wn la Ia l- ~~~~~~ * I, p } a a~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~14 All ~ ~ A LABOR MNARKETS AND SOCIAL POLHCY IN CENTRAL AND EASTERN EUROPE LABOR MARKETS AND SOCIAL POLICY IN CENTRAL AND EASTERN EUROPE- The Tranasition and BeyoIll Edited By Nicholas Bairr Published for the World Bank and che London School of Economics and Political Sciencc OXFORD UNIVERSITY PRESS Oxford UnAimity Pres OXIFORD NEW YORK TORONTO DELHI BOMBAY CALCUTTA MADRAS KARACHI KUALA LUMPUR SINGAPORE HONG KONG 'OKYO NAIROBI DAB ES SALAAM CAPE 'TOWN MELBOURNE AUCKIJAND and atSoeodreueompanies in BERLIN IDADAN i) 1994 The International Bank for Reconstruction and Development / THE WORLD DANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. Published by Oxford University Press, Inc. 200 Madison Avenue, New York, N.Y. 10016 Oxford is a registered trademark of Oxford University Press. All rights reserved, No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photo- copying, recording, or otherwise, wvithout the prior permission of Oxford University Press. The boundaries, colors, denominations, and other information shown on the map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. Manufactured in the United States of America First printing September 1994 The findings, interpretations, and conclusions expressed in this study are entirely those of the authors and should not be attributed in any manner to the World Bank, to its afflliated organizations, or to members of its Board of Executive Directors or the countrics they represent. The cover photograph is of Riga, Latvia. By Curt Carnemark for the World Bank. Library of Cogrss Ca:aMlgig-in-Pub/icaion Data Labor markets and social policy in central and eastern europe: the transition and beyond I edited by Nicholas Barr. p. cm. "Published for the World Bank." Includes bibliographical references and index. ISBN 0-19-520998-2 1. Labor market-Europe, Eastern. Z. Labor market- Central Europe. 3. Europe, Eastern-Social policy. 4. Central Europe-Social policy. S. Europe, Eastern-Economic conditions- 1991-. 6. Central Europe-Economic conditions. 1. Barr, N. A. HDS764.7.A6L.28 1994 331.t2'0947-dcZO 94421174 CIP History does not move at right angles. Nations are bound by their history, geography, and myths. T6 change the direction of events even in a revolutionary period requires tremendous will and perseverance. -Raymond Seitz, U.S. ambassador to the United Kingdom, speaking to the Eurpean Affair Subcom- mittee of the U.S. Se&uate Foretg Relations Commit- tee, April 4, 1993 A Note to the Reader xi Foreword Vddav Haw xiii Preface xv Acknowledgments xvii One Overview: Hopes, Tears, and Transformation 1 Mc-hols BalrandRa J? (V Ha,tbiou The Essence of Reform I A Road Map of the Book 7 The Central Issues 9 The Analytical Framework 20 The Policy Strategy. 23 Early Achievements 24 The Agenda: Priorities and Sequencing 25 Notes 28 Two The Role of Government in a Market Economy 29 Niciolas Barr The Objectives of the Reforms 29 The Argument for Private Markets 32 The Assumptions Necessary for Markets to Be Efficient 34 The Assumptions Necessary for Insurance Markets to Be Efficient 39 The Invisible Hand Theorem 41 Implications for Policy 42 Notes 49 1 vii I 00 NT K N't Part 1. The Political Economy of Transformation Three The Inheritance 53 Sauil E:sin The Intellectual Heritage 56 The General Systemic Inheritance 63 The Systemic Inheritance in the Social Sectors 69 Conclusions 74 Notes 75 Four The Forces Driving Change 77 Nichokas Barr Economic Driving Forces 78 Political Driving Forces 84 Conclusions 87 Notes 88 Five Constraints on Change 89 Nicholas Barr, Sana Gomualka, andlgor Twroee Economic Constraints 90 Political Constraints 95 InstiEutional Constraints 102 Notes 108 Part II. Policy Design and Implementation Six AStrategyforReform 113 Niholas Barr Maintaining Macroeconomic Balance 113 Building Markets tt5 Regulating Market Forces 116 Implementing the Reforms 118 Note 120 I viii I CO N'r P. NTS Seven Labor Markets: Wages and Employment 121 Ric/hardJadwtan atnd v! i-hal Ruonw'i Trp Inheritance 121 The F orces Driving Changc 136 Policy 141 Conclusions: Priorities and Sequencing 157 Notes 159 Eight Labor Markets: Unemployment 160 Daid Frmwell anidRicIardJackmirant . The Inheritance 163 The Forces Driving ChRnge 166 Policy 169 Conclusions: Priorities and Sequencing 188 Notes 191 Nine Income Transfers: Social insurance 192 Nichoks Barr The Inheritance 195 The Forces Driving Change 200 Policy 200 Conclusions: Priorities and Sequencing 220 Notes 223 Ten Income Transfers: Family Support and Poverty Relief 226 S&ndorSrpos The Inheritance 227 The Forces Driving Change 234 Policy 237 Conclusions: Priorities and Sequencing 255 Notes 258 Eleven Education and Training 260 ABrno Laporte andJlian Sch&rier The Inheritance 261 The Forces Driving Change 266 Policy 268 Conclusions: Priorities and Sequencing Z83 Notes 286 *, . , . 1 L[Ii : Twelve Health and Health Care 288 -A/ader S. Preerind Ricard G. A. Feache The Inheritance 288 The Forces Driving Change 297 Policy 300 Conclusions: Priorities and Sequencing 317 Notes 320 Thirteen Driving Change: Politics and Administration" 322 lain GCawfrdandA/an Thompson The Objective: Political Stability 324 Constraints and Potential Pitfalls 325 Driving Change 336 Checking the Outcome 347 Conclusions 349 Notes 351 Glossary 353 References 361 Contributors 375 Index 377 lxii. A Noce to t3he IRoilelr As A WISE PERSON ONCE OBSERVED in another context, tie subject of this boolt Is so large that perhaps a whole library could not h1old all the books that could be written on it. This book is intended as one contribution to a continuing. dialogue. TThe pace of change in the region proceeds unabated, and the time it took to produce the book did not allow it to reflect some of the most recent developments. The authors seek to provide policy tools for those facing the challenges of change and reform, and to encourage further research, analysis, and conversation. The field is ripe for such -efforts. Many other books need to be written: books which have a longer perspective than is possible here, after only the first intense years of reform; books vhich report in more detail on early successes in the region; books which describe-country by country-the benefits of democracy, privatisation, and other fruits of reform; and books which express the voices of the people who are remaking this part of the world. I xi I THE PUBL1CATION OP THIS BOOK marks the fifth anniversary of the full of the daen rigime. It presents the achievements and errors of the post-communist goveniments, and offers suggestions about the way ahead. The main purposes of the reforms, according to the authors, are higher .living standards and increased protection of-individual rights and-freedoms. Labour markets and social policy are central to these aims, not just to protect people from unnecessary suffering but also because they are essential to the productivity of a modern industrialised economy. The authors point particu- larly to the Western European experience. Our countries are part of the same cultural and historical tradition, and the growth of the European Union is likely to assist (if not demand) a measure of convergence. The material aspects of the reforms-higher living standards, freedom to travel, free access to the world's news media-are important.. But they are not the most important. Higher living standards and democracy are only instru- ments; the true aim of the reforms is to empower individual citizens. The first way to do so is to give them knowledge and the freedom to use it. This involves a free press and a good education system. It also involves consciousness-raising-not the least of the tasks of the playwright. Empowerment also has a more technical dimension. It comes very directly from better health. It comes from transferable job skills and well-functioning labour markets which allow people so-me power over their work. It comes from a measure of income security. Though some insecurity is inescapable in a market economy, extreme poverty and insecurity sap a person's identity and destroy his or her freedom. Thesc topics are the subject of this book. They are important t) the material aspects of the reforms. More important, they are central to giving, the citizens of our reforming countries genuine freedom and some control over their own'lives. Ixiii i'oRRogwo) Inii my Ncw Ycar's Addrcss lit the start of the reforms, I said tlint I drearn "of ai reputibc iIndependent, free, aind democratic, of a republic economically prosperous and yet sociully just, In short, of a humane reptblic wvilch serves the 1i1dividullnl and whiCih tlherefore holds thel hope that the Indiviidtdal will servc it in ttirn." I still nYve tlint dreiim. This book vill not brIng it abouti. But, like the booh's autilors, I hopc that it wvill help. 14kr/av Ha*/ Pmg,de, Momh 28, /994 I xiv I Tmis BOOK GREW OUT OF AN IDEA by Ralph W. Harbison, who argued that the large amount of experience gathered by World Bank staff during the early years of reform in Central and Eastern Europe deserved a more systematic and more readable treatment-than is possible in reports which are often confidential, country-specific, and written under intense time pressure. He also dreamed up the idea of getting all the authors together to write simul- caneously, negotiated with the managers of the World Bank Research Support Budget to provide the finance to make that possible, and is the only other person to have read every page of every draft. The book is veCy much a team effort. Its overall shape is the result of long discussions during 1992 between those of the authors then based at the World Bank. The framework vas then extended, with multilateral agreement, into a detailed -outline for each chapter. The central part of the -writing took place during the first two weeks of January 1993, when all the authors got together in a sea-front hotel in Brighton, England, using the first wveek to write the entire book in draft and the second to read and comment on each other's chapters. More important than the time spent at'the keyboard in our respective rooms were.the late night discussions between gagles of authors-World Bank staff, former ministers in and advisers to early reform governments, Western scholars of centrally planned systems, academic economists, political professionals, and civil servants. The teamwork and camaraderie grew out of this time of intense talking and writing, and also because, despite our diverse backgrounds, we all come from either or both of two stables: all the authors are current or former World Bank staff or consultants.(Feachem, Fretwell, Harbison, Laporte, Schweitzer, Sipos, Thompson, Tomes), or current or former staff or graduate students at the London School of Economics and Political Science (Crawford, Gomulka), or both (Barr, Estrin, Jackman, Pre- ker, Rutkowski). (For more on the authors' backgrounds, see the section on -contributors near the end of the book.) Because of this communal writing time, each chapter bears the stamp not only of its author(s), but in all sorts of ways also of all the other authors. The intention is that the book should not be a collection of disparate chapters, but a single, unified volume in which all the parts fit together and reinforce each [xv: PRP.ACH other, Successive drafts were greatly strengthened by comments during tMO extensive review meetings at the World Bank during 1993, comments from many other readers, and a hearing of the Social, Health. and Family Affairs Committee, Sub-Committee on Labour and Employment, of the Council of Europe's Parliamentary Assembly in Paris in November 1993. The book is to be launched at an extenided hearing of that Committee in Prague in October 1994. The book is aimed at policymakers. The intention is not to write an instruction manual-the problems are far too complex for ayronte to attempt such a task-but to offer an analytical tool kit which policymakers can apply to their own country. There is a strong emphasis on practicality because of the growing realisation during the writing that the success of the reforms depends at least as much on administrative and political skills as on policy design. A mouse whose mother lived so far away that he was always too exhausted to talk when he visited her consulted the owl about the problem. After some thought the owlv observed that the problem was the length of the journey and advised the mouse to fly. When the mouse came to try out the policy he realised something was missing and went back to the owl to ask how he should fly. "Ah," came the lofty response, I only'design policy, I do nat implement it." Given our limitations of time and experience, we have not always been able to avoid this mistake. But we have tried. Finally, the reason we thought it important that this book should be wvritten quickly and published early in the transition process is that the development of human resources is fundamental to the aims of the reforms. The achieve- ment of those aims, however, requires technical analysis more than pious sentiments. It was once said of an elderly woman whose quality of life wvas restored by a coronary artery bypass operation that '"he dortors, by treating her body as a mechanism; have restored her humanity." This book treats the political economy of the reforming countries as a mechanism. That, however, should not divert attention from the book's real purpose, which is to assist reforms intended to improve people's daily lives. Nicholas Harr .XVIi Ackinwlle4rgnnents WE HAVE MANY DEBTS. The first is to Gregory K. Ingram, who used his discre- tion as administrator of the World Bank Research Advisory Staff to award the research grant which made it possible for all the authors to get together in Brighton to write simultaneously. Additional financial support from the Sun- tory.Toyota Centre at the London School of Economics and Political Science (IsE) is also gratefully acknowledged, as is the help of the tSE Research Grants and Contracts Office, wvhich made most of the logistical arrangements for the writing period in Brighton. Warm thanks are due to the many people who took time and trouble to comment on successive drafts. A number read and gave detailed comments on the book as a whole: Leszek Balcerowicz, Kemal Dervis, Robert Lie- benthal, Alastair McAuley, Branko Milanovic, Andrew Rogerson, and four anonymous referees. Participants who offered comments on one or more chapters during two review meetings at the World Bank.included Nancy Birdsall, Mary Can- ning, Robert Castadot, Claudio de Moura Castro, Fredrick L. Golladay, Ann Harrison, Stephen Heyneman,. Virginia Jackson, Estelle James, Emmanuel Jimenez, Timothy King, Kathie Krumm, Jane Loos, William McGreevey, Jane Peretz, George Psacharopoulos, Bulent Sayin, Eugene Smolensky, Verdon S. Staines, James Stevens, Zariris Tzannatos, and Christine Wallich. Many other people read and gave detailed comments on one or more chapters: Sue Berryman, Martin Bobak, Maurice X. Boissiere, Antonio Campos, Giovanni Andrea Cornia, John Eaglehart, Guy Ellena, Gaspar Faith, Jane Falkingham, Zsuzsa Ferge, Louise Fox, Elllen Goldstein, James Q. Har- rison, Jeni Klugman, Jon-Eivind Kolberg, Ivar L$demel, Michael Mertaugh, John Micklewright, Michelle Riboud, George Schieber, IsLvin T6th, Anthony Wheeler, and Tatiana Zimakova. Thanks are due also to students doing the graduate course on the Political Economy of Transition at the London School of Economics for spending most of 1993 and early 1994 asking thoroughly awkward questions which helped to debug earlier versions. Invaluable research assistance was given by Barbara Dabrowska (chapters I and 7) and Renee Friedman (chapter 3). I xvii I AC KNOW LEDGNIENTS Zuzana Feachem and Alexander Shakow assisted with and befriended the book from its earliest days. The editorial-production team at the World Bank was led with panache by the indefatigable Alfred Imnhoff, and included most particularly Elizabeth For- syth, Brian Svikhart, and Michael Treadway. They worked unstintingly and uwith unfailing cheerfulness to a very tight schedule on the book's readability and appearance, and on the manifold tasks which lie benteen typescript and the final bound volume. On the other side of the Atlantic, June Jarman, with her customary wondrous and unflappable effticiency, organised the complex logistics of multiple authors in multiple countries. Others at the LSE who helped with logistics and word processing included Deirdre French, Alma Gibbons, Richard Stevens, and Elena Suhir. My final thanks are to my wife, Gill, who has been involved from the start. We travelled together throughout Central and Eastern Europe. While I was meeting with officials, she was going into schools and helping with English lessons, reporting from day one thae the reforms lookcd very different from the school room and bus stop than from the minister's office. Then, in Brighton and subsequently, she was our reality check. She read the entire book in draft, insisted that wve remember the pain of the people in the reform- ing countries, and suggested a tide for chapter 1 wrhich recognised this. We were given many very good ideas. We -were not able to implement all of them-for reasons of space, for lack of expertise -among the authors, or for lack of data. None of those thanked shoukd be implicated in errors and infelicities which remain, forwhich mine is the ultiimatc responsibility. NicholasBarr I xviii I 011 OVERVIEW: HOPES, TEARS, AND TRANSFORMATION NICHOLAS BARR * RALPH W. HARBISON GREAT HOPES FOR THE FUTURE SWEPr AWAY THE OLD ORDER which had stifled growch and crushed frecdom for decades in Central and Eastern Europe (see figure 1-4). After 1989, democracy and free enterprise spread rapidly through- out the region. By early 1994, more than a third of economic output was produced by the private sector, and in a few countries growth had resumed after the output declines of the early transition. Transformation, however, though necessary and desirable, has not come without tears. In December 1989 the main unemployment office in Warsaw paid benefits to five people. A year later, twelve months into their "big bang" reform, more than a million Poles were unemployed, and by mid-1993, 3 million. In Lithuania, output almost halved between 1990 and 1992. Poverty and infant mortality rose throughout the region, and death rates in Russia rose by nearly one-third. Everywvhere, crime increased sharply. The region's peo- ple need no reminder that the early stage of reform is uncertain and painful- in some cases so painful that they look back on the old certainties with some nostalgia. The Essence of Reform The reforms, launched on a vave of optimism, have two central purposes: to raise standards of living, mainly by moving to a Western-style market econ- omy, and to increase individual freedom and protect individual rights. This book is about labor market and social policies during this transformation. The book makes three main arguments. First, enhancing these countries' human resources-making labor markets more effective, improving education and training, reducing unemployment and poverty, and promoting better health- is fundamental to the reforms. Second, the state has a diverse and important role in these four areas. Third, the reforms will fail unless adequate weight is given to the political and administrative dimensions of policy implementa;ion. The Cen"fli.y of Human Capital Effective human resources policies contribute to both the political and the economic success of the reforms. Democracy requires an educated citizenry; education empovers individual choice and so, in a different way, does good [1 1, EYIHERVI K.WH :I(IOBS, TINKS, ANI) TRANSFORMATION Figure 1-1. Central and Eastern EJroe 'I f\ - ; iln .9 ;:/-.X k; Sweden-' - Estonia- BalW sstic Latvia - S Ef._ X :Sea -... -.*X}-' * ~~~LithuaniaN ; I lt~~~~~~ussian Fed.i * V: k ~Belarus ermay - Poland - I rr\ .4 ,. / GCzech Rep. . Ukraine -~~~t -4-, e:<: .0 - ..Re g ˇ\Mo~~~~~ldov - o teng4ffa ova ~-0 ;0 :. - MA7"4 H.ungary, \Slovenia>-%-< Romania iW., ....---Croatia_ \ K V 0 san Bosnia andC\ Rep. *i i,Mllflflo HerWzgovina of' "'~ ''.k.~ 'Yugoslavia '~'~Y' Bulgaria C7 U rl 1 S 1 a . , ; . . . - . ; f f S ............. .. ! . . ...... V..A,an.ef ';' t ' * i, -li . r- . -. Mediterranean £4'~~~~~~ XiTunisiaSe It~~~~~~~~~~ OVERVIEW: IO'ES, TEARS, AND 'lIIANSltORMATION Russian Federation e~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Black Seia,IC a Sea~~~~~~~~~~~~~~~o (VEIRVIEW:0 IIO'PES, T'ARS, AND tl'RANSFORMATION health; effective labor markets are essential to individual freedom. Policy in these areas is also directly linked to the political sustainability of the transition. The whole purpose of the reforms is to improve people's lives, so the reform effort will fail for political as well as economic reasons if it is unable to improve earnings opportunities, provide better education and more effective hlealth services, and increase individual choice. The common economic feature of tiese aspects of human resources is that they have a fairly direct relation to labor productivity and hence to economic growth. Although the causal links are complex and far from completely undcr- stood, the empirical evidence of such a relationship is strong. A study of East Asia argues that, from around 1960, the major distinction between lHong Kong, the Republic of Korea, Singapore, and Taiwan (China)] and most low- income econorries lay in human resource development. In secondary education fur example, East Asian economis . exceeded the average of other developing economies by many multiples. They combined this high level of education with imported technology and returning expatri-. ates to produce rapid productivity growth. [Leipziger and Thomas 1993, pp. 6-71 Health contributes fairly directly to economic growth: It reduces production losses caused by worker illness; it permits the use of natural resources that had been totally or nearly inaccessible because of disease; it increases the enrollment of children in school and makes them better able to learn; and it frees for alternative uses resources that would otherwise have to be spent on treating illness. The economic gains are relatively greater for poor people, who are typically most hand- icapped by ill health and who stand to gain the most from the develop- ment of underutilized natural resources. [World Bank 1993d, pp. 17-181 Effective labor markets, the relief of poverty, and economic growth are also linked in important w-Ays: Rapid and sustainable progress on poverty has been achieved by pursu- ing a strategy that has two equally important elements. The first element is to promote the productive use of the poor's most abundant asset- labor. It calls for policies that harness market incentives, social and political institutions, infrastructure, and technology to that end. The second is to provide basic social services to the poor. Primary health care, family planning, nutrition, and primary education are especially important. iWorld Bank 1990b, p. 31 141 OVERVIEW: HOPES, TEARS, AND TRANSFORMIATION Several arguments apply particularly to the countries of Cenural and Eastern Europe: * Although the general level of schooling in these countries is good, the mix of skills, like the rest of the economy, is seriously distorted. In the absence of appropriate education, training, and, especially, retraining, shortages of the rclevant skills will reduce the effectiveness of the reform's by hindering the supply response: economic growth clearly depends on the ability of firms to hire enough labor with the right skills. The point is worth emphasizing. It took the Federal Rcpublic of Germany until 1955 to return to its prewar level of output, even though most of the necessary human capital-knowledge and skills in banking and credit, in managing competitive industrial firms, and the like-was in place. The greatest need w.as investment inphyjslcapital. The situation in transitional economies is very different: it is not a matter only of physical investment (although those needs are daunting) but also of massive investment in adjusting the knowledge anid skills of the population. * The neglect of human resources in the present can lead to significant costs in the future. Failing to pay adequate attention to relieving poverty can be a false economy, particularly where the result is malnutrition, illness, and crime. Investing too little in public health (for example, in anti-smoking cam- paigns) and in health care leads to premature death. The economic impact is particularly severe when poor health strikes individuals in middle age, because they, as a group, shoulder the greatest family responsibilities. Failure to address their needs condemns whole families to povercy and imposes addi- tional burdens on hard-pressed state budgets. * Some forms. of public investment significantly reduce public costs. Employment services may reduce the average duration of unemployment, and improved methods of finance and administration of health services can pre- vent medical costs from exploding. The scale of potential savings, should not be underestimated: in 1990, pardy as a result of the weil-known problems of uncontrolled medical expenditure, public spending on medical care in the United States, which has essentially a private system, made up the sarne fraction of gross domestic product (GDP) as public spending on the exz,.ri national health service in the United Kingdom. The Continuing Roe of the State The old system in Central and Eastern Europe, in which thc state dominated all economic activity, is not sustainable. The early 1990s were associated rwith a major fall in output in all countries of Central and. Eastern Europe, both those which introduced reform gradually and those which adopted shock therapy. The effects of this decline in output included a sharp fall in tax revenues and, at the same time, rising demands on the social safety net. The resulting fiscal crisis was one of the defining characteristics of the early transi- 15l OVtcRVtW: 1IOPES, I'EARS, ANI 'rRANSFORMATION tion. The second reason why the old system is unsustainable is because the move to private markets by definition implies a reduction in the role of the state, with less emphasis on its role as a public provider and more on its role as an enabler of private activity. The fiscal crisis and the need for profound change in the role of the state give rise to two questions which recur throughout this book: What should be the scale of the state's activities-and hence the level of public spending-on human resources? And what is the appropriate stwtture of those activities; that is,. which activities should remain primarily public and which should become largely or wholly private? It is important to keep these issues logicatlly sepa- rate. The question of scale is largely a matter of budgetary balance. The question of the appropriate mix of public and private activities can be approached either in terms of technical arguments about economic efficiency or in terms of moral values, for example, about the extent of the state's redistributive activities. The technical arguments rest on relatively recent developments in cco- noomic theory, which yield criteria for assessing where markers are likely to work weill and where they are not. These market failure arguments have to be balanced against problems of government failure, vhich are in many ways the root cause of the failure of the old system in Central and Eastem Europe. We return to the topic later in this chapter, and the relevant microeconomic theory is set out at some length in chapter Z. A key conclusion is that, in many of the areas discussed in this book, the conditions necessary for private markets to be efficient are largely absent, and carefully designed state inter- vention can improve matters. Giving the state a major role in developing human capital can therefore be justified for efidey reasons. Most of the policy recommendations derive from these mainly technical considerations. To the limited extent that the recommendations in this book are based on values, much of the discussion is rooted in the experience of Western Europe. In part, this is because the inherited value systems in Cen- tral and Eastern Europe derive from the same culture. Also, and more con- cretely, many of the reforming countries hope eventually to join the European Union; if and when they do, they will have to adhere to its legislation, which embodies those values. As the arguments unfold, it wvill become clear that the technical arguments concerning market failure converge closely with the value systems of the Western European countries. The Role of Politics andAdministarao - Just as important as designing good policy is paying attention to the political structures through which the electorate influences policy and to the administra- tive structures which implement it. The move to a market economy and changes in methods of government require enormous change in both political and administrative institutions. On the administrative side, industries now orga- 161 OVYRVIECW: HO1'1E, TKABS, ANI3 TRANSFORMATION nized as public enterprises need to be privatized. Legal structures rcquire sub- stantial revision, and much new legislation is needed on the conduct of market relations. The administation of income transfers, health care, and education and training needs to be overhauled. These and other changes impose enor- mous strains on a very limited institutional capacity. Reform, at least in the early days, therefore should be as administratively simple as possible. All these reforms, quite apart from their administrative demands, are also intensely political. Indeed the political problem is an integral and wholly unavoidable part of the reforms. As Balcerowicz (l993b) and others have argued, grossly distorted relative prices vere in many ways the essence of the old system of central planning. For reformn to succeed, therefore, the structure of wages and prices must change, which means that some relative wages and prices must fall. Successful reform thus cannot avoid creating losers, at least in the short run, and if the losers are politically powerful, they may be able to block or reverse reform. Part of the problem is that democracy is new to the region, at least since the Second World War. Legislators and civil servants have little experience with democratic politics and yet have to cope with rising unemployment, failing output, increasing demands on declining government revenues, disappointed hopes of rapid increases in standards of living, and, in some countries, growing nationalistic pressures. These are problems which rational policy design alone cannot solve. Political stabilization is just as central to the success of the reforms as economic stabilization. A Road Map of the Book This book draws together the main threads of the first fivc years of experience since the wave of reforms began in 1989. Nearly all the authors have worked in one or, usually, several of the countries in Central and Eastern Europe. The book is ambitious in several ways. First, it covers a wide range of countries. TMis is deliberate. The natiors of Central and Eastern Europe differ in their history, culture, and economic and social structure, but they have important characteristics in common: they share an inheritance of central planning and totalitarian government, their reforms have the same main objectives, and they have already made the same fundamental decisions: to, move to a market system and to political liberalization. As a result, many of the problems are strategic and transcend national boundaries. These problems are the main focus of the book. Second, the book's thematic coverage is broad in that we look at all the major aspects of human resources policy. The linkages among them are so strong and the problems in many ways so similar that a unified treatment strengthens the argument. Third, the book was written early in the transition process. This, again, is deliberate. The book is not intended to be a definitive historical account; rather, it is fonvard looking and should therefore 171 OVERVIEW: 1IO1'KS, TEARS, AND TRANSPORMATrON be timely. A few years from now, it will be intercsting to examine empirically what has happened across the broad range of social policy. In other respects, the book is more modest. There is relativety little discus- sion of central versus local issues, partly because these issues transcend the social sectors and partly because space is limited. Nor is there much discus- sion of cthnic and regional issues; data on these issues are scarce, and none of the authors has the expertise to approach such a difficult area. The major purpose of the book is to help policymakers in the countries of the region. It attempts to draw out a policy strategy deriving both from the decisions,already made about the overall direction of the reforms and from the nature of the transition itself. This is not to deny the inmportance of country- specific policy choices. As explained in chapter 6, the proposed strategy is general, but its application will vary from country to country in the light of their different policy objectives and differendy evolving political and economic regimes. Thus the book is not an operational manual. It makes significant demands on its readers: policymakers in the region know much better than the authors which features of the transition apply to their countries and with what force; it is they who must judge the detailed applicability of the book's content to their own countries. The book makes demands also in that some parts are more relevant to some readers than others. Western economists, for example, might skip the exposition of economic theory; readers in Central and Eastern Europe might skip the discussion of the;inheritance from the old system. The needs of policymakers determine the shape of the book. The first two chapters set the scene. Chapter 2, unlike the rest of the book, is completely theoretical. It discusses the role of government in a market economy and sets out the economic theory relevant to decisions about the dividing line between the market and the state: it discusses why the state might intervene (and why it should not) and how it could do so. The analysis of the policy chapters depends crucially on that discussion. which persons not conversant with recent microeconomic theory should read, but which others may skip. The next three chapters are concerned with the economic and political nature of the transition. Chapter, 3 summarizes relevant aspects of the inheri- tance from the old regime. Chapter 4 discusses the major economic and political forces driving change, particularly those released by market forces. Chapter 5 describes the major constraints which policy design must take into account. The second part of the book discusses policy design and implementation in different parts of the social sectors. Chapter 6 links the two parts of the book by drawing on the earlier chapters to set out a policy strategy which shapes all the subsequent recommendations. The discussion of labor markets in chap- ters 7 and 8 looks at wages and Employment and at policies to ameliorate [ 8 OVRFIVIEW: ElOgPS, lTKAItS, ANI) TrANSP1OlRMATriON unemployment. The next two chapters analyze income transfers: chaptcr 9 concentrates on social insurance, and chaipter 10 an family support and pov- erty relief. Cliapters II and 12 discuss more direct forms of investment in human capital: (a) education and training and (b) health and healthi care. Chapters 7 to 12 have a common structure. Each chapter begins by discussing the inheritance and, in particular, the strengths of the old system (which should be prcserved), its weaknesses- (which the reforms are intended to improve), and perennial problems (vhich are likely to remain however suc- cessful the reforms). Not all aspects of the oid system were bad, nor will the reforms solve all problems. The second part of each chapter discusses the forces driving change and, in particular, the political imperatives and the economic effects of the move to a market economy. Although these shaping forces share elements in common, they emerge in different ways in different chapters. The third part of each chapter discusses the pros and cons of the various policy options. The last section summarizes the main conclusions in the form of fairly specific recommendations intended to answer a hypothetical request from a minister as to the practical policy actions he or she should take. Again, policy design is only part of the story. Policy must also be imple- mented, and even the best-designed and most effectively administered system will founder if it lacks political support. The administrative and political aspects of implementation specific to, say, education or health care are dis- cussed in the chapters devoted to those topics. Chapter 13 considers broader aspects of implementation, such as the machinery of government -and the quality of public administration. Although these issues far transcend the social sectors, they have a crucial bearing on the success of social sector reform. The rest of this chapter offers a microcosm of the book. The next section discusses a series of central themes. Succeeding sections set out the book's central analytical framework, the resulting policy strategy, and some of the early achievements of the reforms. The final section suggests an agenda for policy action. Readers in a hurry can read this chapter alone or in combination with the concluding section (or the whole) of any of the chapters on policy or with chapter 6 plus any of the policy chapters. Te Central Issues Three issues pervade the book and shape its recommendations. Alongside the implementation issues already mentioned are tvo pillars of the economic reforms. The first is stabilization, which consists of controlling public expendi- ture and containing inflation, mainly through macroeconomic policy. The second is restructuring, which consists of introducing private markets (with consequent changes in the profile of industrial production) and designing the legislation and regulation necessary to support thern. 1 9 1 OVHiotttW: cI0I'ut5 T'RAIINS, ANI) TI'liANHIPORMATION S& bif/izwoion ,it/l the i&nat CtGsis A centrall fact of the transition hais been the decline In output In all tie reforming economlics. As table 1-1 shows, outpuit fell by differing amounts In different countries between 1990 and 1992, but the decline was substantial In every case. Among the countries where reform was wiell Ltider way, the smallest declines, of 17 to 18 percent aver the three-year period, were In Hungary and Poland, while the largest decline, In Litliuania, was nearly 50 percent.' T'hc avcrage fall in olutput was tibout II percent a ycar. For reasons discussed in chapter 4, these figures should be treated witl caution. N-ev ertheless, output clearly fell far nmore than it has ever fallen in the induistrial West since the Second World War. Alongside the decline in output were major problems of inflation, which wvas lowest in Czechoslovakia, where prices nearly doubled between 1990 and 1992, and highest in Lithuania, where something wvhich at the start of the reforms cost 10 litas cost 1,750 litas by thle end of 1992. WHY IS STABiLIZATION NECESARY? One of the major purposes of stabilization is to prevent inflation from continuing on anything like this scale. An obvious question (and one often asked by citizens in Central and Eastern Europe and elsewhere) is why inflation matters so much. The answer is simple: inflation, beyond a relatively low level, tends to accelerate rapidly, and high rates of inflation have disastrous effects: Accounting for and monitoring economic activity through the measure of money become impossible. A firm's accounts bear no relationship to its output or its profitability, nor have public agencies c'ny mechanism to control or even measure their expenditure. Borrowing and lending become impossible, unless people are allowed to use foreign. currencies. Although inflation often encour- ages a flight into real assets, this is not much comfort in the former socialist countries because capital markets, including markets in housing, are poorly developed and pose enormous risks. Private saving becomes a high-risk activity. For these reasons, inflation tends to reduce saving and to create consider- - able uncertainty. The former harms domestic investment, and the latter reduces investment from abroad, thus preventing or at least hindering eco- nomic growth. Thus inflation can have major ill effects on output. e The fiscal effects are also deleterious. In many countries, because of lags in the collection of taxes, inflation leads to a sharp fall in tax revenues, unbalancing the budget and generating further inflation. - Because inflation destabilizes values, its redistributive effects are blatantly unjust. Public sector wages are seriously eroded and can become worthless. Partly in consequence, corruption becomes rampant. Profiteers prosper, while individuals wtho work, thereby contributing to output- face declining standards of living and see the value of their savings evaporate. Citizens resent govern- I 01 I OVICItVIKW: HOI'ES, T'AIt, AND) 1ItANSItORMA'1'ION Table I -1. Otqnat CWrowI,, Isf/adoti, aid Unemrplayrneuw is Vadoas Countries in CeArea/ aid Eastemr Eitrope, 1990-92 (percent) - Anlrig mth Couttfty amelyear of GDP ^uflatiotm Unemployment 1990 -3.0 4.5 0,0 1991 -1.0 83,5 0.0 1992 -10.0 969.6 0.5 1990 -12.0 30.0 1.0 1991 -23.0 338.0 8.( 1992 -7.7 9 1.0 15.0 Crchoslocwlia 1990 -3,0 10.0 1.0 1991 -15.9 57.7 6.6 1992 -8.0 10.8 5.1 fitmia 1990 -3.6 17.2 0.0 1991 -1 1.8 210.6 0.5 1992 -3 1.6 1,069.3 1.6 HW gr 1990 -3.3 28.1- -1.6 1991 -9.9 33.4 8.0 1992 -4.4 -23.1 12.2 at via 1990 -3.5 1-0.5 0.0 1991 -B.3 262.4 1.0 1992 -32.9 958.1 Z.5 Lithuania 1990 -5.0 376.2 0.0 1991 -13.4 224.7 0.3 1992 -35.0 1,020.5 1.1 1990 -11.9 585.8 6.3 1991 -7.6 70.3 12.0 1992 1.0 43.0 13.6 Romani 1990 -7.4 4.2 0.0 1991 - 15.1 161.0 3.0 1992 -15.4 210.7 S.I Russian Federation 1990 0.4 5.6 0.0 1991 -9.0 92.7 0.7 1992 -18.5 1,354.0 1.4 *Uivwh 1990 -3.0 4.2 0.0 1991 -11.9 91.2 0.0 1992 -14.0 1,445.3 0.3 Note: The data should be treated with considerable caution, as broad orders of magnitude rather than cxact numbers, both because the construction of cross-country comparative data raises well-known problems and because, for the reasons discussed in chapter 4, measurement problems are greatly exaggerated during thc early transition. a. The unweighted averagc decline in output over the three-year pcriod for the countries covered was 29.6 percent, or an average fall of about I t percent a year. b. Annual percentage change in tha consumer pricc index. The unurighted avcrage incrcase in prices over the threc-yea period for the countries covcred was 3,347 percent. Excluding Lithuania, the average increasc in prices over the thrci-yesr period was 1,959 percent, for an average annual rate of inflation of about 175 percent. c. Annualavemgc. Somne: Unpublished data from the linternational Monetary Fund and World Bank. OVERVIEW:-HOIrRS, TEARS, AND TRANSVORMATION ments which allow such things to happen. These consequences have been seen over and over again, for instance in Latin America. Inflation destroys the capacity of a market economy to allocate goods in any rational way or to create a politically tolerable distribution of income. It thus defeats the central objectives of the reforms. In the short term, stabilization policy must be able to prevent runaway inflation. This requires that real incomes be kept broadly in line with output, and if output falls, as shown in table i-i, real incomes must fail by roughly the same amount. CHOICES AND TRADEOFFS. Given the scale of the decline in output, stabiliza- tion makes hard choices inescapable. If resources (labor, machinery, raw % materials, and land) are used for one purpose, they cannot be used for another. This is always true, but the problem is even more acute when output is falling. Policymalcers must therefore decide how to divide output between different uses at a particular point in time (known as static efficiency) and how to use resources to make output grow faster (dynamic efficiency), for instance by spending less on consumption and more on investment. Choices have to be made in at least three dimensions: Ckoices been altemative activities. Within the social sectors this means that what is spent on medical services cannot be spent on family support, what is spent on pensions cannot be spent on education, and what is spent on hospital equipment cannot be spent on primary health care. Exactly the same choices arise benveen the social sectors and other areas: what is spent on human capital cannot be used for investment in roads or telecommunications. Choices betrween pub/k spending and pHoare spendi g. Higher government spending generally requires higher tawes, which implies less private spending. * Choices betree prent consumption and fwr consmption. Higher consump- tion today means less investment today, hence slower growth in output and lower consumption in the future. The central tradeoff concerns the competing claims of higher standards of living in the present (a source of strong short-term political pressure); higher standards of living in the future (a central objective of the reforms), which depend on past and current investment in human and physical capital; and fiscal restraint, which contains the size of the public sector so as to allow room for the developing private sector. In addition, most of Central and Eastern Europe must satisfy the claims of debt repayment. If output is rising, it is possible to satisfy all four sets of claims simul- tanec.usly. This is, by definition, impossible if output is falling. Consumption can then be higher only if investment is lower; this puts present living stan dards into direct conflict with future living standards. Increased government spending (other than through borrowing abroad) can be financed through 11 1 OVERVIEW: HOPES, TEARS, AND TRANSFORMATION increased taxation, through domestic borrowing, or through an expanded money supply. Each of .hese methods has problems: excessive taxation reduces the incentive to work or to create new jobs; excessive domestic borrowing, by pushing up interest rates, reduces private investment and harms economic growth; monetary expansion creates inflationary pressures and may harm international competitiveness. All these solutions, therefore, conflict with the need to raise standards of living in the present, or in the future, or both. Thus, if output is falling, real incomes must fall, and one of the most difficult decisions facing govcrnments in Central and Eastern Europe is what to cut and by how much. Deciding how to resolve competing claims for resources by the ministries responsible-for different parts of the social sectors, in principle a matter of economic efficiency, is also one of the major political tasks of government. Restrundg: The Market and the State The economies. which emerged from the communist era were very different from those of the industrial West. WvH tS RESTRUCTURING NEcEssARY? In the communist era, - The structure of ownership was heavily weighted toward the state. * The structure of production was strongly biased toward heavy industry and agriculture. * The structure of trade was distorted, particularly by excessive specialization and the consequent giganticism of production units (a small number of plants in Hungary, for example, produced buses for much of the communist world). These structural imbalances were in part the cause of the declining, and eventually negative, rates of growth discussed in chapter 3. If economic growth is to resume, restructuring is required to correct these imbalances. Twvo changes are particularly important for the social sectors: greater power, but also more responsibility for the individual, and a new balance betveen the market and the state. CHANGING ROLES OF THE INDIVIDUAL AND THE STrATE. The reforms require a fundamental change in the responsibilities of the state, the enterprise, and the individual. Under the old system, the economic functions of the state and tic enterprise overlapped, and the two together were largely responsible for satis- fying the needs of workers. The state financed various benefits for individuals, both directly and through subsidies for basic commodities. Considerable state subsidies were also extended to enterprises, often in the form of soft budget constraints, whereby enterprises received nearly automatic financing of any deficits they incuired. Enterprises offered job security and paid wvages which 1131 OVERVIFW: HOPES, TEARS, AND TRANSFORMATION had little to do with market forces; they also administered many benefits, such as family allowances, through workers' pay packets and, in some countries, also through direct provision of in-kind benefits such as housing and preschool education. In a market economy, enterprises are responsible for ensuring that produc- tion is efficient and for making profits which, in the long run, protect existing jobs and create new onies. Enterprise losses are not subsidized out of the state budget. Individuals, with the assistance of the state, have the main responsi- bility for finding jobs or pursuing other earnings opportunities. Reduced Job security is an unavoidable price to pay for increased efficiency and higher standards of living. An effcctive labor market concentrates the costs of adjust- ment on a subset of the labor force: the unemployed. The state offsets this concentrated burden, at least in part, by redistributing income from the employed to the unemployed and other groups such as the elderly. In addition to its distributional role, the state helps the market run efficiently and comple- ments or replaces market activity where private markets are inefficient or nonexistent. Two key principles follow from these new responsibilities: a Wages and employment are largely determined by the market in the intcr- ests of efficiency. Although the quest for efficiency is to some cxtent tem- pered by other objectives (for instance, those specified in the various con- venrtions of the International Labour Organisation), the major purpose of the labor market is to assist the movement of workers into productive jobs.Z * The system of income transfers is the main method for pursuing distribu- tional objectives, including protecting individuals and families from poverty. These twin targets-using labor efficiently and treating people equitably- require twin instruments. THE DIVIDING LINE BETWEEN THE SrATE AND TME MA . The dividing line between the state and the market is in many ways the central issue in the process of economic reform. The analysis in chapter 2 establishes the enor- mous advantages which private markets have in large parts of the economy and thus the need for large-scale privatization of state-run enterprises. But there are excepeions to the rule that private is better. The former socialist countries have learned the hard way that one simple solution, central plan- ning, does not work. It is a fundamental error, however, to assume that the answer is the other simple solution, private markets always and everywhere. A more balanced message is that state intervention is much less frequent in a market economy than under the old regime in Central and Eastern Europe and that such intervention as does occur is often different from the traditional intervention in communist systems, which consisted of public production and allocation. -l 14 OVERVIEW: HOPES, TEARS, AND TRANSFORMATION The following points about the scope and nature of government interven- tion are stressed throughout the book: The distinction beteen the scale of and the structure of the state's activities is important: a budgetary crisis is not per se justification for privatiza- tion. That decision is more properly made on structural grounds. By the same- token, commodities which the private sector produces efficiently should con- tinue to be produced there, even if the state is running a budgetary surplus. Another crucial distinction is bewveen the different types of government intervention. Intervention does not necessarily mean public organization of an activity. It can consist of regulation of private activity (for example, consumer protection in areas such as drug testing, wherc people have insufficient infor- mation to protect themselves). It can take the form of partial public funding in ways which establish an appropriate incentive structure for private activity (for instance, tax incentives which encourage contributions to private pensions). It can take the form of public funding of privately produced goods (for example, free prescription drugs) or privately produced services (for example, vouchers for education). Finally, it can take the form of income transfers to certain groups of people, such as the unemployed. T Technical problems with private markets may justify government inter- vention, but do not automatically justify it. Governmcnt intervention is appro- priate where two conditions hold: there is a market imperfection of some sort, and the situation with intervention is more efficient than the situation without it. Table 1-2 indicates the range of government spending and its major compo- nents across several groups of countries: the industrial countries, the better-off countries of Latin America, some of the high-performing Asian economies, and Central and Eastern Europe. The choice of economies was largely deter- mined by the availability of data, which have severe limitations. They are not always strictly comparable across economies, and they relate only to antral government and therefore represent a lower bound for total public expendi- ture. At the low end of the range (Argentina, Japan, Mexico, and Thailand), total central government spending is between 15 and 20 percent of GDP; the top of the range, the Central and Eastern European economies excepted, is between 40 and 50 percent (France and Italy). The high levels of total central government spending in Central and Eastern Europe present a striking con- trast. The low figure for Yugoslavia is not an accurate indicator of total public spending because most social spending took place at the subnational level. Certain components of social spending in some of the other economies in the region-for instance, health and education spending in Czechoslovakia- showv low levels of central government spending for the same reason. Social spending (social security, welfare, housing, health, and education) in the highly industrialized economies ranged from just below half of central government spending in Canada, the United Kingdom, and the United States to more than two-thirds in France and Germany. These figures, however, do 1 151 Table 1-2. Components of Cawral Government Spending in Various &onomies, 1991 Peereztage of total expendi.urr Total c'pendkwture CDpper - Soc;is.zurity, a as percentage capita (1990 E-oagmy weafmrr, hoasng Health me cation Defense 0:/ar ofCDP dot/ks) OECD wnmbas Canada 36.4 5.2 2.9 7.4 48.1 23.9 20,440 France 46.4 15.3 6.9 6.3 25.1 43.7 20.380 o Germany, Fed. Rep. oPf 48.9 18.1 0.6 8.3 24.1 32.5 23,650 Italy - - - - 49.6 18,250 _ Japan - 15.6 26,930 United Kingdom 31.8 13.3 3.2 11.1 40.6 38.2 16,550 United States 28.7 13.8 1.7 21.6 34.2 25.3 22,240 la- tin dmnkai , c Argentina 39.4 3.0 9.9 9.9 37.8 13.1 2.790 0 Brazil 25.5 6.7 3.1 3.5 61.2 35.1 23940 Mexico 13.0 1.9 13.9 2.4 68.8 18.1 3,030 Hing-pe*tmiNg - dsin cwnomierc. Singapore 8.2 4.6 19.9 24.0 43.3 22.1 14,Z10 Thailand 5.9 7.4 20.2 17.1 49.4 15.5 1,570 Cejral and&uem &upe z Bulgaria 23.9 4.8 6.2 5.6 59.5 77.3 1.840 , Czechoslovakia 27.0 0.4 1.9 7.1 63.6 55.6 2,470 - Elungary 35.3 7.9 3.3 3.6 49.9 54.7 2,7Z0 Poland 20.5 16.1 14.3 7.5 41.6 29.3 1,790 z Romania. 26.6 9.2 10.0 10.3 43.9 37.0 . 