despite the fact that

Franz Joseph forced the provision of revenue corresponding to the goals of

state budget to Hungary – on the Austrian model – by statutory rules and

decrees in an absolutistic way. But the average of deficit equalled to more

than 20 percent of revenue.

2.2 ECONOMIC ASPECTS AND EFFECTS

OF THE AUSTRO-HUNGARIAN COMPROMISE OF 1867

The mechanisms of co-operation immediately prior to and after the Compromise

basically founded the institution of co-operation with another state,

which has been forming since the second half of the 19th century. It could

even have a message value for the mechanisms of the Soviet or the European

Union system (for the future). The political fact of the compromise, and then

the surrounding legal frameworks, together created political and economic

peace, thus providing further opportunities for development, although the economic

regulation of the full-fledged state-building and operations is the bearer

of certain peculiarities resulting from the underdeveloped, emerging position.

2.2.1 Direct economic and political interests leading

to the Compromise of 1867

Referring to contemporary sources, the academician Antal Mátyás also

pointed out that nobility had seen the cause of economic backwardness

for a long time in labour shortages, especially in low-efficiency labour

of the serfs. 89 In the period prior to the War of Independence, Széchenyi

notes in his essay titled Credit that “our population is not so small,

but our system is incomplete …”, 90 i.e. not the lack of quality labour was

the main problem in the Hungarian economy. Undoubtedly, the efficiency

of the serf labour force was less than expected, but after the liberation

of the serfs, a fundamentally new, more severe situation arose for the

landowner class. The use of the serfs’ tools in the corvée – of course -

was removed, as well, from the production system, resulting in a double

production factor shortage in terms of labour and means of production. As a

result, there was a huge need for investment as the main problem was to raise

the wage cost of 12 million yawn days and the same number of journey-work

days. The main concern was the cultivation of half to three-quarters of the

8 million acres of arable land left in the hands of the nobles and the absence

of their own economic equipment, because until then the serf was carrying

out the work required by the landlord with his own means and animals. To

complete the modernization and to replace the production factors, 160 to180


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 29

million forints would have been needed. On the contrary, however, the noble-owned

estate system was charged with a debt of 200 to 300 million forints.

The lack of “technical” input resource resulting from the liberation of the

serfs, i.e. the double deficit in the production factors, was also affected by the

lack of capital to be calculated as another production factor, which has now

created a threefold production factor shortage and forced with elemental

power a political constellation in which agriculture and then industry could

have started to develop.

In other words, an estate system that was capable of carrying out diminished

reproduction processes could have get access by capital to technical

input resources, such as wage labour and means of production, for which loan

capital was needed as a catalyst. The money capital is willing to “move” only

in calm political conditions, in consolidated social circumstances and in a

clean property situation, which has laid the foundations of and economically

supported the demand for compromise from the Hungarian side. Factors

pointing to the compromise on the part of the imperial court can basically be

explained by military-foreign policy. Even the suppression of the Hungarian

War of Independence was only possible with the help of the tsar, moreover,

the war between Austria and Prussia and Italy that broke out in the summer

of 1866 also raised the risk of a reviving freedom fight. The Königgrätz defeat

clearly showed Austria’s weaknesses, the decline of its role in Europe, which

accelerated the search for an internal ally, with the intention of easing political

debate within the empire. Ferenc Deák – the wise man of his home

– was called on 18 th July 1868 for reconciliation with the emperor. Deák had

already expressed his willingness to compromise in his “Easter Act” in 1865,

even admitting that the military and foreign affairs and finances should not

be separate Hungarian powers, but should be part of a total empire. “One of

the goals is therefore the solid existence of the empire, which we do not want

to be subordinate to any other issue. Another concern is the preservation

of the constitutional existence, rights and laws of Hungary, which the sanctio

pragmatica also solemnly proclaims, and from which to consume more

than what is required by the imperative survival of the empire, is neither

right nor expedient.” 91 Deák’s attitude ready for a compromise has played a

significant role in accelerating the process of reconciliation and in the creation

of Act XII of 1867. He also did this by recognizing that in 1864 it was

clear that Bismarck wanted to unite the German states on the basis of the

principle of the so-called small German unity, which meant for Austria that

regarding power she has moved from the centre of Europe to the periphery

of Eastern Europe. As a result, in the imperial court, more and more people

thought of creating a dualist state.

All in all, the intellectual and effective achievements at the beginning of the

19th century, and afterwards, in the 1848-1849 War of Independence, and the

adoption of the modern Austrian administration (tax and economic administration)

in the era of neo-absolutism and the accompanying economic progress


30 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

pushed Hungary to the conclusion of the Compromise that was framed by

further economic development. And from the imperial part, securing the revenue

of the “ailing” state, compensating for the “fading” international role, the

feeling of united and strong imperial “radiation” played a role. Thus, on the

part of the dynasty, the compromise was a kind of “political strength replacement”

and, on the Hungarian side, an “economic strength replacement”. By

reconciling these interests with a compromise, the Austro-Hungarian Compromise

came about. This in turn has created the opportunity for economic

development for Hungary, albeit to a limited extent, which is also true of the

possibility of social development. 23 years later, Ernő Zergényi wrote about

it the following: “When his Majesty, on June 12, 1867, ordained the statutory

compromise after lengthy deliberations, the great task of equitable determination

