OECD Economic Surveys: Hungary 2019

Report

OECD Economic Surveys: Hungary

31 January 2019

Chapter 2. Fostering regional growth and inclusiveness

Regional growth has been uneven in Hungary, leading to a wide dispersion in employment and income outcomes. The divergent growth pattern reflects that the greater Budapest area has benefitted from positive agglomeration effects and the benefits from inward FDI in western and northern regions that has provided important technology transfers as well as links to international supply chains. By contrast, other poorer and rural regions have few linkages with national and international supply chains, holding back growth. Boosting growth in a manner that benefits most people will require further exploitation of positive agglomeration effects as well as the development of local networks that enable poorer areas to make use of their own comparative advantages and join national and global supply chains.

Urban regions have had the fastest growth

Uneven regional growth leads to income divergence, at times even to pockets of poverty. Moreover, the associated underutilisation of labour resources and local growth opportunities constrain productivity developments and holds back aggregate growth. In many countries, such concerns have increased since the onset of the international financial crisis, motivating similar chapters in other Surveys, such as those for Iceland, Italy, Slovakia, Spain, the United Kingdom and the United States. Perhaps more than in other countries, the Hungarian regional problems are multidimensional, ranging from rural poverty to misallocated labour resources over missing links to regional and national supply chains to mention a few issues. Consequently, policy responses are required across many different policy areas. However, two important themes are emerging: a) how to deal with large geographical mismatches on the labour market; and b) how to improve lagging regions’ attractiveness to capital to bolster economic activity.

Economic growth varies across Hungary. Since 2000, the capital region (Central Hungary) has enjoyed faster growth than the rest of the country (Figure 2.1). Since 2012, the Western regions of Central and Western Transdanubia have grown strongly. As a result, the three most developed regions – Central Hungary, Central and Western Transdanubia – account for two-thirds of GDP and more than 80% of inward FDI (Figure 2.2) (Salamin, 2015). The rest of the country lags behind, reflecting economies that used to be dominated by now outdated mining and heavy industries and relatively large shares of Roma, a disadvantaged community concentrated in North Hungary and Southern Transdanubia, and there is a need to continue to bolster inclusiveness measures for Roma communities, especially by better integrating Roma children in early childhood education and care (Box 2.1) (Hardi, 2017; OECD, 2016a; OECD 2016b). Indeed, Hungary is the third most rural country in the OECD with almost half of its population living in predominantly rural regions, which are among the poorest in the European Union (OECD, 2016a; European Commission, 2017a).

Figure 2.1. The capital has been leading growth

Real gross domestic product, index 2000 = 100

Figure 2.2. Income per capita varies across regions

Gross domestic product per capita in HUF million, 2016

Box 2.1. The Roma in Hungary

Roma make up 3-7.5% of the Hungarian population with the vast majority belonging to the Romungo group who arrived in 15^th century. Later arrivals include the Vlách (Oláh) and the Boyash (Beás) groups. Historically Roma worked as day labourers in the rural economy. After WWII, many of them were settled in cities with the majority working in mining and heavy industries (Lukács, 2016). Even Roma musicians became part of the nationalised music industry (Hooker, 2015). The collapse of these industries led to mass unemployment and worsening social problems (Figure 2.3) (Bernáth, 2016).

Figure 2.3. Roma are lagging behind in all dimensions of well-being

Today, nearly two-thirds live in Roma settlements or neighbourhoods with Roma children increasingly being taught in segregated schools or ‘special’ classes (OECD, 2008). The system is highly unequal both in terms of ability of the children and the qualifications of teachers, resulting in low overall educational attainment for Roma pupils (Kovács, 2015). This is reflected in their labour market situation, which is characterised by low rates of employment in mainly low-skilled jobs with low wages.

The government has no specific Roma policies, but relies on general anti-poverty programmes, focusing on early childhood education and labour market entry via public work programmes. The National Inclusion Strategy also tackles poverty issues among Roma through measures focussed on education, employment and housing. Early childhood investment is a strategy with high returns. The main element is the Sure Start Programme to help cognitive developments in cooperation with their parents; however only around 4% of the target group is reached, while the most disadvantaged children are missed (Balás et al., 2016). The rollout of crèches and compulsory kindergarten is also lagging the most in these Roma communities. On the other hand, the national Roma children participation in crèches is 91% as compared with a national average of 95% (Századvég, 2016).

Labour market integration via public works schemes has not been successful (KSH, 2016). This also means that Roma do not benefit from other government employment programmes, such as the Job Defence Action Plan that cuts social security contributions for disadvantaged groups. Another difficult to battle obstacle is that 52% of Roma have experienced negative discrimination in the labour market (KSH, 2016).

International best practices to foster Roma integration include anti-discrimination bodies (Sweden, Germany) and providing anti-bias training for public servants (Romania, Spain) (Carrera, Rostas and Vosyliute, 2017). Other countries have resorted to Roma-specific programmes, such as the Spanish “Acceder” programme that has bolstered Roma employment through VET training tailored to the needs of companies. The programme includes pre-training of Roma enrolees, and is combined with anti-bias awareness campaigns. Other successful policies discussed in the 2018 OECD Economic Survey of Slovakia include trust-building measures to improve Roma’s access to public services, while the 2018 OECD Economic Survey of Australia points to the importance of community-led developments (OECD, 2018e and 2018f).

Western part of Hungary has benefited from inward FDI

Growth in the western part of Hungary has benefited from inward FDI, particularly in export capacity. Combined with its proximity to Austria and Germany, this has allowed these regions to integrate into global value chains (particularly in automobile manufacturing). However, there has been little development of production that links into local or national networks (Lux, 2018a). The attraction for foreign investors is the possibility to locate in pre-transition machine production hubs with amenable sites, plenty of skilled labour, developed business networks and good education institutions (Lux, 2018b). As discussed in the previous Survey, other CEE countries have also benefitted strongly from inward FDI and often for similar reasons, pointing to the increasing importance of favourable local factors, including the integration of local networks into national and international networks (OECD, 2016d). As a result, these regions have a relatively high share of employment in industry and business services (Figure 2.4). More recently, FDI has started to flow into other parts of Hungary, taking advantage of improved road infrastructure, less labour market pressures, and higher public support.

In some instances, cities and their surroundings have become highly dependent on the performance of a single foreign company, such as Audi in Györ in the North West of Hungary, and foreign sub-contractors (Salamin, 2015).On the other hand, Hungarian-owned companies have problems in becoming sub-contractors and thus to integrate in global value chains (Bisztray, 2016). As a result, a dual economy has emerged with a productive and competitive foreign-owned (including sub-contractors) export-oriented sector mostly based in the west of Hungary and a rump of capital-poor non-competitive domestically-owned firms with weak employment and productivity growth elsewhere (Veres, 2018). This also reflects that Hungarian-owned firms are unable to compete for scarce high-productivity workers and in markets for high-value added components (Lux and Faragó, 2018; Csafordi et al., 2016).

Figure 2.4. Employment by sector varies by region

As a percentage of working-age population by region, 20171

The capital region has benefited from agglomeration effects

Growth in the central capital region has benefited from positive agglomeration effects on growth. The economic and political capital, Budapest, is almost ten times larger than the second largest city, Debrecen, and includes almost a fifth of the population and accounts fo more than one third of all economic activity (Figure 2.5; OECD, 2016b; Kocsis, 2015). Urban agglomerations allow for higher productivity through greater specialisation, deeper labour markets and strong network effects – OECD research shows that doubling the size of a city can increase productivity by 2%-5%, depending on the quality of governance structures (Ahrend et al., 2017). This is also reflected in the Central Hungary region having a much higher labour productivity than in lagging regions (Figure 2.6).

The strong agglomeration effects reflect Budapest's deep networks of cultural institutions, transport infrastructure, and economic and business services, including being the main location for conference facilities (Urban Land Institute, 2013; Keller et al., 2016; Gál and Kovács, 2018). The agglomeration effects have also led to an average Budapest wage premium of 12% and as much as 22% for highly educated workers (Czaller and Major, 2015).

Figure 2.5. The city of Budapest dominates all other urban areas

Number of people, 20161

An emerging concern is that the positive growth effects pertaining to Budapest have been slowing. A rarely seen development in the OECD is that the capital's population is declining, partly reflecting inhabitants moving to the suburbs (United Nations, 2016). Moreover, the capital region is creating fewer firms than what could be expected based on its share of firms (OECD, 2018b). Part of this disappointing development can be explained by political and administrative fragmentation with an associated lack of long-term planning vision (Urban Land Institute, 2013).

