Prior to 1990, recorded unemployment in Hungary was virtually nonexistent. Productivity levels were low owing to widespread disguised labor hoarding. The economic reforms that accompanied Hungary’s transition to a market economy led to labor shedding and a sharp rise in unemployment (Figure 10.1). Is the level of unemployment indicative of rigidities in the labor market, or is it merely a reflection of other macroeconomic imbalances? Does the recent reduction in these imbalances bode well for labor market developments or are other structural measures needed? What do other indicators suggest regarding labor market rigidity or flexibility in Hungary?1

Prior to 1990, recorded unemployment in Hungary was virtually nonexistent. Productivity levels were low owing to widespread disguised labor hoarding. The economic reforms that accompanied Hungary’s transition to a market economy led to labor shedding and a sharp rise in unemployment (Figure 10.1). Is the level of unemployment indicative of rigidities in the labor market, or is it merely a reflection of other macroeconomic imbalances? Does the recent reduction in these imbalances bode well for labor market developments or are other structural measures needed? What do other indicators suggest regarding labor market rigidity or flexibility in Hungary?1

Figure 10.1.
Figure 10.1.

Unemployment, Vacancies, and Labor Force

(In thousands)

Source: OECD, Statistical Yearbook, 1996.

The Lost Million

The increase in the unemployment rate seriously understates the loss in employment as there has been a dramatic decline in labor force in Hungary since 1990 (Figure 10.1). Between 1990 and 1996, employment declined by as much as 1.5 million in Hungary, while unemployment increased from about 10,000 to about 500,000. What has happened to the lost million? This decline is not explained by any demographic changes in the structure of the population; the population of working age was roughly constant during this period at just over 6 million. The participation rate simply dropped, leading to a 1 million drop in the labor force. Unfortunately, consistent long-run series on the participation rate are not available. However, combining the data from the Labor Force Survey (only available since 1992) with data published by the Central Statistical Office prior to 1992 indicates that the participation rate fell by as much as 10 percentage points between 1990 and 1996.

It is important to understand the reasons behind the sharp fall in the labor force. A decline in the labor force may lead to lower productive capacity in the economy, particularly if the labor market is not flexible. The drop of 1 million in the labor force may have simply made explicit the fact that under central planning, these 1 million people were employed only in theory but not in practice. If so, then one would expect to see the participation rate in Hungary to be now in line with other countries. However, this is not the case (Figure 10.2). The female participation rate in Hungary is low compared with female participation in other OECD countries. More strikingly, the male participation rate is the lowest of the OECD countries.

Figure 10.2.
Figure 10.2.

Participation Rate, 1996

(In percent)

Source: OECD, Employment Outlook, July 1997.

Where are the 1 million people who left the labor force? Table 10.1 is a rough attempt at answering this question. One explanation is, of course, the “discouraged worker” effect. For example, between 1990 and 1996, the number of employed pensioners declined sharply—by about 300,000. However, other forces have also been at work. Besides unemployment benefits (see below), Hungary has an elaborate system of income support schemes, including disability pension, early retirement, parental leave, and sick pay. In addition, since 1991, Hungary has been developing active labor market programs. By 1995, about 20 percent of the working age population (or about 1.3 million people)—up from about 12 percent in 1990—received some kind of income support, including unemployment benefit (Figure 10.3).2 The disability pension is the most common form of income support scheme, with Hungary having the second highest disability pension rate among OECD countries. Between 1990 and 1996, the number of recipients of this benefit increased from about 500,000 to 750,000 (see Chapter V for more details). About one-half of these individuals (those shown in Figure 10.3) were below the pension age. Labor market programs and early retirement have also become increasingly important. However, the number of those on sick pay has marginally declined.

Table 10.1.

Changes in the Composition of the Labor Force, 1990–96

(In millions)

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Source: OECD, Statistical Yearbook of Hungary.
Figure 10.3.
Figure 10.3.

Benefit Recipients by Income Support Scheme

(As a percent of working-age population)

Sources: OECD; and Ministry of Labor.1 Recipients of the child-care allowance and child-care fee.

The old-age pension system has also contributed to the decline in the participation rate in Hungary as can be seen by looking at the participation rate by age and across countries (Table 10.2). Until the pension law was amended in 1996, the mandatory retirement age was 55 for women and 60 for men. Finally, another explanation for the decline in the labor force is the underground economy, which has partly been fueled by the high burden of taxation (see below).

Table 10.2.

Participation Rates by Age, 1995

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Source: OECD.

Composition of Unemployment

Further insights on the causes of unemployment can be derived by looking at its composition. The Ministry of Labor and Central Statistical Office produce detailed data on the composition of unemployment by region, age, skill, and unemployment duration. Information on the unemployment-vacancy ratio (U-V ratio) is also available. What do these statistics tell us about the Hungarian labor market?