1,390 Russian Federationb 24.5 1.2 5.1 19.1 50.1 26.8 3,220 0 Yugoslavia 6.0 0.0 0.0 53.4 40.6 21.0 * Not availabfc. Nw.: The data should be intcrprctcd with carc. First, because of differences in coverage, the individual components of central government spending may not be strictly comparablic across countrics. Second, the data do not cover expenditurc by statc. provincial, and local govcrnments; this may scriously understate or z distort the statistical portrayal of howv resources are allocated for the various purposes, cspecially in countries where subsidiary levels of governmenr are responsible for many social services. For further discussion of the construction and limitations of the data, sec the technical notes in World Bank 1993d. a. Prior to unification. b. For 1992. Data includc extrabudgetary funds (Employment Fund, Social Insurance Fund, Pension Fund, Social Protection Fund) but exclude all local government expenditures, which constitutc about 80 percent of spcnding in the health and cducation sectors. Souern: World Bank 1993d, tablcs I, I1; for the Russian Fcderation, unpublished data from the Ministry of Finance; for Poland, World Bank data, and Poland, Ministry of Finance 1992, p. t39. OVERVIEW: IIOPIE S, TEARS, AND TRANSFORMATION not represent total governmcnt spending on social services: in Canada, the bulk of health care and education is financed, respectively, at the provincial or the municipal level; education in the United States is financed mostly at the state and local levels; education in the United Kingdom was largely financed at the local level when these data were collected, although reforms have since shifted a larger share of expenditure to the central government. Even the high figure for total central government spending in Germany is biased downnward because most education spending takes place at the level of the Luader. In the Latin American economies shown, social spending is again a significant frac- tion of central government spending, but, with the exception of Brazil, the shares are lower than in most of the major industrial economies. In the two high-performing Asian economies, social spending, particularly in the category -which includes social security, is a significantly smaller fraction of central spending than in the industrial economies shown. What is significant here is the high level of spending on education, alluded to above, which in Singapore made up nearly one-fifth of central government spending. What is noteworthy about social spending in Central and Eastern Europe is that it does not differ greatly as a proportion of oDP from social spending in the highly industrialized economies, whose per capita incomes are much higher. Social spending by all levels of government in all the industrial countries of die Organization for Economic Cooperation and Development (oEcD) is shown in table 1-3. In the countries less oriented toward the welfare state. (Australia, Japan, Portugal, and the United States), public social spending in 1990 ranged from 16 to 20 percent of oDP; at the top end (the Netherlands and Scandinavia), it was 35 percent or more. Public social spending in Ger- many was exactly the OECD average of 27.5 percent'of GDP. Historically, the state has been the dominant spender on income transfers and education in Europe for most of the twentieth century and certainly since the Second World War. Public spending on health in the oEcD countries rose consistently as a proportion of total health spending from 1960 onward, reaching an average of almost 75 percent in 1990 (for the historical data see OECD 1988a, table 1, 1990b, tables 1, 2). The overall pattern was one of rapid growth in spending as a percentage of GDP during the 1960s and 1970s, folowved by a much slower rate of growth during the 1980s. These figures may represent a peak. A major debate about the welfare state is now under way in Western Europe. Prolonged high unemployment and the prospect of growing numbers of pcnsioners have led Western governments to look for savings. Reforms in the United Kingdom in the late 1980s made marginal reductions in the size of the state pension, phased in for persons retiring after 2000. The United States legislated a phased increase in the age of retirement. Searching scrutiny of expenditure and much public discussion led Germany to reduce some benefits in 1993 (unemployment benefits, for example, were reduced by 3 percent). As the editor of the newspaper Die Zeit j 17 I OVERVIRW: iOPES, TEARS, AND TRANSFORMATION Table 1-3. PiblicExpendi/nrt on he Social Sctois na Perretutage of GDP in OECD Alemiber Counties, 1990 Income tranfen Non-aged Aged Country popklatior populatdoyb Health Educaioc rot'al Australia 3.6 3.8 .5.6 5.td 18.1 Austria 4.0 15.0 5.6 5.5 0.0 Belgium 8.7 9.7 6.8 5.0 30.2 Canada 7.6 4.4 6.9 6.8 25.6 Denmark 14.4 8.1 5.2 7.Ze 35.0 Finland 13.3 7.5 6.3 5.7 32.8 France 8.2 11.7 6.6 5.5 32.0 Germany, Fed. Rep. oft 7.6 9.9 6.0 4.Od 27.5 Grececc 4.0 12.8F 4.0 3.4 24.3x Ireland 8.7 5.9 5.2 6.2d 25.9 Italy 3,4 15.8 6.3 5.01 30.5 Japan 1.8 5.0 4.8 4.4 16.0 Nethcrlands 13i.1 9.9 5.7 6.9' 35.7 New Zealand 6.3 .6.7 6.0 6.1 25.1 Nonvay 13.9 7.7 7.1 5.7 34.4 Portugal 4.5 6.7 4.1 4.2 19.5 Spain 6.1 7.9 5.3 z.2¢ 21.5 Sweden 13.9 11.7 7.7 6.5 39.8 United Kingdom 7.4 10.3 5.2 4.8d 27.7 United States 3.5 5.8 5.2 4.8d 19.4 Average for all -members (unweighted) 7.7 8.8 5.8 5.3 27.5 None: Data arc provisional estimates by the oEcD. Data for Suitzcdand are not available. a. Includes unemploymcnt compensation, employment promotion bencfits, sickness bencfits, disability pensions, disability scrvices, family allouances, lowincowme bcnefits, indigenous persons benefits, housing benefits, other miscellaneous services and benefits, and administrative costs. Excludes all benefits to the aged and survivors and health expenditurcs. b. Includes all old-age and survivors' bencfits, that is, all transfers and services to the elderly and survivors. Data for Australia include pensions for vcterans; data for the United States include occupational pensions for civil servants and cxclude expenditures on health. c. For 1988 unlcss othervise stated. d. For 1987. e. For 1985. f. Prior to unification. g. For 1989. h. For 1986. Somres: OECD social data bank and OECD 1992c. 1 181 OVERVIEW: HOPES, TEARS, AND TRANSPORMATION put it, "We can certainly make our welfare pudding with less cream and fewer eggs" ("Fewer Holidays in the Sun," Ihdependent (rondna), October 4, 1993, p. 19; on reform in New Zealand, see Boston 1993; "What Happens When You Scrap the Welfare State?" Indopident Ott Sunday (London), March 18, 1994, p. 17). Despite this determined effort to control expenditure, the strgure of state involvement has not changed significantly, at least in the mix of public and private activity. Instead, the wsai of activity has decreased marginally (for a survey of what Western governments have done, see U.K. Department of Social Security 1993). The last conclusion is noteworthy. In both the United Kingdom and the United States during the 1980s, writers like Murray (1984) and political leaders like Ronald Reagan and Margaret Thatcher argued for a reduced role for the statc. Nevertheless, a U.K. study concluded that the welfare state, and indeed welfare itself, is very robust. Over the thirteen years from 1974 to 1987, wvelfare policy successfully weathered an economic hurricane in the mid-1970s and an ideological bli1zard in the 1980s. The resources going to public welfare 'were maintained; [andl welfare indicators continued to show a steady improvement. ILe Grand 1990, p. 3501 In the United States, the Reagan era ended with the welfare state substantially intact, though somewhat frayed around the edges. It is now tilted more toward its middle-class beneficiaries than it was a decade ago, but the broad con- tours remain essentially as they have evolved since the 1930s. [Peterson 1991,p. 1331 The descriptive picture in the OECD countries, then, is that (1) the scale of public social spending is under review, (2) its structure remains largely unchanged, and (3) even in the loNv-spending industrial countries, public social sptnding in 1990 was between one-fifth and one-sixth of GDP. The first of these observaEions is clearly the result of the macroeconomic situation and the demographic prospects. The second and third can be explained, at least in part, by market imperfections (see chapter Z), which make private financing and provision inefficient or impossible in a number of these areas. In the high- spending countries of Western Europe, morcovcr, social solidarity (also dis- cussed in chapter 2) remains an objective. Why is public social spending 15 percent of GDP in some countries and more than 30 percent in others? First, objectives may differ: state social spending is lower where social solidarity is less of an objective (as is true in Australta and the United States). Second, the constraints may differ: spending is lower where income iF. iow%er and fiscal constraints are tighter (in Portugal). Third, social conditisins may differ: social spending is lower in countries where enterprises pIly a larger social role (in I191 OVERVIEW: HOPES, TEARS, AND TRANSFORMATION Japan)3 or where the extended family can still be relied on to some extent (on the importance of social environment in policy design, see Kopits 1993). Experience outside the West is somewhat different. Eight of the major East Asian dcveloping economics have been among the tvelve most rapidly grow- ing developing economies in the world since l960.4 State social spending in Singapore and Thailand (the two economies from this group included in table 1-2) is both lower and more weighted toward education, particularly basic education, than is true in the industrial economies. This is not the place for a detailcd discussion of the East Asian economies (see World Bank 1993a), except to note the broad context in which they operate. All of them have a more or less single, overriding objective, namely, economic growth, and a political consensus which by implication gives a fairly low weight to distribu- tional objectives and to social solidarity. They tend to have fairly authoritarian regimes. They face fewer constraints tlian do the economies of Central and Eastern Europe: China apart, they have well-developed market systems, sophisticated banking systems, highly developed capital markets (by the stan- dards of developing economies), and relatively stable prices. Their economies need no substantial restructuring which, together with their high level of spending on education, means that East Asian economies have a much more appropriate mix of skills than economies in Central and. Eastern Europe. Finally, the extended family is still a significant part of their social structure. The Analytical Framework Many of the countries of Central and Eastern Europe have introduced market forces and liberalized their political institutions. Chapter 4 discusses those actions, the driving forces-the engine of reform-they unleash, and some of their outcomes to date. Outcomes arc of two sorts. Some, such as greater efficiency and government which is more responsive to tie needs of the electorate, are both deliberate and welcome. Others, such as the Fiscal crisis, are unwelcome because they constrain the speed and success of the reforms. These and other constraints are discussed in chapter 5. The Frres Driving Change The move to a market system liberates two major economic driving forces: a widening distribution of income and a more explicit role for individual self- interest. The widening income distribution is a result of wage and pricc liberalization. Market-determined wages promote work effort and encourage workers to move into more productive jobs; workers respond by acquiring skills which are in high demand. Such results arc a fundamental purpose of the reforms. There are also malign outcomes, however. Although some individ- uals are better off, others are worse off; to a disproportionate degree, the losers have been women, children, and the elderly. Because of the data 1 20 1 OVERVIEW: HtOl'ES, TEARS, AND TrRANSFOnRMATrION problems discussed in chapter 4, the precise extent of change is controversial, but not its direction. The transition aggravates poverty because the fall in output lowers real wages, because the heavy subsidies on basic commodities are removed, and because unemployment rises. Policies to alleviate unem- ployment and poverty become correspondingly more important. Alongside these economic driving forces are the forces released by political liberalization. Some of these forces emerged at the start of the transition; others came later. There was initially a reaction against the inheritance of central planning and totalitarian government; this reaction manifested itself in a swing toward private markets (a reaction against central planning), towyard decentralization (a reaction against eotrat planning), and toward democracy. In general, these tendencies are beneficial. They can, however, overshoot and produce less desirable outcomes. In the absence of regulation, some markets will be inefficient; decentralization can hinder the development of policies best formulated at a national level; and democracy can lead to legislative paralysis, for instance, where parliamentary representation is divided among many smaHl parties. In the social sectors, such tendencies created pressures to privatize too fast in inappropriate areas (for example, moving too fast and too far to replace public, funding of medical care with private medical insurance), led to poorly coordinated efforts to revise educational and training qualifica- tions, and produced legislation which was either badly drafted or too compli- cated to be implemented effectively. Some countries subsequently experi- enced a political backlash against the reformers and sometimes against the reforms themselves, in part because of disappointed hopes that living stan- dards would improve rapidly. Gonstrainrs Constraints arise in many guises and explain why the transformation is taking so long. Although the distinction is notrwatertight, the constraints are usefully divided into those which are primarily economic those which mainly concern political effectiveness, and those which relate to institutional capacity. ECONOMIC CON'nItrNTs. This class of constraint derives, first, from the massive misallocation of labor and capital inherited from the old system, necessitating a large-scale movemcnt of workers and making high unemploy- ment likely, if not inevitable; A second constraint is the fiscal crisis itself. Output fell fastest in the state scccor, where most tax revenue is collected, and was only partly offset by increased actvity in the private sector, where tax enforcement is not yet fully effective. Public expenditure, conversely, fell more slowly. Social spending was thus squeezed by a fiscal crisis precisely when demands on the social safety net increased. A third major constraint at the start of the transition was the deficient legislative infrastructure underpin- ning the operation of a market economy. Major gaps were evident in such 12t1 OVERVIEW: HOPES, lTEARS, AND TlRANSPOHI,ATION crucial areas as the definition of property rights, the conduct of private enter- prises, rcgulation of the banking system and other financial institutions such as insurance companies and stock exchanges, regulation of working conditions, and consumer protection. This deficiency, although perhaps affecting other areas more strongly, also slowed reform of the social sectors. POLITICAL CONSTRAINTS. There are two main types of political constraints: those connected with political attitudes and those arising from the machinery of government. Political attitudes toward unemployment are particularly important. Prior to 1938, countries like Czechoslovakia were substantially industrialized under a market system; reform has largely reconnected such counteries with thicir own history.5 The former Sovict republics are different: they have never been democratic, nor have they ever had a modern market economy. Unemployment is thus completely new, and the political capacity to carry through the reforms (particularly when coupled with the governance issucs discussed belowv cannot be aken for granted. The machinery of government also constrained change in the early transi- tion. The powers and responsibilities of the legislature and the executive were somewhat fluid, and the judiciary was not altways in a position to resolve any particular dispute. The electoral regime sometimes yielded a fragrnented out- come, leading to government by coalitions which were sometimes unstable. The amount of new legislation required and the amount of detail in each law produced parliamentary overload. The problem was particularly acute for social sector legislation, much of wrhich was politically highly charged. Alongside the constitutional arrangements (the rules of the game) was the separate constraint of an initial lack of experience in how democratic politics are conducted (that is, a lack of experienced professional players). One viewv, held by Balcerowiez (1993a), is that the early transition was a revolutionary period in which the first postcommunist governments had to spend their political capital initiating a comprehensive 'big bang' liberalization and creat- ing a fait accompli. The opposing view is that, even allowing for the revolu- tionary situation, the new governments should have spent more time explain- ing their policies to the electorate. INSTITUTIONNAL ONsntAINTS. During the early transition, institutional capac- ity imposed constraints which were compounded by the movement of many of the most ablc public servants to the private sector. The public sector resisted change, in part because change is painfult but also because the indi- viduals in power wanted to retain that power. Asking state institutions to organize the privatization of large parts of the state apparatus, for example, created a clear conflict of interest. A separate problem is that reformers tended to undervalue administrative skills. For instance, little effort was made to involve people with implementation skills in the design of policy for the social sectors. None of these problems is unique to Lhe region, but they are 1 22 1 ovRyVlP,W: I-IOI'El, TAIS, AND VrIANSPOItNATrION posing enormous constraints during the transition because the scale and speed of the chalnges needed are so great. Much of the existing human capital is inappropriate, and this remains a major constraint. As discussed in chapter I 1, the problem is not generally one of too little human capital, but of tihe wrong type of human capital. 'Oldthink" is pervasive. Insufficient weight is given to such key concepts as the tradeoffs discussed above and die importance of incentives. Training in modern tech- nology is often inadequate, and partly as a consequence, attitudes toward modernization can be ambivalent. Missing concepts and the lack of key skills were significant impediments to implemcntation early in the reform. The Policy Strategy The policy strategy summarized below shapes the recommendations made throughout the book. It seeks to harness the beneficial results of die driving forces while recognizing the constraints. The key needs of the early iransition were-and are-to address the fiscal crisis, to privatize large parts of the economy, and to focus on the practical implementation of these gnd other very major changes. These needs lead directly to a strategy with four parts: controlling the budget, liberating market forces, containing market forces, and implementing the reforms: Maintaining macroeconomic balamce isa eessaty n'sponse to the exressivesz of eth state sector generily and to theJiscal oisi sped4#cally. It includes policies to reduce the size of the public sector, policies to balance government revenue and expenditure, and, although outside the scope of this book, policies to maintain a stable monetary system. Containing the explosion of social sector budgets and diversifying the finance of social services are key contributors to maintaining macroeconomic balance. * Building mnrkets the prinmary method by whihd to persume higher standars of living. It involves increasing consumer choice and diversifying supply. Policies to improve incentives include alloawing wages to be determined largely -by market forces and avoiding taxes which are so high as to discourage work effort or new employment. Employer contributions should be neutral with respect to employing men and women (thus, for instance, the cost of family benefits should fall on the taxpayer, not the employer). Building markets also includes actions to raise labor productivity and to encourage mobility betveen jobs and betveen skills. - Reglatng markerfdrres is the complement to building markets. It is necessary for two entirely separatc purposes: to address market imperfections and to redistribute income. Regulation, for instance ;n the form of drug testing reg- imes, is a necessary companion to policies which diversify supply. Policies to address unemployment and poverty include both income support and more direct action to help match workers with jobs. Action is needed to cnsure access to basic goods and services, including nutrition, health care, and educa- 1 23 oVEIIVItlW5 IIOI'KN, 'I'EARS, ANI) 'I'IlANsI'O1MAT'I'ION tion, Finally, lindividuals shouild be able to insure thcmselv:es against loss of Incomc (because of unemployment) and, separately, to redistribute Income to themselves over their llfetimes, Althoughi in principle thcse objectives could be accomiplished through private insurance, private pensions, and the like, various problems- includinig capital miarket imperfections require stntc inter- vention, at least to regulate private sector activity. ,iwpleneNting the reforms requms adminiistrative shil/s and polk/cal expedience as waell as good policy desi;g. Like the legs of a tripod, all three sets of skills arc necessary simultaneously. Early Achievements There are two reasons for arguing that, notwithstauiding the -problems described at the start of this chapter, the reforms are very much a move in the right direction. First, the past is no longer on offer, not lcast because of the increasingly appalling economic performance of central planning. Second, even in the short run, Lhe reforms have produced some beneficial outcomes, and those benefits are real and sustained. ECONOMIC ACHIEVEMENTS. The economic gains achieved early in the reform include increased availability of goods, wider choice, improved incentives, improved creditworthiness, and improved access to foreign know-how. Price liberalization reduced excess demand and encouraged additional pro- duction of desired goods. Queues have largely disappeared, and so have black market prices. Many other ill effects of shortage have faded away: forced resort to imperfect substitutes (for example, buying cheese instead of milk if only cheese is available), forced saving, the humiliation and cost of time spent in queues, and bribes paid to people with access to goods in short supply. What is surprising are not the gains themscives, but the speed with which the introduction of market forces produced them. Not only has the quantity of goods increased, but so have their range and quality. The combined effect of price liberalization and recession has been to switch from a shortage economy to one with low demand. This has given consumers more power to insist on, and sellers an incentive to provide, the goods which consumers want at reasonable prices. Easier access to foreign goods has improved matters further. Wider choice has also sttvrted to manifest itself in the labor market, in health care, and in education and training. The introduction of market-determined wages and prices, together witi liberalization of supply, has improved work incentives. Market-determined wages together with harder budget constraints have also given firms incentives to hire only as many workers as they need, and to hire oi:%r those with the type of skills they need, and have given individuals stronger incentives to acquire those skills. Economic reform has also liberated lateii': entrepreneurial talent, particularly in the emerging private sector. 1 24 I JVKRVIEW' II0I'S, 'rlFAIS, ANI) lTRANSFORMATION Most of the countries of Central and Eastern Europe have improved their export performance and increased their international reserves. One result Is that domestic currencies have become coavertible, at least within the country of issuc, and many of the countries lhave achieved a relatively stable exchange rate,- Finally, convertibility of domestic currencies and increased foreign invest- ment have improved access to Western technology and skills. Significant benefits have been evident relatively quickly in some countries in telecom- munications, banking, trade, and the mass media. Access to foreign books, including textbooks, has also improved. POLInCAL ACHI1VEMENTS. Reform has also brought major political benefits. A free press, including the broadcast media, has developed rapidly in most of the countries. Just as opening the economies to foreign tradc improved the incentives for domestic producers, so opening up the countries to foreign news. (made possible, for instance, through access to television satellite dishes, facsimile machines, and the like) h as crcated incentives for the con- duct of government to be more open. Free, multiparty elections have increasingly become the norm. These, together with a free prcss, have started to build a political culture, which is essenti al for effective democratic government. The protection of individual rights has also improved. This was less an outcome of constitutional guaran- tces (which, in a formal sense, existed under the old system) than of free elections and freedom of the press. The Agenda: Priorities and Sequencing Both the scale and the siructure of state activity will change significandy. The role of the state will diminish. The data in rable 1-2, together with the analysis in chapter 2, establish an overwhelming case for reducing the scale of govern- mental activity. This will occur in some areas more than others. Industry, financial markets, and the production of consumer goods will all becomc almost totally private sector activities, with necessary regulation being the only intervention. The state has a significant and continuing role to play in the social sectors, although the form of that involvement will become considerably more diver- sified. There will be some public production, but on a reduced scale, a continuing funding role in some areas (see, for instance, World Bank 1990b, 1993d, on the state's role in poverty relief and health finance), and more state involvement in facilitating market activity through regulation and through financial and other incentives for certain types of activity. Public social spend- ing will continue but will be substantially reshaped: some social programs will need to be slimmed dowvn, in some cases drastically; others will need to be reformed fundamentally to improve targeting. 1 25 1 OVERVIEW: HOPES, TEARS, AND TRANSPORNIATION Thc appropriate boundary between the market and the state is a matter of continuing discussion. Economics in the region have different objectives and social structures (in part stemming from their cultures and histories) and face different constraints. As a result, differences between economies in the role of government will always remain. That role will be substantial if the Western European model is followed, and rather less so if the models of the high- performing Asian economies and the United States are followved. Key ques- tions for policymakers include the extent to which even a much slimmed- down Western European model is affordable and the extent to which the circumstances of the high-performing Asian economies are applicable. The priority given to different policy actions should be determined in the light of what can be afforded in the short run given the limits to both financial resources and implementation capacity. The recommendations in later chap- ters are divided into two sets: short-term actions which are vital to the success of the reforms iii the social sectors and medium-term actions which require some work now, but whose effects will not be immediate. S£orf-tnm PIWodides Short-term policy has to concentrate on surviving the early transition both fiscally and politically: * In the face of high inflation and rising unemployment, short-run labor mar- ket policies should concentrate on containing inflation through tax-based incomes policies and on removing the major inherited legal constraints which limit the flexibility of the labor market. Given the fiscal crisis and sustained unemployment, the short- Crm priority for the system of income transfers is the relief of absolute poverty. This requires the development of effective systems of unemployment benefits and direct poverty relief. Resources should be concentrated on protecting at least the minimum level of the major benefits. Deciding on the exact level of that minimum will force policymakers to face the acute tension between the economic and the political sustainability of the reforms. The major priorities for education and training are to maintain standards in preschool and basic education and to restructure secondary and higher educa- tion to make them more responsive to the needs of a market economy. Policies for the hcalth sector should ensure that the share of GDP devoted to it are maintained, and should avoid excessively radical restructuring during the early transition. Specifically, they should concentrate on providing immediate relief of critical shortages, adequate budgets for services to pro tect vulnerable populations, cost-effective interventions against preventable diseases, and hard budget caps. A shortage of administrative capacity is one of the most acute constraints to effective reform. Thus there is an imperative that policy design should be as simple as possible. 1 26 1 OVERVIEW: HIOPK:S, TEARS, ANI) TRANSFORMATION Politicians should devote a significant amount of their time to persuading the public that the government's policies are desirable. They should also try to dampen unrealistic cxpectations. Besides these positivc steps, certain policy "black holes"-actions or inactions-should be avoided at all costs. These arise where any parts of the policy strmtegy are ignored: * Postponing action to control the cost of the state cash benefits system, - although politically tempting, destabilizes fiscal and monetary policy. The resulting inflation shows what -happens if the first part of the strategy-. controlling the budget-is ignored. * Introducing private pensions without the necessary macrocconomic, finan- cial, and regulatory infrastructure-an example of attempting to build mar- kcts without regulating them-overlooks the need for consumer protection and ignores the high risk of inflation, which could easily decapitalize domes- tic funds. For both reasons, badly designed schemes risk discrediting the reforms before they take root. The answer is not to abandon private pen- sions, but to introduce reforms in their proper sequence. - Introducing health insurance without the proper regulatory structure is another example of failing to combine efforts to build markets with efforts to regulate them. The problem is that, where doctors are paid by an insurance fund, neither doctor nor patient has any incentive to economize on medical services, and the result is a cost explosion. A regulatory structure is needed to contain medical spending. - Ignoring the political dimension of implementing the reforms is a problem which is at its most acute early in the transition. The most successful reformers, building on Westcrn experience, took steps to prevent over- optimistic expectations, began early to build party structures, and devoted considerable effort to communicating with the electorate. Neglecting such activities can mean that reforms are not implemented for political reasons. Mediam-tnn PrionWers Policies with a medium-term dimension, even though their effects will not be felt immediately, should not be delayed: - Investment in human capital is crucial to economic growth. * As fiscal constraints start to relax, income transfers will need to take on functions other than poverty relief; in particular, the relationship betreen contributions and benefits should be strengthened. * Action on pcnsions, education, and health care should include support for the emergence of private providers. The necessary first step is to design and put into place a regulatory structure which protects consumers, and infor- mation systems which assist consumer choice. 1 271 OVERVIERW' lIU1'ES, TEA:RS, ANI) TRANSFORMATION An early start should be made on policy design and legislation in areas where implemcntation takes time, such as conmputerizing social insurance contri- butions, revising teacher training programs, and devising hospital reim- bursement schemes which encourage the efficient use of medical resources. Upgrading administrative capacity, although its impact will not be felt in the short run, is also a priority. More detailed recommendations can be found in the concluding sections of chapters 7 to 13. The decline in output and the fiscal crisis highlight the inescapable tradeoff between current and future standards of living. The economic problem is to choose a policy mix which alleviates extreme poverty, allows stabilization, and maintains international competitiveness, while still devoting sufficient resources to investment. 'The political problem is to find a meeting ground between the pressure to raise standards of living now and the need to devote more resources to investment in the interests of economic growth. Govern- ment cannot escape making choices about how resources are divided benveen consumption and investment. Because that choice is very much a political one, the electorate must understand the issues involved. The tradeoffs are both economic amdpolitical. Notes 1. These totals arc the result of compounding, not adding, the figurcs. Taking Lithuania as an example, output at the end of 1990 was (100% - 5%) = 0.95 of its level at the start of the year. Over three years, therefore, output fell to 0.95 X 0.866 x 0.65 = 0.5348; that is, output is 53.5 percent of its previous level and thus fell by 46.5 percent. 2. The Intemational Labour Organisation conventions seek to establish employ- ment conditions, broadly defined, which protect the interests of individual workers in ways wvhich do not prectude the operation of marker forces. 3. Recent reports, however, suggest that, in the facc of global competition, Japan is moving away from lifelong employment security, which, in any case, applies only to some 30 percent of the wvork force. 4. The eight are China, the "Four Tigers'--Hong Kong, the Republic of Korea, Singapore, and Taiwan (China)-and the three newly industrializing economics of Indoncsia, Malaysia, and Thailand. 5. Many of the non-Soviet countries had prewar experience with market systems, but their experience with democracy varied considerably. Poland was a dictatorship aftcr 1926, and Hungary an oligarchy with a severely limited franchisc. The countries with the longest experience of democracy betwveen the two world wars were Czechoslovakia and Romania. 28 1 .THHE ROLE OF GOVERNMENT IN A MARKET ECONOMY NICHOLAS BARR THE DIVIDING LINE BETWEEN TH£E MARKrET AND THE sTATE is in many ways the central part of the economic reforms. It is a fundamental error to imagine that capitalist economics means an absence of government intervention. The pre- cise dividing line may differ (for example, the balance between public and private pensions is different in different countries), and forms of intervention can vary (in some countries health care is publicly produced, while in.others it is privately produced but heavily regulated). Yet, as tables 1-2 and 1-3 show, the state plays a continuing and major role in all industrial countnes. This outcome is no accident: as a practical matter it is the rcsult of a process of historical trial and error; in- addition, it can be both explained and justified by recent developments in economic theory. That theory-the underpinning of the policy analysis in part TI-is the sub- ject of this chapter, which thus provides important background for readers whose familiarity vith economic. theory is limited. The first section discusses the economic objectives of the reforms. The central sections summarize the economic theory of private markets and the state. The final section discusses the policy implications of the theory, both generally and in the context of Cen- tral and Eastern Europe, inclutding cases where the theory points firmly toward private markets and others where it suggests the need for state activity. The state's role in the West, though substantial, is fundamentally different from the old system in Central and Eastern Europe: the state intervenes only in parts of the economy, and the intervention tends to be carefully targeted. The implications for Central and Eastern Europe are, first, that intervention should he of the appropriate type (as we shall see, government can intervene in wvays other than central planning) and, second, that it should be in the appro- priate amaw. Many countries in the West have (in one form or another) a national health service; none has a national food service. Why this is so and, more generally, how to decide whether the state should intervene and, if so, how are the main subjects of this chapter. The Objectives of the Reforms The overall objectives of the reforms are to achieve higher living standards and greater individual freedom. This section discusses the economic objec- 1291 THIE ROLE OP GOVRRNMIENT IN A MIARKET E.CONOMY tives in greater detail, particularly as they relate to the social sectors, and divides them into five groups: enhancing efficiency, protecting the living stan- dards of individuals and families, reducing inequality, strengthening social integration, and increasing administrative effectiveness. Ihatincig Effiien-cy In policy terms, efficicncy has at least three aspects. The aim of macro- economic efficiency relates to the division of total national resources between expenditure on humall rcsources, on the one hand, and activities such as physical investment, on the other. Spending nothing on health care is obvi- ously inefficient (since people would die unnecessarily from potentially cur- able conditions); spending the whole of national income on health care is equally inefficient (since people would then die of starvation). The goal of macroeconomic efficiency is to make sure that enough is spent on human resources, but not so much as to crowd out other important activities. A particular aim is to avoid distortions which lead to cost explosions, such as uncontrolled expenditure on pensions and soaring medical costs. The aim, in other words, is to choose efficiently between human resources and other activities in the face of the tradeoffs discussed in chapter 1. Microeconomic cfficiency concerns the division of totat resources among rhe different cash benefits, different types of medical treatment, different types of education, training, and retraining, and different types of employment services. Chapter 12 argues, for instance, that too many resources tend to go into hospital care and not enough into primary care and public health acciv- ities. Another aspect of microeconomic efficiency is to help 'workers move to jobs in which they are most productive. Incentives are a third aspect of efficiency. High rates of income tax, for example, may discourage work effort, and high payroll taxes may impede new employment. Thus where they are publicly funded, institutions should be financed in ways which minimize adverse effects on labor supply and employment. Supporliprg iviwg S&audards Protecting living standards embraces poverty relief, insurance, and income smoothing. The aim of poverty relief is to ensure that no individual or family falls below some minimum level of income or consumption. The aim of insurance is to see that no one faces an unexpected or unacceptably large drop in his or her standard of living. This is a major objective of unemployment benefits and of most health-related benefits. The definition of a minimum and of what constitutes "unacceptably large" poses difficult questions for policy- makers which are both economic and political. The aim of income smoothing is to ensure that individuals are ablc, in cffect, to redistribute income to 1 30-l THE ROLE OF OOVERNMENT IN A MARKET ECONOMY themselves at different stages in their life cycle. This is an important aim of pensions and also of fanmily allowances. All three aims are important. A perva- sive theme, however, is the fiscal crisis which accompanied the early transi- tion. Later chapters therefore arguc that the aim of poverty relief should be given priority over insurance and income smoothing until the fiscal situation improves. As a practical matter, this means concentrating resources on pro- tecting the minimum level of unemployment benefits, pensions, and other major benefits. Redudng Ineqamity The reduction of inequality has tvo aspects. Vertical equity concerns the contentious issue of redistribution from rich to poor. The objective of poverty relief implies at least minimal redistribution. More generally, should the for- mula under wvhich pensions are calculated favor lower earners? Should health care or education be financed out of taxation and given free to the user? Horizontal equity relates to the aim that individuals who are the same in all relevant respects should be treated equally. Once more, the definition of "relevant respects" can raise difficult policy questions. Differences in cash benefits should take account of family size. Differences in education and training should reflect only factors which are regarded as relevant (such as a person's previous education and work experience), but not irrelevant factors such as ethnic background. Snrgrhning Social Integradon Social integration embraces broader and less tangible goals. Cash benefits, health care, and education and training shoutd be delivered in vays which preserve the recipient's dignity. They should also foster social solidarity, an aim which in recent years has received little attention in the United Kingdom and the United States, but which remains an explicit aim of public policy in mainland Western Europe and is an important part of the inheritance of Central and Eastern Europe. As examples, benefits should as far as possible depend on criteria which are not related to socioeconomic status, such as retirement pensions and, in most countries, health care. Additionally, benefits should be high enough and health care good enough to allow recipients to participate fully in the life of the society in which they live. IncnasingAdministradme EfAtiwes- Administrative feasibility is concerned, first, with simplicity, in that the sys- tem should be as simple as is consistent with policy objectives and thus easy for the citizen to understand and for the manager to administer. A second aspect is effectiveness: administration should be timely and accurate, meaning that the benefit both (a) should be awarded in the right amount and (b) should 1311 TIJE ROLE OF GOVERNMENT IN A MIAtKXlT FCONOMY go to all -who are entitled to it. h'llird, insofar as possible there should be as little abuse as possible. Finally, administration should be us cheap as is con- sistent with the achievenient of the other objectives. The Argument for Private Markets The conventional argument for private markets is that they autoniatically achieve the efficiency objective and, moreover, do so at very little cost, since outcomes are the result of individual actions based on individual informa- tion.I Thus there is no need for the expensive information gathering and complex paperwork which would be necessary to achieve efficiency under central planning. In addition, there is no need for government to prioritize activities, since the actions of individuals do so. The free market, according to this view, is a highly efficient, self-adjusting information system, and the state does not have as much information, nor the ability to acquire it as cheaply, nor the capacity to respond to it as quickly or effectively, as docs the free market. Efficiency has a very specific meaning in this context. Broadly, it means making the best use of limited resources given pcople's tastes and available technology. A key underlying concept is resource scarcity (also known as opportunity cost), which means that if resources (labor, capital, raw mate- rials, land) are used for one purpose, they cannot be used for another. Since the quantity of all those resources is limited, output is also limited. It is not possible to produce enough to satisfy everyone's demands completely: policy should seek to satisfy people as much as possible; since resources are scarce, it should seek to use limited resources as effectively as possible. This is precisely what economic efficiency means. It has three dimensions: *Efiiency in prduction means that ilnputs should be comn bined to obtain the maximum outpurfifm given iiput. This is what engineers mean when they talk about efficiency. It is about building a hospital to a specified standard, wasting as little concrete as possible, and having as few workers as possible standing around waiting for something to do. It is also about the choice of technique, taking the prices of inputs into account. Thus, for example, the construction of buildings tends to be labor-intensive in developing economies, where unges are low, and more capital-intensive in countries like the United States. * 4 emenq i productt mix means that the tight combinatn of goods should be produced. The fact that a hospital can be built cheaply is not, on its, own, justification for building it. The resources involved could perhaps give the local population greater satisfaction if used instead to build a school; or the land could be used as a park, and the money saved by not building a hospital could be used to reduce taxes, allowing people to spend the money as they choose on other forms of consumption. 132 1[ THE ROLE OF GOVERNMIENT IN A NIARKIET ECONOMY Efflcienlcy in consumption mweans thar consumers slihodd allocate their incomre inl a way wlhichl axiiniMes their satisfaediot, girtn itheir intcames and the prices of the goods theyh bty. These conditions relate to the efficient use of resources at a point in time (known as static efficiency). Resources have also to be used efficiently over time. Dynamic efficiency is concerned with optimizing the growth of output or consumption. The pursuit of dynamic efficiency impales policymakers on the key tradeoff discussed in chapter 1, the division of resources between current consumption and investment.. An efficient outcome simultaneously conforms with all these requirements. It depends on external conditions (more resources are devoted to hotels on Bulgaria's Black Sea coast than in Murmansk); it depends on tastes (the French spend more on food than the English; the English spend more on gardens than the Germans; Hungarians consume niore paprika than anyone else); it depends on the age of the population (more resources tend to be devoted to education in a country with lots of children than in one with few); it depends on incoine levels (private ownership of cars and personal computers is much more widespread in Western Europe than in Central and Eastem Europe). The "invisible hand" of market forces, it is argued, achieves exactly this efficient result. As Adam Smith (1776) put it over 200 years ago, Every individual . . . generally . . neither intends to promote the public interest, nor knows by how much he is promoting it. By preferring the support of domestic to that of foreign industry he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which *vas no part of his intention. In today's terminology, if a product has numerous suppliers, competition will force them to produce in cost-effective ways (efficiency in production). Firms which are unable to achieve this go out of business. The exercise of consumer choice in the face of market prices enables people to choose the goods they want and ignore the goods they do not want. This maximizes their satisfaction (efficiency in consumption); it also means that the production of unwanted products stops (leading to efficiency in product mix). The role of marker prices is critical in all this. A higher price signals to consumers that the product uses scarce resources, forcing them to economize on consumption. If people continue to buy even at high prices, producers understand that this is a commodity which people want and which they should continue to produce. In contrast, if -people do not buy the product, producers receive a signal to reduce or cease production. Market forces thus give consumers and producers 1 33 1 THrXE ROLE OF GOVERNMENT IN A MtARKEr rCoNOMY incentives to act efficiently. The role of incentives is a recurring theme throughout this book. The Assumptions Necessary for Markets to Be Efficient The problem for policy design is that markets do not always or automatically operate in this way. This section and the next discuss the conditions under which (a) markets generally and (b) insurance markets specifically have these beneficial results. Where those conditions fail, the state may have grounds to intervene for efficiency reasons; in addition, even where markets are efficient, the state may intervene in pursuit of other objectives such as poverty relief. Types of State intervention Before discussing why the state might intervene, it is useful briefly to outline how it could do so. It is important to be clear that pure private markets, on the one hand, and central planning, on the other, are merely the two extremes of a continuum. Intervention is possible in many forms short of complete central planning. The state can intervene in four generic ways: regulation, finance, production, and income tranisfers. REGULATION. In some instances, regulation may have more to do with social values than with economics (for example, regulation of the hours during which shops may be open). But much regulation is direcdy relevant to the efficient or equitable operation of markets, especially where consumer information is imperfect. Regulation of quality, mainly on the supply side, includes hygiene laws relating to the production and sale of food and drugs, laws- forbidding unqualified people to practice medicine, 'and consumer protection legislation generally. Regulation of quantity more often affects individual demand, as with the requirement to attend school and compulsory social insurance contri- butions. Price regulation includes minimum wages. Total expenditure can also be regulated, as occurs with global budget caps for medical spending. FINANCE. Finance involves subsidies (or taxes) applied to the prices of specific commodities or affecting the incomes of individuals. Price subsidies can be partial, such as book user charges in schools and tuition fees in public universities, or total, such as free drugs and free primary education. One of the main reasons for subsidizing some activities is to create incentives Which encourage private sector activity (for example, tax advantages for certain types of expenditure, such as private education). Similarly, prices can be raised by a variety of taxes, particularly in areas which the state wishes to discourage, such as a tax on tobacco. Income subsidies raise different issues, which are discussed shortly. PRODUCTION. Although regulation and finance modify the operation of mar- kets, they leave the basic mechanism intact. Alternatively, the state can take 1 34 1 THE ROLe OP GOVERNMtENT IN A MARKEST ECONOMIY over the supply side by producing goods and services, common examples being pre-university education, defense, and (in some countries) most health care. Finance and production are entirely different forms of intervention, both theoretically and in practice, and are commonly used both separately and in combination. INCOME TRNSFERS. The previous three types of intervention all involvc direct interference- with the market mcchanism. Income transfers do not interfere directly; rather, they enable recipients to buy goods of their choice at market prices (for example, pensions allow elderly people to buy food). Income transfers can be tied to specific types of expcnditure, such as food- stamps or housing bcnefits, or, like cash benefits, can be untied. Necessary .4swrnpiaons How valid is the assertion that the market mechanism automatically leads to an efficicnt outcome?2 The answer is that it is often, but by no means alvays, valid. The efficiency of market outcomes generally rests on four sets of conditions, including (a) that consumers and firms are well informed, (b) that markets are genuinely competitive, (c) that there arc no missing mar- kets, and (d) that several other assumptions hold. These conditions are critical to analyzing the role of the state and therefore require detailed discussion. PER! Ear INFORMATION. Both consumers and firms must be well informed. Simple theory implicitly assumes that consumers know which goods are avail- able and understand their quality. As a relatively recent body of literature on economic theory makes clear, the assumption can fail in two important ways. People may have imperfect knowledge of the quality or the prices of goods.3 The literature thus has two strands. The first analyzes the effects of imperfect information about quality. Consumers might be badly informed, for example, about the quality of a school or about the appropriate type of medical treat- ment. Producers might be poorly informed about the quality Df a worker applying frr a job or about the riskiness of an applicant for a loan or for insurance. The second strand analyzes the effects of imperfect information about prices and wages. The assumption that consumers and firms are wvell informcd about the nature of the product and about prices is plausible for some goods, but less so for others. Markets are generally more efficient (a) the better is consumer information, (b) the more cheaply and effectively the information can be conveyed, (c) the easier the available information is for consumers tO under- stand, (d) the lower are the costs faced by someone who chooses badly, and (e) the more diverse are consumer tastes. Commodities which conform well with these criteria are food, clothing, and such consumer durables as radios, refrigerators, personal computers, and automobiles. Health care conforms 1 35 1 THlE RLE OUF' GOVERNU.rNT IN A MARKET ECONOMY less well: consunier information is often poor; people generally require individual inforniation, so that the process is rarely cheap (violating the need for chea.p and effectivc inforniationi); much of the information is hiighly technical (violating the need for easily understood information); and the costs of a mistaken choice can be high. Education can raise similar problems.. Where the assuniption of perfect infornation fails, several solutions are possible. rhe market itself niay develop institutions to supply information, for instance, computer magazines and professional valuers who can help people assess the price of a house. In such cases, the product being sold is informa- tion. In other cases, the state may respond with regulations, for instance, hygiene laws for food. This is appropriate where the. potential costs of a mistaken choice are high and where the information is sufficiently non- technical for the consumer to understand. Whcre information problems are serious, and where the necessary infomiation is too technical to be readily understood by the average consumer, the market will generally be inefficient, and public production may be a better answer. We return to this issue in the discussion of policy. Along with information about quality and price, individuals also need accu- rate expectations about the future in order to make rational choices over rime. This is broadly true of food, since people know that they will need to cat tomorrow, next weck, next month; it is not true of medical care, because people do not know whether or when they will suffer health problems. In manv instances, the market can cope with this sort of uncertainty through the mechanism of insurance. Private insurance, hoNvever, can be inefficient or impossible for technical reasons, and such problems are especially relevant to medical insurance and private pensions. PERFECr COMPErITION. Perfect competition must apply to the markets for all inputs and outputs and also to capital markets (that is, access to borrowing). The main, although not the only, condition which must hold is that there are many buyers and sellers; thus no buyer or seller controls more than a very small part of the market, and so no individual or firm can control the market price. This generally requires that no major impediments prevent new firms from entering the industry concerned. COMPLETE MARKETS. A full set of markets -would provide all gocds and services for which individuals are prepared to pay a price equal to or greater than the costs of production. In some cases, however, this is not the case. Public goods, which are discussed shortly, are one example of commodities which the market will generally fail to supply at all. A second type of missing or incompletc market occurs 'when certain risks are uninsurable. Third, capital markets may in some circumstances fail to provide loans, an example in the 1361 Trim R lL Ol OVlItNMk N'I IN A MARKE.' ECONOMY West being student loans (for whicli two problems exist: the lender cannot easily assess the risk of the borrower, end ge:nerally no colluteral is possible for such lendinig). Fourth, there may be no futures m:arket, which nicans that it may not be possible to make a contract now to buy or sell a commodity on given terms at somne time in the future. Finally, a commodity may not be supplied because a complementary market is absent. Tlnhis is a particular problem if large-scale activities need to be coordinated, as occurs in the casec of urban renewal projects. Missing markets can arise for two totally separate reasons: sonic commodi- ties are not produced because the necessary market institutions havc not yet been put in place (examples relevant to Central and Eastern Europe include the lack of the necessary legislation conccrning private property and the lack of a stock market); other commodities are not produced, or are inefficiently produced, because the market is inherently unable to supply them (an exam- ple relevant to the social sectors is some types of medical risks). OTHER ASSUMPTIONS. Three final assumptions are that there should be no public goods, external effects, or increasing returns to scale. Public goods in their pure form exhibit three technical characteristics: (I) non-rivalness in consumption, (2) non-excludability, and (3) non-rejectability. Private goods are rival in consumption in the sense that one person's con- sumption is at the expense of another's: if I buy a cheese sandwich, one less sandwich will be available for everyone else. Excludability means that I can be prevented from consuming the cheese sandwich until I have paid for it. Rejectability implies that I can, if I wish, choose not to buy the sandwich. Not all goods display thcse characteristics, the classic example being national defense. If the air force is circling overhead, the arrival of someone from another country does not reduce the amount of defense available to everyone else (non-rivalness in consumption). Nor is it possible to exclude the new arrival by saying that the bombs will be allowed to fall on him until he has paid his taxes (non-excludability). Nor is the individual able to reject the defense on the grounds of pacifist beliefs (non-rejectability). Similar considerations apply wholly or in part to roads, television broadcast signals, and public parks. Public health, too, has important public goods attributes: if the water supply is purified, or clean air legislation enforced, nobody can be excluded from the benefits. The structure of lawvs and, more generally, the rule of law have important public goods characteristics as well. An important distinction should be noted in discussing public goods. For a private good, the additional cost associated with an extra unit of output and the additional cost of an extra user are one-and the same. If it costs Si to produce an extra cheese sandwich, it also costs St to. provide for an extra cheese-sandwich-consumer. But this identity does not hold for public goods. 1 371 'XtI 1t01 .H DI' (i fIVI RN1MIEN'T IN A MAIlKE'X Ut OO NOMV Tlihe cost of cleaning up Uir polilition, for cxampile, Is positive antid generally high, whereas the additioiail cost of haivinig Lin extra person breathc the air is zero. (rhis has imiiportant implications: * Non-excluldability meains dunat, if a puiblic good is provided nt till, it canlnot be charged for (tihis is known as the free-rider problemi). In stichi cases, the market will generally fail entirely. * Non-rivalness implies that the marginal cost of aIn extra user (thougli not of an extra tinit of output) is zcro, Withi a price of zero, no outptit will be produced, how%ever, and the efficient price must be based not on cost, but on the value placed by eacti individual on an extra unit of consumption, Sinice this is impractical, the market is likely to produce an inefficient ouitput. Thus, public goods create one of two problems: cither the market is ineffi- cient, or it fails altogether. If the good is to be provided at all, it w'ill generally have to be publicly organized. This will involve public fiinding, but not neces- sarily public production. For instance, the state may mandate and pay for a water purification program, but the work might be carried out by a private firm. A second potential problem, external effects, arises when an act of person A imposes costs or confers benefits on person B, foir which no compensation from A to B or payment from B to A takes place.4 Suppose, for instance, that -my factory pours out smoke over the neighborhood. This does not affect my private costs, which depend only on the COSt of my machinery, raw materials, and wage bill. However, it does impose an ertenwa cost on my neighbors in the form of dirt, irritation, loss of amenity, health risks, and so on.5 Thus the social costs of my productive activity exceed my private costs. The effect of externalities is to create a divergence between private and social costs and benefits. In these circumstances the market output will generally exceed the efficient output. The same effect also operates in reverse. If I am inoculated againm. a communicable disease, this not only reduces my chances of getting the disease but also benefits other people who will not catch the disease from me. Similarly, many types of education and training not only make the recip- ient more productive but also make other people more productive.6 In cases like this, where an action by one person confers an external benefit on others, the market output is generally smaller than the efficient output. What solutions exist? On occasion the market can resolve the problem. Coase (1960) shows that where the law assigns unambiguous and enforceable property rights, the externality problem may be solved by negotiation between the parties concerned. This is often impractical. Property rights may not be enforceable, as is the case with water pollution. The numbers of people involved may effectively rule out negotiation, as with traffic congestion.7 In such cases, intervention may be justified either through regulation (mandatory water standards) or through an apuropriate tax on the activity generating the external cost (a tax on petrol). 