Planning is being hampered by political and administrative fragmentation. This arises from the lack of a formal hierarchy between the city of Budapest and its 23 districts, each having their own spending responsibilities, funding sources and property portfolios (Ratz et al., 2008). This has led to numerous problems. In public transport, there are poor links between trains and buses, obsolete ticket technologies preventing the introduction of new ticket types and a lack of integrated timetables and fare systems. There is a fragmented public parking management system with a lack of enforceable regulation to counter rush-hour congestion. Other issues comprise slow upgrading and maintenance of shared infrastructure, loss of greenfield sites and difficulties in re-using the city’s many brownfield sites (Urban Land Institute, 2013; Kocsis, 2015; Ratz et al., 2008; Municipality of Budapest, 2014b). All of these problems would point to lower productivity growth than otherwise. Indeed, OECD research shows that fragmentation of cities’ governance has a negative impact on the economic performance of cities (Ahrend et al., 2017).

To address these problems a common planning framework for economic development for the Budapest agglomeration was introduced in 2015. The ambitious framework embodies urban development and transport plans that incorporate visions from five strategy papers and more than a dozen policy papers from various levels of government (Municipality of Budapest, 2014a and 2014b). The framework is based on partnership policymaking between the municipalities in Budapest, the surrounding counties, the central government and civic partners (business associations, universities, etc.). The accompanying programme has a complex objective structure with four long-term goals and seven mid-term goals and contains more than 70 measures. The partnership ensures that all participants are represented, but does not resolve underlying conflicting objectives nor constitute a formal hierarchy for policy implementation. Looking ahead, the complexity of the tasks would call for stronger prioritisation and internal coordination, requiring the establishment of a governing board with full responsibility for all aspects of land, property, planning, investment and project management.

Figure 2.6. Labour productivity is highest in the capital

Real gross value added per worker, in HUF million1

Agglomeration effects can also be found outside the capital

Agglomeration effects can also be found in localities with strong FDI inflows and around the larger cities (Radics and Molnar, 2015). This reflects that smaller cities can obtain agglomeration effects by connecting to their hinterland to secure wider and denser networks (Lux, 2015). Case studies show that the size of these effects depends on how well local firms participate in policy formulation to secure a good business environment and strong links to education and research institutions. Achieving this requires local governments that are engaging with the business sector to enable a gradual restructuring that preserves local technical and institutional know-how.

Overall, business regulation, as measured by the World Bank's Doing Business indicator, has improved since the mid-2000s. Nonetheless, with a ranking below the EU average, there remains considerable scope for catching up to best practice (World Bank, 2017). Local governments can affect the quality of business regulation, notably in terms of time required for starting a business, getting construction permits and access to electricity, registering property and enforcing contracts through local courts. Compared with larger cities in neighbouring countries (Bulgaria and Romania), it is generally more complicated and costly to start a business in Hungary and particularly so in Budapest. The capital is also the slowest in issuing construction permits and weakest in enforcing contracts. In other areas, Hungarian cities generally perform better, although with some variation. This shows that cities can learn from abroad as well as from each other (Figure 2.7).

Reforming the local business environment should focus on securing and streamlining administrative capacity and reducing the number of procedures to move closer to an effective one-stop shop for interaction between business and local public services. For example, business registration could include registering with social security and introducing a single business identification number to limit the need to submit information multiple times, Moreover, some services, such as the fire protection, the public health and building inspections, could be moved into a single function to minimise reporting and number of inspections.

The government aims at promoting agglomeration effects through the 2016 "Modern Cities Program". The focus of the programme is on enhancing transport, education and cultural infrastructure as well as industrial parks, encompassing some 300 projects (Lux and Faragó, 2018). The accumulated financial resources over the programme period 2016-18 amount to half a per cent of 2017 GDP from both central government and EU structural funds. Cities identify which projects are best for them, while a central government committee deciding on the allocation of funding. This process lacks economic incentives for optimal project selection. Projects should be subject to standardised cost-benefit analysis to select those with the highest rate of return to secure a cost-efficient and effective local development of relevant networks. Moreover, the information advantage that cities enjoy could come into play by having a higher degree of co-financing, which would require enhancement of their revenue-raising powers (see below).

Figure 2.7. Learning from better performing cities could improve the ease of doing business at the local level

Distance to frontier score, 0 to 100 (the higher the score, the better), 2017

Rural areas lag behind

In 2011, Hungary went from being among the most decentralised countries in Europe to being among the most centralised, as the government addressed problems of spatial fragmentation by centralising services and decision making (Balázs and Hoffman, 2017). This has left a fractured system of weak and often very small municipalities (three-quarters having fewer than 2 000 residents). Pooling resources is not common, despite existing structures for inter-municipal cooperation (including an obligation to participate in inter-municipal associations). As a result, many smaller localities have low levels of efficiency and quality in administration (Kovacs, 2015; Hoffman et al., 2016).

Centralisation also turned counties into agencies of central government with their role reduced to disbursing centrally provided (mainly EU) funds. Moreover, central government agencies took over decision making in areas of rural and regional development and planning, among others (Hoffman, 2014; Balázs and Hoffman, 2017, Hajnal and Rosta, 2016; OECD, 2017b). This, combined with the system of managing EU funds where local authorities apply for funds for projects that correspond with the centrally determined priority areas, lead to weak planning capacity at lower government levels (Buzogány and Korkut, 2013; Kovacs, 2015). In the EU funded Territorial and Urban Development Operational Programme for 2014-2020, county level authorities have an increased role in planning, implementation and project selection of their own territorial development programmes with technical assistance and funding from the centre.

The centralisation means that policies affecting regional development are determined with few inputs from lower levels of government as politicians pursue national and EU structural funds' priorities rather than focusing on developing local networks and competencies. This also means that there are few attempts to identify local economic advantages or how local businesses are best integrated into regional and national supply chains. The centralisation also contrasts with OECD work that finds that in an increasingly interconnected world local governments are well placed to provide support for local firms' competitiveness – a step in this direction is that municipalities from 2019 onwards can stimulate local business investment by granting tax exemptions or allowances in the local business tax – while central governments are best place to address inequality issues (Broadway and Dougherty, 2018).

To promote local economic development more efficiently, local authorities should have greater autonomy to execute projects, such as in tourism, that develop their local economies. Not all local authorities have the capacity for identifying and selecting projects, as they are very small or very poor. In such cases, local authorities should be further incentivised to co-operate. This could be horizontal cooperation to generate the sufficient administrative capacity. Alternatively, they could be provided with administrative and technical support from higher levels of government (Bartolini et al., 2016).

Municipalities' taxing powers lie mostly in levying local business taxes, property taxes and tourism taxes, although they are capped (National Tax and Customs Administration of Hungary, 2017d). As a result, sub-national governments are reliant on income from earmarked grants and subsidies, leaving them with little discretion in the allocation of spending (Figure 2.8, Panel A; Hajnal and Rosta, 2016). Local governments are responsible for a relatively small share of public spending (Figure 2.8, Panel B). Their spending discretion is further limited by a ban on debt financing (Hajnal and Rosta, 2016; Balázs and Hoffman, 2017). As a result, municipalities adapt to central government priorities to attract funds. However, they lack incentives to raise funds for local development projects, preventing the formulation of local long-term strategies (Hajnal and Ugrósdy, 2015).

Co-financing local expenditures by using own tax revenues (or block grants from the central government) would create spending efficiency incentives, including pooling of municipal resources (Bartolini et al., 2016). Local authorities should be encouraged to further use their existing tax powers. This could be combined with greater tax autonomy to give local municipalities stronger incentives to promote local development in the form of extra tax revenues and improve project selection. If combined with territorial reforms, this could promote both regional convergence and boost GDP by as much as 3% (OECD, 2017c). Concerns about greater inequality between regions could be offset by using block grants for poorer regions. Moreover, restoring the responsibility for regional planning to counties, combined with revenue-raising powers, would give them the tools and incentives to promote regional development (Hoffman, 2014). County-level planning could also help overcome coordination failures among municipalities. This would allow the central government to withdraw from detailed policy analysis and implementation to concentrate more on more traditional supervision of local governments to secure that the devolution of powers lead to improved outcomes s (Phillips, 2018).