of the mutual rights and obligations of the two allies was still far away

from being settled.” 92

2.2.2 The essence of the state treaty, the framework

of economic administration, budgetary processes

On the Hungarian side, “the originators of the Compromise considered the

most important task of the coming decades to make up lost grounds of the

past centuries in all respect, and to catch up with the leading European countries,

or at least the western areas of the monarchy.” 93 Section1 of Act XIV

of 1867 set the provision of costs of common state affairs between the two

states at 30 percent for the Hungarian state and 70 percent for the Austrian

Hereditary Lands. 94 It was a requirement regardless of the proportions that

“the regeneration of the empire should depend on the creation of a deficit-free

budget the items of which allow the improvement of the material and mental

state of the population.” 95 This spirit has followed the whole process of negotiation

and implementation, which is also supported by Eddie M. Scott’s 96

analysis that the quota was intended to be based on tax paying capacity, but

the two countries could never agree on a simple calculation method.

Franz Joseph signed the Compromise Act (act XII) after having been

crowned as king (July 28, 1867), followed by laws regulating economic details

(acts XIV-XVI). Although the circumstances of the agreement, especially

the ratios for covering the common state affairs, were not free from complications,

according to Ernő Zergényi, they did produce results, so they may

have a message value even for today’s Hungarian public and foreign policy

reconciliations. “Regarding the deliberation system, a suitable model was

found in the delegates’ institution, so the entire organization of deputations

reflects that of the delegations. Deputations who determine the ratio also

consult separately and come into contact with each other through messengers.

In some respects, the separation of deputations from each other is even

sharper than what is experienced in the case of delegations. Delegations may,


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 31

if the exchange of notes is three times unsuccessful, hold a joint meeting for

voting; to deputations, this institution, more acceptable politically rather

than legally, has not been extended. It is undeniable that the procedure is

thus cumbersome, but at least is not publicly objectionable.” 97

Section 18 of Act XII of 1867 stipulated that the proportion by which the

countries of the Hungarian Crown provide the cover of joint tasks on the

basis of sanctio pragmatica should be determined by mutual agreement. The

same law also outlined the way in which the Hungarian Crown and the rest

of the countries of the emperor would choose similar number of delegates

to conduct the negotiations. These two delegations developed their proposal

with the involvement of the ministries, which were then submitted to the

relevant parliaments, which, after negotiations, presented the agreement in

the form of a law to the emperor for enactment. The (rate of) contribution

to the common issues was basically adjusted to the tax burden of the countries.

“However, the question of determining the ratio is so vital that we

cannot be surprised that this principle is often confining in the delegations’

negotiations” 98 – writes Zergényi. An objective definition of the ratio was

proposed on the Austrian side, which was rejected by the Hungarian party,

but the issue has kept on coming about. In contrast to the otherwise logical

Austrian position, the Hungarian delegation repeatedly argued that “Section

22 of Act XII of 1867 states explicitly that the agreement to be made on

the ratio may only last for a definite period of time, after which the place of

a new agreement shall be made in the same way. So the ratio is always the

subject of a free bargain, limiting its freedom is forbidden in any form. The

legal nature of the relationship between the two states would not either allow

binding the freedom of ratio determination. Hence financial independence

is the strongest support for legal independence, and the weakening of one

also affects the other.” 99

Zergényi also describes if there would be no agreement, then it is outlined

in Austrian law that the “intervening” sovereign’s coercive measure can only

last for one year, and can only apply to the Austrian Hereditary Lands. However,

this provision was not included in the Hungarian law. The Hungarian

estates were of the opinion that this law of the sovereign, even in this limited

form, was a matter of concern for parliamentarism, as the budgetary law of

the two states would suffer. Some mitigating circumstance was that the sovereign’s

possible interference could be easily avoided by the two assemblies

if the sovereign would temporally “motu proprio” retain the previously held

rate. The sovereign did not exercise this right until 1877, the public law explanation

of which was that the sovereign for the Hereditary Lands was the

Austrian Emperor, while it was the King of Hungary in St Stephen’s empire,

and the two offices were the same, but legally embodied in one sovereign.

According to Zergényi 100 interventions in this budget reconciliation process

“would not otherwise allow such far-reaching consequences”. At the time of

the Compromise, many of the anomalies resulting from the negotiation pro-


32 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

cess were thought to undermine the credibility of both states, which was not

proven, and even “empirically confuted. As to the credibility of Hungary, as

well as that of Austria, the economic development that has gained a new momentum

following the Compromise, had only a beneficial effect on them.” 101

The 30-70 percent contribution rate provided for in Act XIV has been

maintained for ten years, from January 1, 1868 to December 31, 1877, but it

was no longer mandatory for the next compromise, neither in terms of the

ratio, nor the ten-year interval. The shorter and longer deadlines were determined

by the fact that the “mood” of the negotiations should not affect the

mood of the economic actors and the society, while in the longer term the

violation of the budget law of the parliaments was presumed.

