Transition may exacerbate regional disparities in Hungary

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Hungary may face challenges in terms of economic disparities due to the ongoing green and digital transition. A new IMF report suggests that policy reforms are urgently needed. Ongoing discussions on cohesion reform focus on the same areas.

Hungary has made significant progress in closing the income gap with the European Union (EU) average. Over the past two decades, the country's per capita income has risen steadily, from 66% of the EU average in 2010 to 76% in 2022. This progress is largely due to Hungary's integration into global value chains, especially in the automotive sector, and an increase in foreign direct investment (FDI), especially in electric vehicle (EV) and battery manufacturing. However, this national development masks a harsh reality: persistent and significant regional income disparities, as highlighted by the International Monetary Fund (IMF).

Despite overall economic growth, regional income disparities remain a significant challenge in Hungary. Budapest, the capital, has outperformed the rest of the country, while the least developed southern and northern regions have experienced low and stagnant growth. These lagging regions continue to underperform the national average in several dimensions, including education, digitalisation, infrastructure and health outcomes.

The IMF analysis uses beta convergence and growth decomposition techniques to identify the drivers of regional disparities and slow income convergence in Hungary. The study examines whether poorer regions are growing faster than richer ones, assuming that if so, these regions will eventually reach similar income levels over time.

Growth decomposition methods – used by IMF – help to understand the factors that contribute to economic growth, such as the skills of the labour force, the quality of governance and infrastructure. The results suggest that differences in productivity and labour market participation have played a prominent role in shaping regional disparities. This is particularly due to the concentration of economic activity in low value-added and carbon-intensive sectors in lagging regions.

Over the last two decades, differences in labour productivity and labour force participation have been the main drivers of regional income disparities in Hungary. Regions with high initial productivity and labour force participation rates, such as Pest and Győr-Moson-Sopron, have grown faster, while regions with lower initial conditions, such as Somogy, Tolna, Bács-Kiskun, Heves, Borsod-Abaúj-Zemplén and Jász-Nagykun-Szolnok, have lagged behind.

The IMF analysis also re-examines the beta convergence model using good governance as a proxy for institutional quality. The results show that good governance (low corruption, advanced public institutions, and impartial public services) has a statistically significant impact on reducing inequality and promoting regional income convergence.

These findings are consistent with the literature suggesting that addressing governance deficits can foster a favourable business environment, stimulate private investment and facilitate economic diversification. The study also highlights that institutional reforms aimed at increasing female labour force participation, migration and R&D investment can accelerate regional income convergence.

The Hungarian economy, like others in Europe and globally, is undergoing a dual digital and green transition, which requires different structural adjustments across regions due to different economic structures and specialisations. Without targeted policy interventions, regional disparities could widen as higher-income regions capitalise on their high knowledge and green intensity while poorer regions fall further behind.

The IMF warns that Hungary risks missing out on the benefits of artificial intelligence (AI) and related digital technologies. The rapid emergence of AI could deepen existing regional disparities in digital access and skills, and further widen the productivity gap between rural and urban areas.

Despite being less exposed to AI-related labour market disruptions, Hungary is not well prepared for the integration and use of AI technologies. Active labour market policies, flexibility and a strong legal framework are crucial to facilitate the AI-driven labour market transition in Hungary.

Hungary is one of the worst performing countries in the EU in terms of AI readiness. Countries such as Estonia, Finland and Luxembourg show a high level of AI readiness, with AI readiness indices around 0.75 and significant employment rates in high-exposure occupations between 60% and 70%. In contrast, countries such as Hungary, Romania and Bulgaria lag behind, with lower AI readiness indices and lower employment shares in high-exposure occupations, indicating room for improvement in adapting to technological change.

The IMF used an aggregate Cobb-Douglas task-based model to assess the economic impact of AI on productivity, integrating key factors such as labour productivity, capital stock, AI exposure, and complementarities between human labour and AI. The model, calibrated for Hungary, suggests that the more developed western and central regions are likely to experience larger productivity gains, potentially widening regional income disparities. However, increased investment in digital infrastructure (e.g. internet access and digital public services) can help reduce income disparities.

Green transition would increase inequalities

The green transition could also exacerbate inequalities, in particular through regional differences in labour market outcomes. National green policies often have different local impacts, depending on the regional heterogeneity of carbon-intensive activities and employment. In Hungary, higher income regions generally have a higher share of green jobs in total employment.

Budapest leads both in terms of economic development and share of green jobs, with a GDP per capita of around 5.0% of the EU-27 average and a share of green jobs of around 3.0%. It is followed by Western Transdanubia with a GDP of around 4.6% and a share of green jobs of around 2.2%. In contrast, regions such as the Northern Great Plain and Southern Transdanubia, with GDP per head well below the EU average, have much lower shares of green jobs, around 0.7-0.8%.

Cohesion reform urgently needed

Deeper and targeted reforms are needed to promote balanced and sustainable income convergence. The IMF suggests that targeted policy interventions are needed to ensure that the benefits of economic growth and the digital and green transitions are more evenly distributed. This includes investing in digital infrastructure and education in lagging regions, and incentivising green private investment. Good governance, including anti-corruption efforts and the quality of public institutions, can increase the dynamism and growth of regional economies.

The European Commission's Cohesion Report, published in the spring, came to similar conclusions, leading to ongoing work on reforming the allocation of territorial development funds within the EU. In Hungary, the Ministry of Public Administration and Territorial Development is also introducing more targeted support structures to address regional disparities.