Figure 2.8. Revenue of subnational government by type

As a percentage of total revenue of subnational government, 20151

Hungary has a similar rate of urbanisation (migration from rural to urban areas) as in other rural countries (Figure 2.9; OECD, 2016c). The bulk of the internal migration has been to the Central Hungary region and to a lesser degree to the regions with high inward FDI, while people have been leaving the south, east, and north-eastern part of the country. Particularly rural areas have seen outward migration, reflecting the disappearance of job opportunities with the ongoing modernisation of agriculture, leading to an increase in the inactive part of the rural population and a relatively high share of poorly educated low-skilled workers and a high risk of poverty (Figure 2.10 and Figure 2.11; Karpati and Francia, 2010).

Figure 2.9. Rural countries have a higher rate of internal migration

Low-skilled workers in poorer areas have a low employment rate, reflecting insufficient local demand for their skills. Moreover, the advanced technological production in more prosperous regions makes it difficult for the unemployed low-skilled workers to find work outside their region. Despite rising employment rates across Hungary regional differences remain, particularly when taking into account that employment in lagging regions has been boosted by the extensive use of public-works schemes. Almost 3% of the working-age population is employed in such schemes. However, the share ranges from less than 1% in the Central Hungary to nearly 10% in Northern Hungary and the Northern Plains, while the shares are 5% and 7% in Southern Great Plain and Southern Transdanubia, respectively (Scharle, 2017; Eurostat, 2018a). Removing the effect of such schemes leads to employment in the primary labour market that is as low as half of the working-age population in some regions (Figure 2.12).

Figure 2.10. Lagging regions have a high share of people without upper-secondary education

As a percentage of working-age population by region, 2017¹

Figure 2.11. People at risk of poverty or social exclusion by degree of urbanisation

As a percentage of population, 2017¹

Figure 2.12. Employment rates in poorer regions lag behind

Employed persons excluding participants in the Public Works Schemes as a percentage of the population1

Greater mobility could promote regional development

Increasing the relatively low worker mobility can foster growth in regional urban agglomerations and ease labour shortages in more prosperous regions (Figure 2.13). Workers in poorer regions have strong incentives to relocate to regions with better wage and employment prospects (Figure 2.14). The capital region is particularly attractive for higher skilled workers (Figure 2.4 and Figure 2.6, above). For blue-collar workers the western (and the capital) regions offer a large wage premium, reflecting the presence of foreign manufacturing firms and the need to compete with higher wages in Austria. A similar picture holds for employment rates of workers with upper secondary education (Figure 2.15). The generally high employment of tertiary graduates reflects both a structural change in the economy and their relatively small share of the population (OECD, 2016d).

Figure 2.13. Labour market turnover is relatively low

Figure 2.14. Wages are higher in leading regions

Average monthly net earnings of workers by region, in HUF thousands1

Insufficient mobility and the preponderance of low-skilled workers have led lagging regions to have a surplus of such workers, while in more prosperous regions there is an unfilled demand for skilled workers. In some south-western counties, this has induced their excess skilled workers to commute to regions where skills are in high demand. However, most of the lagging regions suffer from a low-skill trap with a large share of low-skilled workers for which there are few employment opportunities (Figure 2.16). The only counties in lagging regions with high employment of high skilled workers are those with sizable cities (Szeged and Debrecen). Although improved mobility can reduce skills mismatches, greater educational attainment is needed to lift lagging regions out of their low-skills traps.

Figure 2.15. Employment of those with upper-secondary education is highest in western regions

As a percentage of working-age population by region, 2017¹

Figure 2.16. Lagging regions have low-skills job opportunities and a low-skilled labour force

20131

As noted above, the skills shortages in western regions are exacerbated by the need to compete with better paid jobs in Austria, reflected in the third highest level of cross-border commuting (mostly to Austria) in the European Union (Eurostat, 2018b). This allows commuters to increase their earnings and improve their human capital by gaining foreign work experience, but necessitates that they are replaced with skilled workers from the rest of Hungary. Further exacerbating the skills mismatch problem is the already sizeable emigration, which has increased since the onset of the international crisis (Figure 2.17). To maintain growth in the prosperous regions a comprehensive upskilling strategy is needed.

Figure 2.17. Emigration from Hungary is moderate

Emigration of reporting country citizens per 1 000 population, 2016

A more responsive education system could alleviate local labour shortages

Vocational schools have limited ability to adapt to local needs after the centralisation of their responsibilities for providing education and training, hiring staff, salaries and determining curriculum (Eurofound, 2016a; Eurydice, 2016). Local firms can influence programmes in VET schools by providing (reimbursed) training to reflect their own needs. However, some firms exist mainly to provide in-work training, with over 70% of their staff being students, implying that students are learning skills that are not necessarily demanded by the primary labour market (CEDEFOP, 2014). A better alignment of training incentives with the demand for skills could be achieved by linking the reimbursement of training costs with subsequent employment outcomes.

Another problem is that the number of VET places is determined narrowly to suit the needs in the immediate local area served by the 44 Training Centres (Szakképzési Centrum) with which each VET school is affiliated. Each centre decides VET priorities and coordinates the efficient running of their (3 to 18) affiliated VET schools (Eurofound, 2016a; Eurydice, 2016). Notably, the centres, in consultation with local chambers of commerce, determine the number of training positions within each trade. As a result, the training centres are not taking into account skills shortages in neighbouring areas, even if they can offer higher quality training than elsewhere. Training centres should take a broader geographical view of skills-needs to enhance their ability to respond to labour market needs. Recent measures to improve skills acquisition in VET schools include the establishment of Sectoral Skills Councils and a VET Innovation Council (particularly for preparing skills formation for Industry 4.0).

In general, VET schools perform well in view of the fact that the employment rates of their graduates are above the EU average, partly reflecting the manufacturing sector’s larger share of the economy. Notwithstanding, there is a significant urban-rural divide, reinforcing the strong links between a student’s socio-economic background and educational outcomes present in the education system (OECD, 2016d). As most attendees of three-year vocational schools are from poor rural areas, they face the longest travel times, limiting student choice as to which trade they wish to train for (European Commission, 2017b; Eurydice, 2016). In addition, dropout rates for those in vocational secondary schools are particularly high (accounting for half the dropouts in the school system), with the Northern Hungary region having a particularly high rate (almost 20%) (European Commission, 2017b; Czabán, 2015).

The quality of teaching in VET schools suffers from a lack of specialisation of knowledge and machinery, as they tend to offer a wide range of courses. This hinders their ability to respond to more specialised needs from local companies. Despite the coordinating role of Training Centres, overlap of similar courses can exist between the associated schools (National Office for Vocational Training and Adult Education, 2018). In addition, Hungarian schools are small by international standards (with schools in rural areas being particularly small) (OECD, 2016e). Greater course specialisation in the VET schools would concentrate knowledge and create scope for investment in modern machinery, leading to better trained students with improved employment prospects as their skills correspond more closely to the needs of local firms. Thus, vocational education and training schools should be allowed greater freedom to specialise and adjust courses and curriculums to the needs of the local labour market.

Student choice could be enhanced through mobility programmes. Student dormitories are available, but demand for them is declining due to high costs (Eurydice, 2016). Reducing dormitory fees for students from remote areas could increase their attractiveness. In addition, an internal ‘Erasmus’ type programme could help overcome some of the difficulties faced by rural students by allowing them to choose a specialisation not available in their school for their final year of study.

Tertiary education institutions can also play a larger role in rural development. In general, there has been an increase in their innovation and entrepreneurship activities, and some cooperate with multinational firms (OECD/EU, 2017). However, cooperation with domestic firms is rare and campus business incubators for domestic firms are seldom in place. This could be improved by establishing consultative and collaborative forums with businesses at local and regional levels and the appointment within tertiary education institutions of a senior manager with responsibility for entrepreneurship and innovation dissipation (OECD/EU, 2017).

The gains from tertiary education could be shared better. Access for students from rural areas is hampered by their far higher grade repetition. Moreover, Hungary has the OECD’s second largest gap between urban and rural children in expectations of completing university: 2.8% for rural children as compared to 43.8% for urban children (OECD, 2016e). As a result, a relatively small share of young people in lagging regions having completed, or are enrolled in, tertiary education (OECD, 2017a). Although 21% of students receive a needs-based scholarship (and must also meet the academic criteria to be eligible for being exempt from paying tuition fees), rebalancing scholarship offers toward students from disadvantaged areas could help boost inclusiveness and also regional development (European Commission/EACEA/Eurydice, 2017). This would supplement the new scholarship programme (Road to Higher Education) that support students in risk of dropping out from higher education.