In addition, the settlement of the Compromise of 1867 was accelerated

by the uncertainty that “at the beginning of 1867 the funds were empty, 9/10

of the staff employed by the financial administration consisted of strangers

who did not understand the official language, and domestic resources were

not and could not be available. Taxes almost came to a standstill in the first

weeks, as people were not used to the voluntary payment. Finally, everything

ended well: the revenues of 1867 surpassed expectations, and the first regular

budget ended well.” 102

Act XVI regulated the law on the establishment of a customs and trade

association aiming at a common customs border to surround the Monarchy.

103 The issue of customs and the tax system, especially the management

of excise duties, was thus an interrelated issue and could not be regulated independently

by the Hungarian government. Customs revenues were entirely

spent on common costs, while the customs union also involved the regulation

of major excise duties, as it would have been difficult for the two states to

regulate the rates of consumption and excise taxes incorporated in the price

of the products in a different way. The reintroduction of customs duties and

excise taxes (salt and tobacco excise 104 , levies on sugar, beer, burned spirits)

could only be carried out jointly with the Austrian Government. According

to Ákos Paulinyi, 105 Austria-Hungary was more than a simple customs union,

as it operated as a true common market with full monetary integration and

a partial tax union. Moreover, the economic reconciliation ensured the full

and free flow of production factors, labour and capital between the two countries,

but true, it has confined the Monarchy within its borders.

Hungary could not use mercantilist tools independently for goods coming

from Austria or from areas outside the Monarchy, but there is no doubt that

the Monarchy’s market of a population of nearly 50 million provided an

excellent opportunity for Hungarian agricultural exports. In the 1875 supplementary

negotiations on economic reconciliation, the re-negotiation of

the customs question – in addition to the distribution of consumption taxes

and the discussion of the independent central bank – came to the fore again,

and in 1878 it also had results: financial, industrial and agricultural import

items favouring the Hungarian party were increased. However, as Sándor


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 33

Matlekovits puts it, “the compromise itself is a definite financial achievement.

The settling of the spirits and sugar tax reform, the customs tariff and

tax reimbursement issues increased the revenues of the Hungarian Treasury

by millions of forints…” 106

Following the compromise, the new Hungarian state, with minor modifications,

took over the previously introduced tax system of the absolutist

regime, its tax administration 107 and even became a legally declared part

of the Monarchy, so the room for maneuver aiming at changing the excise

taxes was minimal, thus putting the emphasis on direct tax reforms 108 , especially

when public finance consolidation measures were needed 109 . While

the 1875 reform – in a more relaxed political climate following the victory

of the Liberal Party – affected direct taxes 110 , repeated reforms of the 1880s

sought only to increase the yield of excise duties, in particular of various

consumption taxes. Consumption tax revenues – due to the market growth

in the market economy boom – rose fourfold between 1868 and 1890, and

during the restructuring of the tax system, emphasis was slowly relocated

from direct taxes to excise. According to the closing balance sheet data of the

general government balance, a significant deficit between 1868 and 1914/15

occurred only in 1870 (72.3 million forints), with revenues of 185.8 million

forints and an expenditure of 258.2 million forints, although the previous

year’s figure of 39.5 million forints diminishes its importance. Between 1868

and 1869, 1873 and 1876, 1878 and 1879, 1882 and 883, 1886 and 1895, respectively,

the budget closing account showed a surplus, even in 1900, 1910,

1913 and 1914/15. 111 Kálmán Széll, Minister of Finance between 1875 and

1878, and his position as prime minister between 1899 and 1903 deserves

special mentioning in the economic administration of the era of dualism. 112

“As a finance minister, he has established order in public finances, has substantially

increased public revenues, restructured financial administration,

acquired the eastern railways and the railways along the river Tisza for the

state […] The financial and economic reconciliation with Austria established

in 1878 is bound to his name… 13 His late descendant, Gábor Hamza, academician,

said: “Governance of Kálmán Széll has brought relative peace into

the already distressed public life,” 114 his political work has formed the base

of the golden age of the dualism.

In the operations of the dualist Hungarian state, in respect of tax policy and

public finance, measures aimed at saving, increasing tax revenues, increasing

the efficiency of financial administration and tax collection were permanent, as

well as the continuous conversion – towards a more favourable interest rate –

of public loans to finance capitalist development. 115 In spite of the efforts

made by the state’s fiscal management aimed at fiscal efficiency, the budget

deficit 116 has remained decisive, stemming from the expansion of state governed

and state-funded infrastructure investments. “The restoration of the

constitution found the country in a state of need in every direction, in every

aspect of state functioning, which required investment.” 117 To ensure back-


34 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

ing for the expenditures not covered by tax revenues (i.e. for the deficit) the

Hungarian state placed state bonds on international capital markets. “In the

years following the compromise, state bonds were only used for state-funded

investments specified by the laws: 85 million forints in 1867–68 and 30

million forints in 1871 for railways construction, and 24 million for construction

in the capital city in 1872. The 54 million forint loan issued in 1872 was

largely used to continue the investments already started.” 118 László Katus also

explains that between 1868 and 1890, public spending increased by 72% in

Austria and 142% in Hungary. However, in his opinion, this fast-paced Hungarian

growth trend was a consequence of the need for independent state

organization and economic development, i.e. it was covered by economic

performance. Especially in the light of the fact that “between 1867 and 1913

Hungary’s industrial production grew by 4.5% on average, and the share of

industry in GDP rose from 15% to 24%.” 119

The Compromise in 1867 thus favoured capitalist development in Hungary.

