Hungary has posted strong growth since the mid 1990s, principally through establishing itself as part of the supply chain for European manufactured goods funded by foreign direct investment (FDI). The international competitiveness needed to become part of the supply chain both in terms of production costs and the wider considerations of investors, has not only been helped by a policy of low corporate taxation but also by other incentives for FDI. In addition, privatisation, regulatory reform and successful policies in bringing down inflation from high levels in the early years of transition have provided investment opportunities and made for a more business-friendly environment. For the foreseeable future, this supply-chain activity is the most viable major route towards generating sufficiently strong growth for catch-up to average living standards in the rest of Europe. Maintaining the international competitiveness necessary for continuing this growth strategy is therefore the key challenge for the authorities. Success on this front requires policies that prevent excessive rises in production costs, for example through wage increases, as well as attention to the business-environment in general. Business assessments will be particularly sensitive to macroeconomic performance in the coming years as Hungary positions itself for entry to the euro area in 2008. And, more generally, how the authorities manage euro entry will have economy-wide effects both in the short and, potentially, the long term. Given a need to bring inflation and government deficits down to meet the criteria for entry, combined with concerns about entering at an optimal exchange rate, this is a difficult task and is the second major policy challenge for the authorities at the present time. Reaping the full benefits of international competitiveness and a successfully managed euro entry is complicated by Hungary’s problem of low labour force participation and highly regionalised labour market. Mobilising untapped labour resources is the third major policy challenge. It requires further attention to the not only to the degree of work-orientation embodied in the taxbenefit system but also the incentives for employers to hire the predominantly low-skilled and often poorly experienced population of non-employed...