1 381 't'IlE HoLY. 01 UOVERANNIENT IN A MARKE'I' ECONOMY Increasinig returns to scale arise when doubling all inputs more than doubles output. For reasons beyond the scope of this cliapter (see Barr 1993b, chap. 4, for a fuller discussion), compctitive pricing under increasing returns to scale leads to long-run losses. Two fornis of intervention are possible in this situa- tion: paying firnms a lump-sum subsidy equal to the loss associated with coni- petitive pricing or nationalizing the industry and paying an identical subsidy. rrlhe appropriate intervention is therefore a subsidy or public production or both. The Assumptions Necessary for Insurance Markets to Be Efficient Many people do not like risk and are prepared to pay to avoid or reduce it. When an individual takes out insurance, he is buying certainty (the certainty that if he is injured, for example, his medical costs will be covered). rhe supply of insurance has an easy intuition. Suppose that 100 pcople decide to fly to Frankfurt to see a footbatll match; each person has a suitcase whose contents (for arithmetic simplicity) are worth $1,000; and everyone knows from long experience that on average 2 percent of suitcases get lost in transit. Thus each person faces a potential loss, L, of $1,000, which occurs with a probability, p, of 2 percent. In those circumstance?., it would be possi- ble to collect 2 percent x $1,000 = $20 from each of the 100 people, that is, $2,000 in total; when the group arrives in Frankfurt, they find which two people had lost their suitcase and pay each of them $1,000 in compensation. This, broadly, is the wvay in which private insurance operates. More formally, an actuarial premium, 7r, is defined as (2-i) - r=pL+ T wherepL is the expected loss of the individual buying insurance, and Tis the insurance company's administrative costs and competitive profit. r is the price at which insurance will be supplied in a competitive market. The price of insurance thus depends on (a) the degree of risk and (b) the size of the potential loss. Car insurance premiums are high for a driver who is young or who lives in a high-crime area (both factors leading to a higher probability of loss); and they are high for someone who drives a Rolls Royce or Mercedes Benz (because the potential loss is large). A middle-aged person with a good driving record and driving a small Ford pays a much lower premium. Although private insurance can operate efficiently in a great many areas, in others, technical problems can arise on the supply side. The efficiency of private insurance requires that the probability, p, in equation 2-1 meets fivc conditions. First, the probability of a given individual having his car stolen must be independent of that for anyone else. If my car is stolen,;that should not affect the probability that yours will be stolen. What this means, roughly 1 39 1 T1111 ROLE IU- OtJOVIINUENT IN A MARKHT ISCONI)MY speaking, is that insurance der -nds for its financial viability on the existence in any year of a predictticalb number of winners and losers. If, in the extremc, intdividual probtibilities were completely related, then if one person suffered a loss, so too would cveryone else; actuarial insurance cannot cope with this situation. An important example concertis inflation wvhicih, if it affects any one m:ember of an actuarial pension scheme, affects all members. Second, p must be less than one. If p = i, it is certain that the insured person's car will be stolen; hence, there is no possibility of spreading risks, and the insurance premium will equal or exceed the cost of a new car." An example of this problem is the chronically or congenitally ill, for whom the probability of ill healthi equals one unless insurance is taken out before the condition is diagnosed. The problem can also arise for the elderly, for whom the probability of requiring medical care is very high. As another example, the private market cannot offer insurance against any medical problem which the individual already las at the time he or she applies for insurance. Preexisting conditions, in short, are uninsurable. A third condition is that p must be known or estimable. If it is not, insur- ance companies cannot calculate an actuarial premium, and private insurance is impossible. For example, the private market generally cann;ot supply insur- ance against future inflation because the probability of different levels of price increases in the future cannot be estimated. The risk of some types of health problems can also be hard to estimate. Fourth, there must be no adverse selection, which arises when a purchaser is able to conceal from the insurance company the fact that he or she is a poor risk. As the earlier example of car insurance made clear, efficiency requires high-risk individuals to pay a higher insurance premium than low-risk individ- uals. But if the insurance company cannot distinguish high- and low-risk customers, it has to charge everyone the same premium, based on the average risk. As a result, lowv-risk individuals face an inefficiently high. premium and may choose Ilot to insure even though, at an actuarial premium, it would be efficient for them to do so; where the problem is serious, the insurance market may fail altogether. This problem arises particularly in the case of medical insurance for the elderly. It can also arise if health care is an important part of employer benefits: firms with the best health care packages tend to attract workers with health problems, thus reducing the firm's competitiveness. Finally, there must be no moral hazard. The problem can arise in two ways: Moral hazard can arise, first, when the customer is able costlessly to manipulate the probability,,p in equation 2-1, that the insured event will occur. The chances of developing appendicitis are beyond an individual's control, and so medical insurance for this sort of complaint is generally possible. In contrast, the probability of becoming pregnant or of visiting one's family doctor can be influenced by individual actions and are thereforc generally not well covered by private medical insurance. Where the problem is serious, the 1 40 1 rTIIE RiOI. Oa GOVI.uNNI-NT IN A MARKETI HSCONOMY supplier cannot calculate the actuarial premium, and private insurance is gen- erally impossible. - The second type of moral hazard, known as the third-party payment problem, arises when the customer can manipulate tie size of the loss,. L in equation 2-1. The problem is particularly relevant to health care. If an individ- ual's insurance pays all medical costs, then treatmenit is "free" to the patient. Similarly, on the supply side, the doctor knows that the insurance company will pay his charges. Thus neither side of the market faces any incentive to economize: both doctor and patient can act as though the cost of health care wvere zero. This is inefficient. It causes overconsumption, creates upward pressure on insurance premiums, and leads to uncontrolled escalation of medi- cal expenditure.9 The Invisible Hand Theorem The validity of the invisible hand argument, discussed earlier, is thus hedged by stringent conditions. As a theoretical proposition, the market ;%ill allocate efficiently when a//the assumptions in the previous two sections hold. In such cases intervention on efficiency grounds is neither necessary nor desirable. Where one or more of the assumptions fails, it is necessary in each case to consider (a) whether the market can solve the problem itscif and, if not, (b) which type of intervention (regulation, finance, or public production) or mix of interventions might improve efficiency. tt is also necessary to ask (c) whether intervention would be cost-effective. As a practical matter, these conditions rarely apply fully; it is generally sufficient that they are broadly true. Competition, for instance, may operate with a relatively small number of suppliers; minor forms. of consumer igno- rance can often be overlooked; and state intervention is, in any case, war- ranted only if it can improve on an imperfect market outcome. Nevertheless, the marker's efficiency advantages are tempered both by the possibility of market failure and, completely separately, by the fact that it can lead to outcomes which are regarded as inequitable. Thus Arthur Okun (1975, p. 119) puts things slightly differently from Adam Smith: The market needs a place, and the market needs to be kept in its place. It must be given enough scope to accomplish the many things it does wvell. It limits the power of bureaucracy. ... So long as a reasonable degree of competition is ensured, it responds reliably to the signals transmitted by consumers and producers. It permits decentralised man- agement and encourages experiment and innovation. Most important, the prizes in the marketplace provide the incentives for work effort and productive contribution. For such reason, I cheered the market; but I could not give it more than two cheers. The tyranny of the dollar yardstick restrained my cnthusi- 1411 T'HE ROLE OP GOVERNMhENT' IN A MARKErT ECONONIY asm.... The rights and powers that money should not buy must be protected with detailed regulations and sanctions, and wvith countervail- ing aids to those with low incomes. Implications for Policy The majority of goods in the West are produced and allocated by private markets (for a fulter discussion in the context of the industrialized countries, see Barr 1992, 1993b; Mueller 1989; OECD 1990b, 1992a; for a more philo- sophical approach, see Okun 1975). A number of examples serve to illustrate why. A4farket Stuaru Food, by and large, conforms with all the assumptions necessary for markets to be efficient. People generally have sufficient information to buy a balanced diet; food prices are well known, not least because food is bought frequently; and most people know roughly how much they will need over a given period. Food production and, especially, distributon are competitive; and there are no major problems with externalities or public goods. A possible violation is con- sumer ignorance about the conditions under which food is produced and about its ingredients. The stare therefore intervenes to regulate hygiene; it may also require companies to label ingredients and to put. expiration dates on packag- ing. Such regulation can readily be understood by the public and enhances con- sumer information, leaving the private market to operate efficiently. It is nor surprising that no one seriously advocates a national food service. Clothing, too, conforms for the mnost part with the assumptions and, quite properly, is therefore provided by the market. It can, however, be argued that people ate less well informed about the quality of clothing than about food, not least because they buy clothes less frequently. Yet fewer regulations govern the quality of clothing. One reason is that the costs of mistaken choice can be high with food (including food poisoning and, in the extreme, death) but are much lower with clothing. It can therefore be argued that, even though one of the assumptions may fail, intervention, though theoretically justified, is not cost-effective. Consumer goods such as televisions, washing machines, kitchen appli- ances, and personal computers fit into the same pattern as food and clothing. The market supplies considerable amounts of information through consumer magazines, newspaper articles, and consumer programs on radio and televi- sion, and aggrieved individuals can seek legal redress. Minor consumer igno- rance is ignored where the costs of mistaken choice are small. Where the potential costs of poor quality are larger (such as electrical appliances which might catch fire), the appropriate form of intervention is regulation. Cars raise two sets of issucs related to their production and their use. On the production side, the arguments are broadly similar to thosc for smaller 1421 T'llF ROLE OP OOVKRNMENT IN A MARKIrT E:CONOMIY consumer goods, a key feature being the extent of consumer information about quality. In particular, consumers cannot easily check that a car's brakes and steering are safe and its tires well designed. Given the high costs of a mistaken choice, regulation of such safety features in the West is stringent and continually evolving. So far as the use of Cars is concerned, regulation mainly addresses the external costs imposed on others by an individual's unsafe driving (drink-drive laws) or by. the operation of a car which is in unsafe mechanical condition (worn tires, faulty brakes) or is unacceptably noisy or polluting. As in the case of consumer goods generally, no efficiency case arises either for a subsidy or for public production. Housing does not conform with all the assumptions. Building a house very cheaply (with materials which catch fire casily or with inadequate sewerage) endangers not only the owner but also the neighbors. This type of external cost justifies regulation on public health grounds. If I build a factory in my back garden which creates a lot of noise and dirt, I again impose a cost on others. This type of externality can justify planning controls. For these and other reasons, a very strong efficiency case can be made for substantial regula- tion of housing. Beyond that, however, there is little efficiency case for state intervention in the housing market. This suggests that housing should gener- ally be allocated by the market, subject to well-designed regulation; poor people should be helped not by price subsidies, but by income transfers which can be tied (paid in the form of housing vouchers) or untied (paid in cash). Given the cost of housing, howrever, any change from subsidized rents to market rents should be phased in. The analysis of efriciency applies equally to factor markets. To make clothes, for example, requires cloth and thread and sewing machines. The managers of clothes-making firms are generally well informed about the qual- ity of inputs produced by different manufacturers of cloth and thread; sewing machines, cloth, and thread are produced competitively, and the problems of missing markets or of public goods do not arise. Car manufacturers, similarly, are well informed about the quality and price of different grades of steel, different machine tools, and so on, which, again, are generally produced competitively. Once more, these areas are best left to the market, possibly subject to some regulation. Marke Faltar Not all commodities, however, lend themselvcs to unrestricted market alloca- tion. Where the necessary assumptions fail, markets may be inefficient or may not exist at all. Health care and medical insurance fail many of the assumptions. Consumer information can be highly imperfect, since much medical treatment is com- plex and technical, and its effectiveness is uncertain. In addition, knowledge of prices is scant. Nobody knows how much health care he or she will need, I431 1-HE ROl.E 01: GOVEIINMUN-r IN A MtARKE'I' ECONOMY antd private medical insurance poses major problems. In addition, medical care connected with communicable diseases can generate externalities. The case for regulation is overwhelming. Information failures justify regulating the qual- ity of medical care, including medical qualifications, and the quality of the testing, production, and sale of drugs; this is true in all industrial economies. The extcrnalities associated with communicable diseases give an efficiency case for subsidizing prevention or treatment, such as offering free smallpox vaccinations or free treatment of sexually transmitted diseases. Medical insurancc also fails many of the conditions necessary for efficiency. There are two generic problems: Gaps in coverage arise vhere risks are uninsurable, such as chronic, preexisting medical conditions, medical insurance for the elderly, and any medical care connected with consumer choice, which raises issues of moral hazard. Thus, for some medical conditions, the insurance market is incom- plete. -'Exploding costs are thI result of the third-party payment problem. The problem is not restricted to private insurance; it arises with any funding system which operates on a fec-for-scrvice basis (one in which medical sup- pliers, like other suppliers, are paid for each item they provide). In such circumstances, neither doctor nor patient has any incentive to economize. The incentive to supply excessive treatment exists even where patients pay some user charges. The Czech Republic introduced just such a system in 1992 without the necessary regulatory structure, leading to an entirely pre- dictable cost explosion. Many Western countries had similar problems in the early 1970s. They responded via regulation. controls on total medical spend- ing (Canada) or controls at the level of the individual hospital (Germany and the Netherlands). The effect of such regulation has been to control medical incomes without interfering with medical practice. The serious problems of consumer information and private insurance together make a case (although not an overriding one) for public production of health care. The case for doing so would be if regulation of qua/fry in the face of imperfect consumer information and of quatiiry in the face of third-party payment pressures were more effective with public than with private produc- tion. Since the case cannot be quantified either way, it is not surprising that medical care is publicly produced in some industrial countries and privately produced but heavily regulated in others. The finance of medical care, in- contrast, is substantially public in all the highly industrialized countries except the United States because of the gaps inherent in private medical insurance. Unemployment insurance raises similar problems. The heart of the diFfi- culty is moral hazard. If someone is still unemployed after six months, eithe: he has genuinely tried to find work, but no suitable jobs have been on offer, or he has not lookcd for work very seriously, being content to enjoy more leisure.. The first of these is potentially an insurable risk, the second is not. The 1441 THE ROLL OF OoVERNMISNT IN A MARKKT ECONOMY problem is that the insurer cannot easily tell which explanation applies. For that reason, private unemployment insurance, except in very restricted cir- cumstances, does not exist in the West (for a fuller discussion, see Bart 1992, sec. V). A separate problem is that private insurance cannot cover preexisting conditions. Thus it is not possible to offer unemployment insurance to a person without a contributions record who is atrcady unemployed, the most obvious example being an unemployed school-leaver. In both cases, the insur- ance nmarket is incomplete. Inflation raises two sorts of problems in the context of pensions. First, if any one pensioner experiences a given rate of inflation, then so do all pen- sioners. This violates the first insurance condition, that probabilities must be independent. Second, the future rate of inflation cannot be predicted. For pensions, it is, in principle, necessary to know inflation rates for sixty years into the future, because pension contributions by a wrenty-year-old depend on the rate of inflation over the years until he or she is eighty, or even older. Thus insurance is based on an unknown probability, and a premium cannot be calculated. For both reasons, inflation is an uninsurable risk.'0 Again, there is a missing market. Training, like health care, requires a careful blend of state and private activity. A worker who needs retraining may be badly informed about the quality of a prospective training course and about what skills the market is demanding. The first implies a need to regulate quality for reasons of con- sumer protection. The second suggests some form of guidance for suppliers of training, guidance which cannot come from the prospective trainees them- selves. A possible source of advice is a tripartite training council, composed of representatives of government, employers, and workers. Subject to such guid- ance and the necessary regulation, there are no arguments against training being provided by the private sector and considerable advantages if the supply of training is competitive. A separate market imperfection is that training may create external benefits, giving an efficiency argument (quite separate from any equity arguments) for a partial subsidy. Gover7rent Failu;r Markers may fail. So too may governments, a fact of which people in Central and Eastern Europe are more painfully aware than most (the arguments are surveyed by Inman 1987 and Mueller 1989). Four explanations are offered for the extent of and growth in government activity: governments role in dealing with market failures, its role as redistributor of income and wealth, its response to the electorate in the form of coalitions of votcrs or pressure groups, and the role of bureaucrats. The government failure arguments point to the behavior of the electorate and of bureaucrats as important distorting influences. I 45 I 'I'HE ROLE OP OUVERNMtENT IN A MAsKKT ECONOM1Y The influence of the electorate operates in various ways. The coercion-via- the-ballot-box argutment (Downs 1957) is that the (many) poor, on their own or in coalition with others, outvote the (fewver) rich to impose redistributive tax and benefit regimes. Writers like Buchanan and Tullock (1962) and Tullock (1970, 197 1) argue that most transfers from the rich are captured by the middle class through their electoral power. Other arguments stress the role of interest groups, such as the poverty lobby. Interest groups are also argued to use their lobbying power to bring about redistribution through regulation, especially where the regulators are "coptured" by those whom they are supposed to regulate (Pelzmann 1976; Posner 1975; Stigler 1971). According to this view, regulation (for example, of the medical profession) is a barrier to entry which allows doctors to make monopoly profits. Distortions can arise also within government, in that public sector institu- tions may in part be run for the benefit of the bureaucrats themselves (Niskanen 1971). This type of government failure is very well understood in Central and Eastern Europe. For one or more of these reasons, it is argued, the size of the public sector may be inefficiently large, or its composition may be distorted to meet the needs of the bureaucracy, powerful interest groups, or voters in marginal constituencies. At least in a Western context, howtever, these insights should not be pressed too far. Some explanations of redistribution (see, for instance, Friedman 1962, and Hochman and Rodgers 1969) offer an explanation of tax- financed redistribution which does not rely on electoral coercion. Interest groups may enhanceefficiency (Bccker 1983, 1985). Regulation may result in monopoly profits (as enjoyed by doctors in some countries), but it also offers protection to imperfectly informed consumers (for instance, the regulation of medical training). The power of bureaucrats can be overstated and their motivation misun- derstood (Dunleavy 1985). Pay increases or enlarged departments can be monitored; voters may be able to vote with their feet against high local taxation (Tiebout 1956); and bureaucratic self-interest can easily lead to less government (officials in Margaret Thatcher's Ministry of Finance won favor by cutting expenditure). In addition, bureaucratic control may be more effective where the state regulates the quality of a publicly produced good or service than where it attempts to regulate a private producer. In the case of social insurance, for instance, the state has information about tax and social insur- ance contributions and powers which would be regarded as draconian in the private sector; and countries where private, fee-for-service medical care is publicly funded find it more difficult to contain costs than those where medi- cal care is publicly provided. Nor are the various government failure arguments necessarily equally appli- cable everywvhere. Tullock's (1971) claim that benefits go disproportionately to the middle class may be more true of the United States than elsewhere: in 146 THE ROLE OF GOVERNMENT IN A MARKET ECONOOMY Germany and Sweden the lowest income quintile in the mid-1980s received net transfers of about 10 percent of gross domestic product. Wher and How Should the State Intewme? The most important contribution of the literature on public choice and gov- ernment failure is the idea that analysis of government should consider the incentives facing politicians and bureaucrats. The outcome of the political marketplace is not, however, necessarily inferior to that of conventional mar- kets. Just as markets can be efficient or inefficient, so can governments. Were it otherwise, we would advocate anarchism, a conclusion from which the govcrnment failure literature pointedly refrains. An important countcrpoint to government failure is market failure. Inmans (1987) survey concluded that, while democratic processes do not generally guarantee an efficient alloca- tion of social resources, mc annor go e nexr stq and cfonsctde that coMkc- dikry decdd allocadons ... are infen'or to individuafly decded market allocadons. [Inman 1987, p. 727; my emphasisl Neither the institution of markets, or voluntary trading, nor the institu- tion of government, or collectively decided and enforced trading, stands as the unarguably preferred means for allocating societal resources. Each institution has its strengths and its weaknesses. llnman 1987, p. 753; his emphasisl The New Right properly criticizes a naive predisposition toward state inter- vention at the slightest sign of problems in private markets, but to argue that public sector inefficiency au:omadally implies that private markets are welfare improving is to make the same mistake. Decisions about the proper bor- derline betveen market and state involve judgment, so that different inter- pretations are possible. TOWARD A coNaustoN. The starting point is to distinguish clearly between the aims of policy and the methods availablc to achieve them. Aims embrace efficiency, equity, and the various other objectives discussed at the start of the chapter. Methods include income transfers and direct interference- in the markec through regulation, subsidy, or public production. The proper place for ideology is in the choice of aims, particularly distributional objectives and their tradeoff with efficiency. Once these aims have been agreed upon, how- ever, the choice of method should be regarded as a technical issue, not an ideological one. Whether a commodity like health care is produced publicly or privately should be decided on the basis of which method more nearly achieves previously agreed-upon aims. A rationale for choosing between methods can be given in the form of two propositions relating to efficiency and equity, respectively. 1 47 1 THE" ROLE OF GOVERNMENT IN A MIARKET ECONOMY Proposition t. If none of the assumptions about efficiency fails, the effi- ciency aim is generally best achiieved by the market with no intervention. Where one or more of the assumptions fail, state intervention in the form of regulation, finance, or public production may increase economic efficiency. Proposition 2. Subject to minor qualifications it is possible to argue the following. * Only cfficiency arguments can justify intervention other than cash redis- tribution; if no such justification exists, equity is generally best pursued by income transfers. * If efficiency arguments point toward public production and allocation of a good or service, then distributional goals can he pursued by in-kind trans- fers, for exampic, redistribution in the form of free education or hcalth care. Care is needed not to overstate the presumption in favor of cash redistribu- tion. In some cases (medical and nutritional supplements for pregnant wvomen, infants, and young children), benefits in kind might achieve poverty relief more effectively. In the context of Central and Eastern Europe, how- ever, the argument for cash redistribution is strong: cash redistribution is necessary in the face of an inherited paternalistic mind-set, and it empowers consumers in a budding market economy. Under what circumstances, then, should the state intervene? It may want to do so for distributional reasons: this is largely a political matter. Insofar as efficiency is concerned, the existence of market imperfections is a necessary but not a sufficient condition for intervention; fiscal considerations and cost- effectiveness are also relevant. [ntervention should occur in cases (a) where it increases efficiency compared with the position without intervention and (b) where it is cost-effective and affordable. The second part of the condition does not always hold. As we saw in the example of clothing, the costs of intervention may exceed the costs of the inefficiency it is intended to prevent. A more poignant example is the fact that in poor countries many beneficial health interventions are not carried out because they are not affordable. POLICY IMPULCATONS FOR CENTRAL AND EASTERN EUROPE. Vital commodities like food are privately produced in the West and, to a greater or lesser extent, sold at market prices, because they conform with the necessary assumptions. Efficiency, in such cases, should be pursued through private, market produc- tion and allocation, subject to regulation where appropriate. Equity should generally be pursued through income transfers, with poor people buying food at the same prices as everyone else and in the t ne shops. This is exactly what occurs in the West for the great bulk of commodities. Tle theory thus shows why the clear policy prescription in Central and Eastcrn Europe is to privatize these areas as quickly as is feasible. The same theory also explains why governments in all industrial countries intervene. If the problem is one of relatively minor imperfections in consumer 148 1 TIIE UROLE OF GOVERNSIENT IN A MIARKE'I' ECONOMlY information, the relevant intervention, if any, is regulation. Where therc are missing markets, particularly in the case of uninsurable risks, the state may have to step in, either to regulate or to subsidize private insurance or (more usually with unemployment insurance, and medical insurance) to opt for a substantial element of public funding, as table 1-3 shows. Although there is considerable agreement about the areas in which the statc does tot intervene, there is less convergence of the precise forms of interven- tion in areas where states do intervene. In all industrial countries most pre- university education is publicly funded and publicly produced, while health care, depending on the country, is produced in the public sector, the private sector, or both. The theory presented here is a useful tool, but it is not a mechanical formula for policy design. The discussion of this chapter, in conclusion, suggests three strategic impli- cations for Central and Eastern Europe: * The private market has enormous advantages in very large parts of the economy. This is the case for substantial privatization of formerly state-run enterpriscs. * The state has an essential and continuing role in creating an enabling envi- ronment for a modern market economy. This includes the legislation which underpins market activity, such as the establishment of clear property rights and the development of corporate law. It also includes legislation and regu- lation to protect people in areas where they do not havc the information to protect themselves, such as consumer protection legislation, the regulation of financial markets, and employment law. * Unrestricted private markets produce some commodities inefficiently or not at all. In such cases, public funding, public production, or both may be morc efficient than other options. In important parts of the social sectors, that is precisely the case. The main purpose of this chapter has been to suggest an analytical frame- work which policymakers can use to decide which areas should be returned quickly to the privatc market, where regulation is neccssary, and in which areas the state should continue to have a substantial role. The objective is to protect the reforms by avoiding two undesirable extremes: moving toD little by failing to move to a predominantly market system or moving too nmuch by privatizing everything, taking no account of the significant technical problems with private markets for some commodities. Notes 1. For a fuller discussion on the economic theory of privatc markets, see Barr 1993b, chaps. 4 and 5; Stiglitz 1988, chaps. 3 and 4.*For a simple introduction, see Le Grand, Propper, and Robinson 1992, chaps. I and 10. For a more technical treatment, seejohansson 1991; Phlips 1988.. 49 1 THE ROLE OF GOVERNMENT IN A MARKET' ECONOMlY 2. The claim is a strong one. It hals three implications: that an equilibrium exists, that it is unique, and that it is stable, whicil rmeans that the system converges toward a new equilibriunm in response to an y external shock. 3. The literature on quality has its roots in classic articles by Arrow 1963 ond Akerlof 1970 and is surveyed by Stiglitz 1987. The literaturc on price is surveyed by Morternsen 1986. 4. More fonnally, an externality arises wlhen A's utility or production function is interrelated with Bs. 5. External costs are so called because the costs are external to the firm which produces them, that is, the firm does not havc to pay for the costs of pollution it causes. The concept of external effccts lies at the heart of modern analysis of environ- mental pollution and the development of policies to encourage producers and con- sumers to act in ways Which reduce it. For a fuller discussion, see Baumol and Oates 1979. 6. For example, if I learn the same word-processing package as you do, -we can swap diskettcs; because I leam the package, you are more productive. 7. Where numbers are small, negotiation may be possible, but only at the expense of violating the assumption of competition. 8. From equation 2-1, if p = 1, then r = L + T, that is, the premium will cxceed the insured loss. 9. To see the intuition of what is happening, consider the way people behave in a restaurant offering 'all you can eat for S9.95" or free drinks, in comparison with the way they behave when faced with a conventional menu. 10. The discussion here is concerned only with explaining why armad insurance cannot deal with inflation in the context of pensions. Possibilities other than insurance are discussed in chapter 9. t 50 I part 0 THE POLITICAL ECONOMY OF TRANSFORMATILON Threlree THIE RNHERITANCE SAUL ESTRIN THE COUNTRIES O1 CENTRAL AND EASTERN EUROPE ARE DIVERSE in their tradi- tions, culture, and history (see the glossary). However, they share a common clement in their historical experience: at some time after 1917 they have all been ruled by communist regimes.' These regimes imposed similar govern- mental and administrative structures and relied on nonmrarket mechanisms for the functioning of the economy. All these countries arc now in the process of transition to democratic rule and free markets. This chapter outlines the main features of the communist system which are germane to this process of transformation and particularly to the development of human resources. The first question is why these countries should reform at all. Reform is costly in both resources and emotional energy, so major systemic failure is needed to justify it. Such failure is exactly what we observe in Central and Eastern Europe. The communist system broke down, in the sense that it had increasing difficulty delivering those material and social goods and services to which such' systems are in principle committed: fast growth, technological advance, rising per capita collective and individual consumption, and social solidarity. It is beyond the scope of this chapter to offer a full account of that breakdown and -its causes (see Kornai 1990; Ofer 1987; Wiles 1962). This chapter seeks instead to summarize the key features of the communist eco- nomic system, with a particular focus on the development of human resources, to indicate how these characteristics ied to economic and social collapse, and to suggest the ways in which the systemic inheritance and the consequential economic breakdown might influence and shape the process of transition. The main economic feature on which this chapter focuses is the slowdown in growth after postwar reconstruction, culm;- ring for many countries in negative rates of growth. There is a strong humas resources dimension to this issue. Kornai (1990), among others, has argued that communist systems of central planning were very effective at mobilizing the transfer of labor from the countryside, where productivity on the margin was very low, to the urban industrial sector, where it was much higher (although the methods of shifting the workers do not bear close scrutiny). This exrtsive form of growth led to rapid industrialization and exhausted the hitherto substantial reserves of effec- tively "free" labor resources. In part because the old system failed to encour- 1 53 1 THIC POLITICAL. KCONOMY Olt' TRANSFORMATION age habits of thought based on tie notion of tradeoffs, however, the highily centralized planning bureaucracy was much less effective at the cfficient allocation of scarce inputs, whether labor, capital, or raw materials such as energy. These deficiencies which hindered growth of an ihneasive sort were miagnified by other widely discussed aspects of communist economic systems. Among the most important of these were failures in the incentive system for both workers and managers, associated with the failurc either to use or to enforce financial constraints on enterprises (what Kornai 1980 has referred to as soft budget constraints), with the inability of central planners to ensure that technological advances are assimilated into production processes, and with deteriorating levels of labor productivity and discipline. Several important caveats should be noted at the outset. The purpose of this chapter is to identify common aspects of the inheritance which have an important influence on the transition process. To do so vithin the space constraints requires placing greater emphasis on the degrec of conformity in Central and Eastern Europe to the Soviet model than is merited by the facts. Some crucial simplifications arc therefore made. First, not all countries of the communist bloc operated a central planning system by the end of the commu- nist era. Mviost notably, Yugoslavia cmbarked on its own road in 1952, based on workers' self-managemrent and increasing reliance on markects and trade with the West (see Estrin 1983). This chapter offers little of relevance to Yugoslavia's situation. Hungary abandoned planning in favor of "market social- ism" with its Ne w Economic Mechanism, introduced in 1968 (see Hare, Radice, and Swain 1981), but, as Kornai (1986) has convincingly argued, market socialist economies displayed rnany of the same characteristics as centrally planned economies. The reform process, particularly the emergence of a private sector, did, however, begin much earlier in Hungary than else- where. Similar provisos could be made to some extent for Poland, which in addition had extensive private agriculture. Second, little ermphasis is placed on the numerous atteempts to reform the planning system itself. Major efforts were made to improve the Soviet plan- ning system under Khrushchev in 1956, Kosygin in 1965, and Gorbachev in the mid-1980s (see Aslund 1991; ElIman 1989; Gregory and Stuart 1986), and these were imitated in much of Central and Eastern Europe (see Hare 1987). Although crucial to a balanced understanding of the communist era, these reform efforts had surprisingly little impact on the fundamcntal charac- teristics and performance of the communist economic systems featured in this chapter. They are invoked only when directly relevant to understanding the inheritance for labor markets and social policy. Finally, as table 3-1 shows, the different countries entered and departed the communist period diverse in economic situation as well as geography. Key differences include international trade and level of devclopment (see Eliman 1989). The U.S.S.R., being large and rich in resources, was able to pursue an 1 54 1 rTHE INltERITANCI; TIable 3-1. lsise ata on hte Eonomies of Central t/t adEstern Erope, 1990 GDPper A4nmher of rapitact as 11po"sVto CAlEd eartper aperrewagr As a. Aa Popes/tal/on 000 of U.S. peneniageof prntage country ftuil/lonsj penotus level totalaports of GP." Bulgaria 8.9 127 26 639 34 Czechoslovwkla 15.7 ls8 35 60 25 Hungary 10.6 156 30 43 16 Poland 37.8 112 25 41 14 Romania 23.3 - 19 - - U.S.S.R. -290.9 46 31 55 8 -Not itvailublc. NVoie: cMiEIis the Council for Mutual Economic Assistance. a. Purchasing power parity. Soiwras:r Bruno 1992; Russian Fcderation 1992; Murrell 1991. autarchic policy, but the countrics of Central and Eastern Europc wvere smaller and more open (see Brown and Neuberger t968; Collins and Rodrik 1991). For Czechoslovakia or Bulgaria, most trade was integrated within the region of the Council for Mutual Economic Assistance, but Hungary and to a lesser extent Poland sought Western markets; by 1989, trade to the countries of the Organization for Economic Cooperation and Developmcnt (see the glossary) represented around 20 percent of gross domestic product in Hungary. Con- versely, Czechoslovakia and the German Democratic Republic saw a Soviet- type planning system grafted onto a relatively developed industrial system. The traditional dcvelopmental strengths of Soviet planning were in principle better suited to less-industrial economies iike Bulgaria or Romania, and this is reflected in the relatively narrow differences in income per head which were established by 1989, with a range from Romania to Czechoslovakia of less than 2:1 (calculated on the basis of purchasing power parity; see Murrell 1991I- Summers and Heston 1991). This chapter contains thrce sections. In the first, the main legacies of the communist way of thinking are discussed, notably the differences (relative to standard Western views) in how key elements in society and the economy were conceptualized and interpreted and the lack of awareness which much of the poticy community had of many basic economic concepts. Although these countries share a common inheritance from the communists, they are also highly diverse in history and culture in ways which influence the process of transition. The general systemic inheritance is the subject of the second section, while the third introduces those elements of the inheritance relevant for the following chapters. I 55 I ''Il I'POLITICAI. ECONOMY or' T'IANSIPORIMATION The lntellectual Heritage rrhe countries of Central and Eastern Elurope wcre under conmmunist govern- ments for a nlinimuin of forty years, and the Marxist-Leninist creed is an all- cncompassing ideology which permeated every aspect of public and private life. At least Lntil the 1950s, tlhese societies were driven and motivated by ideology to a degree hardly imaginable from the comfort of countries which are not totalitarian. Ideology remained a potent force until the revolutions at the end of the 1980s. In sonie countries, the domination of a monolithic ruling ideology reinforced previous historical and cultural experience; in others, it was ruthlessly imposed and enforced. Marxist-Leninist ideology was therefore not a sham behind wlhich lurked more traditional motives of national self- interest. It led the communist parties to manage their affairs in ways which were sometimes detrimental to their interests and which would otherwise be incomprehensible to Western observers. An example is the self-declared aim of economic self-sufficiency, which led the U.S.S.R. and later the Council for Mutual Economic Assistance to choose autarchy as the guiding principle of international trade. An important proviso, however, is that niany of the short- comings which we now identify with communisim were present in the region prior to the Bolshevik revolution, most notably totalitarianism, extreme cen- tralization, and excessive bureaucracy. ComrttnmJnist Ideology Peter Wiles (1962) has provided an elegant and detailed exposition of the ways in which communist ideology influences economic and social thinking. At the heart of the communist vision is the division of society into classes: land owners, property owners, the owners and managers of fixed (industrial) assets, and wage laborers. History is interpreted as a struggle for power between these classes. The Bolshevik revolution was undertaken in 1937 to place poNver for the first time in the hands of wage laborers-the working class-through their "representatives," the communist party. The imposition of communist rule in the wake of the victorious Red Army after 1945 was similarly interpreted by ideologues as a victory of the working class in the struggle with the owners of capital for control of the production process. Marx's original analysis was a critique of nineteenth century capitalism, by which market relations were replacing slavery, feudalism, and other forms of economic management. Marx did not, however, base his criticisms on the inhuman conditions to which early industrialization led; rather, he sought a "scientific" analysis which could pinpoint the direction future reforms must take. iHe was concerned to show that beneath the apparently beinign surface of voluntary exchange through the mechanism of money, which underlay the emerging market system, was exploitation as severe and degmding as slavery or feudalism. The labor theory of value purported to prove scientifically that 156 1 THlE INIIFRITA^NCE the seemingly fair profits earned by the new capitralist class were in fact the fruits of their exploitation of wage laborers. TI'he working classes were there- fore as justified in figlhting against their condition as had been previously oppressed groups in society. Marxist economtc science viewed the triumph of the working classes in two phases. In the second, communism, the technological Capacities of the cco- nomic system would have progressed to such an extent that scarcity of goods would have been abolished. The allocation of scarce resources would not be a problem because the economy would be capable of producing sufficient to satisfy all necds. In the interim, there would be socialism. The fundamental problem of economic scarcity would still pertain, but the country -would be ruled by the communist party in the interests of the working class, the "dic- tatorship of the proletariat." Howvecr, before 1917 the specifics of how to run an economy on socialist lines had never been properly formulated. Its subsc- quent practtcal elaboration can be argued to have had three principal aspects: central planning, job security, and subordination of the individual to the collective. Central planning was not at first a part of the dogmna1 but it became so later. Once the communist party had seized power in the Russian Empire, the many possible interpretations of socialism were the cause of furious policy debates, including a powerful faction in favor of the market mechanism (see ElIman 1989). However, the crude anti-market ideology of much Marxist writing rein- forced traditional state absolutism and the Stalinist vision of a speedy, quasi- militarized process of industrialization, giving final victory to bureaucratic cen- tral planners. This outcome was made more likely by the apparent failure of Lenin's market-oriented reforms, known as the New Economic Policy, in the 1920s. Private ownership of fixed assets and agricultural land was then quickly suppressed and market forces were relegated to a minor role. Only final con- sumer demand and labor supply were left to be allocated by the mark-et. The allocation of other resources was to be based on physically denominated quotas set by the planners, and money was left to play a passive role. Central planning answered the question of how to run a socialist economy, but not how the communist party should use its power in the interests of the working class. One solution was to create as large a working class as possible, an answer consistent with military and strategic pressures for rapid industrial- ization. According to Marx, inequalities would persist under socialism, although the authorities supported widespread social provision and greater equality between blue- and white-collar salaries. Widespread training, particu- larly for agricultural workers joining the industrial proletariat, was also a prior- ity, and the system came to regard absolute job security and, in effect, the right to a job as virtually defining characteristics of socialism. This substantial degree of job security did not, however, significantly increase workers' control over the labor process. 1 57 I Trhiu POLITICAL ECONOM9Y o01 rRANsI'oPMA'riON The subordinationl of the individual to the collective was the third part of the dogma. Because communists viewed society as composed of classes rather than individuals, individualistic activity was inherently suspicious. A signift- cant consequence for the subject of this book was the application of the principle of collective or group, rather than individual, welfare to the evalua- dion of consumption. Thus collective consumption was acceptable and even desirable; except in obvious cases like food or clothing, private consumption was individualistic and potentially on the slippery path back to capitalism. Workers could consume health, education, and even vacations together in groups typically organized around their factories, but the system was not oriented to supply individuals with consumer goods for their private consuniption. This vision of socialism was devised in the U.S.S.R., wherc it was applied ruthlessly beginning in the late t920s from Leningrad to Vladivostok. It was -also impDsed by force of arms on the diverse countries of Central and Eastern Europe brought into the Soviet bloc after the Second World War. The Legacis of COmmunist Ideology The consequences of communist ideology for policies governing the develop- ment of human resources during the transformation can be considered from two angles. First, there are the conceptions about key elements in society and the economy, for example, the rule of law, the role of the state and the individual, or the economic function of wages and bccfits, which are different from those common in the West. Second, there is the lack of awareness among policymakers and administrators of basic economic concepts such as opportunity cost. Different conceptions arose in two important ways: the role of the state in relation to its citizens and the structure of rewards. Under communism, the state, the citizen, and the law related to one another in ways very different from their relations in the West. The government apparatus under commu- nism was not elected to act in the intercsts of society, nor even in the narrower interests of its own voters. Public power was explicitly a dictatorship by the communist party in the interest of the proletariat, as interpreted and enforced in the party through the mechanism of democratic centralism. THE ROLE OF THE STATE. The aim of the party was to maximize the growth of production. Most social institutions and pressure groups were structured to assist in that goal (sec Bergson 1964; ElIman 1989; Gregory and Stuart 1986). Classic Soviet-type planning held sway in most of the communist world until the fall of the communist regimes.2 Maximization of the growth of industrial output was based on virtually total and highly concentrated state ownership of property and was attained by centralized economic decisionmaking under the planners. Although economic entities called enterprises, or bank branches, TIllE INIIERITANCK did exist, they fulfilled few of the functions such organizations undertake in market economies. Thley had little independent authority and acted, in many ways, as administrative arms of the center. Enterprises followed ;ilans which covered in considerable derail most aspects of the firm's technical, industrial, and financial behavior, as wiell as the allocation of investment and the distribu- tion of the fruits of rescarchi and development from central research facilities (see Berliner 1957; Granick 1954). Branches of the central bank verified that transactions in the plan had actually taken place and at official prices. Manage- ment carried out the plans, which werc evaluated by success indicators based on plan targets, many of which were denominated in physical rather than value units. Workers and even the trade unions were also dedicated to achiev- ing targets and, thereby, the wider national plan. Reforms affected the struc- ture but not the objectives or the excessive cenitralization of the system. This is not to say that the central authorities were in practice able correctly to evaluate the producEive capacitcies of firms or the inputs required to attain plan targets. In fact, from the outset, widespread bargaining occurred betNeen planners and enterprise managers about the contents of plans: managers sought and planners tried to resist the inclusion of slack in enterprise plans (see Ericson 1991). The planners responded to the managers' systematic tendency to understate their productive capacity and exaggerate their input needs by using the so-called "ratchet principle," whereby output targets were always raised to match at least the level of previous best achievements. Managers searched for slack in the planning system, which also contributed to their tendency to stockpile considerable hidden reserves of inputs, including reserves of labor, and to underuse capacity. Responsibilities in society were therefore focused on satisfying the needs of the plan and of the party.3 Secondary responsibilities for the stare also existed to maintain the welfare of workers through the provision of basic services- health care and education-and to provide employment or the necessary retraining required for placement. The totalitarian conception of the state and society in Soviet-type systems, however, left no space for decentralized deci- sionmaking or for satisfying the needs of special groups. [t also offered sur- prisingly little role for the state itself, as distinct from the party. Citizens deeply mistrusted their government, and of course the party was profotindly suspicious of the population. Hence, on the one side were the gulags, the show trials, and the vast internal security forces; on the other was the cyni- cism of the populations toward the political process, particularly in countries such as Czechoslovakia, Hungary, and Poland, where reform efforts had been savagely suppressed. Party rule also undermined the concept of the rule of law, because communist parties governed directly by decree and used the legal system only intermittently and as a mechanism for reinforcing their control. The absence of a clear and broadly accepted concept of the rule of law is a major impediment to the operation of market systems, which rely on 1 59 1 'I'ti Im.PLrIICAL ECONUMY OF TlIIANKI'ORMIA'T'ION clearly definied property riglhts and enforceable contracts. All thecse characteristics-the lack of decentralizationi, the distrust of govern nelit, and the undermining of the rule of lowv-emerge repeatedly in later cliapters. 1TiL STrRUCrUuR O1 REWARDS. The' role of wages and cash benefits in a socialist economy is the second major arca of difference with the West Twvo wvell-known principles can underlie the distribution of income. rhe first is the principle of desert, in which people earn wages determined by their contribution to society. If the labor market is competitive, free markets will distribute income based on desert. Alternatively, income can be distributed according to necd. judging needs to bc broadly similar for all people in society implies strict egalitarianism in the distribution of income. Distribution according to need is also consistent wvith allocating higher incomes to groups perceived to have greater demands, for example, the disabled or large families. In Marx's communism, society would distribute according to need, but for most communist parties in office, distribu- tion has been based on desert. Thius, in contrast to China under Mao, no attempt was made to disguise self-interest as the motivating force in socialist labor markets, although many efforts were made to manipulate material incen- tives, particularly in the area of wage determination. Thus communist countries did allow income differentials to be established beEnveen occupations, sectors, and regio!ls, although these differentials were typically narrower than those in the West (see Wiles 1974 and the discussion in chapter 7). In interpreting deserts, howvever4 individual contributions were usually evaluated relative to the demands of the plan. To quote Lenin (see ElIman 1989, p. 209), "Distribution is a method, an instrument, a means, for increasing production." Wages were set centrally, and the Soviets in particular sought a scientific basis for wage differentials which led after Stalin to a system of national job evaluation. The idea vas to grade all jobs and workers in such a vay that actual pay was determined by a combination of occupation, grade, work norms, output levels, hours work-ed, bonuses, and regional coefficients set to enicourage migration to unattractive areas or to offset labor flows to -richer areas. Wages were also used to assist specific groups, for example women. The result of this procedure was a very large and inflexible table of ear nings by sector, which grew more and more complex and incoherent ovcr time. Pay also came to rely on bonuses. According to Gregory and Stuart (¶986) in 1972, the basic wage, which was detemiined by the job evaluation system, accounted for 59 percent of total pay, bonuses for 20 percent, pre- miums for exceeding norms for 1 1 percent, and differencials for regional and special working conditions for 10 percent of average wvages in Soviet industry. The "scientific" basis for determining wages therefore caused problems because it failed to ensure standardized wage rates for given jobs by industry. Notwithstanding these "objective" formulae, differentials were in practice kept very narrow for ideological reasons (see Wiles 1974). 