However, the construction of the railways, the Danube regulation, the reshaping

of the capital city and the construction of the port of Fiume have

consumed large sums of money, which were primarily financed from loan,

thus slightly offsetting the balance of public finances. The restoration took

place – on the proposal of Sándor Wekerle – by increasing direct taxes, dues

and the price of tobacco excise goods, as well as the radical reform of the

spirits and sugar excise and the redemption of the droit de régale on beverage

selling licence. In addition, it covered the conversion of sovereign loans,

which meant the conversion of the bonds of former sovereign debts into

longer maturities and lower interest rates. 120 In addition to making the operation

of the state machine transparent, Sándor Wekerle placed great emphasis

on industrial development, nationalization of railways – mainly to eliminate

misuses –, the development of agricultural sectors and animal health and the

improvement of social conditions.

The chain of laws of social policy 122 launched during the first two governments

of – the three times royal Hungarian prime minister – Sándor

Wekerle 121 , and even already his service period as minister of finance from

1891, created the possibilities of improving the quality of life of teachers,

workers and servants available at the time. In his thinking on social policy

there was a correlation between the economic public interest, the economic

and health interests of the employee, the interests of the employer and the

expectations of public education. By recognizing the connections within

a four-unit system, he submitted his bills and defended them during parliamentary

debates. After the collapse following the First World War, the

governments of the Horthy era, starting from 1926 and 1927, were built

on the foundations laid by Wekerle. During the first government of Sándor

Wekerle (1892–1895), the minister of religion and public education at the

time presented a bill “on the retirement, including care for their relatives, of

the schoolmasters and schoolmistresses, teachers, instructors and instruc-


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 35

tresses of public educational institutions”, who were not yet covered by state

or other similar provisions.

During his second government (1906–1910), besides his economic measures,

social policy measures as important elements were also integrated into

his government programme.By obliging commercial and industrial employees

to provide insurance against accidents, creating a pension insurance

scheme, and settling the institution of sick-relief, he also provided a solution

for the case if these measures were to take huge roll and require considerable

investment. In 1907, the law on the “Regulatory Relationship between

the Landowner and Servantry” was required to ensure the smooth running

of national production and social peace. In 1908, in the Law on “Workers’

Houses to be Established at State Expenditure in Budapest Metropolitan

Capital City”, he considered the implementation of social investments serving

public interest to be a state task. 123

The Compromise made the Hungarian state a constitutional monarchy 124 ,

in which the legislature was exercised jointly by the head of state and the

supreme representative body, the parliament, while enforcement was generally

provided by the king through the government appointed by the majority

party of the parliament. 125 However, the government was responsible not

only to the king, but also to the legislature. Parliamentarism re-established by

the Austro-Hungarian Compromise in 1867 also institutionalized the right

of legislation over the government in Hungary, and the State Audit Office

was set up by the Parliament to carry out economic control. “Act XVIII of

1870 defining the audit office, however, determined the legal status of the

organization in an obscure manner, the task of which was only to perform

the numerical control, which made the functioning of the organization

– from the beginning till the end – judged with contradictory attributives.” 126

2.2.3 Regulatory background and results

of industrial development

There is no doubt that political consolidation has had a positive effect on

Hungarian development. However, it is also an important and favourable

condition that the second half of the 19 th century was a period of industrial

revolution and prosperity in banking business in Europe. 127 As a result of

the combination of the two circumstances, “the country went through an

unprecedented development from 1867 to 1873, especially compared to the

Bach era. Capital has been introduced to Hungary in a previously never experienced

extent, railway lines sprang up like mushrooms, and the number

of financial institutions on which the credit system was based had multiplied:

by 1873, the number of banks and savings banks increased from 78 to 429,

and their capital supply increased from 169 to 531 million forints.” 128


36 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

At the time of the compromise, Deák Party and opposition politicians

agreed that the state of the economy could be improved by allowing free

competition and free trade. It was also agreed that “there is no imaginable

progress, balance in economic development and wealth in a country that

only deals with agriculture and does not have an industry” 129 . The situation

after the abolition of the serfdom was an economic force for both political

and economic elite, and the establishment of conditions for capitalist development