Public work schemes reduce regional employment differences

The main active labour market policy is the Public Works Schemes (PWS). Enrolment in the schemes is being reduced, so by 2020 the level should be a quarter lower than compared with four years earlier. The schemes have limited success in promoting mobility or skills development, as the exit rate to the primary labour market has hovered around 10%-12% (Albert, 2017). The current good employment prospects may boost exit rates, but could also leave the schemes with more difficult-to-employ workers. The former effect seems to dominate as the exit rate has recently risen to 19%.

Rules for public works programmes require that they are non-commercial and of public benefit. Moreover, enrolees receive a wage that is between social benefits and the minimum wage, leading to incomes between EUR 270/month for low-skilled workers and EUR 355/month for high-skilled workers with managerial responsibilities (ETUI, 2016; Kiss, 2015; Ministry of the Interior, 2017). The central-government-financed schemes are mainly project-based and include some targeting of poor rural areas. The schemes are organised and governed by the Ministry of the Interior, while their provision is the responsibility of local authorities, leading to a large regional divergence in outcomes and exit rates (Keller et al, 2016). Similar British and German schemes are designed by special agencies with the involvement of social partners and with private-sector provision (such as SMEs, larger companies, or NGOs) to strengthen the connection between programmes and the primary labour market (Keller et al., 2016).

Local authorities use the schemes to provide services in their area. Particularly in poor rural areas, the schemes reach poor, low-skilled, long-term unemployed workers, many of whom are Roma. This gives the PWS a clear anti-poverty role, mitigating the economic and social consequences of weak local labour markets that leave nearly 1 out of 3 people with severe material deprivation rate (i.e. problems in affording basic needs) (Keller et al., 2016; Social Europe, 2013). The schemes complement the short duration (three months) of unemployment benefits and social welfare benefits that are capped at EUR 70 per month. However, there is a risk that the intensive use of the schemes in poor areas may lead them to become a permanent anti-poverty measure.

The government has tightened criteria for participation in PWS (Box 2.2) and introduced two programmes to increase exit rates. The ‘Pathway to the Labour Market’ programme combines public works with other activation measures (such as hiring subsidies, counselling and job trials) for about 26 000 participants annually. The ‘Training for low-skilled and public works participants’ programme is similar in scale and is targeted at less developed regions with a prioritisation of Roma and disabled workers (Scharle, 2017). However, in 2017 only 15% (28 600) of enrolees in PWS took part in training.

The government should continue to reduce public work schemes and to enhance training of participants and other job seekers in programmes that improve their employability. This could be pursued by enhancing the scope of PWS by widening access to schemes outside a worker's municipality or region in order to promote mobility and on-the-job training opportunities. The latter could also be pursued through wage subsidies to work with NGOs or private firms to enhance links to the primary labour market (OECD, 2016d). Likewise, private-sector involvement in the provision of PWS could secure more relevant labour market experience. To further increase the focus on labour market training and better link the PWS to other ALMP schemes and labour market institutions the responsibility for the PWS programmes could be moved from the Ministry of Interior to ministry responsible for labour affairs. The anti-poverty aspect could remain with the Interior Ministry, helping to focus such efforts on the poorest localities. Exit rates could be bolstered by ensuring that all job vacancies in the national database are published, i.e. removing the right of employers to decide whether their vacant position appears on the Public Employment Service (PES) website. This should be combined with the provision of transport allowances (and other mobility measures) for job seekers finding employment outside their region as is done in several OECD countries (e.g. New Zealand).

Box 2.2. Criteria for participation in Public Works Schemes have been tightened

Criteria for participation in Public Works Schemes have become more targeted, and those deemed more employable (because, for example, of higher qualifications) may now participate only if it is shown they cannot find a job despite sufficient efforts. In addition, those under 25 can now only participate if no other options under the 'Youth Guarantee Scheme' are available. From June 2018 workers can participate only for one year in three, unless they cannot find another job through no fault of their own. In addition, the government will also cover transport costs for long-distance job search (Albert, 2017).

Within the PWS programmes, poor municipalities can apply for investment funding from the central government. Such projects must centre on creating profitable business activities that are adapted to market conditions and integrated into local supply chains to serve local consumer needs without creating competition problems. Moreover, the projects should be based on local traditions or existing agriculture production to develop labour-intensive processing capacities, such as small-scale meat-processing factories or agriculture production (fruits and vegetables, or animal husbandry). In total, more than 100 different activities are supported. Once the investment support ends, the municipalities are obliged to provide market-based employment, for example by creating a business organisation or social co-operative to continue the activity. In early 2018, there were about 300 social co-operatives. A drawback is that the most competent workers tend to gain repeated employment in these projects, creating a lock-in effect of the enrolees with the highest chances of exiting to the primary labour market (Keller et al., 2016).

The long-term viability of many of these small-scale projects is limited, as they lack the capacity to scale up production to integrate into local and national distribution and supply chains or to secure sufficiently low cost to have competitive prices (Keller et al., 2016). Another issue is the lack of strategic planning to secure the economic viability of projects or to move production up the value chain, for example by using Hungarian breeds in meat processing to link into higher value production, such as experience-based gastronomic tourism (see below). Strengthening project viability requires local municipalities to have better project selection incentives through co-financing.

Mobility is reduced by a rigid housing market and poor local roads

A surprisingly rigid housing market is hindering labour mobility. Home ownership is among the highest in Europe, the outcome of privatising public housing in early 1990s and policies to promote home ownership (Figure 2.18; Box 2.3). The latter includes the “Family Housing Allowance” (CSOK) scheme that subsidises the purchase of newly built homes and home refurbishment. Entitlement to this scheme depends on family size, and as it excludes the unemployed and those on public works schemes, the measure does not help the unemployed to move to where job opportunities are better (Scharle, 2017). Ownership is particularly high outside Budapest, limiting the options for those wishing to move to regional urban centres (Hegedüs, 2017; Figure 2.19).

Figure 2.18. Hungary has a small rental market

As a percentage of total population, 2017¹

Box 2.3. The transformation of Budapest housing

Housing in Budapest has changed profoundly over the past three decades. In 1990, the share of municipal rental apartments was 50% (Urban Land Institute, 2013). Today, most housing units are owner-occupied, with 6.4% privately rented apartments and 5.6% municipal rental apartments (Budapest Municipality, 2014). This development reflects that local municipalities have sold their rental apartments to generate income and reduce social problems (Feher et al., 2017). The associated gentrification has led to widespread urban renewal of buildings in the inner city, which together with a cultural regeneration have bolstered foreign tourism demand from Western Europe and America (Kocsis, 2015). Nonetheless, a third of the population lives in less attractive large post-war prefabricated housing estates with a price discount of nearly 40% (Benkö, 2015).

Figure 2.19. The share of rental accommodation is smaller outside Budapest

As a percentage of all housing by settlements' population size, 2015

The rigidities in the housing market include potentially high transaction costs for homeowners. Procedures for registering a property transaction are straightforward, and transaction taxes (at 4%) are moderate compared to other OECD countries. However, a person selling a house (within five years of purchasing it) to buy another must pay capital gains tax (the same rate as for income tax), if a new house is not purchased within one year, although the tax base is reduced over time (National Tax and Customs Administration of Hungary, 2017a and 2017b; Caldera Sanchez and Andrews, 2011). This can add substantially to the cost of relocating, contributing to a low rate of people moving homes each year (Eurostat, 2015). Extending the period for completion of transactions to, for example, two years would reduce uncertainty for homeowners planning to move.

The development of a rental market is inhibited by a tax regime that favours home ownership. From private investors' point of view the rental of residential property is exempt from VAT, although personal income tax (at 15%) or corporation tax (at 9%) must be paid on rental income, compared to only 5% VAT for the purchase of newly built homes until the end of 2019, where after the standard VAT rate will be applied (Ministry for National Economy, 2016; National Tax and Customs Administration of Hungary, 2017c). In comparison, owner-occupied housing is lightly if at all taxed. Property taxation is low (as discussed in the KPI) and imputed income is not taxed under the income tax, while the return on other savings is taxed at 15%.

In 2017, the government introduced a tax-exempt housing allowance to aid mobility. Employers can now give employees tax-free rental subsidies up to a limit of 60% of the minimum wage in the first year (and decreasing in subsequent years) if: a) their residence is more than 60 km away from the workplace; b) or the worker would face a daily public transport commute of more than three hours. In addition, the government gives tax incentives for ‘workers hostels’, but it is unclear how attractive such hostels are for long-term relocation purposes.