There is considerable regional disparity in the incidence of unemployment in Hungary. For example, in April 1997, the average rate of unemployment was 10.8 percent; however, it ranged from 4.9 percent in Budapest to as high as 20 percent in the Szabolcs-Szatmar-Bereg region. The regions with high unemployment tend to be those to the east, while Budapest and western Hungary have consistently enjoyed lower unemployment rates. This tendency is due to the following: first, prior to the transition, the heavy, and now obsolete, industries were based in eastern Hungary; and second, western Hungary with its proximity to Austria, and hence the European Union, has been an important beneficiary of inward investment.

In many European countries that suffer high and persistent unemployment, the rate of unemployment is high among the young, that is, those below 26 years old. This often reflects high labor costs or inadequate vocational or academic qualifications. In Hungary, the incidence of unemployment is also high among the young (Table 10.3); but it is not high by European standards, and it is much lower than, for example, in Belgium, Finland, France, or Italy. However, as in most other OECD countries, unemployment in Hungary is highest among those with low qualifications: nearly 80 percent of the unemployed have less than a secondary school academic or vocational qualification, and about 80 percent are blue collar workers.

Table 10.3.

Distribution of Registered Unemployed by Age Groups

(In percent)

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Source: Ministry of Labor.

The incidence of long-term unemployment in Hungary is rather high: over 50 percent of the unemployed have been out of a job for more than one year—well above the OECD average (Figure 10.4). Long-term unemployment is high among both men and women. There is considerable evidence that the long-term unemployed exert no pressure on wage inflation (Layard, Nickell, and Jackman, 1991). Therefore, long-term unemployment could reduce the potential output of the economy through a higher natural rate of unemployment. In the presence of labor market rigidities such as employment protection legislation, a high minimum wage or high nonwage labor costs, and employers faced with continued uncertainty regarding future orders may refrain from recruitment for long periods of time, causing the persistence of both unemployment and, hence, high long-term unemployment. High fallback wages, for example, unemployment benefits, may also lead to high long-term unemployment through reducing search activity (see below).

Figure 10.4.
Figure 10.4.

Unemployment Twelve Months and Over, 1996

Source: OECD, Employment Outlook, July 1997.

In a typical industrial country, a rise in the U-V ratio would suggest a rise in structural unemployment. However, the U- V ratio in transition economies may not be a good indicator of structural unemployment because of significant structural changes taking place. Moreover, the number of reported vacancies may rise partly because of improving collection and reporting practices. Finally, the official unemployment measure used here is based on registered unemployed, which may be higher than those who are actively seeking work. In any case, the U- V ratio in Hungary, after peaking at over 25 percent in 1992, has gradually declined to about 13 percent in early 1997.

Regulations and Constraints Affecting the Labor Market

To what extent can the high level of unemployment in Hungary be related to labor market rigidities? Below, several institutional elements are discussed, including unemployment benefits, the minimum wage, the wage bargaining system, and the taxation of labor.

Unemployment Benefits

Unemployment benefits are provided through two channels: (1) unemployment insurance, which is financed through compulsory payroll taxes; and (2) means-tested unemployment assistance, which is administered by local authorities who pay 25 percent of the cost. Unemployment insurance is available for a maximum of one year, which is strict by OECD standards, and the replacement rate starts at 100 percent for those earning less than 6,000 forint a month (11 percent of the average wage in April 1997) and gradually falls to about 50 percent for those earning 36,000 forint (69 percent of the average wage) or more a month. In practice, however, the replacement ratio is much lower because of inflation: benefits are based on income during the last year of work. OECD (1997a) estimates that in 1996, the replacement ratio was less than 50 percent. In addition, the real value of the benefit has also been declining (by almost 25 percent during 1994–96). The conditions for receiving this benefit are also fairly strict: job separation must be involuntary (otherwise a waiting period is required); any severance payments are deducted from the benefit; and the individual must have worked for at least the equivalent of one out of the last four years.

Means-tested unemployment assistance is available for a maximum of two years, and is only available to those who are no longer eligible for unemployment insurance and whose per capita household income is less than 80 percent of the minimum old-age pension. The maximum benefit is also 80 percent of the minimum old-age pension, and all other income up to this limit is deducted from the benefit.

Wage Determination and Flexibility

Hungary has a national collective bargaining system whereby each year, discussions aimed at agreement on national wage guidelines are held by the Interest Reconciliation Council (IRC). The latter includes representatives of the trade unions, the employers, and the government. The agreement is nonbinding, but it is viewed as the floor for sectoral or firm level negotiations. Although the IRC agreement is generally applied in the public sector, actual wage increases in the private sector have exceeded IRC recommendation by as much as 5 percentage points. This partly reflects the increasing decentralization of the wage bargaining system (the number of national branch agreements affecting the private sector has declined rapidly in the last few years, and in many branches, wages are now decided directly at the firm level) and the fact that some rapidly expanding sectors of the economy (the financial sector, some sectors where multinational corporations are dominant) are not represented in the IRC.