became inevitable. “The principle of official economic policy has

always remained liberalism. However, the situation of the national economy

and the difficulties of development necessarily required the state to intervene

more directly. This was also acknowledged by the supporters of liberal economic

policy. ” 130 Here, in essence, an identity of thoughts can be discovered

with the theory of the French economist Michel Chevalier (1806-1879), the

advocate of liberal economic policy 131 , who emphasized the importance of

state initiative and involvement in certain branches of the economy, especially

in the development of infrastructure. Friedrich List 132 (1789–1846) saw the

solution for the economic development of the German territories living in

fragmentation in state intervention, especially in infrastructure areas. The

leaders of the dualist Hungarian state were thinking the same way. “Liberal

politicians of the era were convinced that political changes that restored

liberal constitutionality and national sovereignty at a price of some compromise

opened the way for the process of »infinite development«, and that with

the establishment of individual and national liberty, Hungary could catch up

with the more developed nations.” 133

“Immediately after the compromise, the state was directly involved in the

construction of modern infrastructure. The private railway companies were

subsidized by the state with a state guarantee of interest, while shipping companies

were given an annual subvention.” 134 A state loan was issued for the

establishment of railways and canals (Act 13 of 1867). An industrial policy

thought to be liberal (industrial law of 1872) was turned against by the small

craftsmen. The leaders of the National Industry Association asked for industrial

development to be the guiding principle of economic policy, primarily

foreign trade and customs, and they considered the lack of a common customs

area and industrial tariffs as the main obstacle to industrial development.

“The common and unified customs area of the Hungarian-Austrian Monarchy

has undoubtedly had a beneficial effect on the economic welfare of

the two different, but therefore interdependent parts of the monarchy; […]

it does not endanger our not excessive industrial interests. […] Our shiftful

industries have not even fallen during the period of the single customs territory

and the customs and trade union, but where there was enough capital

and intelligence, where there was no fake, but serious will and aspiration,

they moved forward fast enough.” 135

Act 44 of 1881 on the state preferences to be given to domestic industry

has granted state preferences to factories “equipped to the current state of the


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 37

art” that produce “articles not previously produced in Hungary”, as well as

factories that already exist or will be set up, which produce the articles listed

in the law. In the case of textile factories, the law also quoted the conditions

for obtaining the benefits in detail. Until 1895, the concerned factories have

been relieved of paying the taxes due by industrial companies as well as the

payment of community levies on them and the general income tax. They were

also absolved of dues and stamps to be paid for various documents, and they

were entitled to industrial salt at a discount price. 136

Preferences for industrial companies were also extended to a part of the

mining companies by Act 3 of 1887. The Second Industry Aid Act, Act 13

of 1890, has expanded the range of beneficiary industries and products. This

law also granted preferences to the craft cooperatives and the home industry

companies. The Second and Third Industry Aid Acts stated that all companies

could enjoy state benefits for up to 15 years. Act 22 of 1893 (on “Granting

state aid and preferences to merchant ships flying the sea free shipping”) extended

the concessions to shipbuilding yards, shipyards, and the “technically

adequately equipped” repair workshops, floating and dry docks.

As the means of state industry subsidies expanded, the “state committee

organized for the greater use of domestic industry by transport companies

and state factories was established. Then, in 1887, Gábor Baross, Minister

of Transport, called on transport companies to give preference to domestic

products that are available in sufficient quantities, qualities and prices. He

has also imposed the same obligation on industrial companies benefiting

from state aid and preferences. Following the call, 85% of the needs of the

railways and public factories were acquired at home. It was also achieved

that the Hungarian industry would benefit from the orders of the common

army, and at the beginning of the 20th century, the rapidly developed navy,

in a proportion equalling roughly the quota. In 1890, state railway lines introduced