1 60 1 I' 1 INIIt ITI'I'ANCE Since the wage system was based on deserts, the principle of distribution according to need was satisfied through transfer payments and the provisioll of widespread free public services. rhe distinction between wages, cash benc- fits, and benefits other than cash was blurred since sonic cash and many non- cash benefits were allocatcd through the place of work and based on the fact of employment. Wages also differed in nature from those in a market econoniy because of the critical role which state subsidies played in consumer prices (in Czechoslovakia subsidies amounted to around 15 percent of the wage bill) and in housing (so rents in 1991 amounted to less than 10 percent of living costs in Czechoslovakia). Social welfare at enterprises, such as canteens, holiday resorts, transport, medical services, and day care, also amounted to a signifi- cant proportion of the wage bill (around 5 percent in Czechoslovakia). The early communist rulers were aware that education and training could have major economic benefits. Ellman (1989) notes that Strumilin advocated expenditure on education as a high-yielding investment in 1924, and calcu- lated in 1931 a sixfold return to educational expenditures. The socialist econ- omies all rapidly developed extensive education systems and on-the-job train- ing programs. However, these Were focused on the educational requirement of extensive growth and were not well adapted to changing needs in recent decades. Although wage differentials might have given manual industrial workers an interest in building their skills, the signals -were too weak and distorted to encourage many other forms of human capital accumulation. Labor relations, in particular lowvworker morale and low efficiency, became increasingly serious problems for several reasons. First, and most important, wages for most people were very low. The average level vwas often inadequate to support necessary consumption. The reason in part Yas diat high levels of investment were needed to fuel the planners' overriding objective-growth- and these had to come at the expense of wages. Moreover, the wage system generated numerous petty distortions and injustices which undermined the potential incentive effects. The widespread shortage of goods and queuing also called into question the actual welfare gains obtained from higher pay. The emergence of a large-scale black market, while alleviating shortages, may also have demoralized the general public. Workers in socialist countries also typically worked in enormous and unat- tractive factories and plants, because directing fewer firms simplified the planning process and increased central control. For example, Soviet giganti- cism meant tfiat Czechoslovakia, Hungary, and even Poland had very few firms in the industrial sector in 1989, often only a few thousand. Hugc enter- prises in the West have often been riddled with disputes over labor relations, but such disputes were all suppressed in communist regimes. Management principles were explicitly based on Taylorism (that is, a "scientific" approach to management, which treated labor as little different from machines), with complete faith in the scientific principles of labor organization at the Work- 1611 TIIE FoLITcAi. ECONOMY OF TRANSFORNIATION place and the total absence of countervailing influences. In this conception, trade unions were part of the state and party apparatus and represented mercly another tool to ensure fulfillment of the plan. According to ElInian (1989, p. 189), "Workers have little control over their work and are very vulnerable to arbitrary measures by the basses." In a totalitarian society devoted to maximizing production, taking it easy at work represented one of the few ways available to register dissatisfaction with the system. Poor labor morale and effort were also a consequence of people responding to declining real w ages by holiding more than one job. These problems were particularly prevalent in the U.S.S.R.; they were somewhat less acuite in the rest of Central and Eastern Europe, particularly after the late 1950s. LACK OF AWARENESS OF BASIC ECONOMIC CONCEPTS. Wiles (1962) argues that the Soviet-type planning system entailed a deliberate decision to sacrifice efficiency in the allocation of current resources in favor of rapid economic growth. Bergson (1964), in contrast, believes that static allocative efficiency was sacrificed without achieving a significant offsetting gain in growth. What- ever the motivation, central planning systems clcarly were not concerned with making rational economic decisions on the margin and, in the past, had neither the information nor the expertise to do so. Rational el:onomic deci- sions must be based on prices which reflect domestic. or inturnational scar- cities. Prices played nothing but an accounting rolc in a Sovicttype planning system and were, in any case, nor used as the basis for decisions. Thus investment decisions were evaluated on the basis of internal acc"unting pro- cedures and prices, without reference to their implications for shadc.w cost, let alone for scarce energy, raw materials, and imported inputs. Production deci- sions wvere made without reference to profitability at world prices. The reason for such an approach is simple but fundamental: under Marxist principles, scarcity was not an ideologically acceptabole description of the relationship between inputs and outputs. Communist ideology thus ruted out any noot6, of opportnity cost in the allocadon of roure. It follows that there was no concept of efficiency in the W'estern sense of the term nor an avareness of the tradeoffs discussed in chapter 1. A further consequence is that Soviet eco- nomics did not analyze individual behavior and contained no real behavioral assumptions. No efforts were made to predict the reactions of agents to changes in incentives, and there was little attempt to test the validity of economic propositions (and hence no econometrics; see the glossary), and no welfare economics. Hare and Hughes (1 992) suggest one indication of the consequences. They investigate the efficiency and competitiveness of industry in Central and East- ern Europe by applying Western prices to sectoral inputs and outputs in order to see which activities might benefit, and which might lose, from the price realignmcnt associated with reform. They found that around two-thirds of 1-621 TI4E INHIERITANCK output had a comparative disadvanitage ac world prices. Sonic sectors, accounting for more than one-quarter of output in some countries (measurcd at domestic prices), even produced negative value added according to their calculations; at world prices, in other words, the material cost of supplying the products, before considering either labor or capital costs, exceeded the reve- nues that could be generated from selLing them. The methods have been disputed because they were applied at a branch rather than enterprise level and because the approach assumes that firms do not alter their pattern of input use in response to the- new prices. But the study does provide preliminary orders of magnitude for the extent to which resources were misallocated under central planning. It also helps to highlight that a crucial inhcritance of enterprises and the state bureaucracy is an orientation to production mther than profitability, particularly profitability at world prices. This has clear impli- cations for the allocation of human resources. The General Systemic Inheritance This section explains how the planning system allocated resources and what the consequences were for economic performance, particularly with regard to labor. The discussion summarizes a large literature (see Bergson 1964; Ellman 1989; Gregory and Stuart 1986; Wiles 1962). GeeralBackgrvund Communist ideology viewed the private ownership of property as the basis of worker exploitation. Communists, therefore, always nationalized most pro- ductive assets when they seized power and often made private ownership effcctively illegal. In consequence, such economies have almost no capital market institutions and very few small- and medium-size firms of the sort typically privately owned in the West, although some had begun to reemerge in the market socialist countries by 1989. The effects on entrepreneurship, corporate governance, and labor incentives have been widely discussed (see Fischer and Gelb 199 1; Kornai 1990). In the classic Soviet-type planning system, nationalized enterprises were grouped into branches and placed in a hierarchical structure under ministries and ultimately the central planners. The economy was then run like a giant firm, with orders, typically denominated in physical units, descending from the planning organs down through the ministries and their subdivisions to firms and plants. In this way, the economic structure became locked into a rigid pattern with large firms themselves controlled by branch ministries which were defined by their industrial profile. Neither firms nor ministries had an incentive to challenge the structure or to diversify their activities. In a market economy, the bulk of economic relations are horizontal, between different enterprises or between firms and consumers. Under plan- 1 63] TriWi: POLITICAL KCONOMY OU P'MKXNHOItnMATION -ning, the flow of inforniation and orders was intended to be vertical, from planners down to managers. Horizontal relations, which Would imply some degree of decenltralization of decisionmakirig, were nicant to be kept to an absolute miniimum. rrie system was designed to do without, and oftcn to suppress, individual initiative arid effort. In practice, however, plan implemcn- tation required a considerable degree of horizontal interaction to counteract the informational deficiencies of excessive centralization. This took the form of informal exchanges be'tween firms and the gradual cmergence of a full-scale secondary market.4 This is an example of the "paradox of intent," in which decisions arising from short-term opportunism proved to be entirely inconsis- tent with communist ideology. The objective of the system wvas growth, and this was to be achieved in the early years of planning by Lte transfer of labor from agriculture to industry, in particular to heavy industry. Rapid industrialization wvas based on very high rates of investment. Shares of investment to net material product were typ- ically around 30 percent in the U.S.S.R. and Eastern Europe in the 1950s and were still normally in excess of 20 percent as late as 1985. The growth wa*s devoted not to satisfying consumer needs, but rather to expanding continu- ously the production of material inputs. A revealing statistic presented by ElIman (1989) is that, as in most Western countries, the bulk of production in the Russian Empire in 1913 was devoted to the supply of consumer goods, 65 percent as against 35 percent for producer goods. By t946 that proportion was reversed. and in 1985 only 25 perrent of Soviet itnduistda/ Ocpitt noas of oinsumergoomds. The remaining 75 percent was of producer goods. Because it stressed extensive growth, the system also generated faster growth in rela- tively less-industrial economiks, such as Bulgaria and Romania, than in coun- tries which wvere already industrial, such as Czechoslovakia or the Gernian Democratic Republic. The fact that Soviet-type systems wvere inefficient in the altocation of resources does not imply that the plans were slack or that managers had an casy life. The planners' main tool in the heyday of planning was the material balance, a table listing the total sources and uses of each commodity. The potential sources wvere from production, imports, and stocks. The uses were for production, exports, stocks, or consumption. As ElIman (1989) stresses, it is important to realize that the planners not only failed to obtain "optimal" plans, in the sense of plans that maximized social welfare, but also failed to achieve "feasible" plans, in the sense of sources (supply) in the material balance which equaled uses (demand) for each product. When demand exceeded supply, as i: frequently did, the planners did not seek to achieve consistency by reducing output targets; that would have conflicted with the objective of growth. Rather, they cut supplies to uses which were regarded as inessential, based on the application of the "priority" principle. Since there was no subsequent adjustment of plan targets, plans were rarely attainable. - 641 T'HHP INIIERITIANCI This tautness of planning assumes great significance when one reflccts that the institutional and incentive structure, which represented a large proportion of the salaries of vorkers and manage:rs, was manipulated to ensure attainment of the plan. Enterprise directors, in particular were under enormous pressure to attain plan targets, with as much as 35 percent of incomes depending on bonuses related to the achievement of such targets. Although plans were rarely feasible and alwrays hard to achieve, financial constraints wiere seldom if ever binding. This asymnetry of pressures was a major cause of a number of widely recognized characteristics of planned economies: Low labor productivity was wvidespread because hoarding labor was in management's interest. Few penalties were imposed as D consequence of cost overruns or failures to meet output profit targets, but the spare resources could be critical to last-minute attempts to meet plan targets. The same applied to all other factor inputs, most notably capital and raw materials such as energy. Hence Brada (1989) shows that overstaffing in Czechoslovakia reached up to I5 percent of the labor force by the end of the 1970s. Firnis also held excessive stocks: the Soviet ratio of inventories to net material product was around 50 percent in 1960 and 80 percent in 1985, as against less than 40 percent in the United States. The reliance on physical gross indicators of performance implied a persis- tent problem related to quality and product mix, since targets were rarely specified tightly enough to prevent skimping in the production process. Because sellers w%ere never directly responsible to buyers, market forces could do nothing to eradicate the problem of poor quality. Because plan targets were based on quantitative production norms, man- agers were suspicious of technical advances which would imply higher norms. The system therefore failed to offer adequate incentives to innovate. This problem is also related to the "ratchet" effect which attaining current targets had on future plans and which -was an important lerment of the bargaining between planners and managers. * The widespread uncertainty resulting from inconsistent plans also led to duplication of productive capacity within branches and even firms. Thus enterprises, unable to rely on spare parts for minor repairs, ordered extra equipment to cannibalize for parts and built their own foundrics and other service units. * With such pressures to attain plans, and the accumulation in enterprises of excessive stocks of most productive materials, it was inevitable that a secondary market between managers w ould emerge for the supply of inputs. As noted above, the excessive centralization and tautness of the system had the ironic result that enterprises increasingly came to rely on semi-legal (or illegal) exchanges through the secondary market, with communist party officials often playing the role of market trader. The increasing role of the secondary market in the functioning of the econ- omy further undermined the credibility of the rule of law. 1 65 'I'I P POLT''ICAL, ECONOMY O)'CI'TlANSHORMA1'ION 17,e Slowdlowrn i o GwthI Socialist rule was premised on rapid gruwrtl, which was the primary raison d'etre of the economic mechanism. The collapse of the political system steninied from the fact that, after early successes, the growth rates of all the planned economies started to slow dowtn and ultimately declined to zero or worse. TI'lhe most striking feature of this slowdown is that it occurred at levels of income and consumption per head far belowv those attained in the Wcst and below those now achieved in some of the newly industrializing economics of East Asia. The slowdown occurred in countries, such as the U.S.S.R. or Czechoslovakia, where the planning process remained largely true to its ori- gins until the fall of communism; but economic failure was equally pervasive in the market socialist countries, such as Hungary, which had abandoned the centralized allocation of resources. This section describes and attempts to explain the slowdown, with. the knowledge that this is a major problem for post-communist reformers. According to the official figures presented in table 3-2, the Soviets attained very high growth rates during the 1930s and during postwar reconstruction (for a full discussion and alternative evaluations of Soviet growth rates, see Bergson 1964 and Ofer 1987). The slowdown commenced in the 1950s and motivated the Khrushchev reforms. The problem was not restricted to the U.S.S.R., however; table 3-3 shows that even using official data the slowdown was also severe in the rest of Central and Eastern Europe. Growth rates had typically declined from more than 6 percent on average in the 1950s and 1960s throughout the region to around 4 percent in the late 1970s and to close to zero, or in some countries negative, by the end of the 1980s. Table 3-2. Officia GCrth Rates in the U.S.S.R., 1928-91 (pcrcent) Year(s) Grwth rate 1928-40 14.6 1950-60 10.1 1960-70 . 7.0 1970-80 5.3 1981-85 3.2 1986 3.0 1987 1.0 1988 0.0 1989 -5.0 1990 -10.0 1991 -15.0 &wrres: Ellm;n and Kantarovich 1992; Gregory and Stuart 1986; and unpublished reports from Plan:con. l66 1 -'I'llE I NIIZR 'I'A Nc Table 3-3. Cliangus ig , e /Net Afute,ia/ Prmdt in: &nt.'rn/ladrzsletrritpe, 1971-89 (liercent) COuntly 1971-75 1976-80 /981-85 1986 1987 1988 /989 Bullarla 7.9 6.1 3.8 5.3 5.1 2.4 -0.4 Czechoslovakia 5.r, 3.7 1.6 2.6 2.1 2.4 1.3 German Dcmocrntic Republic 5.4 4.1 4.6 4.3 3.3 2.8 1.0 1lungtry 6.2 2.9 1.3 0.9 4.1 0.3 -2.0 Poland 9.7 1.2 -0.8 4.9 1.9 4.9 0.0 Romania 1 l5 7.0 4.5 7.3 4.8 3.2 - - Not availablc. Note: Thcsc dat derive fronm ofrial statistiecs and thercfore nust be treatcd nith caution. S&mar: Unitd Nations 1990. The most obvious explanation of the slowdown in the U.S.S.R. in the 1960s is that the possibilities for growth of an extensive form were exhausted. This is consistent with the slower growth always attnined in the more- industrial countries of the Council tor Mutual Economic Assistancc and with the relatively more sustained momentum in Bulgaria and Romania. The sys- tem grew via rapid capital accumulation and the increasing use of labor in industry. According to Fischer (1991), the capital stock was being expanded at between 7 and 9 percent between 1960.and 1985, which probably implied that the system was rapidly entering the region of diminishing returns to accumulation. At the same time, the economy began to face labor shortages in the 1 960s: most of the easily available labor located near the urban industrial centers had already transferred from the agricultural sector (although the share of agriculture in employment remained high), and participation rates were very high by Western standards (87 percent of the relevant age group in 1980 as against 71 percent in the United States). As a result, the expansion of the urban industrial labor force wvas restricted to around the underlying rate of growth of the population, which was less than I percent after 1970. Empirical discussion has focused on the case of the U.S.S.R. Martin Weitz- man (1970) has argued that the reason for the decline in industrial produc- tivity lay in very low rates of substitutability between capital and labor. As noted already, there were great diffcrenccs in the rate of growth of capital and labor inputs in the U.S.S.R. These would ultimately limit the growth of Soviet output if substitutability between capital and labor was low. Weitzrnan esti- mated the clasticity to be significantly below unity. In contrast, Desai (1985) uses industry and branch data to argue that the cause of the problem was not low substitution elasticities, but more general factors.5 Similar findings have been made by Brada (1989) for other countries of Central and Eastern Europe. These authors explain the decline in growth as a result of systemic 1 67 I ril E I. 11LITICAI. I.CON0IIV 11F TIANS!FH MAT'ION failures, miiost notably the inlerenit inefficienicy of rcsource use, shortaiges of key raw materials such as steel anud coal, bottleniecks in energy and transport, anid aL marked decline in labor morale and discilpline after tde late 1970s. Other explatnationls of declining induistrial productivity relatc to the effects of sustained underinvesttimenit in hu;nian capital, especially educatioll andl * Ofer (1987) argues tihat the exclusive emphasis on attaining currenit plan targets led the system to neglect long-term problems, for example1 infra- structtire and the tnaintenance of physical and human capital. * Particularly in the Soviet case, there is sonie rcason to blame the deteriora- tion of human capital which is associated with both alcohiolisnm and a declin- ing quality of healtlh care. In tie 1970s, the Soviet share of strong alcohol in total alcohol consumption was probably the highest in the world. Consump- tion of pure alcolhol per hcad (persons miore thian fifteen years old) had riseln front 4.4 to almost 12 units between 1955 and 1979 (Ellman 1989), vith a network of sobering up stations being c'stablished to counter widesprcad alcoholism. In the 1980s up to 20 percent of personal income was spent on alcohol. Alcoholism has been associated with nunierous social ills-disease, divorce, car accidents-and was the subject of a major campaign by Gor- bachev in the late 1 980s. i In contrast with earlier periodt, long-twrni human capital formation was neglected aftcr growth began to slow dov n, regarding not only the extent of investment in education and health, but also the quality of provision, such as the course contcnt and teaching methods in education and the neglect of promotion and prevention, compared with treatment, in health. These issues are addressed in niore detail in later chapters. Other relevant factors underly the slowdown in growth as well: * The price of energy increased after 1974, and the situation was exacerbated by the inability of the planning system to respond to it. This was particularly unfortunate for the energy-importing countrics of Central Europe, which faced serious deterioration in their terms of trade. * There wvas an increasing need for industrial growth to be based on flexibility rather than thc mass production techniques of the old heavy industries. The communist system was weak at motivating change and taking risks and was therefore particularly unsuccessful at inroducing information technology. * Perhaps as a consequence of growing internal political wcakness, many communist regimes in the late l970s lost control over the macroeconomy. Most countries in Central and Eastern Europe, -including Yugoslavia, financed higher domestic consumption and investment by borrowing from the West. For Poland and Yugoslavia, the harsher international economic ciimate in the 1980s led to domestic wage pressures, budgetary deficits, and open inflation. 'r 'ontrast, Czechoslovakia and Romania attempted to I 68 1 rTII. INIIII.tI1'1ANt, repay their debts and thereby paid a highj cost in growvth antd real wages. The situarloit in 1989 is sumniarized in tuble 3-4. Finally, tie effect of the Western arms buildup in the 1980s, and the attempt by members of thc Warsaw Pact to matcli it despite their detcriorating domestic economies, diverted scarce resources from much-nccded invest- nicnt in othier areas. Althoughi it is hard at this poinit to evaluate the impact of defense expenditurcs, they cannot, in thc Soviet case at least, be ignored. The Systemic Inheritance in the Social Sectors The communist economies were not all bad. Table 3-2 shows that they wcrc capable of generating high rates of growth when labor as vell as capital was plentiful and before. the cumulative dysfunctional clements of the economic system were fully revealed. This book is about the development of human resources, and some of the most important early positive features of the system wvere in this area, although even here there were always serious prob- lems. It is useful to distinguish between the traditional system during the heyday of planning, say before 1970, and the sharp deterioration which set in after that date. This section is intended to serve as a brief introduction to later, more detailed material on labor markets, income transfers, education, and health. As elsewhere in this book, the discussion of the specific inheritances is divided into three parts: the strengths of the old system, its weaknesses, and those perennial problems which will always remain. As soon becomes clear, the good and bad features are often opposite sides of the same coin. Table 3-4. Level ofHard Cumtry DebJ in Cematml amd Eastern Erorpe, byCounty, 1989 -4hso/ute lel of Ratio of net grs debh Grm deht exports to gri (billions of per capita intest Caonnty- U.S. do/l/fs) (U.S. dollanr) (pnren)4 Bulgaria 10.0 1,149 16.5 Czcchoslovakiab 7.2 480 6.0 German Dcmonstic Rcpublic 21.7 1,312 13.0 Flungary 19.7 1,858 t8.8 Poland 40.4 1.,058 41.5 Romania 0.2 9 1.8 U.S.S R. 49.5 170 3.7 Yugositvia 17.6 743 17.6 a. Merchandise exports in countrics with convertiblc currcncics. b. Newly rcleased official statistics for 1989. c. lncludes an additional $2 billion in hard-currency debt to countries in the Council for Mutual Economic Assistance which the National Bank of Hungry omitted fronm its statistics until mid- November 1989. Sounre: Various natianal statistical abstracts. 169 I i'111' itOtnITiCAI. ECONOMY OPF THANS'OMA'IAJON S&tneuigt/ls 'rme traditional Soviet-typle systelim wvas particularly stroIng in the provision of individual security to the indtistrial labor force, as well as in the provision of relatively generouis cash benefits, healtih care, and education. INDIVIDUAl. SECUII1rY. Socialist economies provided an extraordinary degree of job sccurity by Western standards. Once workers had a job and had passed thie probationary period, which was in most cases merely a teclhnicality, thieir job was effectively guaranteed until they wished to leave. Legally it was very difficult to disnmiss employees for redundancy or incompetencc, and somc groups (older workers, pregnant wvomen, and the handicapped) iwere pro- tected by law against dismissal. Even during downturns in output, workcrs continued to bc paid in full, and enterprises were not permitted to fail, being supported by state subsidy. As noted earlier, however, this job security did not prevent low morale in the workplacc. Marxists were particularly critical of unemployment in capitalist countries and sought to minimize it under planning. Indecd, the "right to work" Was often a constitutional provision. High levels of employmcnt wvcre achieved by giving enterprises and local governments quotas of new entrants to hire from the labor market, and the planners were required to find Jobs for unemployed -workers. This policy was enacted without reference to labor productivity or enterprisc profitability. The Soviets claimed to havc liquidated unemployment in the 1930s, and unemployment pay w'as aban- doned as being unnecessary. Nonetheless, unemployment occurred outside the urban indu.strial sector, and frictional unemployment also persisted; in 1967 the average pcriod spent between jobs in the U.S.S.R. was thirty-three days. A second positive feature of the system was that per capita consumption of necessities and of basic services was higher than onc vould expect given the low lcvels of income per head and the high shares of investment. Gregory and Stuart (1986) report a calculation that put 1977 output pcr bead in the U.S.S.R. at around 60 percent of that in the United States (valued at U.S. prices) with consumption only around 45 percent. The explanation is cicarly the high Soviet ratio of investment to net matcrial product. Despitrc these low per capita levels of consumption, widespread subsidies of goods classed as necessities, such as food, housing, education, and health care, meant that the shortfall was less marked in thcsc areas. Thus per capita consumption of food and education wvas 54 and 75 percent of the U.S. levels, respectively. How- ever, the Soviets wcre not keeping up in lhcalth care, if the United States represents an appropriate standard: health care consumption was only .37 percent of the U.S. level (in fact a lower proportion of the U.S. level than in 1955). Strikingly, per capita expcnditures for consumcr durables were only 13 percent of the U.S. level. 1 70 1 'IlIE INllERITANCE INcOMELTRANSFERS. Cash bcnefits were well established and relatively conm- prehensive in must socialist countries. TIley included a generous system of sick pay and earnings-related pcnsions guaranteed by the state and nominally available Ut retirement ages often significantly below those in the West (sixty for men and fifty-five for women).' Tthere were also child allowances and long maternity leave; the imperative of job security allowed employed mothers to stay at home for a relatively long period without losing their claim over their job and while receiving an allowance, for example, four years in Poland and three years in Hungary and Czechoslovakia. DEVELOPMENT AND REDEPLOYMENT OF HUMAN CAPITAL. The education systenm in Soviet-type economies was an important element in the overall process of developnient; it wvas in large part through the education and vocational training systems that the planncrs tried to mould the skills of the labor force to the dic- tates of the plan. Children could start school at very young ages, in part to facili- tate the speedy return of mothers to the labor force. Secondary education was compulsory, and typically a supplementary group of specialized educational institutions was devoted to technical education, language training, and so forth. Since education policy was a major element in manpower planning, liberal arts education was almost nonexistent, and education was oriented to engineering and science. The impact and biases of the Soviet-type education system can be evaluated for the Soviet case on the basis of table 3-5. The system provided a lot of education for its level of income, far more than the average for the devel- oping world, for example, and somewhat morc than for Italy. By the standards of industrial economies as a whole or the United States in particular, however, average levels of provision, for example of higher education, werc modest. The impact of this relative backwardness on the process of industrialization was mit- igated by the strong bias toward scientific and technical training. Socialist economies wvere also rather progressive on certain gender issues and introduced those policies from a relatively early date. Femalcs enjoyed Table 3-5. Indicators of Human Capital of the U.S.S R. in Ilternationa/ P:espective, 1980 Numher of Unierity &iewce sriwtistms and graduates as graduaes as Aloa- _yarsw rerhnicdirsper apirentage a percentage CoUtiy or rap of Ascoofing 1, OOOprsons of age raup oftllgre dua rs U.S.S.R. 7.6 128 5.8 48 United Statcs 12.2 55 15.5 30 Italy 6.4 83 3.2 50 Industrial countries 9.1 139 9.1 35 DDcvloping countrics 3.5 9 1.1 31 So&a: World Bank 1991. 711 i'll POLITICAL PCON0O1Y OF TRANSFORMATION wide access to education. Female participation rates were very high, and women's cenitral role in the labor farce was underlined by generous maternity leave with job security and by widespread provisioni of child cure facilities at the workplace. A major burden for womcn, in contrast, was the hcavy reliance on abortion as a nmeains of contraceptioni. HEATI'H CARE. The basic provision of health care wtas apparently adequate in many countries, particularly in the period before the full impact of the slowdown in growth was felt. Socialist economies offered universal aceess to free medical care and used food programs to prevent malnutrition. As an example, table 3-6 shows that despite the rclatively low income per head, the U.S.S.R. in the 1950s alreaady had levels of life expectancy at birth compara- ble more to industrial than to developing countries. The gap narrowed further until 1980. Such evidence of success is consistent with data suggesting that the socialist countries had relatively high proportions of doctors and medical staff per head of population. Despite this success, an important dimension of the gradual deterioration of txte economies of the socialist bloc was the worsening hcalth situation. For carmple, the death rate in the U.S.S.R. has actually been rising since the 1970s, from 9.7 per 1,000 population in 1950 to 9.8 in 1980, with a very sharp increase, particularly in the Russian Federation, after 1989 (see uiNicsF/icDc 1993, fig. 7). This is partly because the population is aging, but it also recflcts the progressive rise in age-specific death rates for males and females aged twventy to forty-four. These problems are related to the increasingconsumption of alcohol, rising numbers of traffic and industrial accidents, e%xcessive fat in the diet, and possibly also to the rising consumption of tobacco. The dcteriorating situation has not been helped by a declining standard of health provision, including a shortage of drugs and worsening quality of equipment. WYeakises. Some of the problems in the social sectors, many of them intimately con- necced with the better features, have already been noted. Several additional weaknesses also merit attention. Table 3-6. EcpeCtatiou of Life at Binh in Differmt RegWots of the WVorld, 1950-80 (years) Relion 19S0-55 1970-75 1975-80 Industrial rcgions 65.2 71.2 71.9 Dcvcloping rcgions 42.6 53.4 55.2 U.S.S.R. 61.4 69.A 69.6 &wnre: United Nations 1978. 72 1 THiE INIIERI'TANCK ORGANIZATION AND ADMINIST-RAION. Traditional socialist economies grew by investing heavily, and the share of expenditure devoted to collective con- sumption expanded considerably, mainly at the expensc of private consump- tion. Investment expenditures were devoted primarily to industry, although employment in education, training, and health expanded steadily. Such activ- ities were not priorities in the allocation of investment funds, however, because, followiing Marxist ideology, they were regarded as "non-productive," that is4 they produced an output which wvas not a physical commodity, but a service. The consequence -was a chronic tendency to underinvest in infra- structure and social overhead capital such as roads, schools, and hospitals. As these activities expanded, existing equipment and buildings were used more intensively. This problem wr,s already serious before the slowdown in growth but became more acute beginning in the mid-1970s because several socialist countries sought to resolve their economic problems by maintaining con- sumption at the expense of investment. Thus the share of gross investment in net material product between 1970 and 1985 declined from 29 to 24 perent in Bulgaria, from 25 to 18 percent in Poland, and from 24 to 10 perunt in Hungary. The decline in investment was particularly marked in the non- productive sector and greatly exacerbated the poor condition and inadequate provision of infrastructure in the run-up to reform. A second administrative problem for reformers has been that many bene- fits, both cash and non-cash, as well as much of the vocational education system, were administered through enterprises rather than through govern- ment authorities. In addition to the resulting problems of fragmentation and public sector inexperience with administering social services, such structures havc made it hard for reformers to restructure or close firms until the social sectors have been reformed. Given the low status attached to social welfare activities, it is not surprising to find that administrative principles and prac- tices are very old fashioned. Since reform of the social sectors is highly demanding in its need for investment and its administrative requirements, the absence of reform is easily explained. POVERTY AND INEQUALIT. Despite socialist propaganda to the contrary, com- munist regimes were not especially egalitarian. The data on this topic arc fragmentary and open to varied interpretation (see, for instance, Atkinson and Micklewright 1992; Bergson 1964, 1984. Wiles 1974). The balance of the evidence suggests that thc U.S.S.R. had measures of inequality broadly com- parable with those of the Scandinavian economies or the United Kingdom, but below those found in France or the United Statcs. The inequality measures were also. perhaps, more equal than those calculated for countries at a similar stage of development. They did, however, vary considerablr yentween coun- tries (see Atkinson and MickIewright 1992), with Czechoslovkia apparentlyk 1 73 1 TIlI POLITICAL ECONOMY OF T'RANSPORNIAT'ION maintaining partictilarly low levels of mcasured inequality. T'lhe after-tax ratio of tie top 5 percent to the bottom 5 pereent of income per hiead in the 1960s waus 3.0 in Sweden, 5.0 in the United Kingdom, but 5.7 in the U.S.S.R. However, it was 12.7 in- the United States but only 4.3 in Czechoslovakia. McAuley (1979) calculates that although inequalities had becn reduced signiri- cantly in the U.S.S.R. since the 1950s, even in the late 1960s some 40 percent of the population was living in poverty by the fornial Sovict definition. Even after adopting a much lower norm (half of the "minimum material satisfaction budget"), McAuley still finds that 25 million Soviets (around 10 percent of the population) were living in poverty in 1967. He concludes that 'there arc significant lacunac in the network of support provided by the Soviet social welfare programmes" (McAuley 1979, p. .74). Per,imial Problems It is ;vc . stressing the magnitude and-therefore the likely duration of the process of transition. Using figures for purchasing power parity, incomes per head in Central and Eastern Europe were perhaps between one-third and one- fifth of those attained in Western Europc. This situation has been cxacerbated by the sharp declines in output associated with the transition, shown in table 1-1. Rollo and Stern (I 992), using various assumptions, calculated how long it would take for these countries to return to their 1988 standard of living. Even on their optimistic scenario, the previous situation would not be restored in the countries predicted to grow fastest-Poland, Hungary, and the former Czechoslovakia-for more than ten yeavs. Their pessimistic forecasts extend the period, of recovery to twenty years or morc. Even very rapid growth for a gen .ration would not suffice to bring countrics like the former U.S.S.R. to the living standards of the poorer members of the European Union (see the glossary). Moreover, transition is likely to increase inequality and the proportion of the population in poverty in countries where the initial situation was already poor. These problems will undoubtedly be much exacerbated by the high levels of unemployment likely to be associated with the transition, a topic discussed in some detail in chapter 4. Conclusions This chapter has stressed some common elemcnts of the communist eco- nomic system: ideology, excessive centralization, orientation toward the growth of production, and suppression of market forces. This concluding section briefly mentions some dimensions of the diversity of economics in transition. The first dimetision concerns cultural heritage. The Soviet bloc Nwas X region with at least three cultural and historical backgrounds: Germanic (or 1 74 1 THE INHERITANCE Austrian), for examiiple in the Baltic states, Czcchoslovakia, and l-lungary; Balkan (Turkish), for examplc in Albania, Bulgaria, and Serbia; and Russian, for example in Belarus or Ukraine. Thcse cultural inheritances exert influence today as traditional alliances and trading patterns reassert themselves. Sec- ond, communism lasted a much shorter period in Central and Eastern Europe than in the U.S.S.R., so that in countries like Bulgaria, the Czech Republic, Hungary, or Poland, it is possible to conceive of the restoration of previous property rights, instituttonal structures, and commercial norms vhich in the former Soviet republics have either atrophied or never existed. Of comparable contemporary significance is the previous existence of the state itself. Bulgaria, Hungary, Poland, and Romania, for example, wiere inde- pendent countries throughout the communist era. The cconomy may have always been run on lines similar to those of the U.S.S.R., at least in Bulgaria and Romnania, but separate institutions of central and local government, of public administration, and of the legal apparatus were in place. The same holds broadly for the successor statEs of countries which have broken up since 1989, for example the Czech Republic, Russia, and Serbia. These have typically inherited nost of the former institutional framework, including the currency and the central bank. The collapse of communism, however, has created a number of ncw countries, all of which have to undertake the transi- tion in the context of creating from scratch both nationhood and most politi- cal, social, and economic institutions. Some, such as the Baltic states, have historical precedents upon which to draw. Others, such as the Slovak Rcpub- lic or Belarus, have little in their own nrecent history or experience to serve as a guide. Perhaps the absence of an inheritance in these entirely new states will prove as important for the reform process as the inheritances which this chapter has discussed. Notes 1. This chapter focuscs on the Soviet-typie ornmunist system typified by the dominance of the statc burcaucracy. Other forms of communism, not discusscd here, include thc sclf-managcment variant of Titros Yugoslavia and the Chincse model. 2. The main cxceptions werc China, Hungary, Poland, and Yugoslavia; and all countries experimented w ith reforms to the planning mcchanismn. Since the death of Mao, China has been moving toward radical economic but not political libcralization (sce Ellman 1989; Ofcr 1987). 3. In the market socialist economies, such as Hungary aftcr 1968. the needs of the party werc increasingly cxpressed directly through the governmcnt bureaucracy, cspe- cially that pcrtaining to banking and international trade, rathcr than through the instrument of the plan itself. Underlying institutional structures and behavior remaincd similar, however. Only in Yugoslavia during the latc 1960s did regional fragmentation lead briefly to a rclaxation of the tight grip of the party (see Estrin 1983). 4. The informal bargaining betwecn managcrs and the govcrnmcnt apparatus in the contcxt of planned guidelines in effect came to replace the formal plan in Hungary and latcr Poland. 75 I 'T'llE I)01.1'ICAI. ICUONOMY OF: TRANSFORMATION 5. l)csai's explanation centered on the dezcriniinanEs of dcclininlg tocal factr pro- ductivity, for example poor labor incentives, and resource niisallocation associated with the inforniationul dcficiencies of planning. 6. As discussed in chapter ', these low nominal retirement ages were reached as much on the cxception as the rule because5 many special groups could and did retire early with no loss of income. 1 76 1 IF'our TH[E FO]RCES DRIVIING C ANGE NICHOLAS BARR IMPORrANT HISlRICAI. DIFFERENCES DISTINGUISH THE COUNTRIES of Central and Eastern Europe from one another, as chapter 3 makes clear. The same is truc of their reforms. Programs vary with the size of the country and with its cultural, historical, and institutional inheritancc; and the reform process may be path-dependent, in the sense that outcomes early in the process may influence the speed and direcetion of later policy choices. All the countries, however, share a similar inheritance of central planning and totalitarian gov- errr;i.nt, and all are pursuing the twin objectives of higher living standards and increased individual freedom. According to Balcerowicz (I 93a), three features of the transforniation arc common to these countries and also distin- guish reform in Central and Eastern Europe from relorm elsewherc. Tihe scope of the change is massivc, in that both the economic and the political systems are being almost totally overhauled; the situation is truly revolution- arv. In contrast with that of most other revolutions, the method of change is for the most part 1ieaceful. IMroreover, he argues, the sequence of change is unusual in that political liberalizati ., largely preceded economic reform. At tht heart of the revolution were two central decisions: to move from central planning toward a market system and to move from totalitarianism toward less authoritarian forms of government. This chapter is about those decisions, the driving forces they released, and the resulting outcomes. Understanding the forces driving'change is important1 since they largely explain why the outcomes are as they are. GCreater rcliance on market forcecs produces beneficial outcomcs such as higher productivity and faster rates of growth, but it also leads to increased poverty, greater insecurity, and 'vider inequality. Increased democracy leads to greater individual freedom and greater responsiveness of government to the wishes of the electorate, but it also results iin administrative overload, an increase in crime, and incrcased appeal to cxtreme nationalist political parties. Outcomes are thus of twvo sorts. Sonic, such as greatcr efficiency, are wholly desirable; indeed, they are thc major purposes of the reforms. These beneficial forces, howevcr, may ovcrshoot. The resulting less beneficial out- comes are noted as chey arise and are taken up again in tlhc concluding section of this chapter.. The economic driving forces and their major outcomes are discussed first, followcd by the political driving forces.- 1-77 1 THE P1OLITICAL ECONOMY OP TRANSFORMlATION Economic Driving Forces Markets have three ingredients: demand, supply, and prices, which link the two. The move to a market system liberalizes all three: * On the demand side, individual choice becomes much more important, both for economic reasons (because of its central rule in the efficient alloca- tion of resources) and for political reasons (bccause of the backlash against the old system, which allowed little consumer oice). * On the supply side, liberalization introduces comnpctition by allowing new forms of ownership and by opening the economy to international competition. * Price and wage liberalization connects the changes in demand and supply. These changes release two sets of driving forces: a widening distribution of income and wealth and a more explicit role for economic self-interest. Iflrdenig Disntibudtion of Inome Economic liberalization has major distributional effects. It leads, first, to changes in the distribution of earnings. During the early transition, earnings differentials may be reduced because of anti-inflationary policies; subse- quendy they widen. Second, price liberalization changes people's rcal incomes, for examplc, by reducing the real incomes of individuals facing the largest price increases. Third, the broadening of property ownership widens the distribution of wvealth and increases the incomes of wealth holders. WAGES AND EMPLOYMENT. Increased diversity of earnings is a fundamental purpose. of the reforms. Earnings which bear at least some relation to individ- ual productivity encourage workers to improve the quality of their work, to move into jobs in which they are most productive, and to acqujire new skilis.. The debate in the West has moved on to consider sources of labor motivation other than performance-related pay. In the context of Central and Eastern Europe, however, the issue is to rectify an inhcritance in which wages bore more or less no relation to individual performance (someone talking about the old regime said that "work was somewhcre We went, nor something we did'). Thus performance-related pay improves incentives and, more generally, addresses the major problems of labor motivation inherited from the old systcm. A key outcome of market libcralization, therefore, is a rising number of people with higher incomes_ One way in which this occurs is that workers with skills valt.d by the market, such as speaking a Western language can now command a market wage. This is precisely the result the reforms lre meant to bring about. Second, the liberalization of property ownership, by extending the scope of private wealth, increases the incomes of wealth holders. Where wealth is acquired legitimately, this too is an appropriate 1 78 1 Tl'E FORCES DRIVING CHIANGE outcome. However, highier incomes and hiigher wealth can arise also for malign reasons. Not all monopolies are bad: monopoly profits can encourage new firms to cnter an industry. Sometimes, however, a monopoly of informa- tion or similar cause may enabic a firm to prevent rivals from establishing themselves. This phenomenon arises in part because the reform of ownership takes longer than price and wage liberalization. Similarly, some individuals, often party officials from the old regimc, are able to expropriate former state assets on advantageous terms, sometimes through dubiously legal methods. Alongside higher incomes are lower incomes. In part, again, this is intended. Pcople with few skills or low motivation face incentives to acquire skills and to work harder. That said, one of the major costs of the reforms is rising unemployment and increasing poverty. It should be remembered throughout that the importance of the work ethic in the inheritance, together with the security which the old system gave.citizens, means that unemploy- ment, poverty, and insecurity may be even morc personally devastating in Central and Eastern Europe than in the Wcst, where unemployment has a longer history. uNEMPLOYmENT. Rising unemploymcnt is occurring throughout Ccntral and Eastern Europe. The old system deploycd labor inefficiently, and the intro- duction of hard budget constraints and competition leads to displacement of workers as Firms reduce their work force or close down. As a rcsult, as mnuch as 25 percent of the labor force needs to change jobs. Workers at greatest risk, at least in the medium term, are those in heavy industry and in areas with the greatest concentration of uncompetitive industries. Displaced workers have four major destinations. One possibility is to find new cmployment. A relatively small number-of wVorkers will shifc from their old job in a shrinking industry to a new job in a growing industry with no (or virtually no) intervening spell of unemployment. Such an outcome depends on the growth of new jobs and on the extent to which displaced workers are abic through rciraining to acquire the skills to fill them. A second option is to leave the labor market altogether: as discussed below, this is dispropor- tionately the case with vomen and, depending on the generosity of the pension system, older workers, who may retire early. Emigration is a third possibility, although not one which has yet happened on a significant scale. The fourth outcome is to be made unemployed. As a practical matter, it is difficult for large numbers of workers to change jobs without experiencing an intervening spell of unemployment. Some workers have skills which are no longer in demand. Others havc skills which are in demand, but not in demand locally, and they are prevented from moving by inflexibility in the housing market. More generally, finding the right job takes time. A seconn'. and separate, cause of unemployment is the decline in output. The result, as table 1-1 shows, is that unemployment has risen rapidly in countries like I 79 1 ''Il I'OL.ITIUCAIL CONOMiY OF TI4ANSI'POMATION Btilgaria and Poland and hals beconme significant in ulinost all the counitries in Cenitral andl Easteri Europe. There: Is some evidence tliat, at least in the early transition, women bore a heavier buIrdein of unenmployment thani men. In part this wvas because women's participution in the labor force was traditionally muchi higher in Central and Eastern Europe thin in the West (in the U.S.S.R., becausc of high participa- tion rates and the fact that women outnunmbered men in the population, womeni wcre thc majorily in the labor force), but social attitudes also played a part. Although contrary to the ethic of the old systenm, thc view persists of women as honmeniakers who should cede priority to men so far as employ- ment is concerned. For either or both reasons, women were initially over- represented among the unemployed in most of the countries in Central and Eastern Europe (Fong 1993; Fong and Paul 1992). In the Russian Federation in early 1992, women constituted 52 percent of the labor force, but 71 percent of the unemployed. Althiough outside the scope of this book, eastern Germany is instructive because it has the best data. From a low level.in mid-199 1, uinemployment rose threefold for men and fivefold for wvomen by mid-1992. Limited evidence in. Hungary. and Poland suggests that women, as well as becoming unemployed with disproportionate frequency, are also likely. to remain unemployed longer than men.: Similarly, in Russia, women consti- tute 71 percent of the unemployed, but only 61 percent of new job finders (Fong 1993). Male and female unemployment rates have converged some- what as the transition proceeds, mainly because women are tending to drop out of the labor force (table 8-3). PovErTY. Emerging poverty, a recurring theme throughout this book, is dis- cussed in chapter 10, but it is useful.to summarize some of the kcy issues here. Poverty, although officially denied, existed under the old system (Bergson 1984, 1991; McAuley 1979) and becamc worse during the 1980s. Atkinson and Micklewright (1992, p. 178) report government estimates in the U.S.S.R. of 40 million poor people in 1989. Milanovi6 (1991) found that nearly 25 percent of the Polish population was poor in 1987. Since poverty increased during the 1980s even though output was rising, it is not surprising that poverty continues to wvorscn throughout the region, in soome countries dranmatically (see uNicEl4haIc 1993). In the case of unemployment, the transition creates a largely new problem. With poverty, the reforms do not create a new problem so much as aggravate an old one. Because of political libcralization, the problem becomes more visible, and alongside this greater visibility, poverty increases for at least three reasons: * Price and wage liberalization (an essential part of restructuring) widens the distribution of income. The relative prices which increase most are those which were previously the most heavily subsidized, particularly basic com- modities such as housing, heating, food, and clothing, which form a larger 1 80 1 -II: FOHUF.S 1URIVIN1 OIIANUF fraiction of the consuImlptiotn of people with lowecr incones than of those with higher. The withdrawal of suclh subsidies; thouglh necessary on efficiency grounds, systematically harm1s the least well-off unless the authorities use sonic of cite resulting savings for targeted incomc subsidies (an issue dis- cussed at length in chapter 1O). *The decline in output reduces real wages, contributes to unemilployment, and, because of its fiscal effects, reduces the ability of government to respond; and inflation erodes savings and also income: transfers, which, for fiscal reasons, have often not kept up with price changes. Access to free health care and education can be reduced, particularly if supply shocks lead to shortages of critical drugs or if the fiscal crisis reduces tthe availability of textbooks. Because of the transition, poverty is manifesting itself in new ways. Much of the burden falls on women. In Russia, women outnumber men 2:1 among the unemployed- and pensioners; and 94 percent of single-parent households arc hcaded by a woman. Experience elsevhere suggests that malnutrition is a growing problem, not necessarily because of an absolute shortage of food, but because of a deficient dict. Pregnant women, infants, and young children ore particularly at risk: parents of young children tend themselves to be young and hence to have relatively low earnings; and mothers with young children havc a higher than averagc risk of unemployment. Problenms with health and nutrition for infants and young children can have long-term ill effects. Increases in maternal and infant mortality in Russia in 1992 (Fong 1993) are early warning signs of the impact of the transition. Health problems of other types are aggravated by poverty generally and by related problems such as poor hous- ing, inadequate hcating and clothing, and alcoholism. Drug shortages, which: are a particular problem for the poor, have arisen in some countries. Educa- tional problems are harder to quantify. Malnutrition affects the ability to learn. Shortages of school textbooks particularly affect the poor. Poverty can also aggravatc homelessncss, especially if rents are liberalizcd. For these and other reasons, poverty can also lead to the breakdown of families. Women, the young, and the old are the most vulnerable (see Burrows 1994). Insecurity, though hard to quantify, is at least as important as poverty. It is one thing to know that income is low but relatively certain, as under the old system. It is quite another to face income which is falling and to be unsure how far it will fall.' Insecurity is problem enough for individuals who are able to find wvork but who do not know how much their wages will buy in the future or how long they will keep their job. It is considerably worse for those who cannot find work or for whom work is not an option, such as mothers of very young children, people with severe health problenis, and the frail elderly. Such peopic must rely on state bencfits, the real value of many of which has fallen, sometimes considerably. ' 811 TIll Ol'OI'I'ICAL EOONOMY OF' TRANSPORMATION DA'A PROULIMSo Poor data arc a pervasive problem4 They make it difficult to quantify the extent of poverty but also have much wider ramifications. First, there are well-known problems with determining the extent to which cross-country data measure the same thing. Second, measurement problems were greatly exaggerated during the early trunsition. Data on income are particularly suspect: Before the transition, figures on 'income took no account of the lack of availability of goods nor of the.fact that access to goods&was easier far some. groups, such as the nomenhk/aura, than for others, The problem, then, is. howv to interpret changes in people's incomes.2 * The early transition led to sharp changes in relative prices, making it diffi- cult to estimate inflation and hence difficult to assess what happened to people's real incomes.3 - A significant (but unknown) amount of income after the transition, partieu- larly in the private sector, is not captured in6 official statistics. For all these reasons, data on individual incomes,' and. also on gross domestic product, such as those underlying table 1-1, have .to be treated with consider- able caution. A third set of difficulties, which are treated in a large literature, are specific-' to poverty (see.Atkinson. 1987, 1989, chap.; 1, 1991a; Barr 1993b, chap. 6; World Bank 1990b, chap. 2, 1992c, chap. l). These problems are particularly acute in Central and Eastern.Europe, both because of the difficulties just discussed with the quality of data on-income and because of significant gaps in the data on standards of living. The latter problem arises partly. because the existence of poverty used to be officially denied and also because gathering. such information is expensive.. The precise situation varies from. country to country. Data are relatively. better in the Czech Republic,. Hungary, and Poland, and Russia started to conduct surveys of. living standards in 1992 (for a detailed discussion of data prior. to the.transition, see Atkinson and Mick- lewright 1992, chap. 3). A separate gap is the lack of data on the relative position. of women. Quantitative evidence of the effects of the transition on poverty thus tends to be fragmentary, and policy often has to rely'on more qualitative data. The combined effect of these problems makes it difficult to assess the extent of poverty and even more difficult to measure changes.in the'number of' people who are poor or in theLdepth of their poverty. Official statistics need to be treated with caution and interpreted with care (see Balcero'wicz 1993b;. Bratkowski 1993). The need to gather better information is urgent, for. humanitarian reasons, because such information helps poliujymakers to esti- mate the costs-of poverty- relief and because.poverty, alongside unemploy- - ment, has major ramifications for the political sustainability of the reforms. 1 82 1'111. tOIIaES DRIVING CH^ANGE 4n &p/oicil Role/or- individuVal &lf-Inwen'sr Thie introduction of market forces involves the Iibcralizadion of demand and of supply. Thed first gives an increased role to individual chioice, The. second * ~~introduces a variety of property relationships and ownership options. The increased'role accorded indivdual choice coincides, withi the 'Political * ~~objective, of increased freedo m and assists the efficient operation of a~ market system. -In labor -markets, for both reasons, individuals increasingly chioose wh ich skills they wishl to alcquire and which jobs theyr seek.: Wage ibraliza- * ~~tion is cruicial in this context, since market~-determined wvages infor'm individ- uals about whiich- skills are in greatest demand. Sifiuilarly, in the context. of education, . training, and .active labor .market ~policies, indiv'idu'als haive i'ncreasinig chokce, for instance-of schools, 'teaching methods,..subjctrs stud- ied,~ and: training or: retraining -course's. Again, the execrcise of such choice contributes to''the aims of individual freedom andec6onomic. efficiency.: As the reforms proceed, individuals will also have more choice over their : ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ' hs is dcirb .. ..o_- s- * ~~doctor, h'ospital, and type of medical treatmenit. Thsi eialebt o t ON. . on sake and because, in a vell-~designcd health-finance regime, patient choice's can be used ~to give medical providers incentives to be, efficient. In areas,where consumer information is imperfect, choice can be guided by an appropriate regulafory ructure, for instance, to ality of trai ing or m-tedical services. Supply libeiralization introduces competition in bvarious ways. Diversity. of ownership contribuftes to tha. political aim of increased individual freedom and to economic efficiency. Firs't, private ownership encos.rages competition among mutiprea providers, In ne circumstancis (aicul the existence of well-informed consumers), competition contributes to'efficiency by exerteing dowmnwlvard pressure on prices and byiimproving the respons ive- ness of wh supply: to consume. choice. Seco d,j diversity f ownership allows. different blends of public and private provision, depending on t-:he commodity. in qucstion and on prevaiindg come onditions. Third, alongside private ownership, competition in the economy as a whole is fostered by breaking 'up state monopolies and, through trade' liberali aion, by integraing the do ic economy into world markets. upply libralization is acutelyc relevuant to the social osectors. Diversity of ownership, 'by allowineniloyers makpets for wores, makes the labor. market more coms petitive. This benefits workers, who rio longer fae ab single majCor buyer (the state) in labor markets, and, it can be argued, thus. improves. their bargaining position.oit also increases efficiency more generally, by allow-. ing firms to sn er d for labor thr,ough competing-offers of pay and conditions, thus facilitating the movemcent of workers' into, their most prodc-c tive use. Alongide suh idecentralization ind competition, the tae Dhas a role. -b th s a regulator of private labo kesd a emloyer, althogh on a ;:~~~~ h. bexrtn movnark pestsur onpiand. as rimpovn tereipnyie - h 'a0 1 83 1 THY. P'OLiTICAL ECONOMY OF TRANSFOnMtATION * - reduced scale, in areas like health care, education, and the administration of cash benefits. * In the context of education, training, and retraining, diversity of ownership allows private sector participation. In these areas, again, the combination of competition and a suitable regulatory regime contributes to efficiency. In health care, simililarly, a range of suitably regulated ownership options can improve effi- ciency and responsiveness to consumer demand. Cash benefits are an area in 'which the stare will remain a significant actor, at tables 1-2 and 1-3 show. As a complement to the state scheme, private pensions have a role in the medium term in empowering consumer choice,-in fostering the development of capital - - . markets, and (albeit more arguably) in furthering economic growth. The argument in favor of markets is that they harness individual self-, interest more.effectively than any other method. The purpose of the reforms is to unleash those forces sufficiently to increase efficiency but, through regu- lation and other forms of state intervention, to contain their worst excesses. The benign aspect of relying more explicitly. on individual slf-interest it ehat individuals have an incentive to act in wvays ivhich contribuie to the efficiency of the economy. These desirable effects arc enhanced by a number of effects of the transition: relieving shortages enhances and empowers consumer choice, and opening the economy to international competition increases con- sumer, choice and also facilitates the supply response. Political Driving Forces The core ingredients of the move to a market system are fairly clear-cut. The move toward democracy is less 'susceptible to simple-analysis. It obviously' involves the introduction of free electiohs with a fairly universal franchise. Beyond that, however, key questions remain. Should the electoral system be first-past-the-post, as in the United Kingdom and the United States, or some form of proportional representation (both systems ar&' described in the gloss-: ary)? If the latter, should a threshold be set below which political parties are- not allowed to. occupy seats in the legislature?4 At least as important as. electoral arrangements is the constitution which underpins them. Is there a- strict separation of powvers, as in the United States? Which branch of govern- ment (legislature; executive, judiciary) has primary authonity in any given area? If a conflict arises between different parts of government, does the constitution establish unambiguous decision rules? This chapter makes no attempt to answer such questions (some of. which are taken up in chapter 13; for an extensive discussion,' see White, Gill, and Slider 1993).. Instead, it takes the move to democracy (or, at least increasing glasnost) as its starting point such a move involves political pluralisms decen- tralization of political decisionmaking, and a new emphasis on the rule of law. ' These changes unleash tvo sets of political forces: people's hatred of the old 1841 THE PORO'S DRIVING CHANOE system. and thicr deep distrustaof government, which vas regarded not as'or the peoplc, by the people, ind for the people, but as by the maenkluara, - which trampled on people's rights. More recently, some countries havc experi- ' enced a-separate anti-government backiash, as the electorate begins to feel the * shorrun effects of the reforms, particularly the d&cline in: many people's: standard of living. - Reaetog agaw /I Old Sysitem The antt-government feeling generates pressures to throw%out the good-as well -as"the bad, and leads'to la'ck .of realism about the extent to which pernnial problems can bc removed. Increised political reedom unleashed a swing of die pendulum againstt t twio key festures of the inheritance central - 'planning and totalitarian government. The swing is toward'(a) private mar- kets, (b) democracy, and (c) decentralization. A fourth pressure, a strong .