Municipalities have few incentives to expand the limited social housing stock as political risks makes it difficult to evict tenants, and 20-25% of tenants default on rent. In addition, rents cover only approximately 30% of the costs of municipal social housing. Some municipalities explicitly exclude poorer tenants by introducing minimum-income levels as an eligibility criterion (Hegedüs, 2017). This can make it difficult for less skilled workers from lagging regions to find housing and employment in more prosperous regions. Rebalancing housing support towards the provision of social housing for those willing to relocate could increase mobility of Hungarian workers.

The effects of the rigid housing market have not been offset by a higher share of workers that commute outside their region of residence as compared with the EU average (Eurofound, 2016b). A factor contributing to this is that despite a modern (largely EU funded) motorway network, the secondary and tertiary road networks are relatively underdeveloped, increasing travel costs and leaving regional population centres poorly connected (Figure 2.20; Eurostat, 2017; OECD, 2016d). As a result, Hungary is not benefitting from potential agglomeration effects, arising from reduced travel time for commuters and goods (Ahrend et al., 2017).

Figure 2.20. There are large regional disparities in Hungary’s infrastructure

Road maintenance is highly centralised, with a state company responsible for state-operated highways and other main roads, secondary roads and tertiary roads (Magyar Közút, 2017; European Union Road Federation, 2017; National Transport Authority Central Office, 2017). In the current EU funding cycle, road and infrastructure building and maintenance are priorities. Increasing funding for inter-city secondary roads would improve connections, particularly by using cost-benefit analysis for determining priorities. In addition, assigning responsibility for local roads to the county level could help overcome coordination problems in improving the road network.

Regions have received large inflows of EU structural funds

EU structural funds are substantial, amounting in the 2014-2020 funding period to nearly a quarter of 2014 GDP. The large inflows of EU structural funds have bolstered infrastructure backbones, such as motorways, to improve regional interconnectivity. They have also been used to bolster social investments and other infrastructures (for example benefiting tourism). Nonetheless, poorer regions have not attained the same growth performance as the faster growing regions, despite earmarking for poor regions (43% of funds come from the European Regional Development Fund) (OECD, 2018c; EU Commission, 2015). For example, the construction of highway links to poorer regions has not been complemented by investment in secondary and tertiary road networks, a prerequisite for stronger regional growth (Salamin, 2015). On the other hand, the EU funds are likely to have prevented further economic divergence. A more general problem is that EU funded investment have had little impact on firm level productivity (Bania et al., 2017). The EU commission itself recognise a risk that the high reliance on EU support creates a culture of dependency, and that funds are not used on productivity increasing investment (European Commission Staff Working Document, 2018).

The EU funds are channelled through seven operational programmes (Government, 2015). Each has a managing authority that is subordinated to the ministries responsible for the relevant development expertise. The authorities are responsible for issuing the specific tenders for which SMEs, local governments, governmental bodies and NGOs can bid. One problem is the lack of competitive tendering which hampers project selection and cost efficiency (Figure 2.21). To strengthen public procurements, the government has introduced (in line with the EU Public Procurement Directive) a central electronic public procurement system with simplified procedures and lower administrative burdens.

Investment projects have been finance-driven rather than by the need to promote local economic development. In addition, corruption reduces economic efficiency. As reported in the last Survey, the European Commission estimates a relatively high risk of corruption in public procurement involving EU structural funds (OECD, 2016d). Moreover, perception of corruption is higher than in most other OECD countries (Figure 2.22). Anti-corruption measures include the 2015 adoption of the National Anti-Corruption Programme. As recommended in the last Survey, this should be complemented with the establishment of a dedicated anti-corruption agency.

The reliance on earmarked EU funding means that communities adapt to the externally set objectives of EU regional policy, rather than setting their own long-term objectives (Hajnal and Kovacs, 2013; Varró and Faragó, 2016). As a result, planning is not based on specific local conditions or at intensifying spatial connections (Radics et al., 2015). Looking ahead, the scope of EU structural funds is likely to be reduced, implying a need for better use of increasingly scarce financial resources. This can be achieved by better integration of projects into local economic development, requiring better planning and cost-benefit tools at the local level. The counties seem well placed for undertaking such strategic planning, particularly if it is combined with co-financing measures.

Figure 2.21. Competition in public procurement is weak

Share of procurements with no call for tender or only one bidder, in per cent, 2016

Figure 2.22. Perception of corruption is high in Hungary

Corruption Perceptions Index 2017 on a scale from 0 (very clean) to 100 (highly corrupt)1

Promoting regional growth

Bringing jobs to less developed areas requires integration with the rest of the country in terms of infrastructure, such as transport, education and links to other economic sectors, to integrate into national and international supply chains (Lux, 2018a). The problems are complex. For example, poor local road networks hinder local accumulation of human and physical capital with a negative impact on the formation of new and well-capitalised local enterprises. As a result, local job opportunities are not created. This leads to emigration of skilled workers, reinforcing the problems of new firm creation (Lux and Fragó, 2018).

The main problem for many of the poorer areas is that their economies used to be based on centrally planned industrialisation with little concern for regional, country-wide or international integration (Lux, 2018b). As their main economic activity disappeared, they were left with a legacy of difficult-to-employ workers, little integration into other economic activities and no apparent comparative advantage (Lux, 2018a). Problems that were further compounded by a retail downsizing, leaving many villages with limited shopping possibilities further reducing their economic viability (Nagy et al., 2016).

This lacklustre performance is somewhat surprising, as regional firm creation and destruction rates are comparatively high, implying a dynamic business environment capable of reallocating resources efficiently (OECD, 2018b). However, new firms grow very slowly, if at all, suggesting a lack of innovation and structural barriers, such as sufficient risk capital. Moreover, relatively few firms are created in rural areas (Salamin, 2015). Since the onset of the international financial crisis, the situation has been made worse by the outmigration of younger and skilled workers, leaving the poorer regions with a relatively older and dependent population. Public policies have tried to address these problems, but the centralised development policies tend to promote selected economic activities or broad infrastructures rather than local and regional linkages, thus not addressing the underlying cause of economic underdevelopment (Lux, 2018b).

For poorer rural areas to overcome these challenges, more effective institutional solutions are needed, either as loose coalitions focussing on specific development tasks (as found around Lake Balaton – a main tourist area) or a more formal structure to develop and implement broader long-term economic growth strategies. Such strategies need to be multi-dimensional, including better training and education, promotion of entrepreneurship, network developments and fostering interlinkages between economic activities – and geared towards the promotion of local economic activities that can be used to integrate into national and international supply chains (Lux and Faragó, 2018). Especially, research co-operation incentives between local and foreign-owned firms should be enhanced.

Tourism as a regional growth driver

Tourism is an economic activity that has scope for bolstering regional development and employment (Nagy et al., 2016). It accounts directly for around 6½ % of GDP and 10% of the workforce, a relatively high share by OECD standards (Figure 2.23). Including indirect contributions, these shares are two-thirds and one-third, respectively, higher (OECD, 2018b). The composition of tourism has changed since the financial crisis, as domestic demand has declined and shifted towards international destinations, while foreign demand has increased from mostly from lower income countries (Figure 2.24) (Statistics Hungary, 2017a). The industry remains concentrated on a relatively few destinations and reliant on traditional forms of tourism, making it difficult to attract new high-valued added visitors.

Compared with other countries, the tourism sector is characterised by a relatively larger share (two-thirds) of small firms (Stacey, 2015). It employs a relatively large share of women and younger workers. Employment in the sector is not particularly flexible: the share of temporary jobs is just above half of the EU average and the share of part-time workers is relatively low (Figure 2.25). Indeed, work tenures are relatively long. Moreover, the sector offers fewer job opportunities for low skilled workers than elsewhere, as their share is only a third of the EU average. This organisation of tourism employment hampers the ability of the sector to adjust supply to seasonal changes in demand. Moreover, labour shortages are an emerging problem. In the summer of 2016, service providers around the popular Lake Balaton had to close down because of insufficient staff levels, reflecting the better working conditions in Austria and Slovakia (Hungarianfreepress, 2016).

Figure 2.23. Employment in tourism

As a percentage of total employment, 2016 or latest available1

Figure 2.24. Tourism trends

Overnight visitors as a percentage of total population

Figure 2.25. Tourism overview

As a percentage of total employment by sector, 2017¹

The sector is increasingly serving visitors from the region

Inbound tourism spending is relatively high and has been growing in importance, but mainly from lower income Eastern European countries, allowing this region to replace higher income western countries (like Germany and Austria) as the most important tourist sources (Figure 2.26). Hungary has had relatively little success in attracting visitors from emerging often high value-added inbound markets, such as China, when measured as shares of inbound tourism. Growth in tourism from these markets is relatively strong, but reflects low bases. These emerging inbound markets are one of the megatrends driving international tourism over the coming decades (OECD, 2018c). So, although foreigners account for half of all overnight stays and nearly 60% of travel spending, the tourism sector has become relatively more dependent on visitors from lower income inbound markets (World Travel and Tourism Council, 2015).