tariffs that favoured the products of domestic factories over against

imported articles and applied tariffs that helped export. 137

Act 14 of 1890 on public preferences for financial institutions supporting

domestic industry has provided far-reaching benefits in the event if “a joint

stock company with at least five million guldens fully paid registered capital,

seated in Budapest, would be established to promote domestic industry

and commerce and which, in accordance with its articles, would focus on

the establishment and naturalization of new industries in the countries of

the Hungarian crown, the development and relief of already existing ones,

as well as the provision of cheap loans for craftsmen and industrial companies

in the countries of the Hungarian crown…”. Act 17 of 1884 (the

Industry Act of 1884) made the establishment of industrial associations

mandatory, which has strengthened the state of industrial organization and

the representation of interests of those employed in industry. These laws

promoted the development of domestic industry in respect of capital and

labour organization. 138


38 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

In the initial period of industrial development through state intervention

efficiency issues have already arisen, such as: “… the government must

beware of total indolence, […] but also must be careful not to overstate its

intervening role, because the artificial development of an industry that has

no proper basis would only lead to the collapse of such an industry at the

first time causing even bigger crises.” 139 However, through the four decades

of the dualism, there has been a general belief that “under our economic

conditions, the “laissez faire” system of the state cannot be followed, and the

“intervention” in our country is definitely well-reasoned and adequate. In

Hungary, initiative and incentive is not going to happen or would not have

happened in many production sectors if the state did not act as a cash donor

and did not take the risk of initiation.” 140

“In the years after the compromise, in the Gründerzeit’s booming times

there was no need for any further state intervention to achieve the desired

development of the economy. Although at the time of a smaller stock

market and credit crunch of 1869, the government – from the stocks of

the State Treasury – hurried to help the troubled companies by significant

amounts. However, the great crisis of 1873 stopped the growth of the

Hungarian economy for many years, and then it became more and more

evident that without the active participation and support of the state, the

Hungarian economy could not successfully stand up to the increasing

international competition.” 141 Private economy in Hungary (and also in eastern

Europe) subsidised by the state became the way of implementing the

– final and irreversible – break-away from the “prolonged” feudal production

mode and, at the same time, the fast catching-up with the capitalist way

of production. However, under the conditions of the time, in terms of the

definition by the general spirit of the age, this meant a liberal 142 economic

policy. “We have accepted free trade and its consequences, free competition,

and we thought that the nation was not resting until it managed to catch

up with its neighbouring countries in respect of the issues it was lagging

behind,” said one of the leading economic politicians of the age. 143

Characterizing the state of the active economic policy of the dualist state

and our relations with Austria, Gábor Baross writes: “…in the course of

the past ten years Hungary’s trade, agriculture and her industry in general

have progressed and developed. Therefore, regarding the supposition as to

the Austrian industry would have destroyed the development of Hungarian

industry, or would have put other primitive or developmental industries

to the “edge of destruction”, there is nothing in the data.” 144 In the already

cited writings of László Katus, Béla Makkai 145 and John Komlós 146 , there is

no data or circumstance found either that would justify the deterioration of

the Hungarian economy in the era of dualism; on the contrary, a strong development

has been experienced. 147

A characteristic feature of nearly half a century of dualism is that “state

power today [in 1914] holds the highest powers of economic life in Hun-


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 39

gary and is able to influence competition to the fullest extent.” 148 The most

effective means of the state to support industry was the mandatory provision

of public transport (procurements by the state, other authorities and

state-supervised facilities like railways and shipping, and the purchases of

the beneficiary industrial companies) for the domestic industry. The value

of public transport in the early 1890s was 50 to 60 million and in 1913 it was

404.2 million krones. Hungarian industrial purchases by transport companies

amounted to 308.3 million krones, acquisitions of the government and

other authorities 64.9 million, and the Hungarian quota for the joint military

and naval industry purchases was 31.0 million krones. “Public consumption

in proportion to the volume of industrial production is not as important in

any country of Western Europe as it is in our country.” 149

However, economic policy based on state intervention has more subtle

assessments. Lajos Leopold calls the form of capitalist transformation that

has emerged in the monarchy in Hungary a fake capitalism. In his view,

capitalism is “where, wherever possible, in concentrated plants, they produce

to the market with the best possible division of labour. The means of

production are in the hands of capitalists, who give their confidence in the

production to be made when the required stock is advanced. Confidence is

based on speculation and calculation. Elements of the real capitalist order:

concentration, division of labour and production to the market.” 150 According

to Leopold, only the legal system of capitalism exists in Hungary, which

although promotes, but does not fully allow the development of true capitalism;

it is only pretence held in a politically protected envelope hiding the

appearance of real internal problems. “The tense character of the Hungarian

capitalist development is evidenced by the data following each other more

frequently, “writes Endre Nagy 151 , who says that “the industrial development

did not spread proportionally over the entire period of the Monarchy, but

concentrated mostly to the period from the second half of the 1890s to the

outbreak of the World War.” 152

Iván T. Berend, György Ránki 153 and Miklós Szuhay 154 also refer to the

low level of the Hungarian industrial performance compared to Western

and Central European countries and their modest internal demand. They

highlight: “…the number of cotton-spinning reels in Hungary at the turn

of the century was 110,000, while in Austria more than 4.5 million, and in

Germany nearly 10 million […]; the textile industry only covered 30% of

domestic needs”. Thus, the economic policy aimed at boosting agricultural

production also had many discrepancies that had an impact on the activities

of other sectors, such as the banking sector. “Agriculture, precisely because

it was backward from technical aspect, and it did not have sufficient own

resources for the development, increased the bank operations”. 155 Therefore,

when lending their resources, an agricultural focus was prevailing

in the banks’ activity. The industrial sector itself has adjusted itself to the

dominant role of agriculture in the structure of the economy; while “large-


40 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

scale industrial production, for example in the 1910s, accounted for nearly

three-quarters of total industrial production, entire branches of industry

retained their small-scale character”. 156

By taking the leading role in the state administration and economic life,

the interests of landowner class dominated. During the years of dualism,

Hungary became essentially a developing country characterized by agrarian-feudal

base interests, in which industrial development primarily served

the interests of agriculture and the aristocracy associated with it. In spite of

that, of course, the way of dualistic political and economic relations promoting

development, as the almost single opportunity for its implementation, is

indisputable. 157 State intervention in the field of railway construction, industry

aid subventions, state orders, the role of the state in the inflow of foreign

capital, investment subsidies for private enterprises and state-owned plants

were the determining elements of the era. 158

By the strength of the economy, the organization and capital intensiveness

of the state budget has also increased both in the tax and support system

and in the field of administration. 159 The practical and scientific bases of the

autonomous public finance system 160 developed in the era of dualism. 161

Business life, which has become more active by the coordination of the state,

has also led to an increase in the degree of organization and regulation of

public finances.

2.2.4 Monetary and credit policy and central bank relations

in the age of dualism

“In 1878, after lengthy negotiations, central bank conciliation was established.