- , - ' desire' in many of the countries to integrate with Western, Europe (in part a -! - ,,,- eacton against inherited isilation),othough noteorthy, is discussed only in passing. PRIVATE MARKEr. The swing to private markets is one of.the twin hearts of -'.' ' the .reform. 'The roots of the pressure' include distrust. of governcnt and the low institutional capaciqy-of tie public sector. Reformers face the problem of- balance. There is a da,ngr of not lib:ralizing the economy enough, thereby, at:. worst, blocking the reforms. They also face the oppositc danger of oversloot- ing. The flavs of central planning being very obvious, the tendency in the. ' dearly transition: was to lurch ronvaird another simplc sol,ution which does not: work: private -markets, 'alays and everywhere. The. backlash against state. .' involvement had a range of ill effect's, including deteriorating systems of health - * ' !; carc, education, child carc, and public transport. Unrestrained.privatization, in *, - $-the absence of suitable regilation, couid rcsult in 'the pillaginig of state assets (which happened in'the health sector in some countries) and othcr abuss of 'monopoly power.,Nor.are-the'citizens of,these countries alone in this sort of behavior.- Robert Strauss, U.S. ambassador to Moscow, in fai on-the-record interview in early 99Q', uscd the term "slcaze bags" to describe predatory 'Westerners 'taking advantage of such situations. DEMOCRACr. The swing towardd democracy is desirable for its own sakc,; -- ,.because it increascs individual freedom and gives gove7nment the, incentive to be moreresponsive to the wishes of the electorate. Again,,though, overshoot- ,* . iing is possible. Democratic institutions have been put into piace with remark- ,..: .............. able speed. But reinventing a country is-a huge task,and the'fact that sorne problems remain is neither surprising:nor cause for criticism. One reaction again5t totalitarianism ,vas to democratiz yhg, partly out' of a belief in democracy, pardy out of a distrust of totalitariasn governmcnt, and partly out of a desire to make the change' irreversible.' 185 1 0 ..m. -' - - ;4.* . - ' ; - - - % * ; HIC 1IOLI7ICA 1- ICO14OMY OF TRANNFOPMATION A number of resulting problems emerged at the start of the reforms. One was legisladve overload. The probleim was an inevitable consequence of revo- lutionary' change but, for reasons discussed In chapter 5, also had other, more avoidable causes. A second, more arguable, problem is that the division of' power between executivc and' egislative forces tilts more toWard, the'legisla- ture than is common in the West. The balance benveen democracy, on the- one. hand, and the needs of effective govcrnment' on the other,. is one of the central problems of political economy and has no easy answer. The inability-of - :.. governiment. to be effective is-an important -constraint on tie design and implcmentttion of the reform.process generally, 'and of'social sector reform' - specifically. DECEITRAUEATON. nhe old system imposed one-party' rule,' and central ' '. -- ,management disreggrdedlregional .differences. Regional rplanning, far from. .. . respecting-regional diversity,. was a tool to.impose uniformity. -As part'of.the: samc process, minority differc4es wcre disregardcd' and, where visibe, sub-- jeced to pressures to conform (one cxample wvas the t'reatment of cthni c - minorities in Bulgaria and Romania). The process applied also to, religious groups, 'such as thc Muslims in Bulgaria and the Jcws in Ukraine arid Russia. It is therefore not surprising that the relaxation of excessive centralization is '- - ' ' one of-'the 'major 'forces -driving the reform.' Tie force manifests itself in different ways, including the move toward multiple political parties, toward powver devolved to locally elecied governments, and to. ard regionalism and -ationalisr. he ben"gn aspects of decentralizationi are clear: political plural- ism, incrcased responsiveness of government'to the ivishes of the local elec-. rorate, increased scope for the expression of; inaigenous culture, and recon- *'-nection'w;ith'people's historical heritage. Overshooting can arise in'a number of ivays. The o'ptimal ba-ance of power bctwvecn central and local government is: not determined.easilyand is an area '' of continuing contro' ersy intheWest.T;hereis-'general agrcenent, howeve'r, that'for some aspects of the 'economy national standards are. desirable.' Employment services and the structure of cash benefits,Jfor example, should . foster labor mobility, whch requires at least coordination among regions, if . not identical systemsa Educational qualifications-and occupational standards should be readily transfeiablc. Entitlernent to healtli care should not be con- strained by local'boundaries. Similarly, at' a regional and national lvel, mini- mizing impediments to tradc has major advantages. . - Devolution of po'er ray interfere with these objectives. MOrE generally, a * . : -.'. rcal tension exists between the freedom to pursue local objectives-including, for the first time, the right to cstablish a national identity-and the ruit of.: common. purposes which may be organized more.effectively at a national - . . . '.klevel.- Compromise is often possibil. For instance, decentralization can oper- -ate within a'central frameork, enforced.through regulation or through central - ... , .,: - : . . - , . . ' - . t ::.86 IlEV P'Ol4CES I)RIVING VUIIANUE governmncit grants for approvecd local activity4 Thec constraints resulti'ng from centrifugal pressures are discussed in chaipter S. Back/ash against the Relorns Atlthoughi the matter cannot be proved, there is considerable anecdotal ev'i- dence inldicating tchat whait creates political backlaish is not the outcome per se, but te outome elatie topeople's expectations. The BrItish* populatio endured wvith stoicismi considerable, hardship: duri'ng the Second World War, ntleast be t tcause Churchill promised "nothing but blood,- oi I,rars, and sweat. Ths sggests chat political explosions afe caused not by. poor out- comes, but by'disappointed .hopes. Arth start of the reforms, th ere, was. considerable opriniism, nor least in government.policy statements, that the process of catching up with Wester Europe would be: rap,id.' In part char was true, in char some poiia bectves, particularly the introduction odemoc- racy, were achieved fairly rapidly. So far. as the economic objectives are. concern'ed, the extent of the decline' in output in the early transition surprised most observers even in the West. The slowness of recovery, the increased incidence of unemployment and poverty, and, more generally,.the disappoint- ment of the electorate's -hopes of rapi'd e'conomic gains;led to:a political backlash against the reforms in at least some c'ountries of Central and Eastern Europe. This, backlash helped. va'rious brand of extremnists to gain momen- rum, posing, a potentially serious danger to the new democracie.s.-The r'ole of politicians in ptecvenring inflated exectation is therefore criticalanisd- cussed in more detail in cha, ter 13. onrc1usions Teintroduction of market force and getr political freedom released a' series of driving forces, including a wideninig distribution of income, a greater. role for individual self-interest,, and a political backlash against the old system. Some of the resulting outcomnes contribute directly to'the purposes of. the reform: increased productivity brought about by the incentive effec't's of COrn- petitive markets, improved responsiveness of government to the de'sires of citizens arising from democracy, and die ability to decentralize to allow local electorates and cultural groups greater autonomy. The driving forces also produce unhelpful out'comes, most of which reap- pear in the discuss-ion of constraints in the next chap'ter: *Rising unemployment and poverty emeg reetdly makingstblzio and restructuring more difficult and posing a maj'or political constraint. *Marker imperfecti'ons, in particular missing legislation, an incomplete. regulatory structure, and expl'oitation of monopoly positions, hinder restructuring. 187] THle l'OLITIOAL ECONOMY OITRANSFOlthiATIUN * Thc tendency for decentralizing pressures to overshoot forms part of the discussion of centrifugal forces. * The problems which newly designed democratic systems often face.(such as legislative bottlenecks) affect the machinery of government. Notes 1. In terms of economic theory, a risk-avcrse Individual may gain a higher level of. welfare from a lower but certain income than from n higher but uncertain income. Thus, for sonic people uncertainty causes a l5ss of welfare im add/don to the welfare loss associated withi a lo wer level of income. 2. Suppose that before the transition, a pint of milk, when available, cost SI, and.. individual X had an income of SI ,000. After the tmnskion, milk is always available and costs 55, and individual Xstill.has an income of $1,000. On the face of it, individual X is poorer, but if he or she could rarely get milk under the old system, matters are much less clear. 3. Therc' are at least two sets of problems. First, with non-market clearing prices. (such as existed under the old system), both- Pasche and Laspeyres indexes may overestimate inflation and hence also overstate the fall in rcal wages and living stan- - dards. Second,- in the face of sharply changing relative prices, the pattern of people's cohsuimption changes, thus sharply changing the wveights used to calculate a consunier price index. The use of a consumer price index to mcasure inflation in these circum- stances is, to say the least, problematic. 4. In the Federal Republic of Germany, for instance, a party must win at least 5 percent of total votes cast before it can hold a seat in the lcgislatire. The purposcof; such a threshold is to limit the number of.parties in the legislature,'the idea being that this makes it easier to form stable coalitions. [881 - .'' …-0 CONSTRAINTS ON CHANGE NICHOLAS BARR *STANISLAW GOMULKA IGOR TOMiES SOME FEATURES OF THE EMERGING ECONOMIES constrain the speed of reform and, since the longer-term path of reform is influencedd b-y earlier events, also it direction: The initial conditions are imnportant. Som~e inherited 'institutions and attitudes'are ill-suitied to the needs* of a market econom-y and are therefore exposed as:constraints by the transition; Examiples include missing instiwu- tions like financial markets, gaps in leg'isla'tion', and inappropriate supply rela-. tionships resulting, for instance, fraom the extent of state ownership.c *A second set of constraints arises from the transition itsef The driving. forces discussed in Chaptr 4 have both good and bad outcomcs.Sonieof the' bad oDutcomes, .suc aSrisn unmlyent, are in.part causedbthtrni tion. Others, such as press'ures to decentralize, relate to aspects w%hich Were sUPPressed under the old system a'nd which are therefore released by the transition. 'External shocks arc a further source of constraints, t'he major examrple-s being the collapse of the old trading rltionships and recesointend- trial countries during the early transition. *The final set of constraints is ;inherent, menn tat they fitce all con omies, including those of the industrial.countries.-.An important example is market imperfections. Another is t-he need, because of resource constraints, to, make difficult choices between different types of siociail spending and between social spending and other areas such as investment in-physical capital. Many of the constraints discussed in, this chapteir -(see also Gomnulka .1994). deive from some combination: of these sources. The decline in output, for ~example, is the result of inherited distortions, oif the policies needed to -con- tain the inflationary. pressures released by the: transition, and of the collapse of trading arran'gements. Some of the constraints (most dclarly the fiscal crisis). have an obvious bearing on the social sectors. Others, such as those related tO * ~~~~~~~~ ~~~~ or' widelRA y, are f institutionial capacity, though applying mot iey t also directly iclevant to the discussion in later chapters. Yet others, such as constitutional arrange-. ments, far transcend the social, sectors. They are included here because the sutccess' of social. sctior reform is inextrical likdwth thef uceso traniformation generally. The need for fiscal restraint, for example,'may lead 1 89 1 'rl'. 1'Otl0TICAL. PECONOMY oF TRANHIlOHA'rION governmlent to seek a reduction In expenditure oin pensions; If thie electoral system leads to a fragniented Parlinnient, however, the government may find it imnpossible to enact the necessary legislation. Several countries, for suich - . reasons, hanve had diffictilty passing their budget liws, Though the distinction can become blurred, this chapter divides the constraints into three categories: * economic; political, and institutional. Economic Conistraints -Two major types of economiic policy underpin the transformation: stabilization and. restructuring (see the glossary).'Each faces a series of major constraints. : Coistraints Cotmeceedrwith Stabilizatio. Stabilization is made difficult by key features of the inheritance, by the sharp decline in output, and-separate though connected-by the fiscal crisis which, to a greater or lesser extent, has arisen throughout the region. THE INHERITANCE. The results of the inheritance were low output and, in many countries, foreign debts and a large accumulation of unspent savings (the so-called monetary overhang). The slowvdown in groNth occurred at relatively low standards of living compared with those in the highly:indus- trialized countries. One of the responses, particularly in Bulgaria, Hungary, Poland, and the U.S.S.R., was to import more investment goods from the West using Western credit. Although in some instances bringing short-run gains in economic performance, these imports did nothing to help the long-: run problem. Their major legacy, particularly in the countries just mentioned, was the large foreign debts shown in table 3-4. A second response to the growth slowvdown was a relaxation of fiscal and monetary policy. Under mounting social and political pressure, the authorities increased consumer subsidies with no matching increase in taxes. Given the shortage of goods, one consequence was the buildup of forced savings. The resulting monetary overhang added to inflationary pressures when prices were liberalized. THE OUTPUT COLLAPSE. Output fell sharply in many countries (see table -1). Over the three-year period from 1990 to 1992, according to official statistics, gross domestic product (GDP) fell almost 50 percent in the Baltics, about 40 percent in Bulgaria, 35 percent in Romania, about 27 percent in Czechoslovakia and the U.S.S.R., and about 17 percent in Hungary and Poland. The average fall in output (which is the unweighted average across the countries).was nearly 30 percent. These figures should be treated with caution. The difficulty is no longer the.falsification of official statistics, but rather their lack of coverage, particularly of small-scale activity in the private sector,' which has increased in importance yet is not fully captured in official. statistics. Nevertheless, the output losses suffered.in many countries in the. 0 - OOSI'llAiNTHs NON CHANOK. curly transition were comparable In maugnitud'e to those suIffered by thec West- ern economies duiring che Great Depression of the 1930s. T'here are twvo broad schools of thioughit about Why the decline in output wavs so large In some' countries during the early transition (se'e Desni anid Estrin 1992;- Fischier and Gelb 1991; Goniulka 1991,. 1992; Gomulka and Lane 1 993; Kornai, forthcoming; L'aski and others 1993; Nuti and Portes 1993; on the Pol- isli experience, see Sacks 1993). The first argues that the major causes were the inheritance,~ price liberalization, and external slhocks .Given the previously dis- torted pricecstructure, relative prices could be expected to change in the face of price liberalization'. A particularly'imiportant distortion was the artificially-low price of energy. Part of.the dccline in output was the result of reducing the scale of activities Which wvere toss-making at market prices, especially those with n'eg- ative value added.'I Another influenrce was the size of the private Sector. Inherit- ing a large private sector1 Wvhich is mare responsive than the public sector to external shocks, tenids to reduce the extent of the fall in output. An additional factor was the collapse of the trade arrangements of the Council for MutualI Eco- nomic Assistance (see the glossary) and, in the former U.'S.S.R., of tradec among the, republics. The. output decline, according -t this argument, -was larger the greater the distortion of the i.nher-ited price structure, the smaller the inherited private sector, and the larger the dependence on trade with the Goun- cii for Mutual Economic Assistance.. The second school of thought argues that, in addition to these factors, 'the output collapse was to a significant extenti caused by the icformn policies themselves. It argues that fiscal and monetary policies were excessively restrictive, especially in Czechoslovakia and ~Poland; an'd that domestic:mar- kets were opened to foreign trade too fast. Along: the same. lines, it suggests *that restructuring should be pursued more slowly for instance, by continuing to extend some government assistance -to state enterprises in the sho'r't term. The last issiue is taken up in' chapter 7, which- compares policies to- keep~ workers in their old job in the short run with those which allowv them toi become unemiployed. Discussion of tL.Z cause of the output decli'ne, given its impact on people's lives, is clearly much more than academic. If the second line of argument is true,- the transition could perhaps take place a't a lowevr cost in unemploy'ment and lost output. That view, however, may be optimistic, in that- output losses much greater than those experienced in' Czechoslovakia and& Poland have been experienced in, countries like Bulgaria and most of the U.S.S.R., where fiscal and monetary policies 'were not so restrictive. Thus the- option of a relatively painless transition may not be'available. Despite the importance of the. question, there is as yet no generally agreed-upon answer. THE FISCAL CR151S. Interpreted here asia large budget deficit, the fiscal crisis arose to a significant extent out of the collapse in output. This was particuarly 911 - 111 iPOLITICAI. ICCOHNOMY il 'TRANSFORMATInN true wheln that collapse was coupled withi political constraiiits whicih mnade it difficult for government cither to reject the claims of particular interests and reduce expendituire to niatchi revenues or to Increase their revunues to pay for desired expenditture. One result is downward pressure oin the-resources avail-. able for the social sectors. The crisis mnay not' be inevitable, as the broad budgetary balance of the Czech Republic in 1992 suggests, but it is difficult to avoid (for a detailead discussion, see Miszei 1994).2 In 1992, Poland, Hungary, and the Russian Federation had budget deficits of between 5 and 10 percent of ODP. In some countries, for instance the Ukraine, the deficit was considera- bly higher. Policies.were put in place in late 1992 aimed at containing thie' budget deficit to 5 percent of GDP in Poland, to 6 percent in Hungary, and to 8 percent in Russia. The crisis occurred. because tax revenues fell faster than -GDP, while expenditure fell more slowly. Each aspect requires discussion. During a recession in the West, the fall in tax revenues is generally greater than the decline in income because tax systems are progressive.3 This is also part of the story in Central and Eastern Europe, not least because the profits of enterprises form a major part of the tax basc (see Schaffer 1992 for the case of, Poland), but it is useful to take things further. Two factors are central: what hap- pens to the balance between wages and profits and what happens to the level of real wages. On the first issue, countries in Central and Eastern Europe taxed prorits more heavily than wages. Thus any cliange from profits toward 'wages reduces revenues. So far as wages are-concerned, the decline in output pro-: duces a fall in the real wage base for two reasons: the number of wage earners declines as unemployment rises, and the real wages of people in employment fall. Real wages fall because stabilization requires that real incomes must decline.. to keep domestic demand broadly in line with output. Historically, real income- in Central and Eastern Europe had two sources: monetary income, such as wages, family allowance, and the like, and benefits in kind, such as cheap hous- ing. The decline in real income could in principle occur through a' reduction in. -benefits in kind, but in practice, some of these benefits, such as subsidized heat- ing, cannot easily be reduced in the short run. Thus most of the decline in real income will have to occur through a'reduction in real wvages.4 Separate from the decline in the vage base,' the amount of tax which can be extracted from each million forints (or koruni or roubles) of.wage payments. declines for at least three reasons. First, output falls most precipitously in the state sector, which is where the old system could most easily collect taxes.;As a result, an increasing number of state firms start to delay or default on their tax and social insurance payments. Second, the growth that does take place- tends to be in the private sector, where tax enforcement is not yet fully developed. Third, the combined effect of inflation and lags in the collection of contributions can result in a serious loss of real revenue. (the: Polish social- - insurance authorities estimated that in 1990 about 10-12 percent of their revenue from contributions was lost in this way). 1 92 I 0 N 8 I'll A I N'I'g 0 N10 I I A 14 0 It~~~~~~~~~~0 R\ 0bi - . - e~~~~~oONs'ItAINTR@ (ON OIIANOl Tax revenues fall, therefore, for several reasons: the real wage base declinles, the yield fromra given wage base dccllnes, profits decline, th1e bal- once between profits and wages chalnges, and systemns of personal Income taxation are cithe:r still developing or not yet In plice. Tl'he relative size of these factors, and their timing, varies from country to country. Their overall effect in Central and Eastern Europe wast, however, that tax revenues, even If they did not fall immediately, eventually fell, and.did so even more sharply t hun output over the early part of tie transition.5 The otlier root of the fiscal crisis is that expenditure cannot easily full as fast as revenues'. First, rising unemployment and emerging poverty increase the demands on the system of income transfers; mind in some countries, medical expenditure, particularly on pharmaceuticals,. is rising rapidly.,'Secon'd,somc countries face the.demands of servicing the international debt out of declining GDP, and tie problem of debt service worsens as a country's exchange rate declines. Expenditure may also rise for reasons conneccted more with politics. than with the declinc' in output: enterprise subsidies fell slowlyAin'-some countries; and in some countrics, Poland for example, social expenditure, particularly on pensions, increased sharply;. Agin, there is significant varia'tion between countries in the relatiVe importance of these causes. Throughout Central and Eastern' Europe, however, demands on the budget increased at precisely the timethat revenues were falling.- : - Implications. for the social sectors emerge repeatedly in, subsequent chap- ters. Fiscal constraints. affect. the level of unemployment benefits and are particularly acute for pensions; given the prevalence of early retir&ment. In some countries,Jincluding most of the former U.S.S.R., these constraints are: overwhelming, raising major issues of what level of poverty relief is affordable. Reduced health and education budgets lead to sharp declines in.expenditure on medical supplies, schoolbooks, and the like. The resulting problem is * ;: ' nvtwofold: devising a package to contain. the government deficit and finding a '; - ' way to obtain parliamentary and public: support for the necessary measures.; The problem is critical because of the tradeoffs between competing claimns on output: the claims of individual consumption (a-political imperative),- those of *; ;: ' investment in physical and human capital' (a prerequisite for economic growth), and, in some countries, those of foreign debt repayment. When * 0 output is declining, it is not possible to meetCall three sets. of claims.. Sus- tainability of the transition .thus. involves a balancing act of considerable, deli- : . cacy. The link between economic constraints and political constraints is at its. . .most acute for this aspect of the reforms. Constnints Affectiug Resrnzcuing Restructuring has to contend with three sets of economic constraints: inher-'. ited misallocation, poor labor motivation and inappropriate: incentives, and; 193 1 'r . IIt POlT1'1CAl. RtOONOMY Olt TIIANHPMItMAT1nN market Imperfections. Tlhe reforms arc seeking to deal with the frst two problems; the third, in Central and Eastern Europe as eIsewiere, Is inherenit, - THE INHltRRITIJP MISALLOCATION OF REHOURCIIS. Tle. structure of ownership was much too hicavily welghited toward the public sector. T'h cstructure of production was unbalanced, being tilted toward hcavy Industry and agriculture at the expense of consumer goods, light industry, and services.1The structure of trade was distorted by the arrangements of the Council for Mutual Eco- nomic Assistance, particuilarly the ovcrspeclalizatlon and conseqcuent giganti- cism of production units. The results included Inefficiency so great thit for somce products total value added was negative, making 'output dramatlcally ' uncompetitive at world prices. Thus large numbers of workers need to move to more productive jobs. Such moves, however, ure coinstralIned both by the inherited mix of'skills aind by the misallocation of housing. As yet, no real housing market exists to 'address the problem. Since housing under the' old system was often'part of a person's employment package' housing constrains both the mobility of labor and the restructuring of enterprises. -POOR MOTIVATION AND INAPPROPRIATE INDIVIDUAL INCENVES. Both 'these. problcms^wrere part of the inheritance but, at least in the public sector, con- tinue in different guises during the transition. Poor labor motivatio'n under the old.system arose from low wages and bad labor relations. Neither-the stick.of threatened job loss nor the carrot of higher wages was present to increase productivity. On the first, shortages led to'a sellers' market, giving service providers no. incentive to respond to consumer demand and creating.fertile ground fur corruption. On the second, wages under the old system comprised a system of administratively determined tariffs (something like 60 percent of total pay) plus premiums, which in theory were related to individual perfor- mance but which in practice were often divided fairly equally across the work force. The incentive structure militated against exposure' of poorly designed pol- icy'. Decrees were issued from the top and implemented at lower levels. When reporting back up the chain of command,Jlower-level officials had. little. incen- tive to report anything but success, and middle-level officials had litte incen-' tive to investigate the claim, since they, in turn, 'vould have to report failure to top-level officials. Thus there' was an implicit conspiracy: decrees were issued,' - and everyone then pretended that they had been implemented (something similar went on in labor markets, giving rise tO the view among workers that '"ve pretend to work, and they pretend.to pay us'). During the transition, adverse incentives continue in the public sector. Not -least because of the fiscal crisis, administrators, 'medical perso'nnel,'and teachers are poorly paid in comparison with the private sector and at least some state enterprises. The result is -declining morale and a tendency for some 'of the most able individuals to leave the public sector. In addition, - c - - ... X .D . .. - . - - . ... ; - : - -194 1.. :-- : OONITRAIN'PB ON CIIANOP4 - . - - because wages arc low, ma'ny workers have second and third Jobs andl little nmotivation to perform well in tlielr. primary Job (medical personnel aind teachers arc important examples), lor that reason, the Czech Republic intro- ducecd a 25-percent pay increase in 1992 for admInIstrative personnel who gave up second employment and private business, Poland, too, Introduced a substantial pay Increase In 1992 fot senior'personnel in central administration, MARKIC. IMPBERPWrIONS. As discussed In chapter 4, economic liberalization .:. releases the potential for enormous efciency gains but almo reveals market nimperfections. Thle problem can be particularly severe with Insurance, whore : major risks, such as unemployment, inflation, and Important medical risks, are. difficult or Impossible to Insure in private markets. In the presence of theci. technical problems, the state may Intervene in various ways, so the extent of government intervention in the Industrial c'ountries shiould not be surprlsing. '-. ' - . - :Thus the workings of a market econormy,glargely for efficiency reasons, are underpinned by a substantial body of legelation. and regulation. The. initial deficiencles in Central nd Eastern Europe were twofold: important types of regulation were absent, and much existing; regulation was inadequatcly- enforced. So far as the first problem. is concerned, there iere two sorts of lacuna. First, at the start of the transition, gaps were evident in the structure of. laws establishing key institutions such as the ownership and transfer of p::rivate property, the conduct: of private enterprises, .the operation of 'a Western-style banking system, the operation of financial institu'tions such as private insurance companies and stock exchanges,: employment conditions in the private sector, and the development of a system of unemployment bene- fits appropriate to a period of high unemployment. A second and separate gap was the lack of a regulatory structure to prevent market failure. Examples in the West include hygiene laws connected with the p.roduction and sale of food and the testing and sale of drugs, laws relating to the abuse of monopoly power,.laws concerning,the conduct of f inancial institutions such as private: pension funds, and regulation of total redical spending. The Western economies operate effectively. because they have achieved a balance between the incentives; arising from anr appeal to individual self- interest and the restraining effects of regulation to prevent abusie, for example of monopoly power. The exact balance between these forces is die subject of continuing debate, but-such regulation is indisputably needed to prevent the fraud and abuse which would otherwise occur. The absence of an effective . . regulatory structure hinders the reforns, not least by putting at risk the political support for the move to a market system. Political Constraints Political constraints on the reforms can usefully be divided into two sorts: (a) attitudes and 'pressures unleashed by political liberalization which may impecde [951 f . - -, - 0 ,:. : ;, : C .: ?,f a, .: f; f f - f:- 0 0;d Tll POLT'rICAL PCONOMY Olt TrIANSPoRMATION the refornms and (b) weaknesses In the machinery of government whichi affcct the ability of ministers and officials to make and inmplement decisions. Adtftudes anid Prsswrs Political pressures derive from three major sources: inherited attitudes, a deep distrust of governnient, and centrifugal forces.. INHERITTD Arrl'TuDas. A country's history-shapes attitudes in important ways. Prior to the Second World Wdr, countries like Czechoslovakia, Hun-. . gary, and Poland were to a greater or lesser extent industrial market econ- omies, well acquainted with market systems generally and with unemploy- ment in particular. None of this was true.in most of the. U.S.S.R., where unemployment is a completely ne developrment and where politics of unemployment are therefore of extreme importance. The political capacity to carry through reforms in the.face of high unemployment (particularly when coupled with the governance issues discussed in the 'next section) cannot be taken for granted. - DISTRUST OF GOVERNUENT. Outside the U.S.S.R., government was seen as an alien bodv imposed by the Soviets, thus calling its legitimacy into question. Separately, throughout Central and Eastern Europe, the old regime had con- taminated the law for political ends: individual rights were not protected sufficiently, and such protection as existed was not properly cnforced.. In a-democratic society, individual rights and obligations and basic guararn- tees of their enforcement are established by acts of Parliament; detailed imple-- mnentation is the responsibility. of the executive, usually on the basis of rguia-. tions. Under the old system, in contrast, many enactments were by decree, and significant conditions of.individual eligibility were often not included in, primary legislation but leIc to executive discretion.6 This was true throughout -thie social sectors: labor conditions, incomes policies, cash benefits, health - care, and education. Separately, violations of indiv&idual rights were' generally less harshly punished than violations of the interests of the party.'In-all .-countries of Central and Eastern Europe, for'instance, theft of state property was more heavily punished than theft of private property. Even where sanctions existed, they wevre often ineffective. In Czechoslo- :vakia, local-government :was empoNvered to in pect labor conditions, but.no effective inspecrorate xvas ever buit up. Throughout Central and. Easternr Europe, the effectiveness of safety inspections at the workplace was often - hampered by the propensity to regard an adverse'decision as an attempt to sabotage the plan. Thus dangerous plants were 'rarely, if ever, closed.' The. same was broadly true of hygiene inspections. The result was a very, poor; - ': record on occupational safety;7 A further problem of enforcement was the inadequateprocedureforappealingdecisions.- n most countries, appeals were generally conducted.by the autbority which made the original decision. Ec- 196 1- coNs,rlAINr'S ON CHANGEH utive decisions wvre rarely subject to judicial review. The result wnas an over- nighty bureaucracy, with serious limitations of individual rights. Lies were pervasive: Life in the loldl system is . . . thoroughly permeated with lies: govern-. ment by bureaucracy is called popular government;, the. working class is. enslaved in the name of the working class; :the complete degrndation of the individual is presented as his ultimate liberation; depriving people of information is called making.it available; the use of powerto manipulate it is- called the public control of power, and the arbitrary use of power is called observing'the legal code; the repression of culture is called its. development; the expansion of imperial influence is presented as.support:- for the oppressed; the- lack of free elections becomes. the highest form of democracy; banning independent thought becomes the most scientific' of world views; military occupation becomes fraternal assistance. Because' the regime is captive to its own lies, it must falsify everything. It falsifies the past. It.falsifies the present, and it falsifies the future. It falsifies statistics. It pretends not to possess an omnipotent and unprincipled police apparatus. It pretends to respect human. rights. It preten dsto persecute no one.' It pretends to fear nothing. It pretends to pretend nothing. [Havel 1978; reprinted in Havel 1991, pp. 135-361 Thus it is hardly surprising that there was widespread distrust of govern- ment. In the West, it is possible to trust the pnassby which governments come to pow%er (though perhaps with reservations about some of the individ- uals thereby elected). The old regime in Central-and Eastern Europe gave - f governments no such legitimacy. Distrust went both ways. It is not necessary to look as far as secret police to see that govrernment distrusted its citizens. Examples include the amount of paperwork,claimants for state benefits had to - complete,1the concept'of self-declaration supported by.sample audits being unknown.- Distrust of government constrains the transition. Without well-efnforced individual rights, citizens feel threatened by economic liberalization, particu- larly in -the face of rising unemployment and: falling standards of living. The 'population tends:to suspect idespread self-interest among:officials, including reformers. This is one of the roots of the backlash against.the reforms dis- cussed in chapter 4. CENTRIFUGAL FORCES. When expressed as devolution of power andAdecen- tralization of administrative authority, the resulting liberation of individual, X local,and regional initiative is desirable in itself and contributes to the process of reform. Excessive decentralization, however, can lead both- to fragmenta-- tion and to fiscal problems. The existence of multiple political parties (a- consequence in some countries of centrifugal forces) is not itself a problem but becomes one if.it interferes with the effective implementation of the reforms. :1 97 1 TIlE POLITICAL ECONOWY OF TRANSFORMATION Regionalization, toot may overshoot if it prevents the development of institu- tions which are best coordinated nationally, different regimes for unemploy- ment benefits or lack of widely accepted trainng qualifications, for example1 ccan impede the mobility of labor. Decentralization of health carc and educa- tion can also go beyond what is efficient. Excessive decentralization also has fiscal implications:. the smaller the locality, the greater the need for central government to. make redistributive transfers between richer and poorer areas. Such transfers raise major issues, including the ability of central government to raise sufficient revenue and the need to decide how to divide transfers among localities. The latter task requircs a method of assessing needs by locality, a ta'sk which makes heavy 'demands on institutional. capacity and is likely to be highly politicaL If local authorities administer a service which is largely financed by central govern- ment, a separate problem is the need to design the transfer in a way which minimizes the incentive to spend excessively. The message ir not that devolution is necessarily a constraint. The real message is fourfold: . The extent of devolution and decentralization is a complex matter. * Answers u ill vary across countries, as they do. in the highly. industrialized . countries. .. Central planning had all manner of highly undesirable consequences, and 'some decentralization is clearly desirable. It does not, however, nercawly follow that the optimal solution is to decentralize as much as.possible.: D Decentralization requires an appropriate fiscal regime.. The Machinery of Goamnt-- Alongside constraints arising from political pressures, a separate set of prob- lems constrains the ability.of govemments to implement the reforms: erosion of the rule' of law, constitutional arrangements which can hinder effective government, and lack of experience in the conduct of politics in a democracy. EROSION OF THE RULE OF LAW. :Under the old system, the distrust of govern- ment, together with the tendency of government to override legal provisions' for political reasons, produced a lack of rule of law. in the Western sense that laws (by and large) are respected, enforced, and; obeyed. In the U.S.S.R., many social benefits 'were under the control of the official trade union, and union officials frequently used these benefits as instruments of labor discipline and'as forns of bribery and favoritism. The result was a disrespect for law so' pronounced, according to the then-prime minister of Bulgaria early in his country's ieforr process, as to undermine the moral values of a civil society:8. . By imposing a great number of impractical.and often illogical restrictions and limitations that were inevitably and routinely breached or disregaded, 1 98 1 CONSTRAINTS ON CHANGE [the communist authorities] also cultivated in the individual a feeling of being an offender.. . . This served to blur the line between the permit- ted and the forbidden .. . Honest and moral people would think nothing of stealing from the state or cheating the authorities. [Dimitrov 19921 The disrespect for legal processes is a severe constraint. Marker systems rely heavily on the rule of law because decisionmaking is decentralized. and economic relations founded on the principle of voluntary exchange. Individ- uals undertaking exchanges need to know' that promises have n a contractual basis, which provides some guarantee through the courts that the exchange will'take place on the terms originally agreed to or that the party in breach of the contract will be penalized. A clear definition and enforcement of rights and obligations is a precondition for a well-ordered competitive environment, particularly one intended to attract foreign investment. Legal guaantees of this sort either did not exist or had atrophied in most countries of Central and: Eastern Europe under the old regime.. Even where a legal apparatus was put in place as part of the reform process, proble'ms remain: people governed for years in a police state are unlikely to turn to the judiciary to.resolve griev- ances, and the legal system is often understaffed and, as a result, may not be able to prevent videspread infringements. Both sets of problems arc likely to' be a constraint for the tim'e being. EVOLVING CONSTITUTIONAL ARRANGEMENTS. A key aspect: of governance con- cerns constitutional provisions-the rules by. iwhich politics are played and political conflicts resolved-and, as part of those rules, the respectiVe powers and responsibilities. of the legislature, cxecutive, and judiciary. In he- West, these have evolved over many years and continue to evolve. In Central and Eastern Europe, they have had to be invented almost overnight. Constitu- - tional changes in the early transition were a clear reaction against the inherited system. The importance of the legislature is in many ways a direct conse-- quence of the heavy dominance of the executive under the old system. Even countries like Poland, Hungary, and the Czech Republic, notwithstanding several years of experience with democratic government, are finding problems with the system; and the problems are:even greater in countries like Russia, wvhich are larger and whose reforms began somewhat later. The respective powers and responsibilities of the legislature and executive may not be clear and explicit; or where they are clear, they may-work'badly. In the early days of the reforms in Russia, for instance, presidential decrees and legislative acts could be in direct conflict with one another, with no constitu- tional rules for establishing which took precedence.9 Iri such cases, the judici-. ary may not yet be in a position to reso!ve the dispute. The electoral regime may yield indecisive results. The first democratic elecrion in-Poland was conducted under a system of proportional representa- 1 99 1 TtlE I'OLITICAL ECONOMY OE: TIANHFORMATi.oN tion with no threshold, leading to a legislature wi',% a fragmented party struc- ture which hindered the formation of a stable coalition."' Even when the powers of the executive are clear, the executive might not be able to enforce them, particularly where administrative structures lack the capacity to enforce the law. The problem is niost acute in newly reformed countries. in Russia in 1992, for example, the central authorities experienced. difficulties in persuading localities to remit tax revenues to the center. The problem exists on a-smaller scale in other countries. In Hungary, the pressures for decentralization initially made it difficult for the 'central authorities to. requtire localities to adopt a common code for categorizing pharmaceuticals. An additional problem is the poten-tial for legislative overload.' In part the .problem is unavoidable, given the ambitious reform program.(the Czech and Slovak legislators had to pass' more than 250 substantial pieces of legislation in' the first year of the transition to launch the first phase of ecornomic and social -reforms). A second source of overload, in part a result of the distrust of executive authority, is the inclusion of considerable detail in.primary legisla--. tion. For exampie, at least in the early days of the reforms, the level of benefits such as pensions and unemployment benefits wvas frequently included in primary legislation, so that changes in benefits (because of inflation, for example) required extensive parliamentary debate. The combined effect of large numbers of new laws and of the amount of detail in each can be a legislative bottleneck, slowing down many reforms both within and outside the social sectors. A final issue-the power of the authorities in a democracy-is more subtle and needs to be interpreted with care. The old system was based on imposed discipline. Democracy, because it relies on the consent of the population, is based largely on self-discipline. At least during the early transition, however,- democracy was often interpreted as the right.to do anything-a reaction to totalitarianism which confused democracy with anarchy. People were no longer terrified of the police: although this outcome was in many ways desir able, crime rose and, in the absence of incentive-based wage structures, disciplinary problems increased in the workplace. Problems of governance are an inevitable consequence of the transition.' The issue is rot that democracy is a constraint on government: -that is pre- cisely thepurpose of democracy. The problems being discussed here concern constraints on the ability of government to implement reform policies even' where there is general support for those reforms. THE DEMOCRATIC DEFICIT. The issue of governance concerns the need to have clear rules of the game. The so-called'democratic deficit concerns the lack of experienced professional players of the game of- democratic politics. The early transition Nvas a revolutionary period, and many of the usual rules of politics could not apply. As-discussed in chapter 13,.a key political aim is to 1~100 1 N .O ONTKAI NTS oN CIJANO1; restore "normal" politics as soon us possible. Even then, the political problems of transition are acute. Politicians facing a fiscal crisis have to reduce expendi- ture. They can do so only if they enjoy sufficient political support, and the development and maintenance of such support require. an ability to manage - - the political dimensions of policy, particularly where it creates a. significant number of losers. These are major problems 'even for experienced Western politicians, so that the difficulties facing politicians in Central and Eastern Europe should not be surprising. Virtually no politician in the early reformnjprocess had any practical experi- ence with democratic politics. Many early ministers Were former, academics who did not intend to stay in politics. Few understood ho Western politi-: c ians; operate, in particular (a) how they use the printed and broadcast media-, to inform the public, to shape the political agenda,. amd to learn what the electorate thinks and (b)-how they-usc polls, encounter groups, and similar. devices to gauge opinion in different constituencies. In the iWest, such skills are possessed by successful politicians, by leaders of pressure groups (such as Friends of the.Earth), and by the best public relations experts. The lack' of political experience manifested itself in a number of ways: the absence of top-down communication, scarcity of feedback, lack of political accounta- bility, and inconsistcnt. time scales of -economic reform and political pressures.- Top-down communication has been absent since the start of the reforms,'. when relatively little weight was given to information :and persuasion. Under the old,systern, the gowvrnment deliberatel k-ept the people poorly informed. and used information as a device.for politicai control and manipulation. Many, but not all, post-reform' politicians underestimated the critical importance of informing and persuading the electorate in a.democracy. One of the key roles'. of politicians is to inform and 'shape public opinion.'Implementation of good policy requires the government not only to get policy right but oro to educate' and persuade the electorate of that fact. The second leg is critical if policies. . are not to fail for lack'of political support. Lack.of publicity and information, during the design and implementation of policy can create a:serious political constraint.by reminding pcople of the.common praceices of the. old system. iThie issue of communication during the,early transition is controversial... One view (Balcerowicz 1993a) is that communication costs precious time and wastes short-lived political capital.;That may be true during the early, revolu- tionary phase of the reforms. However, once that phase is over, if not earlier, communications become 'vital.' Although the matter cannot' be proved, it mightebe argued that one of the ingredients of the political problems which. eventually faced the first Polish' reform government was that it did not devote - .enough time. to communicating with the electorate. In contrast, the .Czech elections of 1992 were. won by a party which had made a considerable and sustained effort to communicate with the citizenry. In the medium term, if not 1101] THEI POLITICAL ECONOMYI o r TRANSFORMATION in the shiort termi, the absence of communication constrains the reforms because government cannot gain sufficient support for the necessar policies. Politi'cal communication in a democracy moves in two directions: -fromi the top down and from the bottom up. The second aspect is j'ust as important as the first. Feedback mechanisms i'n the early transition tended'to be-partial .~~~~~~~~~~~ and rudimn-intary. At least one seniior (and otherwise politically astute) minis- ter expressed surprise when an adviser Wanted relevant newspaper-cuttings on his desk every, morning. The issue is not just the q,zandty of feedback (am few year s into therfrs pltcians in som-ie countries complai ned -that they were deluged with criticismi from opposition parties, economists, televi-~ shin programs, and trade unions) but alsoi its compleeness.: Ministers need -to know the views not only.of the intelligentsia (typically the group with access to.the media), bu't of /tvIgroups:which might..vote for the party in power.- The' shortage of such broad-based-feedback in the early transitkion me'ant that ministers Often lack-ed information about which policies were acceptable an'd which were not and aboutiwhere the majori.sources of support and opposi- tion were. The problem is decliningi cuties which haehdtlason full elctioral cycle since the:start of the reforms. Political ac&countability is -weak. Many government officials do not under stand the concept of-a-politicalI mandate; that is, they do not understand that --they are accountable to the electorate for past promises. A manifestation of the problem is the way in which policy can cha nge very sharply w%%ith a change- of ministerc * ~~~The problem of inconsistent timing arises because the timc scale for eco- nomic reform is medium, term, but. all the pressures of dtimocratic politics are short term. This rcrates a vulnerability to populism which is greater the more' painful are the policies. Government wds granted some re'spire at: the- start of the process, giveni the high political capital of the first reform -admnsrtionS. Oetime,:thoughi,,the problem became' acutei, particulal beas f the need for fiscal'stringency; and rsr1nvlially in countries which had never experi- enced unemployment. The heact of the political proces's is to cope with this dilemma. In part, thecse problemis; are dimninishing.; Many countries have bad at least one election since the start of the transition and are building up their political e-xperience. Countries:which have initiated reforms relatively recently,ohow- ever, would benefit fromr advice from Wes,terni political parties, trade unions, and pressure groups on the practical operation of democratic' politicsi. Institutional Cnstraints Institutional constraints arise through~ inadequate legislation and lawv-mraking, throughi inappro p'riate attit-udes -and priorities wvithin adrininistration, and throuigh deri'ciencies in phjysic'al and human capital. 1021 CONHTIRAINITS ON CHANGE The Legal Fmmeaw-:t Countries in Central and Eastern Europe inherited important gaps in their legal and regulatory framework. In addition, much existing legislation was inappropriate to the needs of a market economy. Legislators had little time to reform substantial parts of the legal order. Legal expertise wvas (and remains) in short supply, affecting the lawyers who draft the bills, the e,gislators who adopt them, and the administrators who implement them, many of whom lack experincec both with the substance of the newv laws and. with democratic procedures. The shortage of legal skills arises because totalitarian systems, for obvious reasons,.reduced education in law: lawvyers are a low priority where decisions do inot require a democratic legislature and where their implementa- tion does not require Judges.-Thus many lawvs were-passed.by "students" of the reform who were learning on the job. . LACK OF THE CAPACITY ID DESIGN A LEGISLAE PROG. At the stair of the rransition, the pressures 'for speed were immense. A health minister asked early in the reform process. "Can't you get these lunatics [his ministerial co1leagues1 off myvback; they keep on saying You've been health ministernow-- for six weeks, where is our health care reform?"' The speed of the legislative- process led to gaps between laws, inconsistency between laws, and some- times inconsistency within a singe picce 'of legislation. Problems arose also because of faulty sequencing of the development of la ws. Because of time pressures, legislators.sometimes adopted the tactics of the old.system, dele-: - .gating crucial'parts of the' more difficult and politically controversial decisions to-executive discretion and failing to develop adequate sanctions against fraud and -abuse. For all. these reasons, legislation often had to be revised soon after adoption. LACK OF A CAPACITY t0 IMPLEMENT LEGISLAION. Effective implemcntation requires both acceptance of and support for the new legislation. Without acceptance, implementation is reduced to tenroughthe; use of superior power, one of the inherited problems which the reforms sought. to remove. This problem is connected with the democratic deficit (particu- larly the importance of maintaining two-way political communication) and - ' ' Xwiththe human cpital deficiencies discussed below. A common problem is that insufficient time is allowed for-administrative ' - - needs. The existing institutions. are expected to preparea the administra ttive rules for-implementing newv legislation, to establish'the necessary procedures, and to revise their own 'organizational structures to match uthe needs of the new law. To accomplish this, however, administrators need to understand the : : new legislation, accept it, and have the capacity to -implement it. Without sufficient time, implementation will fail -to mcet .the intention of the legisla- :'. ' - . ' : tors.-Similarly, citizens may not have sufficient time or information to adjust. Much of the new legislation involves new concepts, new institutions, and new 11031 THE POLITICAL ECONOMIY OF TRANSFORMATION rules and procedures. Problems arise where people are not given sufficient time to understand what is being proposed, an example being the panic caused by introducticn of the newv medical insurance scheme in the Czech Republic: people knew they had to register but did not know hoW or where.' A final problem is the lack of sufficient judicial capacity for enforcement. Where therc is no judge, there is no law. Most of the ne.w Iaws increase the' work load of the judicial system, a natural consequence of the transition from a totalitarian system, which creates little -work for judges. However, there is no immediate prospect of a substantial increase in staffing (there are not- enough lawyyers), nor in the 'supporting personncl or the physical infrastructure of judicial institutions. - The Administradw St7entre The structure of administration. can constrain change in important ways'. enterprises will need to be relieved of some of their administrative responsi- bilities, there is resistance.to change within parts of the administration, imple- mentation skills are undervalued, and the concept of decentralization is insuf- ficientdy understood.' THE ADMINISTRATIVE ROLE OF ENTERPRIS. Administration under the old ss- tem had a hierarchy. within the central structure based on two criteria: (1) the importance of the institution for protecting and strengthening the regime and (2) the size of its budget. The result, as explained in chapter 3, was the high priority given to- the army and police, to the productive sector over the unproductive sector (mainly human resources), and to investment goods over consumption goods. These priorities nwere particularly evident during times of fiscal constraint, when the instiutions which were administering the social sectors were.even more starved of resources than usual. In consequence, the administration of parts of the education, health, and social welfare systems. wvas transferred to enterpriscs. A resulting fundamental'constraint on reform is the need.to relieve enterprises of most of-these social responsibilities at precisely the time when the public sector faces an acute fiscal crisis. 'GF . d.o- , RESISTANCE T0 CHANGE. The old system was characterized by top-down central direction, often with political interference in administrative matters. One.of the results was a passive administration which was reluctant to changc. Change was resisted, first, because it is painful. The needs of the transition include a reshaped administration to do away with the redun'dant administra- tion of central planning and new administrative strucmres designed to :assist: the operation of the private sector. Such restructuring makes heavy demands on the skills of administrators and often forces them to be retrained or to leave. When the new agenda is entrusted to the old establishment, old prac- tices are applied to the new tasks. The paradox is that generally no one else can carry them. out. A second type of defensiveness arises from efforts to * 1~~~t104 1 CONSTRAINT'S ON CHANGE retain institutional mnonopoly in the 'face of economic liberalization. Asking state institutions to organize privatization, thereby dismantling large parts of the state apparatus, creates an obvious conflict of interest. In the social sec- * . tors, the reforms provoke administrative defensiveness by demonopolizing health care, cducation, and, to some extent, cash benefits. - UNDERVALUATION OF tMPLEMENTATION SKILLS. In part because of the political . nature of significant numbers of administrative appointments, officials under, the old. system tended to be more concerned with carring out orders and less concerned *rith the outcomes of their ictivities. Thie resulting lack of interest in outcomes persists. At least in the social sectors, there is little assessment of w whether a particular policy is working or of whether it is being effectively : administered. The result is a lack of information on which to base future policy or future administrative policy and a lack of administrative accounta- bility. Policy is based on the assumption that previous policies have been effectively carried out, which may well.not be the case.. Since there is little interest in outcomes, implementation skills are-under-;.