The IRC also sets the minimum wage level, which the government then accepts and writes into law. About 5 percent of employees in Hungary earn the minimum wage, which is not particularly high by international standards.3 Furthermore, the ratio between the minimum wage and average wages has declined by about 20 percent since 1990.

Nonwage Labor Costs

Nonwage labor costs and, in particular, employer payroll taxes have been widely identified as one of the key reasons behind high unemployment in a number of countries, especially of the young and low-skilled workers (Moghadam, 1994; OECD, 1997b). In Hungary, the tax wedge is high: in 1995, it was about 45 percent, the fourth highest in OECD countries, against an average of about 33 percent (OECD, 1997a).4

Of course, a cut in labor taxes should increase the demand for labor. But would a switch from one form of tax to another—say, a cut in employer taxes and an increase in employee or income taxes—increase employment? From a theoretical perspective, the invariance of incidence proposition (IIP) implies that the replacement of an employer tax by an equal employee tax has no effect on the real economy, that is, the product wage, the consumption wage, and the level of employment will be unaffected (Layard, Nickell, and Jackman, 1991; OECD, 1990). However, this result may not apply, at least in the short run, if there are market imperfections—for instance, if wages are above market clearing values and adjust slowly, or wage negotiators care only about the “insiders.” Even if the IIP holds, differences in tax liability could alter the allocation of resources. For example, employer taxes apply only to the wage, whereas personal or corporate income taxes also apply to income from capital. A switch from income taxes to employer taxes implies an increase in the overall rate of taxation on employment and a decrease in capital taxation, which may lead to a substitution of capital for labor. Similarly, personal income taxes are usually progressive, whereas social security taxes are not. A switch from one to the other could lead to changes in the total tax bill for many individuals and firms and affect labor supply or demand decisions. Empirical studies (OECD, 1990) suggest that even when using a model where the IIP holds in the long run, a cut in employer taxes and an equivalent rise in employee taxes could reduce unemployment (OECD, 1986).

Whatever the theoretical considerations, there is a perception in Hungary that high payroll taxes are an impediment to job creation and a major contributor to the widespread incidence of tax avoidance. Realizing this, the government has been reducing employer social security contributions every year since 1995.

Other Institutional Elements

A detailed analysis of labor market laws and practices (OECD, 1997a) concludes that despite some strict employment protection and working time legislation in Hungary, there is no evidence that these institutional rules are particularly binding. For example, if a firm wants to reduce its workforce by more than 5, it has to go through an elaborate consultation exercise with the unions. However, most firms bypass this requirement by making redundancies in small groups over several months. Similarly, the standard workday is 8 hours and the maximum overtime hours permitted are 144 a year.5 Overtime hours have to be remunerated at between 150 percent and 250 percent of the normal rate depending on when the overtime is done. However, most employers bypass these rules by not specifying working hours or by contracting out their work.


The significant structural changes that have taken place in Hungary during the transition to a fully fledged market economy complicate any assessment of the state of the labor market. Nevertheless, the above discussion supports the following conclusions. The flexibility of the Hungarian labor market has improved in recent years. Indeed, one could say that the Hungarian labor market is in many respects more flexible than several western European markets: in particular, the unemployment insurance system is one of the most strict in OECD countries in terms of providing incentives to search for work. Moreover, the reduction in the minimum wage in relation to average wages in the last few years, the declining weight of public enterprises, and the tightening of the budget constraints on the latter have increased flexibility in wage determination. However, together with the high unemployment rate, certain features of the labor market, such as high youth and long-term unemployment and low participation rates, do point to certain rigidities. One key impediment to job creation is high labor taxation, in particular high employer social security contributions. Although these contributions have been reduced in recent years, they remain high by international standards, and further reductions are necessary. Another key element that may hinder employment growth is the existence of a number of income support schemes that discourage labor market participation. The recent pension reform will certainly help in this area. Nevertheless, a fundamental reform of the disability pension system is also essential.


  • Layard, R., S.J. Nickell, and R. Jackman, 1991, Unemployment, Macroeconomic Performance and the Labour Market (Oxford, United Kingdom: Oxford University Press).

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  • Moghadam, R., 1994, “WWhy Is Unemployment in France So High?IMF Working Paper No. 94/58 (Washington: International Monetary Fund).

  • OECD (1997a), OECD Economic Survey: Hungary (Paris: OECD).

  • OECD (1997b), Job Study Synthesis (Paris: OECD).

  • OECD (1986, 1990,1991, 1996, 1997c), OECD Employment Outlook (Paris: OECD).


For a more detailed analysis of the labor market in Hungary, see OECD (1997a).


There may be some double counting here if individuals receive more than one benefit.


About 8 percent of employees earn the minimum wage in France and 3.5 percent in the United States. The number for Hungary may also include some double counting because of more widespread practice of holding two jobs.


The tax wedge is the sum of employees’ and employers’ social security contributions and personal income tax as a percentage of gross labor costs (gross wages plus employers’ social security contributions).


This limit could be increased to 200–300 hours in collective agreements.

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