The Austro-Hungarian Bank, reorganized on a dualistic basis, although it was

not allowed to lend directly to the two governments, created stable monetary

integration between the money markets of the two-centred monarchy.” 162

Hungary would have had the chance to introduce its own monetary system

and money (with defining the mint par) in the process of reconciliation, but

it did not take the opportunity. 163 It was believed that the autonomous monetary

system and its stability could not be assumed by the underdeveloped

Hungarian economy. By doing so, the Austrian side managed to maintain

the monetary union. There was also Hungarian money in circulation, produced

in 30 percent of the imperial money. The common monetary system

has made it easier for Austrian capital to flow in, and the Austrian National

Bank’s loan disbursements mostly favoured Austrian capital. 164

In the process of economic reconciliation launched after the 1875 largescale

election victory of the Liberal Party, banking was a priority. In 1877, an

agreement was reached on the establishment of the Austro-Hungarian Bank,

which also appeared in law in 1878. The Hungarian government thought first

to set up a cartel bank instead of setting up an independent central bank,


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 41

and finally they concluded on a parity-based central bank. As a result, a separate

directorate, equal to the one in Vienna, was established in Budapest,

the number of branches in Hungary was increased, lending processes were

stimulated, the basis of which was a capital injection of 50 million forints to

the institute in Budapest. Participation in the management of the bank was

also determined on a parity basis.

The 1892 currency reform of the Austro-Hungarian Monarchy, due to

Sándor Wekerle, was launched by a Hungarian initiative. The introduction

of the gold currency was economically indispensable in order the Monarchy

not to be isolated commercially or economically and, respectively, conclude

contracts with foreign states with more favourable conditions. The gold currency

system of the Monarchy helped economic development. It was intended

to compensate for the defeated war in Italy, the inherent loss of international

political scope and influence, and to ease the unstable public atmosphere

in Hungarian politics that have evolved due to the War of Independence of

1848-49 and the arbitrariness subsequent its suppression.

However, the failure to set up an independent Hungarian central bank was

later debated – as the common bank had modest effects on the Hungarian

economy – despite the progress made in 1877. In 1909, József Csetényi said:

“…there is no economic success that would have no political benefit. The bank

issue perceived this way is not a purely economic or political problem, but

a problem of national autonomy. From this point of view, it is of the utmost

importance that Hungary, in lack of an independent bank, is deprived of the

possibility of organizing a single national fund with the help of which the nation’s

all economic powers could prevail.” 165 Csetényi qualified money as the

outcome of a legal system, “according to which every independent national

legal system necessarily presupposes a separate monetary system, so that an

independent nation cannot have a common monetary system with another

power, because that already means the adoption of a foreign legal system. Due

to the fact that we have a common monetary system with Austria […] the

common bank incorporates our financial strength into the Austrian organization

[…]. A separate bank opens the way to the forces and opportunities

of independent development and by solving this issue, our other difficulties

will also be settled spontaneously…” 166

In spite of the relatively settled bank issue, as a result of the compromise

of 1867, Hungarian economic life began to develop, in which the activation

of bank operations 167 played a significant role. “Banks managed lending in

a more liberal way. The stock exchange contango business was overgrown

[…] From 1866 to 1873, the number of credit institutions increased from 85

to 637, the rate of foundations, which lost its power after 1869, reached the

maximum of the current period with the establishment of 165 new institutions

in 1872. The development of the equity capital of financial institutions

has been more inordinate. It jumped from 6.7 million krones in 1866 to 21.4

millions in 1867, then increased to 53.1 in 1869, 63.3 in 1870, 70.2 in 1871,


42 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

161.9 in 1872 and finally to 183.4 million krones in 1873.” 168 The Hungarian

Commercial Bank, seated in Pest, played a decisive role in banking, and in

1867 it was no longer the only bank in the capital, and “had to face the increasing

competition.” 169 In addition to this, it is important, and this implies

the weak international status of the monarchy, that “the share of the multinational

or national businesses considered »resident in respect of customs

border and paying duty« amounted to a small fraction in the international

activity of the banks of the Austro-Hungarian Monarchy during the entire

period of the dualism.” 170

Economic development has been hampered somewhat by the depreciation

of silver, but mainly due to this the depreciation and value fluctuations

of the Hungarian currency. In the 1880s and 1890s, the value of the currency

reached a fluctuation of 2 to 3, sometimes 7, and even 8% within one

year. 171 Currency fluctuations 172 made planning more difficult in business and

international trade, which had a negative impact on the country’s competitiveness

and foreign capital investments. The positioning started between

the Austrian and Hungarian governments in 1892 173 , which resulted in the

silver value being replaced by the gold value (krone value), and in 1896 the

governments agreed on the central bank reform. On the Hungarian side, the

most important element of settling the central bank issue was to increase the

government’s influence in the management of the bank. “In the bank’s general

council, an equal number of Hungarian and Austrian residents had to

be settled, who are members of the Budapest or Vienna board of directors

by their nationality.” 174 An additional result of the central bank issue was the

transition from the silver-based currency to the gold-based currency.