Figure 2.26. Inbound tourism spending is relatively high

As a percentage of GDP, 20161

Tourism is concentrated in Budapest, which generates more than two-thirds of Hungary's international tourism revenue (Table 2.1) (Ratz et al., 2008). The second most important tourism destination is the Lake Balaton (Box 2.4). This distribution reflects the traditional pattern of Hungarian tourism, where activity is concentrated in the highest income areas (Bártfai and Bátfai, 2015; Virag, 2017). So far, tourism's contribution to the development of rural areas has been minor, catering mostly for domestic visitors. Indeed, foreigners account for about 10% of rural tourism, an insufficient number to stem the decline in overnight stays by Hungarians since 2006 (Nagy et al., 2016).

Rank	Tourist region	Number of overnight stays (2016)	Share of overnight stays (2016)
1	Budapest and Central Hungary	11461543	38.5%
2	Lake Balaton	5759700	19.3%
3	Western Transdanubia	3226739	10.8%
4	Northern Hungary	2445776	8.2%
5	Northern Great Plain	2161001	7.3%
6	Southern Great Plain	1913482	6.4%
7	Central Transdanubia	1311959	4.4%
8	Southern Transdanubia	1121227	3.8%
9	Lake Tisza	367343	1.2%

Source: Hungary Statistics.

Box 2.4. The main tourist destinations

The Balaton lake was the first tourist resort developed in Hungary, combining the attractions of the lake’s natural scenery with spa activities. Originally, tourists were serviced by a cottage industry, which in the 1930s developed into mass tourism as demand surged with improved transport connections. Tourism started on the northern shore of the lake that benefitted from thermal activities and wine production. The south shore was developed afterwards with the construction of a new resort with large hotels and landscape gardening. Today, foreigners account for about 37% of all overnight stays (Bártfai and Bátfai, 2015).

Budapest has always attracted the most visitors for business purposes or to enjoy the city's strong cultural heritage. While there is consensus among local authorities on promoting tourism in the city, a similar consensus regarding direction and methods of development is lacking. Frequent shifting of development responsibilities between different governmental bodies has hampered the implementation of tourism development strategies (Ratz et al., 2008). Private-sector initiatives have been more successful with the emergence of "ruin" bars in early 2000s in dilapidated buildings and empty plots and guided tours based on urban experiences (Lugosi et al., 2010; Ratz, 2016). This has led to conflicts with the municipalities' wishes to close the bars to create space for urban regeneration (Kocsis, 2015; Ratz et al., 2008). At the same time, state support has mostly been directed towards accommodation rather than developing new tourism experiences.

The supply of tourism services remains centred on traditional offerings

The tourism sector remains centred on providing traditional tourism services based on cultural heritage, lakeside activities and thermal services. The number of health tourists have increased, benefiting from thermal services and other health services (such as dental and other medical services), accounting for 13.3% of all foreign visitors. There has been little expansion of (often higher value-added) eco- and agro-tourism. Only Budapest has seen the emergence of more modern experience-based tourism services, such as "ruin" bars and guided tours based on the urban environment, which has complemented the city's traditional cultural heritage based attractions. The character of tourism has changed over time, with average stays falling to 2½ nights per guest – among the lowest in Europe (Hungary Statistics, 2017b). These developments have done little to counter the problem of a high degree of seasonality, entailing low average utilisation of tourist infrastructure (Aubert and Csapó, 2006).

The limited development of new tourism services is somewhat surprising, as existing tourism resources and attractions have the potential to develop different and often overlapping aspects of tourism (Káposzta et al., 2016). For example, eco- and active outdoor tourism could exploit the diversified landscape and natural endowment, providing the basis for water- and land-based activities. However, infrastructure for active tourism needs further development: for example, the number of golf courses is similar to Hungary's smaller neighbour Slovenia, but less than 10% of the number found in Austria (Kiss, 2014). Likewise, combining cultural tourism with gastronomy, where notable strengths are a long-established wine industry and four restaurants with Michelin stars in Budapest, could further expand experience-based tourism. Unlocking this potential would enable the tourism sector to become competitive in attracting high-value visitors by offering complex experienced-based tourism services, often combining new and traditional offerings.

Another issue is that the international competitiveness of Hungarian tourism has been declining. Since 2013 Hungary's ranking has dropped 10 places to 49^th out of 141 countries in the World Economic Forum's ranking (WEF, 2017). Strengths are competitive prices, international openness, health and hygiene, and environmental sustainability. Weaknesses are in areas where domestic policies have a direct impact, such as tourist service infrastructure, ICT readiness, human resources and the business environment. Also, endowments that favour tourism, such as natural and cultural resources, have relatively low perceived attractiveness (ranked 88^th and 45^th, respectively) (WEF, 2017). Altering such perceptions is difficult and requires a coherent and comprehensive approach to tourism promotion (see below).

Tourism policies are focussed on expanding tourism infrastructures

Programmes to bolster tourism focus on investing in tourism infrastructure. EU funds will support these programmes. During the EU structural funding period 2007-2013, a tourism programme with seven sub-programmes formed part of the National Tourism Development Strategy for 2005-13. The new 2017 National Tourism Development Concept for 2014-2024 has the very ambitious aim of making Hungary the most popular tourism destination in Europe by developing heritage, cultural, congress, religious, gastronomic, agro/village, eco and active tourism. By 2024, the expected results are that the sector nearly double its share of GDP to 10%, accompanied by a 50% increase in employment and foreign visitors (Kaposzta et al., 2016). The strategy also shifts support from individual attractions to tourism regions with a focus on ensuring high-quality experiences for visitors (Hungarian Tourism Agency, 2017).

The strategy has 12 pillars, including nearly EUR 1 billion in funding for upgrading and developing accommodation outside Budapest, targeting 30 000 rooms in 2 000 hotels. Other financial support includes low-interest loans (up to 30% of the project value) from the Hungarian Development Bank. Other pillars include branding, enhanced professionalism, transparent and reliable regulation, and the development of family-friendly tourism in local communities using digital technologies. The cumulative available financial resources up to 2030 amount to nearly EUR 3 billion, of which two-thirds come from the national budget.

The responsibilities for the formulation and implementation of tourism strategy and policies are spread across government departments. In 2018, the Cabinet Office of the Prime Minister took over from the Ministry for the National Economy the responsibility for tourism policies, including preparing and implementing the development strategies for tourism. The crosscutting aspects of tourism policies requires co-operation with the Ministry of Human Resources for cultural and health aspects; the Ministry of Agriculture for rural tourism and eco-tourism; and the Ministry of Foreign Affairs for visa issues. The National Tourist Office is responsible for promoting tourism domestically and internationally, supported by 85 local destination management organisations (DMO) (OECD, 2016f). The DMOs work with local tourism stakeholders on planning, product development, information management, booking systems, research and marketing, human resource developments and stakeholder co-ordination. In addition, there are nine touristic regions, which do not match any other regional structure or public administration units, each with its own tourism development strategy (Káposzta et al., 2016; Virag, 2017).

The high number of government bodies complicate the coordination and effective implementation of tourism strategies and policies. Moreover, the top-down approach is not effective in identifying local opportunities for tourism developments. A more streamlined approach, i.e. involving fewer bodies, and more adherences to the subsidiarity principle of moving decision making to the lowest possible level would address such concerns.

An important pillar is to develop regional tourism, with two special programmes in place for Lake Balaton and the (wine-growing) Tokay region in the relatively depressed north-east. The focus for developing regional tourism is on tourism infrastructure investments, pursuing a destination-based tourism model. A challenge for developing regional tourism, particularly in poor areas, is that it requires a range of policies, including providing adequate communication infrastructure and upgrading human skills, which necessitates a large degree of coordination across policies and government levels. A problem in this context is that at the local level there is often a lack of cooperation and of a broader regional approach to developing modern experience-based tourism. Moreover, local tourism outfits may often not know or may underestimate local resources, potential attractions or the scope for creating new tourism services, such as using sustainable agriculture to promote eco- and gastronomic tourism (Nagyné, 2013; OECD, 2013).