- valued, and policymakers rarely involve individuals with implementation skills in the formation of social policy. The'problem arises repeatedly. An anecdotal but illustrative example is the flag of one newly independent.country, whose initial designr was so complicated that it proved impossible to manufacture by. machine and had to be amended. Similarly, the initial speaker in one newly elected Parliament had to be replaced w.hen it became clear that someone with a severe hearing problem was not best-suited to the job (Radio Free Europe/Radio Liberty, ';Chaotic Opening Session of Stare- Duma," D.aily Report 7, January 12, 1994). Of greater importance, the time scale for increas- ing the levels of complex cash benefits is often unrealistic, and health care-X reforms can be too complex to implement effectively within a reasonable length of time." LACK OF CAPACITY -n DECENTRA&LIZE. The needs of central political control under the old system meant that power was rarely devolved to lower levels of administration and that the behavior of-lower-level officials-was monitored centrally. Although central administration wvas often small, it was powerful. Planning remained a top-down affair, with local government little more tharn. an arm-of the central administration. Although the central administrative structures were largely dismantled dur- ing the early transition, and the central planning mechanism largely abolished;. the distinction between (a) devolving power to a loNver level of government with its own elected legislature and executive authorities and (b) assigning tasks to lower-level administrative branches of central government was not always clear. The mentality of centralized decisionmaking took -time to change. The winners of early elections sometimes reverted to old practices by trying to use central power to enforce the-reforms from-the top down. Such 11051 THE POLITICAL ECONOMY OF TRANSFORMATION behavior was based on the mistaken idea that electoral victory gave govern- ment a blank check. Although concentration. of power may ease the adoption of policies, the top-down mentality creates continuing problems: it prevents the widespread discussion which assists the development of good policy, it hinders speedy decisionmakingat lower levels, and it reinforces the grass-roots pressure to -decentralize. The resulting social isolation of the advocates of the reform program may lead to opposidon not only. to -hem personally but also to the wholeidei of the reforms. ---Thc problem is more general than an ability to decentralize. What is lacking is the ability toinfluence opinion in situations where decisions are to be made and implemenmed withAou the use of top-down pouer., Again,. this problem is l* inked clearly wvith the earlier discussion of the democratic deficit. - Ha^ma,i and Physla Capital. Thc physical infrastructure in Central and Eastern Europe is obviously defi- - cient. So, too, is the human capital infrastructure; skills are outdated, old ways of thinking arc pervasive, and these are unrealized communication, problems because new concepts need time to take root. DEFICIENT PHYSICAL iNFRAsTRUCluRE. Buildings are in bad repair, which is a: - particularly important constraint in the health sector, transportation is gener-, galy old, and communicatons are a bottleneck. Telcommunications have - insufficient capacity and arc grossly incffective, and compuing capacity is totally inadequate to meet the needs ofa modemrneconomy. OUTITMD.SKILLS. Inappropriate human capital is pervasive..The problem is not primarily one of mao Aitn-human capital but of .-tbe wrog tpe. Selection critcria under the old system were mainly political. The quickest route to an administrative post'uas to have worked in the p;tyq organization. This was true of all white-collar professions. Similar selection criteria, determined, admission to high school and university, especially to the most prestigious schools where future administrators were ducated. Personnd structurcs therefore tended to have two strands: the politically motivated and politically -well-connected senior staff and the loyal professional junior staff. The former needed the latter to implement orters without exposing the superior's lack. of professional expertise. The problem arose even in professional institutions like hospitals, schools, and universities. In part because of these selection critena, outdated skills are a widespread problem.. No significant training in modem. anagement was available under ,the old'system because, for at least two reasons, there wvas no intention to : . - modernize administration. First, neither senior staff, who did not want to have better-qualiried. subordinates, nor junior staff,- who had no financial or othfer incentive to upgrade their skills, were interested, in'modernization. Training 1-06 1 CONsTiIAINTS ON CHANGE abroad was generally restricted to technicians working with foreign equip- ment. Second, administration, which in the 1950s was considered bourgeois and alien to the working class, was deliberately downgraded. Much damage. - was done by purges of administrative staff and by wage policies favoring 'manual wvorkers. Thus teachers and public officials had littie or no contact outside the communist Nworld. With a few exceptions in medicine, sciences, and some technical areas, their knowledge rapidly became out of date. OLDTHINK. The problems of old ways of thinking are pervasive and will not be overcome without effective education and publicity. The first major prob- lem is that important concepts are missing. As discussed in chapter 3, a ;consequence of communist ideology is the absenee of any notion that.scarce resources have an opportunity cost (that is, the cost of resources used for one purpose is the other uses to which they could have been put). Without such a concept, there is no recognition of the sort of tradeoffs discussed in chapter 1 and hence no possibility of dealing with them. Another conceptual gap tn the .old system is that under state ownership, no clear distinction was made bwnveen the property of the state and that of the enterprise, and hence there was no clear concept of taxation. A second problem is that old priorities remain. The old economic system was based on the priority of communal interests over individual rights and on the vision of being perfect at all costs, even if lies were necessary to preserve that vision. These values became internalized in individual behavior: subordi- nates hideunpileasant news from their superiors,'and this continued at least; during the early transition. Third, old fears create defensiveness. Under the old system, economic and political difficulties were "solved" by reorganization,iwhich was used as awNvay of hiding failure. The Cost of such reorganization was paid by the personnel of institutions, who were manipulated like inventory. Thus citizens fear reform and tend to distrust anything.new; for example, while the managers of social insurance institutions seek to computerize their activitk,s, their staff hampers. the installation and operation of tie new equipment.. COMMUNICATION PROBLEMS. Difficulties arise both from lack of training and from missing concepts. The lack of a common educational background, aggra- vated by the inability to communicate in Western languages, creates diffi- culties in communicating with Western experts. Training received abroad and.. training. from foreign experts are thus often less effective than had been hoped. A more subtle manifestation of the same problem arises because missing concepts lead to missingwords. This creates major translation prob- lems, both for oral interpretation and for translation of written documents. The term cash benefits, for.example, initially proved a consistent problem for interpreters, since there was little understanding of the Western distinction between wages, which are mainly related to individual productivity for reasons 1 107 1 r1 IPOLITICAL KCONOMY OF' TRANSIoRMATrION of economilc efficiceny, and inconme transfers, which are miostly paid out ofrthe state budget for distributional reasons. Tliese, largely unrecognized, commu- nication problemis act as a barrier to the speedy and effective transfer of informatIonLand know-how. The Major institutional constraint is thle lack'of appropriate skills, resulting from the procedures for selecting aidministrators, from the persistence of. oldthink,. from isolation from the -Western professional world, from conimnu- nication problems, from -the lack of the necessary equipmient, and fromn the lack:of individual incentives either for- increasing skills or for high-quality performance. Manifestations include a lack of knowledge of modern admini's- trative theory and practice, a lack of technical know-how, and,' frequently, also a hostility toward mnodern admiinistrative techniques and technology. Administr'ative methods in Central* and Eastern Europe have changed little since the end of the Second World War. 'They are generally.cumbersome, unnecessarily complicated and slowv, -and under'mined by distrust,' with exag- gerated (but ineffective) monitoring of 'abuse. In the early transition,. admin- istrative personnel in most of Central and Eastern Europe generally relied on pencil and paper; typewriters were often the highest tech'nolog'y available. The combined effect of legal problems, of re'sistance to change, of under- valued imnplementation skills, of 'Outdated administrative methoDds, and of missing'skills has been to crecate major constraints in institutional capacity. Since much social sector reform raises complex issues of the mix between public and private, the; problem is particularly acute in that area. The''adminis- tration of cash benefits needs to be largely remboved- from enterpris~es. Health sector reform involves -both new ways of organizing the supply of medical care and more co'mplex forms of finance. An important part of the agenda for. the reform of education is d'ecentralization. In all these areas, the constraints on * ~~institutional capacity limit the speed and effectiveness, and hence the political * v~~~iability,- of the reforms. Notes I. In die early transition in mast countries, the fall in output -was fairly uniform- *across broad sectors, althouigh it va'ried considerably at a more disaggregated level (see the discussion' in chapter 3). 2. The Czech situatieon is open to different interpretations. On-one view, it shows htat economic transformation can occur in conditions of relative economic stability and with relatively low levcls of unemployment. On another interpretation, such an out- come occurs only because the real pain of transition has been postponed. It is pointed out, for instance, that in Finland,i which faced anexternal shock similar. to that experienced by the Czech Republic, unemployment rose relatively quickly from 4 percent to more than 17 percent. 3. To illustrate the pointrwith a simpce ecxampe, suppose income tax is paid at 25 percent on income above szoo0 rSomeonewithanincome ofs$6,000 will-therefore 1108 1 Q0NWI'I4AIN'rH oN OIIANU It :py $1,000 In tux. If, during n recession, hiH iniconie oills to $4,000, hili. tax bill will be 0S4OO Thus, if Income fillsl by one-third, tax revenues wtiill halva. .- 4. If output flils, there Iltos to be. decline In present conSlmption In investiieit (and henicc, generally, infuturt consuimptiotn) or in both (se the: discussion In chapter * . 5. In lPoland, for cxample, real wagas as menstured by official statistics fell so miuchl- at the start of the reforms tltit profits were anlntained atnd hence t'ax revenies did not :' ' full itnkially. II tnlw following year, in plrt b icause Of tie suiceCs of tho olntd-inflatioinotry policy, profits fell (sce Schaffer 1993).'Thus the flscul crilss became a tmnajor probliem only In the second y9a'r of the reformis, s . - ' ~: .6. In the West, the pdip4el of eligibility are generally included In primiary legisla-' tion; tJe lemlt of beMftts Is genemlly set under regulationis. Thic respective roles of, primary and secondary legislution Are discussed In chapter 13. 7. Poor occupational safety led to high expenditure on sick pay and disabilty' pcnsions and, nmore gencrally, to.poor hcaltil (see chapters 9 und 12).. 8.- More anecdotally, when a mnior scuffle.broke out.beewi,cn two parliamentarians - In the Russian Duma in early 1994, one of the participants ;ius quoted as saying that, - - - . should hc become president, his first act would be to imprison thiC othier, 9. As an examplet "Russian Economics Minister Andrei Necciev told Inrerfax:.. thlat the government hias ordered the Central Bank to reverse its decision canceling * debts owed by: enterprises. But in irnniya, Central Bank Chairman. Viktor Ocr- ashchenko defended his controversial instructions ie conceded that the debt - ' forgiveness hid disadvantages but what other altcrnative -do wc have? . . The Central Bank answers to Parliament, and it is not clear what the government, which is split on this issue, can or will do if the bank holds firm." (Radio Free Europe/Radio * '. Liberty, DailyReport 148, August 5, 1992). In Ukraine, similarly, the primc minister "accused . . . Parliament. of interfering in the cabinet's work and said. that if a clear delineation of powers between the government and Parliament was not established, his 'government would resign" `(Wall Strne Journal, ERre, July 6, 1992, p. 7). ' . . =* 10). To deal with this problem, Poland introduced a threshlold in S993tof 5epercent ' : i of total votes for single parties and 8 percent for coalitions. The purpose of the :. - threshold was to reduce the number of political parties in Parliament. II. The Russian Supreme Souviet announced at the end of the first week of -April. 1992 that all pensions would be revalued as of May 1, 1992. The revaluation involv'ed recalculating, vithout the help of computers,.the pension of each individual, based on his or her earnings record over the previous ten years indexed by a complex formula. In addition, some pensioners, by submitting additional documentary evidence, could count as pensionable service additional periods which had previously been ineligible.: Those in charge of implementing the decision estimated that the task would real- - . istically take at least six months. 110 9 1 ______ ~~Par( H1 * POLICY DESIGN AND IMPL]EMENTATION six. A STRATEGY FOR REFORM ~NICHOLAS BARR ThiS CHAPTER LINKS THE DISCUSSION of Part I with the rest of the book. It draws on the analysis of the pre'vious four chapters tolset 'out a strategy whtich shapes * the recommedations for policy and for;implementtatio in th remaining. chapters. To encourage economic grow~th and increase' individual fre'edom, * many countres included -economi'c an'd political liberalization in ~their eary reforms. Those actions, the driving for6es they unleashed,.and their major outcomes were the.subject of chapter 4. Some outcomes, such as ireater efficienicy and greater responsiveness of government to the electorate,ar major purpos u~~ 0 X com c majorpurpoes of the reforms. Ocher less-benefikial outcomes becm con- straints 'and were discussed in; chapter 5. The following strateg seeks to harness thueefca oucomes of the- driving forces while taking accouint of the constraints. A fundamental pu'rpose. f: - l : 0 | : ::- t~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~tts fcnrl'4nn of the transition has been to dismantle the apparau ofcnrlpann nd to mnove toWard a. market system. As'a practical-matter, however, such a, move was associated durinig the'early transition with a' decli nie itn output and mostly* * also with a fiscal 'crisis. The policy, strategy which follows is conn ected in .a very direct way with the effects of the output decline, on the one, hand, and. the.move toward a market system, on the other. It 'seeks: to (a) ma"intain macroecono mic balance. Economic libefflization involves policies. both (1$ t build markets and (c) to regulate~ markets, (teltter to adesmret imper-: fections and for equity reasonts). Achievirng these aims requires the capacity (d) to implement th'e reforms, taking account not only offiscal a'nd other economic constrainits, but also of the-coitstraints on political and institutional capacity disc'ussed in chap'ter 5. Maintaining macroeconomic, balance con- cerns stabilization; libera'lizing the economy relates directly 'to restructuring.'I Maintaining Macroeconomic 'Balance Maintaining macroeconomic balance, 'w%hich involves both monetary and fiscal policy (s6ee the glossary), is especially difficujlt duriLng a time of declining ou~tput.~ Monetar 'policy which, for the ma~st part, lies outside thme'scope of this book, includes control of the mone-y supply and regulation of the bankir:,g sstem in the interests of monEtary stability and consumer protection. Fiscal. policy hs two prime cocrst is concerned first: with the balance- of 11131 POLICY L)ESIGN AND IMPrLMENTATION government revenue and expenditure. Attention should focus particularly on those .areas* which could. yield substantial savings, rather than on changes which- yield only marginal savings. A major purpose of this aspect of fiscal policy is to assist stabilization. The second concern of fiscal policy is to contain the size of the public sector, bothl to allow private sector growth and- by facilitating private investment-to assist economic growth. AfohXizi&igResources Policies to mobilize resources include improving the system for collecting- taxes and developing ways to increasecthe participation of the private sector. Often the way to accomplish this is to privatize, but even in areas where the state maintains a major.role, it is possible to mobilize private resources. Charges can- be levied in some areas, such as copayments for some types of miedical care, and incentives can be used, mainly through the tax system, to : encourage certain types of private activity. . Courntami?J;g .penditwre Containing expenditure a direct. response to the fiscal crisis. The starting point is the notion of targeting, which has nvo aspects:. - Horizontal efficiency implies that benefits should go to all who need them, which means that there should be no. sigilficant gaps in coverage. This is mainly a matter of poverty relief. - Vertical efficiency has two imp'.ationis. First, benefits should go aiy (or largely) to those who need them-(there should be no excessive.leakage of benefits). In.the context of poverty relief, this implies that benefits should ; be aimed at the poor rather than the entire population. Second, in the contexts of health care or education and training, treatment or education should be relevant and effective for the itldividual concerned.. - Co st containment thus involves policies to increase vertical efficiency and arrangemients to discourage exploding costs, important examples bcing pen- sions and health finaincc. Cost containment is particulariy necessary during a. time of fiscal. difficulty-all thc more because of the political and administra- . tive constraints on raising revenue-to prevent taxes from being so high that they create significant- incentives against work effort. The role of competitive labor markets'is important in this context: wages should contribute as little as - - possible to inflationary pressures, and payroll taxes should not create incen-. - tiveswhich hinder additional employment. -Competitive labor. markets also * --contribute more broadly to a country's macroeconomic health. They assist the performance of exports and increase the capacity of the economy to adjust to changing external conditions. 1114I A STRATEGY FOR REFORIth Building Markets Building markets, the major vehicle for pursuing economic growth, involves the liberalization of (a) demand, (b) supply, and (c) prices and wages. hzoesMzg Consumer Choke Increasing consumer choice is unportant for political reasons, as an aspect of individual freedom, and also for reasons of efficiency. Greater choice leads to chaiges resuting.from the pursuit of personal sadsfaction,'in furtherance ofi cultural identity, and from. a desire to move away from the old system. In education, for instance, consumers exert pressure for new textbooks., Con- sumer choice.also arises for income transfers, as the rangge of voluntary private. savings and insurance options increases, and health care, as the scope for individual choice expands and more aand better consumer information becomes available. Employers also make choices. Indeed, employment-driven changes are a central part of the reforms. In a system with hard budget constraints and : vages deterrmined largely by market forces, managers take increasing account of labor productivity in their employment -decisions. .Changes in consumer demrand and in derived employer demand for education, training; and retrain- ing therefore lead to major changes in the roles of the recipients of education and training, service providers, government, and employers. En particular, increased emphasis is placed on the relevance of training. Diw Xf,f.g S,pply Diversifying.supply also contributes to individual freedom and to efficiency. Large sections of the economy will be returned to the private sector. Exam- * ': ' . pies in later chapters include.the phased introduction of private pensions and sick pay schemes, ailowing different types of hospitals and primary health care. and allowing both public and private providers of education, training, and employment services. More generally, such liberalization allows a more effec- - 0 = tive mix of public and private services. Imprmving incentves Improving incentives 'is a central component of restructuring and also a response to the fiscal crisis. Prices should be efficient. In cases like food and: clothing, this means that consumers should generally pay market prices. As discussed in later chapters, it does not imply that patients should necessarily have' to'pay the ill Cost of drugs, not chat schoolchildren should pay market prices for schoolbooks. It does, however, mean that providers of medical services and managers of educational institutions should be aware of the full cost of these commodities, in the interests of efficiency and also because of. E - Sf 0 Ft 0 i f 0 f - 1IllSl I 0ff POLICY DESIGN AND IMPLEMENTATION the fiscal crisis. A second aspect of incentives is to have' an appropriate structure of income transfers, such as a system of unemployment benefits which gives workers the incentive to rejoin the work force promptly.- Emplovers, too, nced to face efficient prices.-Thus the cast of family support, such as maternity leave and child care facilities, as well as the costs of administering it, should generatly be borne not by the employer but by the . taxpayCr. Employment costs should be neutral with respect to employing men and women; imposing on employers the costs of farmily support gives a signifi- cant incentive againsrcemploying woomen. Raking Labor Prl dumatliy Raising labor productivity is a.response to the inheritance of low growth in output and of misallocation. Policy has two aspects: workers' existing skills have to be put to more effective use, and their skills have to be increased. An im-plication of the first is that labor needs to be more mobile, both in terms of acquiring new skills and, to some extent, of moving to where their skills are in demand. Wages more closely 'related to market forces contribute to this objective; so does betterjob information. Effective redeployment of labor also includes policies which minimize impediments to labor mobility, through appropriate labor legislation and through broader policies such as improved. operation of tde housing market. So far as increasing the skills of workers is concerned, education, training, ' retraining, and other forms of investment in human capital have major roles to : play in imparting flexible .skills which allow workers to change jobs -more easily; and wages, again, give individuals the incentive to upgrade their'skills. Regulating Market Forces Regulating market forces is. the counterpart to building markets. Marker - forces, introduced for their efficiency advantages, need to be contained both to address market imperfections and to come to grips with important equity issues. Jntd'ucmnga Regrhory Srctnhr Regulation is central to. the effective operation of a market system for the reasons set out in chapter 2. At its most basic, the regulatory structure needs : to include legislacion.governing property rights, the conduct of private corpo- rations, and dhe operation of institutions such as .the banking system and financial markets which are essential to a modern market economy. Regula- tion is also necessary to address important market imperfections, particularly for. consumer protection in complex areas such as financial markets and medical care, where ind ividuals are typically imperfectly, informed. :' 0 -,-.; .--. . f - - - 0 .[116. 1 A STRrATEGY FOR REVORMDL Polices to Addrn Unemployment Two sorts of-policies are involved in coping with unemployment.. Income support, for instance. in the form of unemployment benefits, is discussed in chapter 9. Active labor market policies, discussed in chapter 8, include ser- vices providing' information designed mainly' to help workers to 'move more quickly to a new job, investment' in human capital tihrough training or retrain- - ing, and possibly also short-term job creation. .E ding Access o Basic Goods and Servces Two separate types of activity are involved in guaranteeing access w basic . .gnods and services. The first, strengthening poverty relief, is a respDnst to the widening distribution of income. An implication.of targeting is that, so far as - possible, benefits should go toal who need them. Thus benefits should' ideally go to all the poor. This involves improving and expanding unemploy- ment benefits and poverty relief. A second set of policies seeks to provide access to health care, education, and similar services. This involves ensuring the availability of commodities such as critical drugs and textbooks and designing policies such as systems of health finance which do not exclude uninsurable risks. It also includes any necessary redistribution by central government to assist poorer parts of the country. * . -The joint pursuit of poverty relief and cost containment at a time of fiscal crisis means that well-designed targeting is more thai usually important. Targeting requires identification of the -poor, which can in principle be - : achieved in two ways. It is possible, first, to look ac.thc income orconswpd-o: of individuals and families. This approach,, however, faces significant diffi- - culties: it runs into problems of poverty measurement, is administratively costly, and, particularly if based on family' rather than individual income,. is often intrusive and liable to cause political resentment. In addition, means testing is likely to be ineffective for individuals with a significant amount of income in kind, such as home-grown food. An alternative approach' is to look for indicators of poverty, that is, the - possession by the individual'or family of one or more characteristics which are highly correlated with poverty. Examples of such characteristics are ill health, - old age, and therpresence of children in the family. The advantage of this *: approach is that many characteristics are easily observable, which facilitates administration. The disadvantage is that the indicator may. be correlated only- imperfectly with poverty. This leads to either or both of two targeting errors: gaps in coverage or leakage of benefits.. Determining the extent to' which policy should seek to prevent leakage of . -brenefits (the pursuit of vertical efficiency) is-a conmplex matter. [gnoring the .*- y ' problem leads to increased expenditure, violating fiscal constraints. Target- I £1 =- POLICY DESIGN AND IMPLiMENTATION ing too strictly, however, produces gaps in coverage'. In addition, middle- class participation in at least some benefits helps to.maintain political sup- port for the relevant programs (World Bank 1990b, p. 92). A possible. line of attack is to devise schemes based on selkargeting. The idea is to construct benefits in such a way that only. the genuinely poor. will apply for them. An example in the famine literature is to offer work at a subsistence wage, for which only the genuinely indigent will apply (Ravallion 1991). The issue of targeted poverty relief is one of the main topics of chapter- 1O.' Providing a Eniabling &tiroumentfir Insurance and Ionme Snoothing Alongside poverty relief, income transfers also seek to enable individuals.both to insure themselves a inst the risk of income loss (for instance, because of unemployment) and to reallocate consumption over their life cycle. In princi- pie, these could be done through private.insurance, personal savings, and private pensions.. However, the private market cannot- supply insurance against some important risks, giving the state a-role in ensuring iat protection against such risks. is available, and capital market imperfections and other problems mean that state intervention is required for pensions at least to regulate activity in the private sector. Implementing the Reforms Maintaining macroeconomic balance, building markets, and regulating mar- kets allrelate'to policy design. Effective reform, however, also requires admin- -istrative capacity and the ability to manage the political dimension of reform. All three sets of skills-policy analysis,'administrative expertise, and political experience-are needed simultaneously. Building Initudonal Capa ciy Policies which build institutional capacity are a response to the constraints dis-. . cussed in chapter 5 and also a necessary element of the design and implementa- tion of the regulatory structures just discussed. The problems are acute. First, the task of central administration, though much smaller, becomes more'difficult because complex new systems are needed to provide cash benefits, health care, education, and training in a period of constrained resources. Second, institu- -tional capacity is low: skills in short supply include those involved in designing a legislative program and in drafting individual laws. Policymakers are not familiar with basic economic concepts such' as opporturity cost and theirnportance of incentives and often do not understand how markets Work, including the need for an effective regulatory structure. Low pay and poor morale have driven many of the best people our of public service. *~~~~~~~~~~Il I.......................... ,;....:.. A STRATEGY FOR REFORMi To cope with these difficulties, administrative needs should be given greater weight:: Policy design should be as simple as possible. . Individuals with implementation skills should be involved from the start of the process of designing policy and drafting legislation and regulations. Greater emphasis should be placed on monitoring the outcomes of policies. Building Polkieal Cap acity Increased political skills are. necessary to enhance the ability of dermocratic -. ' political systems-to meet the wishes of the electorate, while simultaneously putting into place policies which assist the process of.:reform. These include implementing cost-containling policies during the fiscal crisis, coping.with the political implications of rising uncmployment, and accommodating disap-' pointed expectations that living standards would increase rapidly. To be effec- tive, policies should have two important components: top-down communica-. tions and-feedback. Top-down communication needs to be improved so that politicians can be more effective in persuading the clectorate of the correct- ness of their policies and can, where necessary, defuise unretlistic expecta-. tions. Of equal importance, better feedback is vital to inform politicians oabbut w vhat the electorate wants and about the main sources of support for and opposition to their policy proposals. -~~~~~~~~~i-a cc ,., buidtp The strategy thus involves maintaining macroeconomic balance, building markets, regulating markets, and implementing the reforms. Thicir detailed .*-- 9 . application has twelve elements: M* obilizing resources : . - Containing expenditure Increasing consumer choice ' Diversifying supply * Improving incentives * Raising labor productivity .* Introducing a regulatory structure * Addressing unemployment * Ensuring access to basic goods and services ' Providing an enabling environment for insurance and income smoothing * Building institutional capacity' . Building political capacity. These twelve elements have their roots in the decisions already made and in. the: nature :of 'de transition itself. They form a mosaic which emerges in - different patterns in each of the following chapters. 1191 POLICY DESIGN AND IM{PLEM{ESTATION Note 1. Balcerouicz (1993a) argues that the transition has thiee components: stabiliza- tion, mainly through macrocconormic policy; liberalization (for exampic, of ownership options and prices and uages) to allow an cffcctive market mechanism; and institu- tional restructuring. These threc aspects broadly correspond to the rerorm strategy presented here. 11201 Seven -LABOR MARKETS: WAGES AND EMPLOYMENT RICHARD JACKMAN * MICHAL RUTKOWSKI THiE MOVE lflA MARKET SYSTEM IS CENTRAL ifl THE ~REFORMS 'in Central and Eastern Europe.. This -is -as true in labor markets as in other parts o-f the economy. Effective labor markets are. essential, to assist the movemrentoof ..workers into'jobs where they arecmost. productive. This chapt-er discusses'(a) J~~ ~ ~ ~ p methods of sEttng ivages which gve appropriate incentives to work effort and labor miobility while& minimizing infbationarv pressures and (b) ways of main- maining employment which nevertheless facilitate the movement of wVOrkers Into more productive jobs. The ain ess'age is that freecenterprise labor markets need the econoi infrastructure of a market eCOnomy-private OWnerShIp COMPetiEtion, capital markets, labor mobility-if they are to function efficiently. T'he priority:for policy is to put this infrastructure intoD place; until this can be done, govern- ments retain important responsibilities for limiting wage.inflation' and for containinig the growth in unemploymeint. Such interventtonist policies should be~ phased,. out over the medium term as the growth of mark-ets and the elimination of constraints on labor miobility remove the need for then., Even where labor markets workvwell, hOwevCVer, unemployment remains a problem. In Central and Eastern Europe, at least in the short*ru.n, -the problem is likely, to be particularly acute. Unemployment is the'.subject oDf chap-ter 8, which addresses the failures of labor markets-and recom'mend's policies to aSSiSt labor mobility and to reduce the extent and dumration of unemploymenit. The Inheritance There is a widespread image of labor allocation in countries before the transi- tion as having been similar to the planned allocation of energy, raw materials, or goods. Workers are often assumed to have been ,allocated by planners to a job., enterprise, or region and obliged to st~ay there. This image is rooted in the Stainst erod, when worker wvere forbidde'n to quit their jobs, and special- ists and skilled %vorkers could bec forcibly transferred from one enterprise to another. After the end of the Stalinist period inothe mid-1950s, however, the prncipes ofsettin6g emploIymen't and, to a lesser extent, waeschanged in many re.sp becoig more like those of markCE economies. The r markeatbecam moure of a market than other markets. Except for a few jobs, *. eonmy Efetvelaormakesar.esetil oasis tc-moe11211.;d 00 POLICY DESIGN AND IMPLEMENTATION which continued to be centrally allocated, workers were free to choose their job, skill, or profession, as tvell as the region where they worked, and were free to quit their jobs. Even in the U.S.S.R., where restrictions remained more widespread, there is little evidence of effective compulsion either on an employer to accept a particular worker or on a worker to accept a particular job. Employers were legally permitted to create redundancies, and, although state employment services had exited in Poland since the late 1950s, in the U.S.S.R. since the 1960s, and in many other countries, they did not neces- sarily exercise a monopoly.over the allocation of labor (for details of the former Soviet system, see Marnie 1992). Restrictions on wages were greater. Some countries, such as Bulgaria,: Czechoslovakia, and the U.S.S.R., developed a system based on "scientific" wage differentials, grading all jobs according to output levels, hours worked, regional coefficients, and so forth. Other countries, such as.Hungary and Poland, replaced a wage system based on a central tariff structure with upper arid lower tariff limits negotiated by the government and trade unions at the industry level. The individual vage structure remained complicated, involving bonuses, premiums, and regional and special coefficients. (for example, for arduous work) paid on top of the basic wvage. When the system was unable to contain wage pressure, various types of incomes policy, including a tax-based incomes policy, were applied. To avoid confusion between the different periods, it is useful to distinguish the. traditional (early dr Stalinist) labor market and the reformed market (late or ost-Stalinist). Five general features of the carly labor market were substan- tially reformed after the mid-1950s: Geerraladmonidonswto work. Workers not only were guaranteed the right to work but had a positive obligation to do so (staying outside the labor force was considered "parasitism'). For that reason, the countries of Central and East- ern Europe did not have a system of unemployment benefits.- The principle *was "he who does not work, neither shall he eat." Absenteeism and tardiness lvere often subject to criminal sanctions. Mandatory assignment ofgraduaates. In some countries, the'state had a right to assign the graduates of technical schools and universities to a specific location for a few years. The state's right to assign students geographically (for instance; to remote areas) was viewed as a means by which students could repay society for their free education. Noncompliance was always high, how- ever, even in the U.S.S.R., where the system was harshest. Fored labor. The U.S.S.R.-and also some other countries-had a record of using concentration camp labor for construction, mining, and forestry. The * economic benefits of forced labor may have been significant during the initial drive to collectivization and industrialization. * Mobizdon campasjvs. Some organizations, in particular mass.youth : organizations, frequently engaged in the semi-voluntary recruitment of ucn ngage ary. .-c-:u-122 - -I~~~~~~~ 122 1 : tAllOR MARKETS: WAGIS AND NMIPLOYMENT workers and students to carry out special tasks, such as construction or agricultural, projects, or to help collect the harvest. These arrangements sub- stituted for wage differentials when labor had to be mobilized tepidly. &Srict control of migratiov to urban anas. A system of internal passports or permanent resident permits was introduced. Initially it was applied widely, but later only in some cities. The major objective'was to restrain the migration of peasants from rural to urban areas. . These rules were all lifted or substantially relaxed in the 1970s and 1980s, : though at different paces in different countries, Hungary and Poland-being. * > -; ahead of the others. Thus the labor market just prior to the transition was very L : . - different from the traditional one; it was, in a sense, eclectic, because it- combined features adopted from different origins. Below wve review the major aspects of the late, post-Stalinist system. *The old system had significant strengths: it offered job security, essential benefits were guaranteed through employmcnt, workers were. involved in enterprise matters, and labor force participation was high. First, .by the post-Stalinist period,: workers in most countries had job secu- drity and were free to leave one job in favor of another and to relocate geo- '' f graphically. Although their mobility was constrained somewhat- by housing and endemic administrative restrictions, they could move and were more or less guaranteed employment and job security. The combination of these three . possibilities was hardly achievable in Western countries. Contrary to common belief, labor mobility in Eastern European countries and.the U.S.S.R., mea- sured in turnover rates and number of moves between regions, was not much below thatofwesternEuropeCseetables 7-1and7-2;Marnie1992).I Second, essential social benefits were guaranteed through employment. In2. a sense, everybody' was a civil servant, knowing that-within a substantial range his or her benefits were independent of performance. All family members, :whether working or not, were automatically covered. The system was broad- ranging and did not require activc pursuit of security, for example, by buying insurance. Everyone enjoyed a feelingof stability and certainty. Third, workers were more involved in enterprise matters than is commonly realized. Almost everybody employed in a factory-assembly line worker, janitor, engineer, and supervisor-belonged to the.same national trade union organized on a,n industrial basis; Union membership, though not compulsory, -.: . - was very-high because it 'gave preferential access to some social benefits. : During an initial period based on a Taylo'rist approach to work organization, workers were expected to perform very narrowly defined. functions.2 Once ' this period had passed and workers' councils and unions were rnore active, however, employees became much more involved in the enterprise, especially in Hungary and Poland. This, however, was onlv partially. successful in 11231 Table 7-1. Employee Turnoverin Various Counies and Years, 1987-90 (percentagc of total employment) -- ~~~~~~~Rcmrforkmgr. g Hirid Quit Contract Region andcounty AWl lndustry .dll Indumty ended Rctgned Dismiwd Tmr&rf red Otler Czechoslovakia, 1989 19.1 19.5 19.6 19.4 - . 9.1 - 0.7 9.8 Hungary, 1989 20.2 - 22.6 - 1.3 16.3 05 1.9 2.6 Poland, 1989b . t6.2 6 15.8 19.8 19.3 . 0.7 12.5 0.3 4.6 _-E Ramania, 1989W . . - - 10.5 0.5 5.5 4.5 - - titus, Rumpe FranCe, IJgod 32.2 22.3 31.8 229. 15.9 8.0 2.7 1.7 .35 Italy, 1987c - 5.4 - 8.0 - - - - - United Kingdom, 1988' - - 23.2 - Z2.6 - - - - - Japan, 1988 18.9 15.5 17.7 15.0 0.9 11.7 0.7 3.4 1.0 a. Excluding farming cooperatives and, for iridustry, including manual workers only... b. Ful-timc workers in the state sector only; reasons for leaving arc for 1988. c. Ile categories "transferred" and "other' arc included in resigned. d. Establishments with SO or more cmployecs.: e. Establishments with 500 or morc employees. f. Calculated as twelve times the four quartcr moving averages for August 1988. &ufe: B6eri and Keese 1992. .AIIUR MARKETS! WAGER AND ILMI'LOYMI:NT Table 7-2. h inernalfMigradionhin Various Counnrdes ad Yeatr, 1987-90 (percentage o total popul.ation) POp1a/aNon internal (Willions of. .Rc ion. mun, anidyear ml Mmia peraos)m * Cennw/ andRawr E-urope *Cicboslovymldo, 1989 2.476 1lungary, 1989 1.9 10.6 Pocland, 1990 1.4 38.0 * Vestem, Emp e Geriany, Fed. Rep. of, 1987 I. 61.1 Italy,.1987 0.5 57.3 Netherlands, 1989 1.7 14.8 Stain, 1987 0.3 57.3 S%veden, 1990 2,2 8.5 Honk dmedea Unite'J States, 1988 2.7 .37.4 Note: Internal migration includes migration across twelve rcions for CzechoslovakIa, twen regions for Hungry, forty-nine counties for Polikand eleven Lander far Germany. twsent regins for Italy, twelve provinces for the Netherlands, twenty-two coumntidaides for Spai,n twenty-four counties for Sweden, and fifty states for the Unitcd States.. a.. At the beginning of the year, cxcpt Spain, which i's mid-year. &j-re? Boeri and Keese 1992. increasing the voice of workers because managers and sector mi'nistries resisted the reforms. The major consequence of workers' councils and unibn activity in practice was the rising-number of industrial conflicts. At the same time, workers could increasingly influence their employers by threatening to leave the enterprise. 'Fourth, labor force participation wvas high. Countries in' Central and Eastern Europe achievedt a higher overall race of participation- than th highly indus trialized countris primarily as a result of the greater economic: activity of women, as shown by table 7-3 for womedn forty to.forty-four years old, who are miostly past their peak childrearing age but still below retirement. The high participation rates of females reflected the abundance of j'obs, created by *: :: .pid- in edusriliato and0 de o a, i ,5.r rap mindustralorizration and, more: recently, the emgr ow phic mbalance- between m'en and women as a result of the Second World -War. As noted in chapter. 3, economic growth - oin Central and E en ErfopCe typically, was do btky, ver rvnsfothNeclad, henynv o"dak o npin ownt-fo spurred by te extensive, and o ly to a lesser. extnt the inte:nsiv, use. o inputs, including labor. High partic ipation rates were arssociated with greater ity for women in educa on and training ad, equale ah reors'-h maoonsequeneofwr ers onclysit beuiter career prospects fo h women in many sectors than exist in a number of moharket economies. By enhancing the financial independence of women,alabor force participation helped to raise the social and political,status of! women. Child Euop chevda ihe oeal at o ariiptinthnth 11251du- - '- POIC.IY DRSION AND IMPLEMENTATION Table 7-3. Rates of ParticpaoNon in thc Labor Fome of fl omen Forty to Fony-Jour Yean of Age in Varous Counties, 1950-85 (percent) Region and oanlNy 1950 1960 1970 1980 1985 tkwnu/ and &Anwe Ifrone Bulgaria 78.6 83,4 -88.5 92.5 93.3 Czechoslovakia 52.3 67.3 79.9 91.3. 92.4 Gcrman Democratic Republic 61,9 72.7 79.1 83.6 86.1 Hungary 29.0 51.8 69.4 . 83.2 84.7 Poland. 66.4 69.1 79.5 83.2 84.7 Romania 75.8 76.4 .79.5 83.1. 85.1 U.S.S.R. 66.8 77.9 93.2 96.9 96.8 Northr &urnpe: 30.9 39.9 53.B 69.9 71.1 IVwrnwc7Euntce - . . - . 34.5 39.5 46.4 55.1 55.6 Sohan:Eurqflt 22.4 25.3 29.7 35.7 37.1 -ote: The countries covered are Austria, Blgium, France, Federal Republic of Germany, the Netherlands, Switzerland, Luxembourg, United Kingdom((Western Europe); Greece, Italy, Malta, Portugal, Spain (Southern Europe): Bulgaria, Czechoslovakia, German Democratic Republic, Hungary, Poland, Romania, U.S.S.R. (Central and Eastern Europe); and the Scandinavian countrics (Northern Europe). Regional averages are unweighted. Thc classification o of countrIes by regions in this table is different frum the Intcrnational Labour Organisatiorns - - origin-al classification. S:errr: Kornai 1992, p. 207. care facilities and generous maternity leave allowed women to stay in the labor force even when they spent significant amounts of. time at home. On the darker side; many women may have been forced to work by social pressures or low incomes. High participation may, in the long run, have contributed to lower birth rates (Kuniansky 1983). Given all the other burdens placed on women, their productivity in work may often have been low (Kornai 1992). As figure 7-1 shows, participation rates were higher in Central and Eastern Europe at each level of income than in capitalist countries.~7 Weaknesses Alongside these strengths were major weaknesses= (sometimes the oppo'Y ie side of the same coin): labor productivity was low; wagesbore no relation to productivity, with a variety of consequential ill effects;.the approach to unem- ployment was deficient; the system of wage bargaining contributed to infla- . tionary pressures; employment was xcessively concentrated in industry and agriculture; and international migration was very limited. LOW LABOR PRODucrivifTY. Low labor productivity was in part a consequence of labor hoarding. Although there are major problems of measurement, par- ticularly when trying to adjust the value of input-, and outputs for differences in 1216 1i LABIOR MARKETS: WAGES AND EMPLOYMENT Figure 7-1. Rates of Parkidpadon in the Labor Fo,rceand Lexl of Devlopm-ent, &Sekaed Counffies, 1980 Ratio of employment to population (ercent) 60 RO/0 RO GDR\I s0oi HUN CZE/,J YUG POL S fO USA - ~0 0. USSR7 DEN'O I AT BUL.X ~ FG 40 - TUR S *ARG NZJ~ SORE FRA' SBEL,LUX IRE * ITA PORO #4 MEXO spA NET * CR-T. ISR 30 EGYSa 20 I I I I I I 0O 20 40 60 .80 100 GDP per capita (Unfited Stares -100) Note: in ascending order Of GOP pcr capita. the names of countries given above in codes: EGY,~ Egypt; TUR,-Turkcy; MEX Meiltico; CHI.,Chile;t ROM, Romania; YUG,.YugDslavia; ARG. Argentina: POR, Portugal; GRE, Greece; POL, Poland;, BUL, Bulgaria; HUN. Hungary; ISR, Israel; USSR, U.S.S.R.; SPA, Spain; IRE, Ireland; CZE, Czechoslovakia; ITA, Italy; GIJR, German Demoasitic Republic; JAP 'JapaLn; UK. United Kingdom; NZ, Newr Zealand; DEN, Denmark; ASA, Austria; NEr, Nethcrlands; FRA, France; SWI, Switzerland-, NOR., Norway; BEL., Belgium; LUX, Luxcmbourg- FRO, Federal Republic of Germiany before reunification; FIN, Finland; SWE, Swveden; AUS, Australia; CAN, Canada-, and USA; United States. AMI the formecrly socialist countries are in the ringed area above die capitalist countries and:arc at a cmaalleeofdvlpnL Inodro DP, the soCialist countries included are Romania, formner-Yugoslavia, Poland, Bulgaria, Hungary, U.S.S.R., and formner Gerfman Demo- cratic Republic. Sowzr:t Kornai 1992, fig. 10.1, p. 209. Used by permission. quality across countries, studies comparing: estimates of: per' capita gross domestic produCt (GDP) suggest chat for teni190laoproductivity in Central and Eastern Europe was about one-third of that in a -middle-income country in. the, Organization for Economic Cooperation; and Development (Boeri and Keese 1992). 111271- IPOLICY DESIG;N AND IMPLEMENTATION WAGES BEARING NO RELATION r PRODUCtIVITY. The second, and arguably the= key, adverse inheritance affecting the labor market was that wages bore no relation to productivity. The system of setting wages paid considerable atten- tion to compensating wage differentials according to risk of injury, fringe benefits, job status, job security, and so forth. At the same time, it did not capture differentials resulting from diffcrent human capital investmcnt. Governments tried to set the wage structure, taking into account notional marginal productivity and other criteria such as effort and social factors. Even the first criterion could not be implemented becausc distorted prices, made productivity impossible to measure. If the government (sector ministry) noticed a shortage of, say, carpenters and decided to increase-their wage rate (which was far from easy because of collective agreements and institutional rigidities), . it could easily misjudge the elasticity of labor supply and' the responsiveness of workers to training opportunities. In addition, government wnded to underestimate the marginal productivity of skilled and educated labor. Introducing social factors alongside productivity criteria 'in wage setting obviously aggravated the problem; In consequence, notwithstanding the effort put into its construction, the - wvge structure became random and did nor reflect differences in skills or productivity. In contrast with the West, high incomes did not go to individuals with greater skill in the .sense of. human capital-doctors, lawyers, or accountants-but typically to highly.skilled manual%workers in the material, largely industrial, sphere. If two jobs, one skilled and one unskilled, have the same wage, the value of additional earnings for individuals contemplating training is zero, whereas the costs are positive (books, sacrificed earnings, and so forth). Thus workers had no incentive to invest in education. Governments" tried to counteract such distortions by making education free, but this, in turn, meant that arbitrary wage.differentials or other factors could lead to excessive training in some areas. The data presented in table 7-4 and figures 7-2 and 7-3 show that the spread of earnings between different high-paying jobs was much wider in the West than' in.Central and Eastern Europe. With the exception of Hungary, the overall differentials between skilled and unskilled wages were not that large in Central and Eastern Europe. Wage dispersion across indus- trial sectors also appears to have been lower in Central and Eastern Europe than in the West. The'International Labour Organisation's YearBookof Labour Stadrsdc (Various years) shows wage dispersions in Czechoslovakia, Poland, and the-U.S.S.R. which were lower than in any market economy except Sweden. Rather surprisingly, it also shows'a significantly higher dispersion in- Hungary. But the key element lacking in the wage strucure of Central and Eastern Europe was its failure to take.account of.investment in human capital. The absence of any connection betwveen wages and human capital had further ill effects. First, the system did not oencourageworkers to acquire general skills and produced many narrow. specialists with nontransferable- *128- LABOR M1ARKETS: WAGES AND EM1PLOYMEtNT. Table 7-4. WVage Relddvides, by Ocrcpation and Gender in lAious Contmies anJd Years, 1988-90 (percent) Femtale-to -ina/ Nonmanana/-to- o R--eon and eounry manuatl worker 411 jatnal- 6r"atnt0sd FAst En,tanpe Bulgarial 1990 107 74 * Czechoslovakia, 1990 6111 6i: - Hungary, 1989 162 64 65 * Poland, 1990 - 119 76 _ Romania. 1989 118 - - Bclgium, 1988 175b _ 75 GCernany, Fed. Rcp. of, 1989 147 - 69 : 'United Kingdom, 1990 140 60 60 Note: For all countries, wage rcfer to avcrge monthly earnings ept averge annual earnings for Germany and average weekly eamings for fulkime employee far the United Kingdom. a. For 1988. b. Estimated from data an hourly wages and avcrage weckly hours of manual workers and average monthly earning of nonmanual workers. .sum: Bocri and Keese 1992. skills. A much higher proportion of secondary students attended vocational schools in Central and Eastern Europe, though probably not in the U.S.S.R.,, than in the West, even compared with, for example, the western part. of Germany with its traditional emphasis on vocational training (see table 7-5). Moreover, by the late 1980s the overall share of skilled and educated workers in the labor force was substantially loWer than in the West, as -were enrollment ratios, which had been at the same level as in thc West in the mid-1960s (see L tables 7-6 and 7-7). The structure of skills was different, too. The lack of appropriate wage differentials-hindered the movement of labor toward- the services sector. Decisions about investing in human capital were detached from the real costs of acquiring skills. Free education apparently did not contribute to the social advancement of the rural or poorer population. Another ill effect-was that there was inadequate variation in wvages both by skill and by. region. One result was that job changes frequendy did not improve- the allocation of labor. If wages did not reward skills sufficiently, it might, for example, be rational for a skilled worker to move from a job where his or her skill was required to one which required no particular skill. Several studies point to a low dispersion of wages and stability over time (see, for example, Boeri and Keese 1992). The structure of wages with respect to' educational qualifications was also compressed, although not as much as com- (fa awdnae oas pag 133.) I129j PbOLI CY D3ESIGN AND IMPLPMENTATION Figure 7-2.- Relative Rantings by Occupation, &Ilected Inidustries andl Countries, 1990 (earniings of laborers in the chcmic-al industry IOU0) High-paid jbs Low-paid jobs Mtining- Food Chemaicals Iran and construction Catering Transport *Education Health o 50 100 IS50 200 25 300 0 50 100150O 200 250 300 Pcrcent Pececnt * RBulgza[2 CzeChOSlIkViaCI Romania 'Ausnia FederAl Republic ofItl Germany (North Rhine, WesuphZai) Sunre. hoedr and Keese 1992. chart 1, which used data from International Labour Organisa- ti* on 1991. 11301 LABOR MARKETS:' WAGES AND lLMPLOYMENT Figure 7-3. OVccupadonial Earnings Differenlias, &/ecnrd Jndusries and Gouisies, 1990 Coansructan 0 so 100 IS0 200 250 E Bulgaria CzachoslovakiaRoai MIIIAustria Fedcmat Repu blic or Italy Gemmy (NrthRhine, Wcsphatia) Mmn: Differentials measure earnings in high-paid jobs relative wo low-paid jobs. Sworre: Boeri and Keese 1992, chart 1, which used darn from International Labour Organist- tion 1991. 11311 -* ~~Table 7-s.'. Typ mfEadacion P wAk7u inVar'ous Ceunjiaie and Yfs 198 7-99 (perccr) fiugiufWiNg,' Regox,7and c(pvjqy. VoctIJONal a GeN?il trrhAW*n# mUkahwtia AudkmiN EdtaON OtAer Butgarki 60.3 .39.7 ZBl4.7 752.. 30..3 - Czechoslovakia ~~~~ ~ ~~~53.8 46.2 ..92.6 6.6. 17.8 3. 1-ungary 76.1.2. 1. . 7.3 35.3 31.5- 2 ~~~~Puland. .77.4 22.6 -16.9 2.9 15.6 2953L1 Waeano Fmvpe Austria 28.5. 71.5 12.5. 8.5 14.3 14.4 . 50.3 Gcrm'any, Fed. Rep. af 36.3 63.7 20.9 - 7.1 24-.3 7.0 40.6 * luly ~~~~ ~ ~~40.6 591.4 .11.5 9. 582850.3 Netherlands 44.3 55.7 .16.4 4.1 11.7 14.5 53.3 Sweden-. 35.6 64.4 29.5 5.5. 23.1 16A4 25.5 United Kingdom . V. 90.2 14.3 13.9 16.8,- 8.3 46.8 a. Includes tescher training.>- * b. Fat Germany, Netherlands, and United Kingdom, figures arc tar 1987; for Austria, Czechoslovakia, Italy, and Poaknd, figures are far 1988; and for Bulgauia. Hungary. and Sweden, figures are for 1959. S &wr:. Boeri and Koms 1992. LABOR MARKETS: WAaHS A ND1N EP LOY MEINT Table 7-6. Leveldoffducadion of the Lab'or Fonr in Vadious Gountrier anid Yewts, 1988- 90 (percentage of total labor frwe) Region, enuhy and year Basic or 1w Vocational Secondary Higher Bulgaria, 1990 44.6 I15.8 30.0 9.6 Czechoslovakia, 1959 26.0 21.0 43.8 9.2 Hungary, 1990 38.4 23.1 26.9 11.6 Poland, 1988 34.2 '29.5 27.9 8.4' Romania, 1990 35.8 31.4. 24.0 8.8 EamsFmpe Austria, 1990 28.8 57.8r 6.3 7.1 Prance, 11989 35.3 . ..46.0. 14.6 Greece, 1989 52.6 ..35.3 11.4 Ireland, 1989 26.8 ..55.5 17.5 Italy, 1990 26.6 ..66.2 7.2 Netherlands, 1989 12.Z. 61.3 19.7 f'4min, 1990 4...46.1 .5.5 Not reported. &mxnes. Bocriand Keesc 1992 for Czechoslovakia and Poland; [ado and others .1991 for 1-ungasy; Robosca 1991 for Romania; and data base LASEDUC of the Internazionkal [about Organisation, as reported in Imbert 1991t, for all DiEco countries.. monly believed. As far as the overall distribudion of earnings is concerned, the average earnings of workers in the ninth decile of the earnings distribution in Poland was 2.4 times that of the first decile in 1989; the comparable figure for *the UJnited Kingdom in 1990 was 3.3 (Boeri and Keese 1992). The distribu-. tion of waige and non-wage income, both in the 1970s and in' the 1980s, also appears to have been more equial in Central'and.Eastern .Europe th-an in.the West (see Wiles. 1974; Atknson and Micklew right19). A further HIl effect of wage controls was excessive reliance on fringe bene- fits. Historically, wage setting was administrative and highly centralized. Because enterprises were generally u'ntie to raise wages, they made increas- ing use of fringe benefits to recruit -workers and reward effor't. Over rime, more decentralized systems evolved,: and by the early 1980s, some countries introduced tax-based incomes policies. Various forms of this type of policy were Put in place; all imposed high taxes. on wage growth above a target level. This again provided an~ incentive to in-creasc fringec benefits; which were 'not taxed. A DEFICIENT APPROACHi T UNEMPLOYMENT. The third Weakness of the old system was that its approach to,unemnploymncrt was deficient'. The root of the problem is that government denied its existence, and, as a result, p olicies to* 11331 POLICY DESIUN AND IMPLEMolENTATION Tab lc 7-7. &iullmnent sea Perrentage oaAge Grotp, by Levl of Education in ariaous Coun ties and Years, 1965-89 -&eoneky edcaion- Higher Cowntry, agenp,.andyear Al Pborrionyal/ Gentral education Polondb 1965 69 71 29 .t8 1989 81 .77 23 20 Former Czechoslovakir- -1965 29 - 75 25 14 1989 87 654 4 Is Hurgary . 19f5 - 64 36 13 1989 . 76 . . 76 24 - I5 Greece, 1965 -49 18 82 10t 1986 97 . 14 86 28 Germany, Fed. Rep. ofe 1965 . - 58 42 t4 1988 99 36 64 32 Hong Konge 1965 29 6 94 5 1987 74 . 0 90 - Korea. Rep. o0 1965. 35 16 84 6 1989 86 16 B4 37 Spaine 1965 38 31 69 6 1987 105 27. 73 32 Swedene 1965 62 39 .61 13 1988 90 36 64 31 - Not available. a. Includesteachertraining. b. Ages 15-18 for seconday; 20-24 for higher. * c. Ages 14-17 for secondary; 20-24 for higher. d. Ages 1 2-17 for secondary; 20-24 for higher. c. Ages 1l-17 for secondary; 20-24 for higher. SOnU: UNESCO 1991. address it were inadequate. The resulting ill effects were twofold: hidden unemployment and lack of assistance for the genuinely unemployed. Hidden unemployment is a major adverse inheritance. The most important strength of the old system-the lack of open unemployment-wvas possible only because it wvas replaced by hidden unemployment, which was caused by "over-full employment planning,";distorted relative prices, soft budget con- straints, and shortages (see Gora 1993 for details). Hidden unemployment increased after the end of the extensive period of industrialization, when labor 11341 LABOR MARKETS: WAGES AND EMPLOYMENT reserves were already absorbed, and reached an estimated 15 percent of the labor force in Czechoslovakia in 1979 and more than 25 percent in Poland in 1987 (Brada 1989; Rutkowski 1990). The direct costs of hidden unemploy- ment are the output lost by not eniploying workers in enterprises where they could contribute positively to output and the low productivity, poor.labor discipline, and excessive degree of capricious labor mobility associated with a regime of permanent excess demand. Lack of assistance to the unemployed was.a consequence of job security. Although unemployment was lowi, some seasonal, frictional, and structural, unemployment did.occur (Bornstein 1978). Unemployment benefits were nonexistent; moreover, individuals who became unemployed were not auto- matically covered by other forns of income support since socialFassistance .was limited to certain vulnerable categories. The so-called job placement offices primarily mobilized labor reserves, mainly. moving workers from agri- culture to manufacturing. . INFLATIONARY PRESSURES. The fourth adverse inheritance-problems with inflation-arose bccause no countervailing forces contained the growth of wages. The system of wage bargaining and wage setting was liberalized. and made dependent on managers' decisions, subject to minimum and maximum tariff rates negotiated between branch-level trade unions and the relevant ministry. Although the mjyriad collective. agreementsat the industry level: initially made it difficult for enterprises to set their own wages, these con- straints decreased over time as the autonomy of enterprises increased. Enterprise-level wage setting was a source of inflationary. pressurewhich led int the l980s to the introduction- of tax-based incomes policies. Because of .numerous exemptions, these policies.were rarely binding: wage-push infla- tionary pressures were not contained,` and the problem was exacerbated by the absence of countervailing pressure from profit-earners. Powerful trade unions widely perceived tax-based incomes policies as the enemy of justifiable differentials among industries, and they are now exerting strong pressure to restore industry-level bargaining: Since industry-level'bargaining has tradi- tionally played a decisive role, it may not be easy to switch either into decen-. tralized (enterprise level) or centralized (nationwide) bargaining, which would be desirable from the viewpoint of containing wage pressure. The lack of employers' organizations made it impossible to have proper col- lective bargaining. Prior to the transition, countries in Central and Eastern Europe did not have a bargaining system based on tripartite agreements, mainly because no clear. distinction was made between the state and the employer. State involvement in wage bargaining was thus high, with even minor industrial conflicts becoming"state" issues. In one or two countries, Most notably Poland, trade unions were powerful and, together with the lack of employers':organiza- tions and of bargaining at the industry level, aggravated the pressure on wages. 