The optimization of the operation of the central bank, as well as the international

economic recovery beginning in the 1990s had a positive effect on

Hungarian enterprises. Especially the German prosperity had a significant

impact on the country. “The number of credit institutions grew by 1398 in

the 1990s and by 1960 in the 1900s, reaching 4583 in 1910. Of these, 363

and 645 were banks, savings banks and land-banks, respectively; the savings

banks grew more strongly in numbers, regarding the multiplication by 1035

and 1315 in the relevant two decades. Capital formation was demonstrated by

an increase in the institutions’ equity from 348 million krones by 494 million

to 842 million krones, then by 1015 million to 1857 million krones, with the

development of various income deposits from 1199 million by 952 million

to 1971 million in 1900 and, respectively, by 2309 million to 4380 million

krones in 1910. The growth of the discount portfolio reflecting the development

of lending also surpassed the previous rates. In the 1890s, 1900s and

1910s, the bills receivable stock was 663, 1313, and 3053 million krones.” 175

Regarding the interest conditions, in 1876 a slow recovery occurred, followed

by one of a faster pace started in 1879. Institutions’ interest rate and interest

margin have also decreased. According to the data of Gyula Vargha 176 ,

when discounting, banks diminished interest margin from 4.53% in 1875 to


2.2 Economic aspects and effects of the Austro-Hungarian Compromise of 1867 | 43

3.98% by 1878, then reduced it to 3.05% by 1883. In the same context, the

downward trend was 4.51% -3.76% -3.19% for advances and 3.93% -2.62%

-2.72% for mortgage loans.

To sum it up, the more relaxed political environment following the compromise

favoured economic life. Except for the contradiction of the agrarian

side, the political and economic elite were a supporter of free competition,

in which they enjoyed the support of the state. “Immediately after the

compromise, the state got directly involved in the construction of modern

infrastructure. The private railway companies were subsidized by the state

with a state guarantee of interest and shipping companies with an annual

subsidy.” 177 The state issued a government loan for the construction of railways

and canals (Act 13 of 1867).

According to the pre-cited writings of László Katus and John Komlós, the

foreign capital and equity ratio remained below the critical 40%, so – according

to their unified wording – we can speak of a sovereign economy. The

post-compromise Hungarian economic administration followed a strategy of

catching up with using protectionist means, with the increased involvement

of the state, large factory sizes and the early emergence of finance-capital,

and the “pulling industry” of agriculture became the processing industry. 178

Conversely, the survival of (millions of acres of) entails (on both sides of the

Lajta river) suggested feudal atavism and, in the long run, prevented the land

from becoming a capitalist property, and hog-tied the peasants who made

up the majority of society, resulting in the emigration of millions, as well as

social, and partly ethnic dissatisfaction. According to the contemporary conception,

it was the Hungarian landowner who “screwed” (also) the ethnic

peasantry, at least the main ideologists of parallel nation-building perceived

that this way, mostly as one of the reasons for separation, although there was

no ethnic (social) discrimination in dualist Hungary. 179

The phenomenon of nearly half a century of operation is characterized

by strong state influence on economic life, essentially the establishment of a

state-controlled economy. As a result of the first industrial law, “280 new factories

were created, 227 of which were agricultural distilleries. Four factories

have expanded with new branches of industry. The number of old factories

benefiting from the preferences was 195, 75 of which were agricultural distilleries.

A total of 479 factories received preferences, but 302 (63%) of them

were agricultural distilleries.” 180

As a result of the state’s industrial subsidy – more comprehensively than

previously described – “between 1867 and 1873 capital stock have been

multiplied by six […] 170 new joint stock companies and 552 financial institutions

were founded, more than 4000 kilometres of new railway line was

built, mostly from private capital, but with state aid through interest insurance”

181 . Between 1881 and 1914, 959 new factories were created with state

subsidies, including 432 agricultural distilleries, 572 other industrial plants.

The state supported the expansion of 234 factories, while 865 old factories


44 | Chapter 2: State-controlled Economy in the Era of Dualism (1867–1918)

were granted preferences, including 267 agricultural distilleries, 598 other

industrial plants. In total, 2058 factories received state subsidies and cash

grants, of which 699 agricultural distilleries (34%) and 1359 other industrial

companies (66%), plus 380 factories received state aid for the acquisition

of machinery.

The most effective means of the state to support industry was the mandatory

provision of public transport (procurements by the state, other

authorities and state-supervised facilities like railways and shipping, and

the purchases of the beneficiary industrial companies) for the domestic industry.

The value of public transport in the early 1890s was 50 to 60 million

and in 1913 it was 404.2 million krones. Hungarian industrial purchases by

transport companies amounted to 308.3 million krones, the acquisitions of

the government and other authorities were 64.9 million, and the Hungarian

quota for the joint military and naval industry purchases was 31.0 million

krones. “Public consumption in proportion to the volume of industrial production

is not as important in any country of Western Europe as it is in our

country.” 182 In a short period of time, a state-driven market economy was

built up from a feudal society, creating an increasing production value, a

growing state budget, the results of which, unfortunately, were largely lost

in the First World War.

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