The following OECD assessment and recommendations summarise Chapter 1 of the Economic Survey of Hungary 2005 published on 19 July 2005.
Hungary’s expansion is becoming better balanced. Manufactured exports and investment have both picked up and GDP growth is expected to be about 3.5% this year and increase further to 4% in 2006. The rise in export and investment growth follows a period in which aggregate demand was largely driven by unsustainable increases in government spending and by private consumption that was fuelled by minimum wage hikes and large increases in public-sector wages. With the impact of these measures coming to a close and supportive external developments, the composition of growth has become healthier. The capacity of the Hungarian economy to respond fairly rapidly to this change in macroeconomic signals is a tribute to current and previous reforms.
Hungary's long-term growth in GDP per capita is reasonably good
Year-on-year percentage change
Source: OECD Economic Outlook, No. 77 Database.
Building on this base and ensuring that growth can remain healthy over the long-term will require further improvements to the macroeconomic and structural environment for business. If manufactured exports are to play an important role in growth then, as local wages catch up with the rest of Europe, producers will need to continue moving up the value-added chain through increasing capital intensity while workers need to upgrade their skills in order to remain employable. The service sector has to be the main source of new jobs to help absorb labour from declining manufacturing sectors and to bring more of Hungary’s large pool of non-employed into the labour force. And, as in manufacturing, the service sector has to move up the value added chain through productivity improvements within firms and by compositional shifts towards high-value-adding activities.
However, key challenges lie in euro entry, public spending, employment potential and business support
The broad policy challenges to improve macroeconomic conditions and the structural environment for business can be summarised as follows:
Entrenching macroeconomic stability and smoothing entry to the euro area: The government aims to join the euro area in 2010. This will require further co-ordinated efforts to reduce inflation and the fiscal deficit by the Central Bank and the government. Going forward, the Central Bank should aim for slow but sustainable further reductions of inflation, avoiding unnecessary sacrifices in output growth or excessively high interest rates. In fiscal policy, further reductions in the deficit have to come about largely through spending cuts because the level of taxation is already harming competitiveness and labour utilisation as well as encouraging grey sector activity. This implies that tough spending discipline will be needed to meet the Maastricht criteria. Above all, a more effective communication strategy and the visible achievement of targets will be essential to reducing the rather high degree of financial instability that Hungary has experienced.
Building sustainability in public spending: Tough budget discipline needs to be backed up by structural reforms to public spending that redefine service commitments and re-organise systems towards more efficient provision. This Survey assesses the best way forward in one of the key areas, namely health care. While substantial reforms have been made over the past decade, results so far are somewhat disappointing. Furthermore, the demand for health care is likely to rise significantly in coming decades due to a combination of ageing, rising incomes and new treatment options, underlining the need for additional reforms. The costs of failure to reform would be prohibitive and would undermine the sustainability of public finances.
Raising employment potential: There is substantial room for increasing Hungary’s employment potential. For instance, OECD calculations suggest that the employment rate could be far above current levels. In part the low employment rate arises from high tax wedges that are damping labour demand and encouraging grey-sector employment. But there are serious disincentives to work in current assistance schemes which have generated inactivity traps. In particular large inflows into disability benefit and early retirement schemes mean that many non employed of working age with some remaining work capacity have little or no incentive to re-enter the official labour force.
Getting the right menu of business support and regulation: Reflecting the focus on competitiveness, the government is conducting a campaign of general and targeted measures in corporate taxation and business support. One focus is to encourage greater levels of innovation, and this Survey takes an in-depth look at the recent steps taken. Policymakers face the same basic uncertainties in developing innovation policy as those found in other countries: while Hungary indeed has a relatively low level of innovative activity, policymakers have difficult decisions in deciding how far, and with what degree of targeting, policy incentives should go.
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