1135 1 POLICY DESIGN AND IMPLEMENTATION DISrOICrED PATTERNS Ott EMPLOYMEN. Employment was concentrated exces-- sively in industry and agriculture. As a result of the slow growth of produc- tivity and policies to promote heavy industry, the share of total employment in industry and agriculture remained high in Central and Eastern Europe (table 7-8 and figure 7-4), whereas it declined considerably over'the last two decades in the West. The inherited structure will exert a negative impact on labor productivity for a long time. LIMITED INTERNATIONAL MIGRATION. The final weakness of the old system wvas that international migration was very limited. Strong arguments suggest that surplus. labor in one country can be productively employed in jobs Nwhich the population in another country is reluctant to undertake. Emigration and immigration in Central and Eastern Europe were formerly prohibited and then severely restrained. Since liberalization, restrictions on migration, have been replaced by restrictions imposed by potential host countries. PeenntialProvblems The old distribution of income Was widely perceived to be unjust, in the sense that it was not related to effort, to individual productivity, or to the quantity and quality of wvork performed. Despite wage compression, incomes and welfare differed across regions and sectors, but not in ways which reflected the quantity or quality of an individual's. work.- Economic reform will change matters, but income differentials will still not be related to individual effort or the diwidualproductivity of the worker. Income differentials are not related to individual productivity in market economies, because capital intensities and rates of technological progress are different in different industries and regions. The feeling of a weak association between effort, productivity, and wages will remain and, indeed, be augmented by a rising share of income derived from sources other than work. Much time will .undcbtedly pass before popular understanding of the rationale of wage and income differentials develops. A widespread black market for labor developed* under the old system, driven by collusion benween employers and employees to evade taxation. This is niot inevitable, but it -uvii remain for a long time because of cultural patterns (cheating the state is not regarded as shameful) and inefficient mecha- nisms to control it. The endemic problem of the lack of rule of law, which emerged repeatedly in chapter 5, is as much a constraint on the design and effective implementation of labor market policies as it is elsewhere. The Forces Driving Change Fundamental political and'economic forces were instrumental in efforts to change the labor market. The rush to democracy, liberalization, and stabiliza- 1136 1 LABOR MARKETS: WAGOS AND EMPLOYMENT Figure 7-4. Disribudo, of Enplaymetrby Sctol,; Vadous Cowbuties, 1980-91 Pcrcentage of total employment 100 100 60 60 40 40 20 20 0 0 1980 1989 1991 198D 1991 1980 1991 1980 1990 1981990i 1980 1990 Poland Czeihoslavukit Hungary oEcMEuiope OECD : sea = . s Indus-y' Constuicion nmm SeIVices Agicultg cXure a. 1979 for Dennark and Switzerland; 1981 for Greecc. Industry includes Japan's hotels sector. b. 1989 for Grecce and Iceland. Industry includes Japan's hotel sector. No..: oEC, Organization for Economic Coopertion and Development; EEC, European Bco nomic Community. - Srit.w: OECD data, collcted from various govemmcnt sources. tion created new incentives as well as new constraints which changed the economic landscape in important ways. PoliicalFo,res The major political force initially driving labor market reforms was a desire to make the economic system more democratic. However, there are two very different interpretations of what a democratic labor marketr should look like. The first view emphasizes the importance of giving employees participatory - . rights in the management of enterprises'. The second argues that the introduc- tion of market forces per se would produce a more just system. The reform programs put forward in the early transition endorsed the latter approach and advocated policies of mass privatization which would transfer' the control of enterprises from the state to capital markets. In practice, however, privatiza- tion proceeded slowly, and workers' councils and trade unions found them- -selves playing an important role in managing enterprises. In countries such as Poland, and especially the Russian Federation, privatization legislation retains a significant amount of worker participation in the ownership of enterprises. 1 137 1 Table 7-8. IndusnialkEmplymznentby Occupation in Vaiotus Conttries and Yean, 1985-90 (percentage of employmcnt) - Sha of *pmoducdon Other, wnor*n in Region, country, Profesional, 4dminiSnraiit, Ses/, Poduction, not total Searof total sniphamnent -anidyear zechakale clerical service transpon definred eMplaymnenr Attn/nut In7dUMr Conunetdon Service Centraland Eastern * ' ;EaEtmpe Bulgaria, 1985 14,9 2.9. 2.8 79.3 0.1 54.5 16.5 37.9 8.7 36.9 Czechoslovakia, 1990 21.0 - 75,6 3.4 50.7 10.1 365 9.3 44.1 Hungary, 1989 9.5 12.0 4.8 73.3 0,3 49.6 17.0 3215 52 45.3 Poland, 19dB . 16.0 6,0 0.4 75.3 2,2 53.4 27.8 . 28.2 7.9 36.0 WVestemn Eum~pe - . Austria, 1989 7.3 16.h 3.7 72.1 0.2 38.3 7.8 28.9 8.5 54.8 Germany, Fed. Rep. of, 1989 10.6 19.4 6.4 60.3 . 3.3 34.0 3.7 33.5 6.7 56.1 Nctherlandst 1990 13.8 18.9 9.9 55.7 1.8 25.7 4.6 19.7 6.5 69.1 Sweden, 1985 18.7 9.9 6.0 59.0 6.4 26.7 5.0 22.7 6.0 66.4 MormA Ameica Unitcd Stares, 1990 212.2 3.7 5.3 58.4 0.5 - 27.5 2.8 . 9.9 6.5 70.7 Japant 1990 4.8: 18.3 5.5 71.3 0.1 38.1 7.2 24.6 9.4 58.7 -Not available. a. Excluding agriculturc and agricultural occupations. . &wures: Bocri and ICeese 199Z. Data for Bulgaria, Poland, and Swedcn arc.from the census; data for Czechoslovakia and Hungary arc from thc.microcensus; and data for Austria, Federal Republic of Germany, Japan, Netherlands, and the United States arc from labor force surveys. LAHOR MARKF.Tr0 WARlK ANI) hMIP1.OYMNItNT Several reasons explain thie initial preference for akingenterprise manag- ment responsible to capital rattier than to workers.. F'irst, there is a pressure to throw out everything connected with the old systemi The transition is inter- preted as a transition to capitalism and, as discuissed in chapter 4, capitalism is mistakenly. interpreted to me:an. unfettered private markets. Th,is Interpreta- tion implies that any type of worker participation violates the employer's right to choose tie most efficient options and that employer freedom Is cssenitial to creating a.system in which workers, altlioughi deprived of the right to partici- pate in decisionmaking, would feel justly appreciated ond remunerated, Seen from this perspectivc, the concept of worker participation appears "socialist" and hence lacks credibility. A second reason for emphasizing market forces is the weakness of trade unions, not least because of their prominence under the old system. Workers. tolerated the old system because it seemcd egalitarian (rclative wage differen- ials wvere small) and because it Was promulgated and supervised by the trade unions within a 'totalitarian framework. In the new system, trade unions occupy an ambiguous position because their actions supporting workers can easily be misinterpreted as supporting the old system. In exceptional cases, for instance Poland, where independent trade unions becamc powerful under the old regimc, trade unions either function in ways similar to political parties (and hence are subject to the pressures toward market forces) or are reluctant to oppose the parties coming out of their camp. Policymakers have pressured workers not to pursue participatory rights, in part because-the stabilization program requires a sharp decline in real wages which might not be acceptable if worker participation were significant. Even in a non-participatory regime, workers will accept a dramatic decline in real incomes only when the drop is regarded as temporary and they expect to regain their former incomes later on (Rutkowski 1991). : he drive toward democracy, if interpreted as getting rid of all features of the old system, may lead to the excessive swving of the pendulum discussed in chapter 4. : Eonomic Forces The fundamental economic forces driving changes in the'labor market are the liberalization of demand, liberalization of supply, liberalization of prices and wages, and macroeconomic stabiliiation.-These changes create newv incen- tives and new constraints, to which, as described shortly, different groups in the economy adjust with different speeds. Economic disruption occurred in many ways, of which two should be highlighted: inflationiary pressures and supply dislocations. In all countries, price liberalization led not to a simple once-and-for-all adjustment of relative prices,,but to a sharp jump in the overall level of prices, reflecting the end of the.overvaluation of the domestic currency and the traditional excess demand 1.139 1 IPOLICY DESION AND IM11'1.MRNItNTATION for goods tit previously fixed prices (the "monetary overhang'). The increase in the price index Lising conventional methods overestimates the actual rise in tices because it takes no account of the increased availability of goods and the end of black markets. Although tlie precisc magnitude of the problem is in dispute, the large jurmp in prices has clearly made all of the transitional econ- omies extremely vulnerable to very rapid inflation. . . .T liberalization of supply and deniand led almost immediately to the collapse of trading relationships between cnterprises which had been adminis- tered throught the planining system. Supplies of rawn material inputs and semi- .-manufactured goods prescribed by the plan weredisrupted. The problem' arose within countries, between countries (given the collapse of the Council for Mutual Economic Assista'nce), and among the former Soviet republics. Inputs'could, of course, be purchased from the West, but normally only at much.higher prices than previously. This dislocation of supplies obliged firms to reduce production and to cut real wages'. Different groups responded to these disruptions in very different ways. Households adjusted most quickly. They reacted swiftly to price increases and adjusted' their .work effort in the light of ch anges in real wages and the emergence of unemployment. The main effects wvere twofold:= household demarid for goods declincd, with adverse effectr on employers' demand for labor; and households increased their supply of labor and effort. State enterprihes responded-to the driving forces, primarily the dislocation of input supplies and product markets, by reducing activity (Estrin, SchafferS and * Singh 1992). The fear of the imposition of tight budget constraints and bank- ruptcy laws, however misplaced, induced.state enterprises.iinitially'to seek no - . more than viability (an operating surplus sufficient to service debt), not neces- . sarily tO maximize profits. In practice, in the early stages of the transition, given past injections of free capital from the budget and low and often negative real interest rates, financial viability was ;relatively easily attained. Oncc :it was ensured, enterprises tended to stop exploring new cost-saving opportunities and continued to hoard surplus labor and to use it inefficiently; they also contin- ued to waste energy and materials. The first signs of efficiency adjustment have been slow in coming. As the financial situation deteriorates, the main concern is often one of maintaining employment, in part because employers still see it as their responsibility (not least because in some countries the employer still offers the only access to social benefits) and in part beciuse irn some countries man- agement is responsible to the representatives of the workers. In the face of fall- ing revenues, state enterprises.have often chosen to allow real vages to'fall rather than to cut back employment. In the context of the transition, this -approach may be appropriate,. in that a faster rate of job loss in the state sector-' ; ', :: :coupled with slow growth of employment in the private sector would produce even higher unemployment. Nevertheless, these decisions are being made for: nonmarket reasons and indicate slow adjustment to market forces. 140 1 LABOR hIARKETS: WAGES AND R1MPLOYMRNT Private enterprises responded to developnients faster than state enter- prises, although less promptly than houseliolds. As they found new -markets, their demand for labor increased, with a preference for better-educated workers. The effect on the'labor market, however, has not been significant because, though growing fast, the private sector is still small. Newly estab- lished private firms have difficulty reaching the minimum size necessary for efficient manufacturing and hence tend to be concentrated in trade and service sectors. In a market economy most private sector growth comes' from the growth of medium-size firms and from new firms founded by medium-size and l.arge private firms. As Nuti (1992) points out,' neither is available domestically in transitional economies. Plans for privatizing large-scale state enterprises have proceeded slowly. The driving forces and the. responses to them produce five key effects: * The collapse in output and the resulting fiscal deficit make it necessary to restrict expenditure on labor markets and social protection, just when the need for them is rising sharply. * Incomes are decompressed by wa%ge liberalization and by the 'growing num- ber of low incomes as.unemployment and short-time working increase. This takes place in spite of incomes policies aimed -at egalitarian indexation' of wvages and benefits, in part because the'private;sector is-generally exenmpted from incomes policies;. * The private sector is growing rapidly, leading to increasing diversity of potential employers. U* nion coverage decreases,. mainly because liberalization of supply leads to *; - 0 0 ian enlargement of the private sector and increasing self-employment and to a general decline, in employment in state enterprises. - * Unemployment increases for'all the reasons- discussed in chapter 4. During '' 0 -' : the early Lransition, jobs were lost primarily by older workers and women, and the rise in open unemployment was: usually preceded 'by 'a. period of : unpaid vacation and reduced working hours. Notvithstanding hie amount : of labor hoarding which occurred prior .to the reforms, the declinei in employment over the first three years of the transition was much smaller * than the decline in output (see table 7-9).. Open unemployment, the main subject of chapter: 8, is a new and major phenomenon in Central and Eastern Europe. Its size and speed of growth are one;of the main challenges for labor market policies. :- : Policy: Within the labor marker, the essential element of reform' is the'replacemento f a system of wages and employment regulated. to a greater or lesser extent by the state with one in which they are determincd in the market by. the forces of supply and demand. 1141 1 POLICY DESIGN AND IMPLEMENTATION Table 7-9. Declinein GDPandRateofUnemploymmtiSelkcted Counjties of Centrl and Eastern Europe, 1992 (percent) Decine inn GDP Ffrpxnion of- compared Unempkymrnt uewpijwsen: ratt 2ouJtiry wit 1988 rvte n d-nelin it GODP Bularia . . -32 13 0.46 Czechoslovakia 15 7 0.47 - erman Dembcratic Republic 42 14 0.33 Hungary 1.6 9 0;56 Poland 19 I 0.58 &tarre: Nateinal economic statistics. Tle liberalization of wages and employment might be expected to provide individual workers and employers with the incentives to allocate resources efficiently in the labor market. Market-clearing wage levels might, in principle, also be expected to be consistrnt with full employment of labor in conditions of macroeconomic stability. Provided labor is reasonably mobile, wages will also be consistent with horizontal equity (workers doing the same work can expect to receive the same pay). There is, however, no presumption that the distribution of income generated by-market-determined.wages will be socially or politically acceptable. The Stratvy Although the objective of policy may have been to have wages and employ- ment determined by the market, the reality during the first years of transition was very different. Even in countries like Poland, which introduced compre- hensive price liberalization, wages remain subject to administrative control, with a penal tax on firms exceeding their permitted levels of wage increase. Incomes policies (generally tax based) have also been imposed in Bulgaria,the' Czech Republic, Hungary, Romania, and. internittently in Russia and other countries of the former U.S.S.R. The employment decisions of state'firms are also determined as much by political considertions as by market forces. In general,: enterprises have been prepared to extend and take credit from one another irrespective of their financial situation in thc. belief that; in the final analysis, the government (or the state banking system) would underwrite their debts to prevent mass layoffs. The immediate reason for continuing government intervention in decisions about wage setting and employment has been macroeconomic. As already. noted, the countries are very vulnerable' to accelerating inflation. The'shock therapists" (Bulgaria, the Czech Republic, and Poland) have made the control 1.1421 LABOR MARKETS: WAGES-AND EMPLOYMENT of inflation a priority and have used incomes policies to support restrictive demand management. A second'objective of incomes policy has been to hold ' down wages to improve compedtitiveness and thereby to help maintain employment. Incomes policies have a number of allocative and dknsibutional effects. Insofar as they affect wage setting, they maintain the compression of ' the wage distribution. This prevents, or at least slows down, the emergence of wage differentials as a guide to decisions about how to allocate resources in the labor market; it also cushions the fall in the- living standards of lowv-paid workers . Likewise, .delaying the imposition of financial discipline on enter- prises slows down the rise in unemployment and thus may help contain one of the main causes of household poverty.. * The very cautious approach to Nvage liberalization and to the adoption of hard budget constraints for state firms in the first years of reform reflects the - inheritance from the planned economy. Efficiency in the labor market requires not only the liberalization of wvage and employment decisions but also the ' institutional infrastructure of the free market. This means private ownership and competitive markets for products, capital, and labor, with labor mobile between employers, occupations,,and localities. The competitive labor mar- ket is characterized by an absence of government intervention in wage setting or in emIployment decisions, but behind the scenes, as it were,;the govern-w ment has the responsibility for upholding private property rights and maintain- ing competition. As already noted the inheritance of the economies of Central and Eastern Europe is very different. The abscnce of private ownership -means that - enterprises' do not face incentives to minimize costs in terms of wages paid or employment decisions. The concentration of industry means that price and wage liberalization.offers opportunities to exploit monopoly power. The absence of capital markets means that there is no basis for efficient invest- ment decisions either for firms or for workers.'And there are many restric- tions on:labor mobility. One essential component of labor market.policy, then, consists of structural policies designed to establish:the institutions and legal: framework necessary for an efficient labor market. In part, this depends on the progress of the reforms generally: developing the private sector by privatizing existing enterprises, enabling and encouraging new ventures to start, setting up capital. markets, and opening up product mar-. kets to competition, for example, through trade liberalizatiorn. In terms. more specifically of the labor market, it implies removing impediments to labor mobility such as residence.permits or employment-linked social bene--: fits, ending administrative restrictions (for example, on ielf-employment), and introducinglegislation to define the rights of workers, employers, and trade unions and the role of government within the context of 'a market economy.; 1143 1 POLICY DESIGN AND IMP'LEMIENTATION IThe policy strategy thus has two aspects: In the short run, the main concern is with the management of wages and employment in the. absence of the infrastructure of a m;arket economy (primarily an issue of macroeconomic stabilization). * Over the longer ternm, the main objective is. institutional reform. } aintaining Aflaaecotnornic Balatmce Macroeconomic. stabilization is usefully discussed in terms of wages and incomes policies (the price of labor) and employment policy (the quantity of labor).' WAGES AND INCOMES ouCY. Policies on wauges and incomes are intended to restrain absolute wages, preferably without unduly affecting relative w'ages. Conrtaiing absoh/e trager. All the countries in Central and Eastern Europe have retained wage controls to contain absolute wages, notwithstanding the disappointing record of incomes policies both in industrial economies and in Latin America (Kiguel and Liviatan 1992). There are several reasons why incomes policies might be more effecdve in the context of transitional ccon-. omies than elsevhere. First, the inheritance of government wage regulation. means that the administrative apparatus for incomes policy is already in place. Enterprise managers can be expected to set. wages in accordance with the policy because that is what they have always done. Second, and also deriving frorn the inheritance, state enterprises in transition economies may be less resistant-to wage demands than would be a private-firm motivated by profit maximization (Hinds. 1991; Lipton and Sachs 1990). In some countries, such as Poland, the managers of enterprises are to a significant extent responsible to the representatives of worktcrs through 'workers' councils, which might be - expected to weaken their opposition to wage claims. Third, the inflationary turbulence of the last years of communist rule and the enormous price leaps at the time of price liberalization may have created a situation in which inflation expectations are highly volatile and thus perhaps more easily influenced by policy. Incomes policy has typically taken the form of regulating the. rate of increase of the firm's wage bill, with punitive tax penalties levied on firms exceeding the norm.3 This mtchod of regulation basically continues policies adopted in the communist era (Bosworth 1991; Commander and Staehr 1991). These policies were not particularly successful under the previous regimes, no doubt because they were applied in conditions of generalized excess demand, rather than in conjunction with restrictive fiscal and monetary policies. It is not clear whether in the early transition these policies helped to contain inflation (or did so with less unemployment than *Would have occurred. in their absence). In Poland, for example, wage growth -was significantly below I1441 LABOR LiARKETS: WAGES AND EMPVOYMIENT the rate permitted by policy during the first six months following the reforms but significantly higher thereafter. Therc is sonic evidence that Polish enter- prises responded to an incomes policy related to their total wage bill by reducing employment in order to pay higher wages to the workers who remained, but as unemployment rose, the wage ceiling was redefined in 'terms of the average wage per employee. Nor is it clear whether incomes policies contributed to the sharp initial fall in real wages which characterized labor markets in the early transition. Real wages have fallen everywhere as a result of the collapse in output and the associated fall in labor' productivity, The1 degree of compliance with theexcess wage tax has also becn a cause of concern. In Poland,.tax collections at the beginning of 1991 were only about. half what was aived, while in Bulgaria only about tO percent of the excess wage tax was apparently collected in 1993. By contrast, in Russia, the excess wage. tax is collected along with and at the same rate as the profits tax, and * . ' -compliance has therefore been quite high. : --The effets on n/adve wtog. Incomes policies have not prevented, and were not intended to prevent, any adjustment of rIaiive wages in response to relative scarcities of different types of labor. Relative wages can adjust within the confines of the policy in at least four ways: Incomes: policy operates at the level of the firm.' Whether the control is' based on the total vage bill or on the avenge wage per employee, there is scope within the rirm to give larger wage increases to some workers than to others, within a given overall constraint. In conditions of rising unemploy- ment, it is generally better for policy to relate to the average wage.rather than to the total wmage bill. if the objective is to restrain wage inflation, since usincg the total wage bill encourages firms to lay off workers in order to raise the wages of those who remain. * Various countries such as the Czech Republic and Hungary have exempted firms with particularly rapid gro%vth in output, productivity, value added, or profits. * Private firms, and sometimes small firms, have generally been exempt- fro.om the scope of the policy. * In any event, firms facing labor shortages may choose to increase:wages in excess of the limit and pay the tax liability thereby incurred. * In writing about Poland in 1990, the first year of the reform, Coricelli and: : - Revenga (1992) note clearly disparate patterns of sectoral wage behavior and, in particular, a strong correlation between wage growvth and profitability, on the one hand, and output performance, on the other. The Polish experience seems to suggest a rather limited impact of incomes policy on relative wage adjustment, and the evidence for Bulgaria and Hungary appears to point in the same direction. In most countries, in contrast, the minimum wage has been increased by at least the same rate as the permitted rate of wage growth for.the economy as a whole and in countries such as Bulgariain 1991 by considerably 1145 I POLICY DESIGN AND IMPLELMENNTATrION more. In principle this will protect the low-paid workers (or at any ratc those in full-tinie vork) from any reduction in their relative wage. The longer tnn. A system of wage controls supported by punitive taxation cannot be consistent with the efficient workings of a market economy over the longer term. Current tax-based policies maintain one of the worst labor mar- ket features of the inheritance: lowv effort and poor workmanship on the.part of a relatively. vell-educated, skilled, and potentially highly motivated work force. The question is how best.to loosen thie controls. One approach, adopted in Poland in January 1992, is to exempt private firms fronm the policy. To the extent that incomes policies were put in place to counterbalance a lack of financial discipline-the result of an implicit understanding that any losses incurred by the enterprise Nvould be underwritten by the government-the lack of discipline is specific to state firms. This then implies that incomes restraint should not be imposed on private finns. Exempting private firms not only encourages the process of privatization but also, rather. conveniently, mneans that as firms become privatized, incomes policy automatically fades' away. Arguments can be made, however, for extending equal treatment to state and private firms on grounds of cquiity. Doing so, it is argued, would preve'nt a brain drain in-which the best workers move to the private sector irrespective of relative productivity and would help newfly privatized enterprises to contain wvage pressure and generate a return on capital (Lane 1992). Evidence from highly industrialized economies suggests that private ownership and reason- ably competitive markets are not necessarily sufficient to contain wage pres- sures. It may also be necessary either to take measures to erdicad e the sources of inflationary pressure by veakening the trade unions, restricting. unemployment benefits, and the like or, alternatively, to involve unions and employers with government in setting wages. EMPLOYMENT POLICY. The key questions for employment policy in theashort run are (a) whether government should allow unemployment to rise sharply - and, if not, (b) what policies they might adopt to contain unemployment. This section addresses mainly the former question, discussing in particular the issues surrounding continuing goveMment support for enterprises. The ques- tion of how best to respond to unemployment as it emerges is postponed until the next chapter. In the early transition, the collapse in output was associated with a less- than-proportionate fall in employment in the short term. But attempts.by enterprises to maintain employment have been leading, in many cases, to substantial and growing financial deficits. Governments have tolerated contin- ued lending by the banking sector to financially insolvent enterprises and have delayed the introduction of bankruptcy. laws. The indiscriminate imposition of hard budget constraints and the bankrupting of insolvent enterprises would I 146j LABOR hMARKETS: WAGEfS AND RMPLOYNIENT lead to' massive losses of jobs. Although growing rapidly, the private sector was initially too- small to provide new employment on the scale required. In contrast with the situation with wage controls, where policy has been : explicit, employment policy has thus typically taken the formn'of an uneasy compromise between (a) the explicit objective of ending financial support to loss-making state. enterprises and (b) the political pressure to avoid mass layoffs and large-scale unemployment. Much expert advice, both private and official, has argued for imposing hard budget constraints on firms, with: high levels of unemployment, should they emerge, being dealt vith by a mix of active labor market policies and the social safety net. There are arguments for allowing unemployment to rise sharply (Gomulka 1991). Unemployment, it can be argued, is helpful in the medium term for the growth of the private sector. High rates of unemployment might be expected to facilitate the starting up. of new enterprises by ensuring an abundant supply of labor. High unemployment will also hold down wages and strengthen the hand of employers in enforcing discipline and work effort. Some unemployment is no doubt inevitable and will have to be accepted as part of the price of a market economy. Most private sector firms recruit their workers directly from state enterprises, however, and it is by no means clear that unemployment plays a useful role in the reallocation of labor. Very high levels of unemployment create economic waste, social distress, and - severe personal hardship. They are likely to be associated with a high incidence of long-term unemployment which, evidence from OECD countries suggcsts, has corrosive economic and social effects. Evidence from the OECD countries also sugests that, beyond ia certain point, an increase in unem- ployment, and in particular an increase in long-term unemployment, has . very little effect in holding down wage pressures (Layard, Nickell, and Jackman 1991. chap. 9). The costs of unemployment must be measured not only in terms of lost output and.fiscal pressures but also in terms of the stress placed on families and society, which brings with it the potential for generating a political backlash against the whole reform program. At some point, the costs of' unemployment become so severe as to justify interven- tion. This point cannot be quantified with. any precision, not least because it will obviouisly differ according to the history and circumstances of each country; but unemployment rates well in excess of 20 percent,.as experi- enced in many industrial towns and cities and sometimes even wvhole regions within Central and Eastern Europe, go far beyond levels' which, on the experience of oEcD countries, could be regarded as necessary.for the efficient .working of a market economy. To' slow the growth of *unemployment, government has.tvo lines of attack: it can continue to 'support loss-making state enterprises, or it can introduce active labor market polcies, such' as the. provision of temporary jobs and the establishment of large-scale retraining. schemes. 1147 1 POLICY DESIrlN AND IMP'LEMENTATrION -'4etiu labormartprpolicies. Thc usefulncss of such policies as the main instru- nient for combating mass unemployment should not be overstated. As dis- cussed in the next chapter, they can be very useful in particular situations; but there must be serious doubts about whether they can be applied on the scale rrequircd: The first doubt relates to the effectiveness of such policies in the context.. of a generalized collapse in output. With fewv jobs on offer, policies to promote labor mobility: are likely to place few vworkers in new jobs and to cncounter lo-w take-up. Among the highly industrialized countries, only Sweden' has attempted to provide training and temporary work schemes on the scale required to cater to everyone who becomes unemployed. But Sweden has not had to confront the levels of unemployment experienced in parts of Central and Eastern Europe, and it would not necessarily be feasible to provide temporary jobs, public works, or retraining at the local level for 20 or 30 percent of the work force. * Even on the more limited scale actually implemented.in Sweden, active policies are likely to be beyond the resources of. countries in Ccntral and Eastern Europe. The policies are too costly and involve too much administra- tion (Swveden spends around 1.4 percent of cop on active policies and has one labor office official for every nine persons unemployed). Given very limited resources, active labor market policies will need to be applied selectively and. targeted toward particular groups of individuals, such as the long-term unem- ployed, who have specific needs. P-oliies to ast entrprivss. This' is an alternative way of trying to maintain employment. Governments are* already pursuing such policies, through - implicit or explicit subsidy, delay or nonenforcement of bankruptcy laws, and so forth, and are likely to remain under political pressure to continue doing so. Not only will producer interests.argue for continued.support for individual enterprises, but public opinion is likely to support so-called common sense arguments that it is better: to pay people for producing something than for producing nothing and that unernptoyment is bad for individuals.. All these arguments have particular force where a commercially insolvent firm is the'. main source of employment in a locality.- Nonetheless, existing large-scale. and indiscriminate policies of enterprise support insulate enterprises from commercial pressures and the need to adjust to the market cconomy. A total and immediate cessation of such policies, how- ever, would add intolerably to unemploymcnt and economic dislocation in the short run. What is needed is to replace policies of genera fizedsupport with those of se/ecdtv sspport, targeted toward firms=which have some prospect of ceo- nomic viability and which operate in areas of acute economic distress. In assess- ing whether particular firms might qualify for support, 'several questions must be considered:' 1.148 I - . - - :~~~~ LABOR MtARKRTS: WAGES AND 'IIlrLOYMhENT Is value added positive? This is an empirical. question of whether, evalu- ated at market prices, the value of the output produced exceeds the value of the inputs used. Since, in most enterprises, employment is already excessive, quite substantial reductions in employment may perhaps be achieved with no loss of output. But if an entcrprise is on the point of closure, a loss of output is inevitable, and the relevant issue is the average value added in the industrial sector. An attempt to measure value added at world prices has been made both,for the (non-Soviet) countries of Central and Eastern Europc (Hare and Hughes 1992) and for those of the former U.S.S.R. (Senik-Leygonic and Hughes 1992). Although some sectors have negative value added (up to almost one-quarter in some countries), most countries have positive value added in most sector-s except food processing. In general, state enterprises make a positive contribution to economic welfare. * Is the fiscal cost sustainable? Of more immediate cnncern for many governments is the question of whether there wvould. be a budgetary saving fr*om closing down a loss-making enterprise if most of the workers are likely to remain unemployed? Some savings will arise because the net of tax -wages of persons in work 's likely to be:higher than the unemployment benefits paid (though maybe not much higher, given that many workers have part-time jobs or are obliged to take periods of unpaid leave). In contrast, a firm with positive value added will produce a net cash income. To think in terms of illustrative numbers, one might have value added per worker in an enterprise, of $40, a . -wage of, say, $70, and unemployment benefits of $50. Supporting the enter- prise is then both cheaper to dhe government (costing $39 per worker as against $50 per worker for benefits) and economically more efficient in that. the value added in the enterprise is positive.4 * Can public authorities deliver benefits effectively? This question asks - whether local authorities or other public agencies have the capacity to take over the social services and other benefits formerly provided by enterprises. Again, enterprises often continue to provide benefits to former workers, but if- the enterprise itself closes down, other arrangements are needed. * [sinsolvency only transitional? A further consideration concerns longer- run industrial policy. There may be no point in keeping alive enterpriscs which are doomed to extinction, but in many cases enterprises face financial problems attributable as much to temporary features of the transition, such as .the collapse in output and.its effect on demand, supply disruptions, and so forth, as to a lack of longer-term viability. Notwithstanding their obsolete technology and -antiquated capital,: at appropriate! competitive levels of the exchange rate and labor costs, most countries in Central and Eastern Europe can expect to continue production across a wide range of industrial sectors. In principle; then, an argument can be made for supporting some enter- prises. This support, however, should be exceptional, temporary, and offered only in very specific conditions: 1149 I .. PO LICY DESIGN AND IMiPLIiMENTATIoN * Where the local unemployment rate is very high relative to the national average, * Where external constraints, such as housing rigidities or lack of the language skills necessary for migration, limit the mobility of labor * Where high unemployment clearly creates major social and political ten-. sions (an extreme example is the former Yugoslavia, where the large pool of unemployed youth exacerbated the tensions leading to the war) Finally, where support for enterprises is transitional and transparent. The most difficult task of industrial support is. to avoid creating perverse incentives at the level of the enterprise. A;.general employment subsidy (proposed for eastern Germany by Akerlof and others 1991) would be relatively non-distortionary,but enormously expensive. Given the resource constraints facing most countries in Central and- Eastern Europe, any scheme of industrial support will. need to be selective, for insta;nce, enter- prises in areas of high unemployment or company towns, or. enterprises with some chance of surviving without subsidies in che longer term. In practice, this may mean'that support has to be.discretionary.-Most important, support should be for a limited period (perhaps three years) and should stop auto- - matically at the end of that time, so as to ensure that the enterprise uses the support to restructure its activities rather than to perpetuate inefficiency'(as has often been the case lwith industrial policy in the West). The level of support.should be a predetermined amount (not a- policy of writing off all losses) -and conditional on employment within the'enterprise. To ensure compliance with these conditions, the firm may be required to file for bankruptcy and to hand over.management to an official administrator while receiving support. Finally, any support should be explicit to avoid confusion betveen (a) policies, funded mainly by taxes, whose 'objective is to mitigate the social and financial costs of unemployment and (b) loans made to firms by banks on the basis of purely commercial criteria. This is another area where government has'to make difficult choices which have a major political dimension. Building Mar*ets We turn now from short-run economic management to longer-term issues of institutional reform. The basic prerequisite for economic efficiency is a vell- functioning market, but it is by no means sufficient. The labor market is prone to many-of the market failures discussed in chapter 2, and in many instances such problems justify some form of government intervention. Of course, market failure does not always or automatically justify intervention; govern- ments often do worse than an imperfect market, and we give some examples of this below. The.extent of intervention differs considerably across the highly industrialized countries, partly for reasons:of culture or political ideology and 1.150 1. LABOR hiAIKErtsF WAOI'S AND ENMI'LOYMENI partly because evidence about the relative efriciency of different policies is far from conclusive. Whatever the degree of intervention, however, the labor market remains at root a mark-et in all market economies, and this implies a general acceptance of the idea stressed in chapter I that the prime purpose of Wage differentials is to guide the allocation of labor in the interests of effi-' ciency rather than to achieve an equitablc distribution of income. .In developing policy for the longer term, therefore, a first objective is to create the institutions of the free market as a precondition for liberalizing. wages and employment. The most important of thesc institutions are the private ownership of the means of production, free access to all markets, and a legal framework to establish the rights of employers and workers and to define ' theroleofggovernmentinthelabormarket. DIVVERSIMNG SUPPLY. Efficiency in a free market requires competition' among a large, or potentially large, number of profit-seeking individuals and enterprises. It has, in practice, proved relatively easy to privatize significant areas of the economy, such as shops and local services, where enterprises are * typically small and capital requirements low. Self-employment has also grown in these areas. In some countries, the private sector has expandecd significantly in . agriculture. But generally the privatization of large-scale - nianufacturing . enterprises has proceeded very slowly. By late 1993, only Russia and the Czech Republic had actually started to implement a scheme of mrass privatiza- tion of manufacturing enterprises, and Poland and Bulgaria had enacted legis- lation to privatize all state enterprises (see Estrin 1994).' :E:ven in the absence of private ownership, enterprises in the state sector apparently are beginning to behave!more like private firms. The collapse of the central planning system has devolved imanagerial'responsibility to the enterprise, and price liberalization plus the imposition (or threatened imposi- tion) of hard budget constraints has obliged firms to adjust to more market- like behavior. Even without changes in formal ownership, effective control of the enterprise has passed from the state to the firm's managers and workers. INCREASING CONSUMER CHOICE. In a competitive market, wvorkers are in.prin- ciple free to choose their employer and type of work, just as the consumer is free to choose between the different goods and services on sale. In the early years of transition, potential employers became visibly more diverse as shops and other small enterprises were privatized and numerous service sector activ- ities started up. Although the range and variety of employment activities have already increased and can be expected to increase further, employment opportunities for the average worker have not expanded commrensurately. In a depressed labor market with high, unemployment, few firms will be taking on new recruits, and workers, far from being in a position to choose among the jobs that exist, may in practice have no alternative but to stay in the job they [151 1 I'OLICY iDESIUN AND IIh41i'.IiMItNirATioN al!ready have. In the longer termt the extent of chioice over jobs seems to be nich nmore restricted in market economies than is the choice of goods. UInder perfect competition, there are many buyers and many sellers and no one has any market power. Under imperfect competition, sellers set prices above marginal costs and thereby create buyers' markets. In product markets, pro- ducers struggle to sell, whilc consumers have an abundanec of choices. Labor nmarkets, too, are buyers' markets. Wages tend to exceed marginal products for reasons of "insider' powver and of efficiency wages (see Layard, Nickell, and Jackman 1991). As a result, workers, who sell labor, look hard-for work, while employers, who buy it, can pick and choose. In a, market. economy, there are many potential employers, but workers have difficulty getting any * . particular job. In the medium term in Central and Eastern Europe, even if economic recovery, liberalization, and restructuring crcate conditions similar to those prevailing in market economics and even if the quality of the jobs themselves improves, any individual worker may find it just as difficult to secure a particular type of job than under the excess demand regime in place before the reform. IMPROVING INCENIVES. In the context of the labor market, improving - incentives means giving both workers and employers the incentive to. use scarce labor resources most productively. In theory, under the assumptions of private property, perfect competition in product and factor markets, full information, and an absence of externalities, market-clearing wiages will allocate -ibor efficiently in a static sense and also, intertemporally, will provide the right incentives for investment in education, training, and job mnobility. In competitive markets, profit-maximizing firms pay vages reflect- ing the value at the margin of what tiey produce. On the supply' side, market-determined wages should therefore give workers appropriate incen- tives.to put forth effort and acquire skills, to take responsibility,6and to move * betveen enterprises, occupations,' and localities. More generally, a competi- tive market should give people the right incentives to- set up businesses, to become self-employed, and to take risks. On the -demand side, market- determined wages give firms criteria to choose between more or less labor- intensive techniques of production and an incentive to take account of relative scarcities of different types of labor in their employment and invest- ment decisions. Two sets of incentive issues are particularly relevant in the labor market: (a) the effects of minimum wages and income transfers and (b) incentives affect-. - ing-employment. So far as minimum vages and income transfers are con- cerned, the fundameiatal incentive issue is the conflict between economic efficiency and income distribution. A central purpose of the reforms is to have wages determined in the market for efficiency reasons. One of the results has been a widening distribution of earnings. At a time of falling real wages in * ~~ ' ~1 152 1I --: LABOR MARKItlTS; WAU,S ND EMPI.OYMVKNT many countries, however, this can greatly worsen poverty. Intervention cali then take one of two forms: G* overnment may intervene in the process of wage setting, most obviously by imposing a nminimum wage floor or * It may introduce a system of income transfers. The provision of a social safety net w%ill of itself put a floor beneath the wage distribution and prevent wages from being set at market-clearing levels. Both forms of intervention are common in industrial market economics. (althiough: more so in Europe than in the United. States); they have. not been a feature of the newly industrializing-economies of East Asia or L-atin America. Incomes policies, and in particular the relative protection of the minimum wage, w ere significant in the first years of the transition. Yet to maintain a government-determined:minimum wage clearly violates the principle of hav-' ing wages. determined by the market. The general presumption must be that minimum wages can price lowv-skilled or young workers out of ajob and hence cause unemployment. In addition, in some countries such as Belarus and U Ukraine, the minimum wage has become a sort of numeraire for the whole wage structure, thus inhibiting the flexibility of relative wages. In the highly * industrialized countries, minimum wage legislation tends to be seen more as a * means of protecting unorganized or casual labor rather than as.a significant instrument of poverty relief. These considerations suggest that, as the econ- omy. starts to recover, the minimum wage should be abolished or at least substantially reduced.3 Unemployment benefits also place a floor beneath wages and can again price young or unskilled workers out of ajob. Additionally, the tax costs of financing benefits weaken incentives when. numerous other budgetary demands and a diminished tax base mean that tax rates are already high. Such costs may be lim- ited in two ways, consistent with the cormmitment to ensuring that no one falls below a minimum poverty line. Government could seek to introduce a system of well-targeted benefits, either for: all workers.or for particular groups (for example, young persons or married women). It could also:require the unem- ployed to search for ajob or to participate in a public works scheme as a condi- tion for receipt of benefits so as to reduce the duration of unenmployment and - deter fraud. Even so, unless the poverty line .: very low indeed, poverty relief will entail significant efficiency costs in two wa±ys. First, the tax burden must be increased t pay for benefits. Second, incentive effects exist for the low-paid: in many economies,.the unemployment benefit is higher than the minimurn wage, and many people work parr-time or are made to take unpaid holidays and thus rnay receive less than the minimum wage. For bothreasons, unemployment X . benefits can be higher.than the realisticalternative eamings. If the minimum wageis no. abolished, the question arises of its relationship : to the poverty line. Given the adverse conditions of the labor market, an i153 1 P0OLICY DIESIGN AN11 IM1'tHhII tEN'rArAION argument cani be made for allowing thie inimitnum wage to drift downward to reduce. its lharmful effects on employmcnttE However, it cun hardly fall much belowv the poverty line. First, sucii a move would create adverse incentives at the lower end of the wage distribution. Second, it would be ethically and politically difficult to argue that individuals whvo work should accept.a lovwer stindard of living than the unemployed orpensioners. Tlird, in the' short run, it is not financially or administratively easy to supplement an inadequate minimum wage with means-tested support to bring low-paid workers up to the level of the social safety. net. If the government sets both the minimum wage and the poverty line, it will probably need to set them at about the same level, taking into account the consequences for both tihe budget and the labor market.; It is essential to avoid an automatic link between the minimumrwage and-the poverty line. Other- wise, an increase in the minimum wage would lead to a commensurate increase in many cash benefits, which could lead to unsustainable budgetary costs. Alongside their effects on labor supply, incentives also affect employment. The effect on employment of a high mrinimum wage has already been dis- cussed. The.employment status of women can create similar problems. In contrast with the Wwt, the enterprise rather than the state has been responsi- ble for providing support services ranging from maternity leave to preschools. Women on maternity leave in the countries of Central and Eastern Europe have been. counted as employees, whereas in Western countries, they are: recorded as "bout of the labor force." In the transition, enterprises are becom- ing more and more reluctant to employ women with young children, because they may have to pay wages. and child care. costs for workers who may be at home much of the time on maternity leave. These considerations argue for divesting social benefits from the enterprise to the state. RAISING LABOR PRODUCTIVITY. In the short run, two sets of policy to increase- the productivity of labor stand out. (a) those aimed at adjusting effort and hours and (b) those aimed at increasing labor mobility -(that is, reallocating labor to morc productive uses). The scope. for increasing wyork effort and hours worked is considerable. Under central planning,- total factor productivity was low, but raising it encounters problems in the short run. First, relevant *rmanagerial experience is absent. Efficiency in the use of resources Nvas never. the main objective of firms under central planning, and the techniques for achieving it are thus basically unknown. Second, in conditions of depressed demand, raising labor productivity is seen- as destroying jobs, and managers arc under considerable piessure from their. work force to permit productivity to fall to protect jobs. Mobility of labor prior to the reforms iwas substantial. This might suggest that few barriers exist to the movement of labor between enrerprises, occupa- 11541 LABORK MARKUTxrS: WAGtS AND E hPIPOYMI ENT tions, and regions during the transition. In particular, the worry that linking the provision of social benefits to the employer would inhibit mobility may - perhaps have been exaggeratcd. But it may also be true that in tite past, much - - of the mobility w,us a "churning" around of people with little overall change in the structure of employment. Experience in highly industrialized economies suggests that manual workers are particularly. resistant to moving from manu- facturing to service jobs. Similarly, a large-scale movement from industrial toWns to major. cities, where service activities inevitably concenrr-r w%,ould put pressure on housing. These difficulties are aggravated by the abscrice of a - market in housing and by the unresolved questions of property restitution, Which mean that people are reluctant to leave their homes. Clearly, any remaining administrative controls on a household's place of residence should : ' ' be removed, but this is unlikely to.have more than a marginal effect on labor mobility. Occupational mobility, involving the acquisition of new skills and the recraining of workers, seems also likely to run into bottlenecks if everyone * -vwants to learn the same thing (for examnple, management oracountancy). In the long run, the most important factor is the education provided in schools and colleges. ReguladngAMaret Fomres- An important element of labor market policy consists of determining the a appropriate longer-term role-of government and establishing the required types of labor market.institutions. On the macroeconomic side, the important choice is betveen centralized'.and decentralized bargaining. If government chooses to take the "corporatist" route, it will be necessary to build up the . appropriate institutions representing employers and the trade union move-- : . ment:' On the microeconomic'side,.the role of government in the labor market goes beyond the fundamental responsibility for upholding private property and maintaining competition. Many countries have laws concerning minimum wages, working conditions, unfair dismissal, the right to strike, ard other aspects of the employment contract. Numerous regulations and codes of practice, including those of the International Labour Organisation to which many OECD and Central and Eastcrn European nations are signatories, affect the conditions of wages and employment .. They seek, for the most part, to protect vulnerable groups such as children, to outlaw discrimination by race or * . gender, and to protect workers' rights. * - - Although intervention is widespread, its scope and nature vary considera- ' bly. With regard to wage bargaining, for example, several, of the smaller * . economies-in Central and Eastern Europe have set up centralized wage bar-- gaining arrangements along the lines of the Scandinavian countries or Austra, where wages are set by agreement among the social partners (employers, trade unions, and government) rather than by the market. Empirical research (see, for instancc, Bruno and Sachs 1985, chap. 11) has often noted that the 1155 I I'DLICY UHSION AND INIPI.IMBt1'N'rAVION more regulated labor markets of the corporatist economies have been able to achieve higher and more stable employment rates than economies with decen- tralized wage bargaining. There is not space here to review at any length the experience of different wvage bargaining systems in the OECD countries (see Culmfors and Driffill 1988). However, three conclusions of particular relevance to tile economies of Central and Elastern Europe stand out: Recent crises in the Nordic countries notwithstanding, the corporatist ccon- omies have been conspicuously successful in holding down unemployment, though arguably at the expense of economic growth aackman 1990; Lay- ard, Nickell, and Jackman 1991). * Centralized bargaining systems are inherently unstable. They hold together only in relatively small countries and even then only with difficulty. (see, for instance, Calmfors and Forslund 1990 on Sweden). * Where bargaining is decentralized, unemployment is higher when trade unions are powerful and is lower when markets are competitive (Caimfors and Driffil 1988; Layard, Nickell, andJackman 1991). Policymakers in these countries have to decide whether it is feasible or desir- . able to setup corporatist tripartite systems for determining wages. In countries such as the'Czech Republic and Hungary, a triprtite centralized system of wage bargaining has been set up along the lines of the corporatist economies of the Nordic countries and Austria. Experience in the higbly industrialized coun- tries suggests that centratized bargaining may Well he successful in the smaller economies (such as the Baltics, the Czech Republic, H'ungary, and perhaps Belarus), but'that it is less likely to succeed in the larger countries (Poland, the Russian Federation, or the Ukraine), particularly those with a history of union rivalry or other social divisions. In the medium term, however, maintaining cen- tralized wage bargaining may not be desirable, given the highly distorted inher- ited wage structure and ihe objective of using market-determined wvage differ- entials as one of the instruments for restructuring the economy. lmpfemendngthe Refbrmns The institutional capacity required for a corporatist approach to economic policy includes some form of centralized confederation or association of trade unions and employers which is competent to make decisions on behalf of individual unions and employers. The central organization must therefore be both representative and encompassing, so that decisions made centrally evi- dently reflect the wishes of the majority. In the absence of a consensus, it may be difficult to' hold even a representative association together, and this limits the scope of its activity. On the microeconomic side, matters are more straightforward, at least in principle. Employment will be governed by contracts between individual .1 1561 LABORl MAKKBVl'S: WAGES ANIN LPIIJ`OVAiENT workers and their employers. These contracts will be legally enforceable and thus recquire the backing of a legal system. Enmploymcnt tribu'nals will need to be set up to adjudicate disputes, unions will want to providc specialist legal advice to-their members, anrd the government will want-to frame legislation governing employment contracts (for example, to ensurc that they protect workers' rights as defined by the International Labour Organisation charter).. Conclusions: Priorities and Sequencing - Labor market policies can be divided into those which require immediate attention and those which will become more important once restructuring is - , firmly under way. Shorn-termnPoliAces The first phase (up to two years) should concentrate on alleviating the worst - - 0 adverse effects of stabilization and should lay the foundations for restructuring the labor market. Tax-based incomes policies should be maintained, at least in the state sector. The overriding objective in the early transition is to control inflation while avoiding a catastrophic collapse of output and employment. 