Tourism promotion plays a relatively small role

In contrast with other countries international tourism promotion plays a relatively small role in Hungary, rendering the success of the tourism strategy dependent on supply-side measures. Even the well-organised Balaton Lake area is lacking in terms of co-ordinated developments, marketing and packaging, integrated and up-to-date information data and appropriate human resources (Bártfai and Bátfai, 2015).

Internationally, many countries, including Austria, France, Japan and Korea, have active international tourism promotion strategies to attract high-spending visitors. These often use social media and creative industries to promote central elements of national tourism strategies, such as culture, lifestyle, ecological and local agriculture produce (Box 2.5.; Lee, 2012; Scheuch, 2012; Murayama, 2012; Fouassier, 2012; OECD, 2014; Richards, 2012; OECD, 2012). Social media is being used to link people, places, knowledge and resources to create and promote tourism experiences. Tourism promotion is complemented by the greater use of digital platforms for the shared economy, such as AirBnB and taxi services. By contrast, public tourism platforms in Hungary remain centred on cultural heritage and destinations, without, for example, exploiting the potential of downloadable apps.

Box 2.5. International branding, promotion strategies and creative industries

International branding strategies are increasingly focussed on creating new tourism experiences:

In Austria a government agency distributes content from the contemporary urban scenes, using traditional and social media as well as international events reach global cultural opinion leaders (OECD, 2014).
In Japan the "islands of art" branding strategy links the Setouchi Islands to creativity to increase attractiveness for visitors and creative workers.
Berlin uses its creative image to attract visitors, including its "soft infrastructure" for creativity (restaurants, bars, street-life, etc.) and with policy actions focussed on using existing creative resources and networks (such as the electronic music scene) (OECD, 2014).

Experience-based tourism can be driven by linking creative industries to places, such as festivals, or more general branding strategies, such as the Cool Britannia and Japan programmes, or national and international networks, such as Creative Tourism New Zealand and the international Creative Tourism Network (OECD, 2014). Another approach to create new experiences is to combine culture with heritage, such as Hamlet performances by English actors at the Danish Castle of Elsinore and the use of the cultural legacy of the Dutch painter Hieronymus Bosch to promote contemporary art in his town of birth – 's-Hertogenbosch.

Promotion often uses new media, such as the Parisian tourist web sites for workshops/courses in creative activities and the use of public spaces for creative activities. Another approach is location-based apps for visitors to use on their smartphones and tablets to access contextual information during visits to complement the rapid growth in peer-to-peer reviews and shared-usage web platforms (OECD, 2017e). Promotion is also increasingly being tailored to market segments that have been identified as potentially attracted to creative tourism experiences through social media or other direct marketing (Richards, 2012). This is the case when major events interact with creative industries to create post-event momentum (OECD, 2017f). A notable example of social media campaigns is Tourism Queensland's "The Best Job in the World" advertising for working in their national park. In addition, tourism promotion is increasingly based on a narrative to link experiences and places, such as in the Nordic countries, where gastronomic experiences are connecting locality and origins of food with the history of the people preparing the food (Ljunggren, 2012).

The common approach in these strategies is that they focus on linking tourism and the creative industries to provided creative tourist experiences through talent development with a focus on clusters and networks. Moreover public intervention aims at engaging creative industries as well as recognising consumers' co-creation role in creative experiences, while connecting branding of new products to destinations using new technologies (OECD, 2014).

These approaches have in common that successful tourism promotion and policies focus on integrating sectors and spatial development rather than targeting individual sectors or areas (Nagy et al., 2016; Haxton, 2015; OECD, 2009).

Important aspects for strategies to promote creative tourism experiences are that the offered services create uniqueness (Kaposzta et al., 2016). This requires linking authenticity with the local environment, while securing quality and consistency through measures like labelling. At the same time, tourist generators (such as restaurants and food producers) need to be repositioned as creative industries to build up locations' vibrancy and attractiveness, supported by linkages (often using social media) between natural endowment, creative industries, cultural heritage, etc. (Richards, 2012).

The shift in demand for tourism services has an impact on the organisation of tourism promotion policies. In countries, such as Australia, Sweden, the United Kingdom and the United States, funding is increasingly based on matching to direct money towards the most promising promotion projects. Another approach is to have funding (partly) based on a fee on tourism activity, such as hotel room taxes, airport or immigration fees (OECD, 2017e). In addition, effective promotion requires cooperation between local destination marketing and national tourism organisations. This calls for strengthening (international) tourist promotion with better targeting of key source markets. An additional avenue could be to further the use of the Visegrad Group Co-operation to promote the region through strategies targeting inbound markets or specific themes, following the example of the Baltic countries (OECD, 2017d).

Attracting high-spending visitors in search of experience-based tourism involves the integration of the many SMEs in the sector. That requires investment in the upskilling of tourism workers, particularly in terms of languages, but also in ICT knowledge to enable the SMEs to link to new information platforms (OECD, 2013; Káposzta et al., 2016). Such investments are particularly important for SMEs in rural areas to link local agriculture, food production and accommodation with broader aspects such as branding and creative industries (OECD, 2014).

Tax policies are used to stimulate tourism demand

The tax system supports tourism demand. The VAT rate on most tourist services is 18% –9 percentage points lower than the standard VAT rate – and5% for restaurant services. The change in relative prices between tourist services and other goods and services creates an uneven playing field between companies in different sectors, diverting resources from their most efficient use. Another growth concern is that the co-existence of several VAT rates increases both private and public administration costs. Thus, the current VAT tax break for tourism-related activities should be removed by taxing them at the standard VAT rate.

Demand for tourist services is further stimulated by the granting of tax reductions for employers that provide their staff with tourism-related fringe benefits through the so-called Szechenyi Recreation Card. Employers receive a tax discount for each card up to EUR 1 500 per year. The card is an electronic voucher, which stimulates accommodation, catering and, to a lesser extent, leisure services. The card was introduced in 2011. In early 2018, more than 24 000 companies had issued 1 ½ million cards with an accumulated value of nearly EUR 310 million (OECD, 2016f). The card has similar negative effects as the preferential VAT rate and should be phased out.

Agriculture as a regional growth driver

Hungary's agriculture sector is restructuring, which has increased average farm size by more than 50% since 2005, as the reliance on crops has increased (supported by the European Common Agriculture Policy) at the expense of more labour-intensive and complex meat production (Póla, 2018). Nonetheless, the average size of farms remains among the smallest in Europe (Figure 2.27). Moreover, most farms have little commercial viability: two-thirds of them consume more than half of their own production. In addition, about 80 per cent of all farms have livestock, reinforcing the picture of an agriculture sector that lacks specialisation and economies of scale. Thus, the agriculture sector's growth potential remains large and the associated restructuring will further reduce the sector’s high employment share (Figure 2.28) (Póla, 2018).

Figure 2.27. Average farm size is amongst the smallest in Europe

Hectare, 20161

Figure 2.28. Agriculture labour force constitute a relatively large share of the labour force

As a percentage of total labour force, 2013¹

A number of policies are hampering the restructuring process. Foreign investors are banned from purchasing agricultural land, slowing the transfer of external expertise and the consolidation into larger production units. Other Eastern European countries have benefitted from inward FDI into their agriculture sectors (Kuijpers and Swinnen, 2016). For example, Danish and Dutch investors in the Polish pork industry has been instrumental in raising the sector's productivity and export performance (Swinnen, Van Herck and Vranken, 2009). Smaller producers are further protected from domestic competitive forces by a special sectoral exemption in the competition law that allows producer cartels if they lead to “reasonable and justifiable income”, which potentially leads to inefficient production (OECD, 2016d). SMEs, including those in the agriculture sector, receive extra protection through a recent “second chance” provision in the competition law whereby a warning is issued rather than imposing a fine for a first-time infringement.

Looking ahead, agricultural employment can be supported by developing more labour-intensive activities or alternative income streams. A common requirement for both paths to become successful is integration into national supply chains, or direct access to markets in larger cities (Póla, 2018). The expansion of labour-intensive forms of agriculture, such as fruits, vegetables and animal husbandry has helped to sustain employment over the past decade. Organic farming is a developing niche, although the sector remains small, involving 3.5% of total agricultural land and some 1 200 farms (Benedek and Balazs, 2015).

Local agricultural production can be further supported through developing short supply chains between producers and consumers by cutting out intermediates, creating direct access. This often requires additional value added activities at the farm level to produce final products. Public investments have backed the development of traditional short supply chains (farmers' markets, market halls, farm shops, etc.) (Benedek and Balazs, 2015). Nonetheless, the development of the local food-production sector remains in an early stage, particularly outside the Budapest region (Benedek and Balazs, 2015).

The slow development of local food production reflects a basic problem of linking rural producers to population centres. Poor rural road infrastructure increases transportation costs. Moreover, small-scale farmers do not fully exploit digitalisation as they typically do not use online and social media to reach their customers (Banedek and Balazs, 2015). Modern internet-based short supply chains, such as internet based shops, box schemes (i.e. subscription to a regular delivery of a box with foodstuff) and buying groups, have emerged in urban areas but cannot be described as established supply chains (Balazs, 2012). Further developing modern short supply chains requires greater use of the possibilities offered by digitalisation (see below).

Developing alternative income streams for farmers is to a large extent linked to rural tourism in the form of agro-tourism. However, rural tourism is only slowly being developed, with about 4 000 hosts providing relatively short stays for just over 100 000 visitors (of which 90% are Hungarians) (Kulcsar, 2012; Nagy et al, 2016). Currently, rural tourism is mostly focussed on accommodation and rarely offers extra local services that link to other local rural activities. Rural tourists have access to few thematic experience packages despite surveys revealing such a demand (Kulcsár, 2015).

Developing more experience-based tourism in rural areas would link activities based on rural traditions (farm stays, gastronomic specialities, connecting with local communities) with nature-based activities (trekking, sledging, animal observation, etc.) as well as traditional tourist services. In addition, high income visitors would also expect access to non-tourist services, such as pharmacies, quality shopping opportunities, well-developed internet services, and transport services. The latter is held back by poor road infrastructure and public transport that are rarely devoted to servicing tourists (Virag, 2017). An additional issue for foreign visitors is a general lack of language skills among hosts in rural areas (Nagy et al., 2016).

Quality agriculture products and traditions can be used to develop rural tourism by creating experiences that combine authenticity, environmental and culture heritage with gastronomic services (Richards, 2012). Such products and traditions are promoted through a government-run programme named Hungarikum (Hungarikum, 2018). However, this effort is not similar to building networks to secure complex value creation as part of domestic and external tourism promotion of traditional products, such as Hungarian long-horned Grey cattle, Mangalica woolly coated pigs and Racka sheep with unusual spiral-shaped horns.

Other countries have used local produce and labelling to create new culinary experiences, including ham from Italy and Spain and beef from Japan and Scotland. Similarly, it is difficult to promote Hungarian wine internationally in the absence of recognised and unified quality labelling, as used in many other European wine-producing countries (Box 2.6). Wine tourism remains centred on traditional winery experiences (visits and tasting) in the cities. In contrast, wine tourism in other countries is increasingly providing additional services, such as using wineries for museums, art galleries, event venues, estate destinations for families or firms, retail outlets, education institutions, and as part of the heritage experience or linking to tourism services outside the region (Virag, 2017; Nagy et al., 2016; Richards, 2012).

Box 2.6. Hungarian Wine

Wine production was introduce by the Romans. The organisation of Hungarian viticulture into the main wine regions dates back to at least the 14^th century. The six wine producing regions are divided into 22 sub-regions, which offer the whole palette of wines, including the internationally renowned sweet wine Tokaji aszú. Traditionally, the main production was red wines, including the kadarka grape (part of the blend in the well-known Bikavér – Bull’s Blood). Today, production has reverted to be mainly white grape-based, including olaszrizling, cserszegi fűszeres and furmint and for one third still based on indigenous grapes (Hegyközségek Nemzeti Tanácsa, 2016a).

Most winemakers are small producers with an average production size of less than 10,000 hl per year, making for a fragmented wine industry (agrárszektor.hu, 2017). The diversity of wine production has complicated collaboration between producers. For example, there are no common brands for international promotion purposes, nor a recognised wine labelling system apart for Tokaj wines. Moreover, the industry's National Wine Strategy is focusing general long-term objectives without clear guidelines or action plans for each wine region (Hegyközségek Nemzeti Tanácsa, 2016b). Indeed, spending on marketing and promotion is too low to create a global reputation (Hegyközségek Nemzeti Tanácsa, 2016b). Consequently, wine export as a share of total production is low and the lack of international recognition is also reflected in very low export prices (Figure 2.29).

Figure 2.29. The export share of wine is relatively low

An OECD survey of main Hungarian winemakers indicates that a main problem is the favouring of quantity over quality in production, slowing a move up the value added chain. This reflects that domestic wine production covers domestic demand. Hence, additional production would have to be exported. In addition, many of the small producers often rely on older and more traditional production techniques as they lack the financial resources to invest in new technology. Poor international presence is also reflected in the low participation rate of Hungarian wine producers in international wine competitions.

Digitalisation as a promoter of regional growth

Digitalisation can contribute to regional growth if the right framework conditions are in place to allow cheap access to high capacity networks. This would include efficient, reliable and widely accessible broadband communication networks and services, data, software and hardware (OECD, 2017d). The lacking use of the possibilities offered by digitalisation in tourism and agriculture reflects insufficient skill levels. That said, digitalisation is also being held back by low fixed and mobile broadband penetration. For mobile broadband this can be explained by relatively high prices (Figure 2.30).

The telecommunications market, however, is becoming more dynamic. Providers are offering higher speeds on fixed broadband. In addition, after several delays a fourth mobile network operator is entering the market. In other countries, such as Australia, Italy, Japan and France, this has disrupted the market status quo, leading to more intense price competition. If this disruption does not appear, competition could be promoted by securing non-discriminatory access for MVNOs (Mobile Virtual Network Operators – resellers of bulk purchases from the network operators) to networks, either through regulation or through the competition law’s provisions against abuse of dominant position as recommended in the last Survey (OECD, 2016d). An additional measure could be to shorten or abolish (as in Finland) the minimum length of mobile phone contracts from the current 24 months for subscriptions that come with a device.

The relatively low use of digitalisation is a general problem for the domestic economy. The shares of the value added and employment from the ICT sectors in the total economy are higher than the OECD average, but this reflects investments by multinationals (OECD, 2017d). In contrast, a relatively large share of companies has no broadband connection or website. Moreover, their use of planning software and cloud computing services is also lower than elsewhere. Households have higher internet usage than companies, but still less than the OECD average. For example, online purchases are much less popular than in most other OECD countries. In addition, relatively few use the Internet to interact with public authorities. The government could stimulate digitalisation by increasing its use of the Internet and expand the relatively low share of ICT graduates, as more than half of all companies report hard-to-fill vacancies in this area, and their share of total employment is lower than the OECD average.

Figure 2.30. Telecommunication prices remain relatively high.

Box 2.7. Main recommendations for promoting regional growth

Key recommendations are bolded

Improving local governance

Increase the autonomy of local authorities to execute projects, such as in tourism that develop their local economies and further incentivise local governments to co-operate.
Introduce co-financing and expand revenue raising powers for local authorities. This should be combined with block grants for poorer municipalities.
Establish a governing board with the full responsibility for economic development of the Budapest agglomeration.
Introduce a single business ID number for interactions with authorities. Minimise interactions with businesses by streamlining local services.
Establish a dedicated anti-corruption agency.
Continue to bolster inclusiveness measures for Roma communities, especially by better integrating Roma children in early childhood education and care.

Boosting regional growth by boosting skills

Allow vocational education and training schools greater freedom to specialise and adjust courses and curriculums to the needs of the local labour market.
Vocational training centres should consider the demand for skills more widely when setting numbers of training places.
Introduce an internal ‘Erasmus’ type programme to enable rural students' access upper secondary education outside their region. Increase scholarships for students from disadvantaged areas.
Continue to reduce public work schemes and to enhance training of participants and other job seekers in programmes that improve their employability.
Enhance the geographical reach of public work schemes. Expand private-sector involvement in provision and the use of wage subsidies. Link the reimbursement of firm’s training costs with employment outcomes.
Enhance research co-operation incentives between local and foreign-owned firms.

Developing agglomerations by boosting mobility

Extend the period for completion of housing transactions to two years, and rebalance social housing support towards those willing to relocate
Assign responsibility for local roads to counties and use cost-benefit analysis for determining investment priorities.

Promoting regional growth

Streamline planning and implementation of tourism strategies to reduce the number of official bodies involved.
Develop a modern international tourism promotion strategy based on branding and on innovative tourism experiences.
Remove tax incentives to stimulate tourism demand, including the preferential VAT rate for tourism services
Enhance knowledge transfer by allowing foreign entry in agriculture.
Support development of short-supply chains by promoting (through labelling) the production of quality agriculture products.

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