'T'ax-based incomes poli- cies contribute to this objective by containing wvage pressures, even though they may inhibit the adjustment of retative wages. Palliative reasurevs ar necssary to alletiaete labor markersiras. To the extent possible, the brunt of the initial adjustment should be borne by the wage bill - rather than the size of employment. This would be assisted by: - Reducing working hours * Introducing work-sharing * Subcontracting workers to -other enterprises * Introducing more flexible working schedules for women. Regulatiotn whih aggratvate aborrigrd;iresshouldbeflaxd and then. abolished.- In particular, rules for hiring ind dismissal should be made more flexible to improve the effectiveness of internal labor markets in enterprises. Cood lining to pawide sekctive financial suppoi for some loss-making- entrporises should no, be riled out. Such a policy has some advantages because it would slow the adjustment in depressed areas. It softens the shock of the transition by preparing wvorkers psychologically for possible layoffs, in the future and may.: therefore induce some workers to quit. It may assist the political viability of the reforms, and it enhances the initial ability of the private sector to create new jobs, as well as the effectiveness of training institutions; both of which are limited. ' Despite the danger that support may hinder rapid closure of struc-- turally inefficient plants (as happened in Western Europe, see Houseman 1:157]1 POl.ICY D:SIO.N AN) 1M1'lt.E1hN,rATltON 1988), the current financial weakness of firms is not necessarily an indication of their viability in the future (Svejnar l992)., Nevertheless, such support needs.to be designed with great care. It should bc: * Explicit and designed to minimize distortions * Limited to particular localities where labor mobility is particularly lowv (due, for instance, to housing constraints, language problems, or enterprise- or region-specific skills) * Paid only:when palliative. measures are insufficient to keep the unemploy- ment rate in the short run below a politically tolerable level * Paid only for a limnited period and.stopped automatically at the end of the - period. Meditum-term Poaides- Once labor market restructuring has started, attention should shift toward policies concerned with building viable labor market institutions.. The most importaInt arc institutions to deal with unemployment, although they should be supplemented by arrangements which improve the use of resources withini enterprises and by an appropriate collective bargaining scheme. Policies against open utnemployment should become a priority, with particular emph asis on policies against long-term unemployment. The already high proportion of long-term unemployed in the labor force may soon lead to the serious problems of deskilling, demotivation, and marginalizarion suggested by the. - OECD expeience (see Layard, Nickell, and Jackman 1991, chap. 9). .dcliou isneeded to imprnove these of rurtswithin evterpres. Such action is a proper concern of pblicymakers. The initial emphasis on measures to reallo- cate labor across enterprises and close down seemingly unprofitable organiza- tions should be supported by measures to increase the efficiency of resource use within enterprises: * On the supply side, policies should focus on education and training. * Incentive structures within enterprises should be improved. The govern- ment should resist any temptation to apply the basic wage scale developed for the civil service to state-owned enterprises. * The minimum wage should be adjusted by discretionary action. * Fringe benefits incompatible. with the incentive structure of market econ- omies should be discontinued. This should not be-difficult once the tax system is reformed, when workers will likely prefer cash payments. Collective bargaining reforms should not be delayed beyond the end of thefirt labor market shock. The development of a stable bargaining system is vital: * Large countries will generally find decentralized bargaining more useful than centralized bargaining. 1158 1 LABOR MARKETS: WAGES AND EMl'PLOYMENT Small, open, and highly unionized economics should move toward more centralized bargaining, so that the bepefits of wage moderation can he shared by all participants of the bargaining process. Notes 1. The tables give data for the late 1980s to show the situation just prior to the major changes taking place in most of Central and Eastern Europc in 1990 and 199 1. 2. Taylorism Was a so-callcd scientific approach to management, in which workers were simply trcated like another rnachine. 3. Such incomes policies can take two forms.They can impose a maximum ratce of growth of x p'ercent either on the total/wage bill or an the atwwge wage. Under the first approach, if some workers are laid off, those who remain can have a wage incrcase of more than x percent; the second approach dues not have this effect. Thus the first approach gives a stronger incentivc to shed labor than the second. 4. One might ask whether a better solution might not be to reduce' the wage. Evidcntly, if the benefit is 50, and plausibly the disutility of work might be 20, the individual firm cannot reduce the wage below 70, but this obviously raises questions about how benefits are set. 5. One reason for rctaining a minimum wagc in the short run is the lack of capacity to administcr incomc-rested poverty relief on a large scale. Targeting is.therefore likely to be more effcctive if it is based on indicators of poverty such as unemployrncnt or. family sizc. The minimum wage is one way of targeting assistance to the working poor. This argument for a minimum wage becomes less compelling once the capacity exists to administcr incomc-testcd assistance to the working poor. S9 ERighi LABOR MARKETS9 UNEMPLOYMENT DAVID FRETWELL * RICHARD JACKMAi,N SOME UNEmPLOYMENw IS AN INVITABsLE PtATuRI OF A PRWF mARExT EmOOMY, and the objective of policy in Central and Eastern Europe can no longer be, as it was ijnder communism, to prevent any unemploymient. Rather, it-should be to moderate the risc in unemployment during the process of transition and to -.- . . . nmaintain it at reasonably lowi levels -thereafter. Full employment in a market economy depends above all on a well-fiunctioning labor market, with most jobs being.provided by private firms producing marker output. Over the longer term, a recovery of employmcnt, in Central and Eastern Europe will. - liklewisc depend on the growth of the private sector and an putting into placc the infrastructure of an efficient labor.markeL In the meanwhile, labor mar- kems in Central anrd Eastern Europe have been hit by.cnormous shocks and are subject to rigidities and various forms of markct imperfection which may ead d to unemPloyment rates in excess of what is economically efficicnt or politi- cally tolerabic. This chapter examines the role of active labor market policies. Two ques- tions precede the 'Main discussion of the chapter: What'is the rationale'for this. kind of policy? What are the major types of such policies?" . ' -Active labor marker.policies are aimed at helping the.unemployed rcturn to :work'(as against the passive policy 'of paying unemployment benefits)' The - 'starting point is to ask why such measures are necessary at all. Their rationale is at root the same as that'for unemployment benefits-namely, to protect :' . ' ' households from fluctuations in, their incomemnaore violent than policymakers regard as.acceptable. In the absencc of private.insurance, govemment has a' role in supporting the. living standards of individuals whose employment opportunities have collapsed. This insurancc'can operate through cash.bene- fits, but it can also take thc form of cushioning labor marnat shocks or of helping people move into new jobs.' . The balance benteen active and passive measurcs, givcn a commitment to provide swne help for the unemployed, will depend in part on their relative budgetary costs, and in part on thcir economic effects-both positive and negative-on tihe'workings of the labor market. Active measurcs, sudi as job .- -counseling, training schemes, and temporary work, tend to be morc costy than cash' benefis but may decrease the' duration of unemployment and increasc productivity. Cash benefits involve less government interference but. 1-160 1 LABOR MtAIK : UlNK MI'OYNIKNI ' blunt thte incentive to seek work and may be subject to aLbuse by the fraudu- lent or idle. Wlhnt, thien, determines the balance between support in cash and support in kind in the labor market? Cash benefits allow the individual to choose between different types of jobs and to choose whether to acquire new skills or move to a diffcrent locality. If the consumer (worker) is the best judge of his or her best interests, he or she niay well do. better than a government agency in determining the best course of action. The unconditional availability of cash benefits may, however, deter peo- - ple from takingjobs which pay ivages close to the benefit level and may discour- age them from devoting resources to seekingwork or from incurring the costs of . retraining ar the.risks of moving to a.new locality. Cash benefits may also * . strengthen the underground cconomy, because persons working in undeclared activities may additionally be ableto claim benefits. Of course, these ptoblems * 0 can in part be countered by vigilant administration of the benefit system, but employment office staff in Central and Eastern Europe often have neither the resources nor the experience tO prevent abuse. What has often. happened - instead is that entitlement to benefits has been restricted, for example, to those with recent work experience, or confined:to a limited.duration of unemploy- - ment. Although these administrative restrictions may cut abuse, many people, in particular the long-term unemployed, fall through the net. Active policies have major advantages in that they attempt to counteract mar- ket imperfections,.including the inefficiencies associated with the payment of benefits. Actiye policies help the unemployed to find work by means of coun- seling and bringing together information on vacancies. They also encouragc labor mobility by financing training and relocation. They may maintain an indi- vidual's work experience by providing a temporary job during a downturn, thereby improving his or her chances of getting back into work once the recov- ery comes. And lastly, active policies may be an effective way of stopping abuse: benefit claimants who already have undeclared jobs, or who are not seriously looking for work, will stop claiming benefits if payment is made conditional on participation in some temporary work or training scheme. But active labor mnarket policies are costly and subjecct to many oF the problems of government failure discussed earlier. It is one thing to organize interviews or to finance training schemes or temporary-jobs, but quite another * - to ensure that these activities truly benefit the unemployed. In principle, obviously, people should be trained only in skills for which there is, at least . potentially, a market demand. In-practice, however, the persons running the employment services are.not necessarily the best judge of what skills may be * .i needed or how new skills should be taught. They may not even havc an incentive to do so. So even where active policies are desirable in principle, they may wvell not be cost-effective in practice... Why, then, are such policies desirable at all? They are not, after all, used in East Asia. The answver is that the relevance of such programs depends on the 1 1611 I'UlCY DESIUN.ANU IMPI'EIENTATION context. Active programs are a response to declining industries-sommnthing unknown in East Asia, but all too well known in the West. Persistent unem- ployment in countries of the Organiz.ation for Economic Cooperation and Developrnent (oECD) is now generally attributed to structural factors, them- selves resulting from various rigidities in the labor market (oECD 1990c). Western governments are therefore urged to make their labor markets more flexible, in part by removing rules and regulations which impedc adjustment and mobility and: in part by shifting from passive to active labor market policies, such as job counseling, work experience, or longer-term training, * - 'which are designed to help workers relocate themselves from one sector of the labor market to another. An extensive survey of their experience argues that active labor. market policies, if properly designed, clearly targeted,'and Ceffi- ciently managed, can reduce unemployment (OECD 1993). Discussion later in: the chapter therefore refers to different programs in the highly industrialized - countries. Given the enormous structural imbalances and the great barriers to mobility, these arguments may apply with particular force in Central and Eastern Europe. An example may illustrate the scale of the problem. In Poland, where unemployment was at 13.5 percent and affected about 2.25 million persons in mid-1992, employment in the steel industry declined from 190,000 in 1988 to 123,000 at the end of 199 1. It is estimated that restructur- - ' . ' -ing will lead to another 60,000 redundancies, about half of them in one region. Although the scale of this decline is dramatic, it resembles those which have' occurred in other countries, if over a longer period. In the European Union, for example, employment in steel declined from 784,000 to 434,000 between - 1975 and 1985, and the competitive forces of market restructuring were substantially mitigated in their impact both by industrial policies involving continuing support for the steel industry and by labor market policies assisting labor mobility. The main message of this chapter, therefore, is that -ictive policy measures do have an important role but, because they are costly, intervention will have. to be selective where there is no immediate market return. The need is to target measures on areas where they can be most cost-effective. To illustrate the importance of context, the return to spending on retraining is likely to - - depend not only on the existence of gaps in the provision of private training but also on the existence of job openings.. With rising unernploy ment, the. cost-effectiveness of expanding training schemes indiscriminately may be quite low. In these circumstances, public employment services can be effec- tive in assisting the disadvantaged, including the long-term unemployed Jac- obson 1991) and can help maintain employment by supporting public works and temporary employment schemes. Turning to.the seccmnd question-the range of policy instruments-active labor market policies in the context of Central and Eastern Europe may 1 162Z -LABOR MARKETS: UNUMPLOYMENT. usefully be divided into three types, each addressing a different element of unemployment. Although the causes of emerging unemployment vary in intensity over time and across countries three main dimensions arise fromi different sources and require diffcrent policy rcsponses: In thc short to medium term,.economy-wide unemployment is the result of aggregate shocks, such as the impact of macroeconomic stabilization and the sharp fall in aggregate demand, the collapse of central planning arrange- ments including the Council for Mutual Economic Assistance (see the gloss- ary), and, for many economies, large increases in the price of imported energy and raw material inputs. These shocks cause. the demand for labor to fall across the economy as a whole, although the impact is often more severe on some sectors than on others. The response to the short-term economy--wide shocks resulting from liberalization and stabilization is discussed in chapter 7, where the main emphasis is on the possible role of wage policy as a means of containing inflation and on policies to make support for enterprises more selective and linked more explicitly. to employrnent objectives. This chapter discusses whether arguments can be made. for other measures of direct job - creation such as public works or temporary job schemes. : In the- medium term, structural unemployment results from sectoral imbalances caused. by changes in relative prices, exposure to world trade, modern technology, and management practics. These shocks, which are fundamental to the whole process .of transition, make it necessary tO restruc- ture the economy and to shift labor from one sector to another. Active policies for retraining and assisting labor mobility are crucial in this area.. Even in the long run, the labor market will have to adjust from the excess demand regime.characteristic of centrally planned economies to one in which unemployment is-:a permanent feature of the economic landscape. In most market economies, the public sector is the main agency.responsible for running employment exchanges. for unskilled and semi-skilled workers. Redeployment or job brokering. policies bring together information on job vacancies and advice and expertise about employment opportunitics. These three- types of active policy-information services, retraining, and job creation-are summarized in table 8-1. The Inheritance Although formal unemployment was not recognized in Central and Eastern Europe before the transition, some active labor policies existed and were used to ensure the availability of workers for the productive sector. Production targets were the dominant force in shaping policy for the development and deployment of labor. Although individuals could choose where to work, career opportunities were primarily subject to the needs of the enterprise within the confines of the overall plan. 1163 1 pOtI.cY *DIsIGN AND IMPI.RMENTAFttON Table 8-1. DI ncrni ion and dszessrnent ofArrive Labor Mfarket Po/icics A faro. Dnmirnn AIssrwmtw, itCD rofnines Employment scrvices Placement, counseling, and Found to be effcetive in vocational guidanc; job increasing job placements in search courscs and intcnsive United Kingdomn United counselingfor the States, ind Netherlands disadvantaged; assistanrce with geographic mobility Training Training prograims focused on Mixed evaluations; targeted the adult unemployed or progranis, including thosc for those at risk of losing their plant closurcs, successful in - - job; training takes placc Canada. Netherlands, and - usually a training centers or United States; general in entcrprises programs improvedjob prospects in Norway, Swe*den, andl United Kingdom but were ineffectivc in Federal Rcpublic of Germany and United Suatcs Dircet job creation Subsidics for regular Wage subsidies for itcruiting Scvcre problems of dcad- - employmcnt or retaining particular weight and substitution, workers (such as long-term implying very low nct unemployed) cmployment effect Enterprisc allowance Grants or prepayment of Most studies find quite high benefits to allow the survival rate of enterprises, unemployed a capital sum to but dcadwveight of about 50 start up their own business percent Temporary public sector Tcmporary work in the Relatively fevw studies of this jobs (public works) public sector for the practice. which is now unemployed uncommon in oEco countries Job security minimized social conflict and stress related to job loss. Job con- tent and wages were highly structured. Although this facilitated job mobility within and between similar enterprises (the Lenin-Steel Works in Hungary had more than a 20 percent turnover annually), it did not necessarily assist occupational or geographical mobility. So far as. redeployment vas .concerned, labor oiffces in several countries assisted the mnovement of %workers between firms and had a limited capacity to organize social and occupational rehabilitation services for disabled workers. The offices and statistical institutions also had the capacity to collect statistical information on employment. This netvork of offices provides a platform to help administer active labor policy and related income support programs during the transition. 1164 I LABOR MARKETS: UNEMPLOYMlENT An extensive training infrastructure was present in both public institutions and state enterprises. Training was partially financed in sonic countries by a payroll tax (for example, a 2 percent contribution in Poland). In addition, enterprises made considerable in-kind contributions to pre-service youth training and adult in-service training. ' ieaiess-es rrThe.veaKnesses of the old system involved unhelpful attitudes toward unem- ployment and job seeking, inadequate institutions for resolving political con- flict, restricted occupational mobility, and active labor policies and institutions which were poorly adapted to the needs of the transition. 'he inherited attitudes to unemployment and job seeking are poorly suited to the needs of a market system. Workers under the old system.did not have to- worry about finding employment. They were not accustomed to unemploy-. ment, nor to the continued fluctuations of and changes in labor demand which are common in market economies. Nor were they used to the varied patterns of.work in a market economy, including contract employment, Job sharing; and part-time work. Taking responsibility for finding work is likely to be particularly difficult for displaced workers, many. of whom will expect the state-or, more specifically, the tcchnically weak and understaffed public labor offices-to allocate them a job, as under the old system. Inadequate mechanisms exist for resolving political conflict. The social partners-government, labor, and employers-are less useful thantheymight ' be in resolving conflict because their role was subverted under the old system. Although unions existed, they were part of the state or party apparatus and did not represent workers in the way that trade unions do in the West. Employers .were also part of the state structure. There was no experience of building.a consensual approach to labor market policy-based on the roles of the social partners in representing their respective constituencies. Occupational mobility was restricted.uThe system of wage setting did not encourage workers. to' acquire skills, and many workers have only narrow technical skills, often specific to industries' now in decline. Both factors reduce occupational mobility. Active labor policies were unable to address effectively the needs of the transition. The first deficiency was that before the transition, labor services were poorly. funded. Given low or nonexistent unernployment, expenditure Nvas obviously lower than in most Western economies,cparticularly in the case ' * of active policies.' Even so, labor services were understaffed and their employees poorly trained. Hungary and Romania in effect disbanded some active labor services such as occupational counseling.2 In addition, there was a' lack of technology and labor market information to support cost-effective administration. 1165 Pril y PS4ION ANI) INII'.lHMIMNTATION The seconld deficiency of existing arrangements was the narrow rangc of employment services. Unemployment benefits. were limited or nonexistent; public labor offices provided minimal local matchinig of workers with vacanl- cies, cot'nscling was normally available only for selected individuals with significant social or physical handicaps, and no policies or techinical.expertise dealt with large-scale layoffs, because they did not occur. Access to public employment services wvas limited, no private services were provided, and no competition existed among service providers. Policy toward training and retraining was narrow, did not include provisions to target the unemployed, and did not address the needs of a changing and increasingly technological era nor of private and small-scale enterprises. There wvas a.lack of competition in the provision of training services, a lack of private training capacity, and little investment in programs providing adults with easy access to retraining for career advancement or other reasons. A final inadequacy of the inherited arrangements "as tchat community economic development was, and is, poorly understood. Local authorities had no experience in identifying areas where their communities had competitive * . ; -Iadvantages for specific types of investors or in marketing thesc advantages to potential investors. The system did not. encouragc individuals or local authorities to take initiatives and offered almost no experience in the use of human capital as an investment incentive, such as offering state-supported worker recruitment and training services as part of a package giving firms an incentive to invest in an economically depressed area. The Forces Driving Change.. Unemployment, democracy, decentralization, and supply/dernand shocks resulting from stabilization and restructuring are the key political and eco- nomic forces of the.transition. Above all, countries urgently need to develop new mechanisms to enable the labor force to respond to market signals. Politict Fones The political dimension of unemployment has already been stressed. Citizens need to understand the nature of unemployment in a market economy, receive the necessary income support when they are unemployed, and have confidence that economic measures, including active labor policy,'will allevi- ate and shorten periods of unemployment. The move to democracy, combined with the need for consensus among the social partners, makes it itmportant-to establish a tripartite structure to incor-- porate government, labor, and employcr organizations in discussions and to find out how the interests of different factions can-be heard. The development of tripartite mechanisms is complicated by two sets of factors: - -'Many trade unions exist whose legal status and number.of members are. sometimes not clear. Unions which played a key role in the revolution feel that [166 1 LABOR IthiARKErTS: tIN EM-I'PILOYMENTI thecy are now being squeezed out of die political process end that they muist chiange thecir role and rake the side of workers in dliscussions with a govern- nment which thecy hlcped to create. New organizations representing private entreprenieurs in smell businesses arec-only now being created. Even where they exist, thecy aire somectimes in comipetition with inherited organizations. such as chamnbers or commnerce, whichi primiarily represent state-owned enterprises. Decenitralization is an additional major political force. If taken to extremes, it can inhibit the:development of national labor exchange mc6hanisms and fragment previously established occulpational -stanidards wvhichl promote workertmobility. Decentralization can also lead to retention at a local level of' the majority of resources for active programs (70 to:90 perc:ent in some counitries of the former U.S.S.R.), largely -ruling out redistribution between localities.. Frontowic Forces Trhe shape of unemnployment is becoming eclarer: w;Employment in the rranufacturing scector in Central and Eastern Europe wsaround twvice as high as in market Economies., Manufacturing enterprises, on average, may therefore expect to shed up to 50 percent of their workers during. the transition. Many industrial sectors and enterprises will have to *make even larger adjustments, including complete closure in a significant minority of cases. The closure of enterprises, When translated to the local level, will create *large-ascale unemployment in some communitiesl This is a special concern Where employmient is concentrated in a single state enterprise. As table 8-2. shows, the variation in unem'ployment rates across regions wvithint countries is greater than in many Wes;tern economies,i reflecting in part the fact that the regions themselves are smaller and, more important, that there is greater. concentration of production. oAlthough unemployment in many countries initially occurred largely among professional and skilled workers, as the collapse dee.pened, the uniem- * ployment rates- of unskiled workers, started to rise. In. most countries of Central and Eastern Europe, as in most market economies, the highest unem-. ploymenit rates are nowv found among the unskilled. *During the initial phase of restructuring, women tended tu be more affected than men by uneinployment: they iitre laid off more often, and their chance of being re-employed wvas lower. Over time,. the first factor has become less important, sin'ce mass layoffs generally affct meni no icss than women. Howe~ver, the probability of finding a new job remains lower -for women.3 One would therefore expect: wvomen to be a majority among the *. unemlye,yt,antbe8- hws, by the third year of the transition, this 11671 * Qimai~~y, aM~ofrwg~~va4 ~ kwgr. &JINd'Id o~f B oawm . !neqf 4admapnd oawawphiyawtm Aitiadw, ai" TOOpwi pmwan- usa Bulpn;ri (nine re4ona) *FLsit quirtei 2.6' 0.7 .024 4.0 2. 027 Second quarer . 5.3 1.0 0.17' 7.0 .4.7 ..0.43 * ~~~~~~~~~~December 12.5~ LI 0.19 14.8 - 9.7 0.4S vahs1tin"(iwe1vs * . .. ~~~~~~regouns) . Januat 1.5 0.7 0.47 Z.6 0.9 0.31 June ~~~~~~~~3.8 5.0 0.79 6.8 1.9 US5 * . . Nee~~~~~~~tcmber. 66 4.0 O.nO IZ.6 .7 Z32 January 2.1 2.4 1.14 Z.9 0.3 0.36, June 3.41 2.3 (159 1.0 05 - ~~~~~~~December .56.2 0.73 13.9 2.9, 0.98 * ..~~~~~~ ~Poland (In ryinc regiops) 6.5 2.5 ~~~~0.38 .3 0.84- * June ~~~~~~~~~~~~~~~~~~8.4- 3.2 0.38 125 . 10 December ~~~~ ~~11.4 4.0 0.35 I66 .93 Ramnwis (nine rgOpns) - ~~~~Firnquarter 0.7 .0.7 0.73 U. 0.3 -- . .. . Se~~~~~~$cond quaner 1.5 0.9 0.4 .3.1 1.0- Frsnce(ecvcn rcgow)' 10.5. 1.7 . 0.16 -12.9 86 Spain (eleven reglons)' 20.1I 5.0 02 .7. 7 14.7- Sweden (rive regions)d 1.9 0.6 0.30 2.6 IS1 a.Wcothedby,dielab forc. .b. UneriplQyma. ralas for Cthe botrom uancer of thc Wbor facwe by region'ieae cakulated by ordering rgidons in temns of ascnd~mg unmpt3a z,rkn c~mun h cumulaive labor forcc passed one-ufc ieiea,icuigtelatrgo ndeealculadon %iLhd an appropste fractional vWcii and doing the same fo erpqwr. C. Compnud follows: I 1/2 Z',Jr. -A ~- (U-I' It. .where,r. the number of reglons; .1 -- dhe labor aresm Sae t= regia. r. U'and 4, we. respoftivel.- resios.! unmlomntaudvcac rlsand Uar Fare the cauntrlesaverageunenploymenr and vxantymes. d. 1987...- Setwrau owe 192a.tablef6.7, p. 257. For Czechoslov-akia. Hungary. d Poland.daafrom nationsl istaatclollcs; firPBIpiriasand R--oa,.Coinntissi--fthie aaiep Communitme 1992. except Deci:niba for Bulgaria, which wspoidbyteBlranMntyofLbcan noooutries. wn19 I.A.1.A111 MAIIKKI5N UNlHMILOYMlBNl' is no longer generally thc case. The eplunation of this apparcnt paradox is t1itit women drop out of the labor force. Two ptessures are at work, The deterioration of Services and ffinge benefits provided by enterprise's, such as kindergarterns and maternity leave, discourages wonien from participating in dic labor force; tlic decline In real family' income works in the opsite- - direction. During the carly years of the traniskion, die first effect was stronger. The- m'edium-temi outcome is not clear, ulthough intemational comparison. suggests that incr-asing numbers of women will leave the libor forcec. -In'-all countries, youth unemployment rates ire very high, sometimes three or four times the-overall' unemployment rate.- As in market cconomies, in bad times firms protedt their existing workers but no longer recruit new ones (see table B:4). cA onspicuous fetture-of labor'markets in the transition has. been the- abnormally low outflow rates from unemployment. With,the exception of-the C'zech Republic, the prospeccs for unermployed people to find a new job fairly -rapidly -are far below those of the inndustrial economies.'Thesc countrics facc . - . . an incrcasingly severe problem of long-term unemployment. Policy A prinary objective of activc labor policies is tO facilitaie restructuring and to.. a'n-onticipate, shorten, and alleviate -unemployment to the extent that doing so is feasible and cost-effectivc. At the same time, active labor mrket senrices can-., increase labor' productivity, particuarly, for the economically disadvantaged :and unemployed. The provision of active- labor market poticies in Central and Eastern Europe in' . - - - terms both of expenditure and of ihe number of participints is set out in table 8-5. Although the table is not compr*ensive; it shows clearly thc difference between, on the one hand, the forrmer Czechoslovakia, wvhere. active policies. : .- - -.sabsorbed well over half of total spending on the unemployed, 'and, on the other,. the remaining countries, whereactive policies absorbed only sorne 1O: * 'percent of cxpenditure. Given the'exceptional achievement of the former. 'Clzechoslovakia,-particularly the Czech Republic, in achieving very low rates'. of unemployment (Q.5 percent at the end of 1992), this might indicace-the efffcacy 'of active policies. Czechoslovikia, alone of the countries in Central and Eastern Europe, attempted such-polcies 'on the' scale required to provide . 'work 'or training for all ;who -became unemployed. In evaluating the Czech *'approach, however, three factors should be taken into account: I In common with other countries in Central and&Eastern Europe,'the Czech' Repuilic, postponed the introduction of bankruptcy legisladon until .April 1993, thereby-implicitly-supporcing the continuing operation of numer- 1169.1 Tabie 8-3. Registerd Unemployment Rates of Females anid Males in Va, jous Counvits, by Quartei; 1990- 93 (pcrccnr) Bulgaria Cwhecosdoitia? Hungary Poland ~ Romemia Year and qwzMer Females Afaks. Femals Ala/tz Females Alales Femtfrk Mls Fmae ae 1990 2.0 .1.1 1.0 0.9 0.8 1.0 6.6 5.6 - 1991 First quarter 3.5. 2.4 2.3 2.S 2.4 3.0 8.1 6.4 1.2 0.5 Second qufnrc'r 62 5.5 4.0 3.6 3.3 4.2 4.6 -7.4 2.3 13.3 Third quarter . ~9.6 . .7 6.3. 5.0 5.0 5.9 lZ.0 9.2 31 1.7 Fourth quarter 1.6 11.3 723 6.0 7.1 - 8.2 132 10.2 4.0 2 I - ~~~1992 o ~~~~~~First quartcr 14.2 13.2 6.8 6.2 8.8 10.8 13.8 10.7 5.6 3.3 Sccond quarter 14.8 14.7 5.8 5.1 9.9 12.2 14.6 11.1 7.5 4.4 Thirdi quarter 17.3 .16.4 .5.7 4.7 11.5 13.7 1S.6 11.'8 .9.6 5.9 Fourth quarter- 19.0 18.7 5.4 . 4.8 ..12.5 14.6 15.5 11.9 10-5 6.3 1993 First quiartcr -- 3.3a 2.5a 11.6 16.1 . 16.1 13.0 11.7 7.7 Second quarter .- 3.7a Z-In 11.4 15.4 16.8 - 13.1- 11.6 7.2 12.5b . Z.4bP -Not available. a.Cze h Republic. b. Slovak Republic.' Sowre: Commission of the Europenr CommuniCies 1993. LABOR MARKETS: U NEMPi11LODVYME9NT Table 8-4. Unieniployrnenti Rates, by 4igw in I'adogus (kmln&ids, / 991 anid 1993 (percent) sC"h SloatWk Republic, Republie, Poa/ad, HAnga,y, * 4ge (years) )991 199) 1993 1993 .0-19 20.9 .51.2. - 34.9 * 20-24 6.5 18.5 36.0i 15.0 .25-29 6.2 15.! 28.1b 11.1 30-39 3.7 .10.8 24.St; 10.2 40-49 3.2 9.8- 50-54 Z.3 .69,5d8. 55-59 ~~~0.9 2.6 1.9 8.5 -Not available, a,18-24. b. 25a-34. c. 35-44'. d. 45-54. Sownrs: For Czech'Republic and Slovak Repiublic, I-am,i Svcjnar, and Terrell 1993;.for Poland, Poland, GUS 1993 for Hungary, acsu 1993b. ous loss-making scare-owned enterprises. This policy may assist in holding dowvn the growth in unemployment in the short run, but does so at the expense of postponing essential economic adjustment. Howvever, the idea chat low unempoloyment in the Czech Republic can be attributed solely to the delayed implementation of bakuptcy laws seems implausilsncbak ruptcy remains virtually unknown throughout Cental and Easter Eroe -Like' Sweden,. but probably more successfully than other countries in Central and Ea'stern Europe-, the Czech Republic has a central ized wage bargaining:system,. in whfich trade unions are involved both in setting wage norms andl in enforcing policy'. Wage moderation may have helped to maintain * mployment in st'ate and private enterprises, thus easing the task of' labor markecE poUcy.. Again 'like Sweden, but unlike at least some oa the other countries in ..Central and Eastern Europe, the. Czech Republic has' maintained very~ tight *conditions, especially since January 1992, on the receipt of unemployment benefits and limited to six mo nths the duration for which people can obtain -benefits. -These elements of policy are mutually reinforcing. The conditionality and limited duration of benefits put pressure on unemployed people to find work or to go onto schemes, whiile the avalblt f placestenables the government to impose a restrictive regime of bcncfits. Employment in teeooya whole is maintair:ed by these measures, tgctthcr wvith enterprise supportcand w%age moderaton. Should employment in state enterprises ail nbegin to beg7in to. I1711 IrOLtCf DESIGN ANt) IMrLKMENWrATION T'able 8-5. Public &upendftnure anid Pamhjopant' I,qlows ini Labor Marke~ Pwgrarns In (participant infloWs ais a percentage of labor force; public expenditures asi a pececntage of oow) Bulgaria LwehA Republie llNfgaiy Pwgrum /~~~~~~~991 1992 1992 1992 199) 1992 /992 1992 dcdtrnevwr- - 0.18 0.32 - 2.78 P3ublic emiploymilent services and administration - 0.09 0.09 - - 0.16 - UAbor marketutraining (1.5 0.5 0.01 0.0! 0.3 0.09 1.2 1raining for unemployed adoltsaind those atrisk 0.5 0.5 0.01 0,01 - 023 0.09 1.2 T.'raining for emloyed adults .. . .. . Youth measures .. ..0.01 0.04 0.3 0.4 Measures for.uncemployed and disadvantaged youth . .. 0.01 0.04 0.3 0.4 Support of apprenticeships and related farmis of gener al youth training . . . . . Subsidiz.edecmployrnent . 0.2 0.08 0.16 .. 2.3 0.14 1.3 Subsidies or fegiltar emnployment in the private scector . .. 0.05 0.10 0.4 1.2 0.04 0.8 Support of u nemnployed persons stantingecnccrprises .. 0.1 '002 0.03 0.2 0.5 0.10.1 Dircct job creation, public or nonpmroft .. 0.01- 0.03 - 0.6 0.08 0.4 Measures for the dis ..cd 0.01 . .. Vocational rehabilitation . . . . . .. WVork for the disabled .. . .0.01 . .. Mobilizing1labor supplya 0.6 0.7 0.08 0.19 - 2.5 0.1 5 2.1 Non-targeted truinint . . .. . Work as a social objective.'. 0.01 0.04 0.6 0.03a 0.4 Pa.aim Nmeavs- 0.23 0.19 - .31 Unemployment compensation - - 0.23 0.19 . .. 2.36- Early fretireent for labor market re-asons - -- - 0.03 - Total -OA0.4 0.51 . - '21578 -NoE available. Nil or less than half of the last digit used. a.Framn for- unemployed adults and thos'c at risk, 'measures for unemployed and disadvantaged youth, subskidies of regular cnmployinen in. the private sector, supportt of unemployed persons starting enterprises, and vocational rehabilitation for the dis'abled. * 1~~~~~~~~1721 LABOR MARKETS: UNKMIISLOTMENT Ce#ovIa( adE&ten,Runpea CeuFrnif, 1991-92 Pdoad S . ah RspWiit AV6kr PAffdptm Pubic P.mirrWaxt Pamr.Wkcp uiexwAAiM,. jaAmfO, OpeAwMadi iuJfeu "iAnAform un0ms '199?1992 /991 199? /991 11992 1991 '1992~ 0.32 - . ~~~0.02 .0.18 - -13 *0.02 - ~~~~0.01 .16 - - 0.09- - 0.02 0.4 0.01 .a .. .3.10.3 10 0.02 0.4 ~~~0.01 0.01 .. 0.3 0.10 03 . 0.16 L.. 0.01 0.1 - . 0.01 0. 0.16 2.3. . . . 0.08 0.9 . . 1.16 0.8 3.1 0.04 .0.6 . .. 1.01 0.5 -2.3 0.02 0.2 .. .14 0.3 D.9~ 0.04 .-.. 0.01. .0.07' 1.0 0.01 0.01- 0.1 0.3 1.12 0. 3. 0.16, 2.3 . . . 0.07 -. .. * . 0.15 0.3 0.9- * .2.51 I 0.30 0.79 - - 0.65 - 1.73. - .0 0.79 - - 0.65 . 0.78- 2.83 - .0.32 .0.96 - - .2.01- - b. Training for unplaycd adults arnd suppart of sapprenticeships aind rclmAd forms of gencrsl iramia (o Youhs. * c~. suipport of unemployed persons stiaringcnterprises and wojrk for the disabled Saw-wuz'or 1 993, table 2.1.2. * . .. 11~~~~73 1...> * . POLICY DESIGN AND IMPLEMENTATION fall more rapidly as a result of the bankruptcy law, unemploymcnt may rise above the levels with which active policies can cope, and the duration of benefits will havc to be extended to care for increasing numbers of unplaced peopic. This would reduce the pressure on the unemployed to look-for work, thereby aggravating the rise in unemployment.4 Poland, in contrast, has had to grapple with more rapidly rising unemploy- ment. Approximately 14 percent of the labor force was unemployed in 1992, an additional 11 percent of the labor force was on short time, and the number of large-scale layoffs was significant. Poland has a comprehensive active labor policy framework but only limited institutional capacity to 'administer it: in 1992 active labor policy involved only about 8 percent of the unemployed, and staff/client ratios in labor offices were in the range of about 1i300. With unemployment such as that on' the Polish scale, active policies-and institutions cannot cope well, and, though the duration of unemployment benefits has bee' duced, additional social assistance schemes have been developed (in Poland about 30' pecent of individuals who have exhausted their entitlement to unemployment benefits qualify for social assistance). I In other countries, as in Poland, rapidly growing unemployment has meant that resources, both administrative and financial, have bcen stretched to the limit, and active programs have suffered as a result. Eastern Germany is alone in attacking the sharp decline in employment, from lOmillion in 1989 to 6.5 million in 1992, using activelabor market policies on a large-scale. This has been 'possible becausc of the availability of resources and institutional capacity from western Germany. Schemes for retraining, for promoting ocecipational mobility, and for directly crcating jobs (together with "passive" measures Such as early retirement, parttime work, east-west commuting, and migration) kept the rise in unemploymcnt to 1.2 million, with 43 percent of expenditures being-devoted to activc as against passive measures. In the countries of thec former U.S.S.R., enterprise support has becn maintained almost without regard to fiscal co0t, and this has moderated the rise of unemploymcnt, but at the expense of allowing inflation to run out of control.' Given this experience of active labor policies in Central and Eastern Europe, a strategy for addressing unemployment might usefully comprise the following elements:- The starting point is to monitor the incidence of unemployment by sector (industry, region, occupation, age,-and gender), and in particular the incidence of large-scale layoffs, so as to initiate policies to help the unemployed find work. In the short run, there are many' more job seekers than jobs (the ratio was about 200 to 1 at the public labor exchange in Romania in latc 1992). With labor demand everywhere depressed, policy for the early years of the transition may need to concentrate on measures for creatingjobs, particularly in areas or sectors where unemployment is exceptionally high (for cxample, in company towns or among young people); such policies might be allied to 11741. LABOR M1ARK ET$ UNEMPI.OYMENT linking the payment of unemployment benefits ts participation in public works or tranining. 'hese topics are the main subject of the section on regulat-I ing markct forces. *.' At the samc time, althougi with a more medium-term perspective, the infrastructure of a labor niirket can be put in place. As demand for labor begins to grow and as new,private firms take root, policy should facilitate the movcment of labor between jobs, regions, and -occupations, including encour- agemcnt -of new- entreprencurs :and sclf-employment. TMe institutional arrangemcnts for employmcnt scrvices and'training or rctraining programs should be refined to assist the efficicnt operarion of the libor market over the longer term. These.topics are discursed in the section on building markets. * First,. however,'is 'the'question of whac resources are availabe to support' such policies.. AMainzaini#g AMacvexoaNic Bak--- Even in times of severe fiscal constraint, public spcnding can be justiried to thec extent.that it can pay for itself (by reducing the need to pay. une'mploy- me-aont benefits) or. is the best availaUle means of dealing with acutc social distress and.potential political unrest arising from high or persistent unem- -ployment. More gencrally, vonstraints on public expenditurc focus atenltion on the role of private finance. These are questions of-mobiliing resourcs. 'Thcn there are issucs Of cost-cffectiveness, chat is, of attempting to ensurc that resources are used to best: effect and outcomes achieved at minmum. ..cost. The are issues of cos ntainng costs. MOBILIZING RESOURCES. Resources to support active labor policy may come from both private and public sources, but during thc early transition the scope for,private finance was vcry limired. Private dnancing is not uncommon in market economies. Iapan depends extensively on cnterpriscs to finance thr: ideployment. of labor. In the U.S.' automobile- in'dustry, members of the. United Auto Worker who ar' made redundant arc eligible under their' labor contract to receive training.funded by company contributions beforc being: released. Morc recently, the collectcive ,. .. bargaining agreement signed-with all threc major U.S. auto manufacturing companies cstablished incomnc support' programs which guarantee rnembcrs almosi full wages for the life of the contract. Arguably, privatccompanics will -insurc their workers against the risks of nuctuations in the demand for their -. labor only if checompanies themselves can off-oad these risks onto thcapital market. In Central and Eastern Europc, such capital markets do not,exist for much of the emcgirig privatc- sector, and, unions would be ill-advised under -current conditions to insist on these types of provisions in employment con- .iracts..In any even.- most of the unemployment results from labor shedding by state-owned entcrprises rathe than by'privte firms. .1175 1 P'OLICY DESIGN.AND IMILP.EMEN'rAT ION State-owned enterprises in Central and Eastern Europe often continue to support workers who have been laid off by.allowing them to continue using social benefits supplied by the enterprise (in particular, housing) and, in the Russian Federation, even by financing public wvorks on Which they can be employed. But such activitics are not very systematic and, in any event, their costs are likely ultimately to fall on the state budget. Public funding may be primarily from general tax revenues (Australia, Ire- land, and Poland) or from employer/employee wage taxes (Germany, Hun-. gary, and Romania). In the case of employer/eniployee wage taxes, the state. administers what are, in essence, private resources, earmarked for the provi- sion. of employmcnt services, but usually including the payment of unemploy- ment insurance. As the economic situation improves, finance should increas- ingly be shared betveen the state budget and the contributions of employers and employees. (Hungiry has moved in this direction, but with difficulty since hard budget constraints are being imposed on enterprises.) In some cases, and- as full employment is reached, all financing may be shifted to thc employer. and employee, as in Japan. In determining how different types of active labor policies are financed, particularly in countries with rapidly increasing unemployment, the finance of cash benefits should be separated from that of active labor policies vhich support displaced workers. This policy has been established in Hungary, but not in i o'and. In the absence of such a policy, expenditure on cash benefits. tends to crowd out labor redeploymcnE and investmcnt policies, as occurred in Poland in 1991. However, in countries such as Albania, which are facing a particularly severe budget constraintt, massive unemployment, and collapse of. the formal economy, government May be forced to place.the majority of resources into income support and other poverty alleviation programs.. CONTAINING COs. Cost containment in active-labor policyrcan be addressed in various ways. Careful targeting of programs improves cost- effecciveness, as does combining different measures and policies (OECD 1993). A common technique in many countries, including those in Central and Eastern Europe, is to limit the time individuals may participate in any active program. Romania, for example, imposes a limit on the time spent in retrain- ing and on the proportion.of resources which can be allocatcd to active programs. Research in the West and initial evidence from Central and Eastern Europe suggest that the type of targeting for displaced worker programs strongly influences the degree of participation in the.program, the overall cost,.,the timelincss of the assistance, and Ehc overall effectiveness (DEeD 1984a). Broadly targeted assistance (aimed, for examplc, at an cntire sector) runs the- risk of escalating costs. Excessively narrow targeting, however, may exclude w zvorkcers who need assistance. Regardless of the approach to targeting,.declar- 11761 LA IIOR MAKE.TS: UNE t4IIOYM PNr ing a group of displaced workers eligible for special assistancc raises problems of equity.. - Most countries in Central and Eastern Europe have not developed compre- hensive capabilities to monitor, target, and evaluate the cost-cffectiveness of active labor policies and the allocation of resources: to particular groups. : :-- Improved targeting will require clearer definition of the intended recipients of specific programs. Automation is critical to the success of any large-scale a-nd comprchensive targeting and evaluation system. Such wvork is well advanced in Hungary and is under way in Poland. Bui-ding,41arfers It is necessary to strengthen the markets both for labor per se-and for the various typcs of labor market programs. This involves policies to increase consumer choice, diversify supply, improve incentives, and raise thed produc-' t .ivity of labor.' lINCREASING ONSUMER 01oiCE. The exercise of choice requires.(a) that workers and. employers have sufficient information on the labor market to make rational choices, (b) that labor exchange services exist to match job seekers with vacancies, and (c) that effective assessirent and counseling-are- available, where necessary, to assist the exercise of choice. In the past, most labor market information in Central and Eastern Eturope, -: although of high quality, concentrated on providing data for controlling and directing the econsomy, rather than on monitoring changing economic condi-- tions. The provision of informathon is crucial to building amarket, and all the more .so during times of change. To exercise choice, workers need to know. what jobs' are available and their characteristics. Firms need to know' the skills'.' and attributes of job seekers.' Institutions implementing active labor policy : need to know the number and attributes of people at risk of becoming unem- ployed. Labor market information, including information on households and enterprises,-should show changes in employment andjanticipate changes in demand. Such information must be easily understood by individuals or instiru- tions attempting to develop labor investment programs. Public labor exchanges in Central and Eastern Europe under central plan- ning were not fully automated, were primarily local, and were based. on a: situation .of labor-shortage which no longer exists. Although of limited use in reducing unemployment when an entire economy is in recession, labor. exchange services match vacancies with job. seekers. They' also contribute to labor mobility. Even during the worst of times, the job-seeking aspect of the labor exchange should be based in the public labor office, if that office isto be. responsible for operating unemployment benelis. Public exchanges need to. be cotinully efind ad atomated, making;itpossible to increase h number of vacancies listed at employment offic laborexchanges. Inaddition,- 11771 I'UI.ICY l)SHIN ANI) tMP'Ll,I.4NTATriON economies in both Central annd Eastern Europe, for example Hungary, and the West are increasingly legalizing complementary private exchanges. Assessment and counseling were virtually disbanded in most of Central and Eastern Europe before the transition, and the services -which were rctained wcre mainly for a sniall proportion of wvorkers with scverc physical or social' problems. In a rapidly changing market econonly, sucl services. should. bc available to a much broader range of clients; The services are particularly important for redeploying labor, and also for scrcening potential ciients for expensive training programs. Improved eniployllient counseling, including the assessment of aptiiude and interest, and the provision of information about education and training opportunitics are a central aspect of labor mobility (oECID 1984c). These services have proved effective' in market economies (U.S. General Accounting Office 1991) but are not well developed in Central and Eastern Europe. Job search training and reiated job club activities for the long-term unemployed are also generally cost-effective in market economics because they help clients to define job objectives and discover employment dpportunities (Commission of. the European Communities 1990; Leigh 1990). Initial evidence in Central and Eastern Europe is also positive. DIVERSIFYING SUPPLY. This part of the strategy deals mainly with diversifying the supply of labor market services-in particular services which assist the redeployment of labor-and training and retraining services. Deploying labor torn effetivwly. The liberalization of labor redeployment. policy and, in particular; the regulation of private employment services, has been the subject of considerable. debate, as exemplified by the International Labour Organisation convention no. 96, which provides for the-regulation of private employment services. The majnr concerns. relate to the licensing of. employment . agencies. and training establishmnents, the. accreditation of courses, and the monitoring of standards. However, the restrictions on private services addressed in the convention do not reflect current conditions, and the mnonopoly of the public employment service, where, exists, is being chal- lenged (World Association of Public 'Employnient-Services 1992). There are two sets of reasons for this trend; (a) public employment services in Central and Eastern Europe.are having increasing difficulty fulfiling all market needs, and (b) notwihistanding the extension 'of services offered by public instiu-. . tions, private intermediaries are effectively filling the gap and are increasing in- number and importance (EECIhLo 1991). Private agencies in the. West tend to target their services to particular segments cf the labor market, for instance, white-collar workers or workers who already have a job but are looking for a new onc. Many countries, !.uch as the United' Kingdomn and the'United States, encourage private feepaying. placement services (although regulations of the Intcrnational Labour Organ- isation pcrmit fees to be collected only from the employer), and -Hungary has IllS] LABOR MARKETS: UNEMPLOYM EN?' also enacted legislation to allow private services. Sonic countries, such as Belgium, France,Germany, and Norway, apply considerable regulation to such services, although this regulation is being reduced in the lighit of the Social Chiarter of the European Union. A few countries, such as Denmark, Poland, and Spain, have laws which do not allow such services to operate at all. Countries in Central and Eastern Europe need to reevaluate the relation- 'ship betwveen private and public service providers. Creation of an effective tnix of private and public providers, together with an appropriate reglatory- structure covering both sectors, is essential if the advantages of having both' systems are to outweigh the disadvantages. -Inarasing the skils of lahor. Policies could also support private and public retraining programs. Experience indicates that the introduction of market mechanisms increases the responsiveness of retraining programs to. labor mar- ket needs (Leigh 1992). Contracts are usually competitive and impose condi- tions which regulate quality: contracts can be for a selected number of training slots or for a number 'of days from a selected* training agency; the training contractor. niay provide modular training with some degree of flexible entry a.nd exit for clients;the training contractor may also provide additional coun- seling services; contractors may be required to accept responsibility for sue- . cessfully placing a portion of the trainees. (for example, 70 perccnt); 'and a specified minimum may be set belowv.which-the starting vage must not fall. Several Western econornies-Sweden andi he.Unitcd Kingdom-which:., used to maintain an internal training capacity for displaced workers have divested themselves of direct control and opened training to market forces. Poland has a. highly developed private Land semi-private training capacity (approximately 700 registered training associations in 1990), many of which provide training services for displaced workers on a contractual basis for local .labor offices. This suggests a change in the role of employment services: instead of public provision of training, policy would rest on a dual foundation of public funding for displaced workers and an appropriate regulatory structure to ensure quality, with the training itself contracted out to public and private agencies.5 Programs promoting-occupational mobility, however, may not be a priority, particularly for older and'married workers given the factors, such as housing, which restrict mobility among displaced workers. Moreover, evalua- tions in Western economics have noE found these programs to be very effec- tiVe (OEco 1984c). IMPROVING INCENTIVEs. The incentive system chosen to support the devel- opment of labor markets will depend on which labor adjustment model is- selected and on which.of the key players-the individual, the employer, or the government-takes the major role. V Countries iin Western Europe allow major government intervention in. adjustment and in support of active labor programs. Many countries have 1179 I: POLICY DESIGN AND lMPI.AME:NTATION enacted lws which make it difficult (or enterprises to shed labor and require dtiem to give lenigthy advance notice andrcompensation to.employees. Gov- ernments allocate considerable resources for active labor prograims, -the highest being Sweden, at just over 2 percent of gross domestic product (GDP). Japan's strategy relics hevily-on private enterprise to bearl the major responsibility for alleviating the adversec effects of rcstrucCuring. Concern with employment security has always becn a guiding principle. For that portion of die work force covered by Japan's lifetime employment (roughly 30 perCenQ: unnecessary workers are moved froni job to. job within a company and afforded the requisite training in the process, Unique to Japan is the concept of loaning redundant workers co other companies. The government absorbs some of the costs of these arrangenments and allocates about 0.5 percent of cDP for labor market programs. - * In the United States and Canada, worker. adjustment strategies give dis- placed workers a central role. The private employer, however, is playing an increasingly important part in assisting the readjustment process, as are state and federal governments, by cnacting a variety of income support and : employment and training schemes to ease the transition to nciv employmcnt. The United States allocates' an average of about 0.4 pereenof CDP to active: labor programs. - If individuals are tol be the key players, they must be given appropriate incentives, such as substantial wvage differentials and easy access,to effective . redeployment and retraining services. Disincentives must also be removed: excessively generous cash benefits; artificial blockages to employment,.such as occupational certification or other forms of discrimination; and other bar- riers to mobility. If employers are to take the initiative, again, the incentive structure necds to be right. So far as redeployment is concerned, they should have easy access to high-quality services and no unnecessary impediments to hiring and releasing labor or to transferring personnel within' the organiza- - tion. To encourage employers either to invest in labor directly or to support external labor investment policies (for example, through training levies:financed by payroll deductions), government regulations and labor . . contracts should allow such investment to be integrated with related busi- ncss decisions such as changing-production processes.An addition, the quality of labor investment should be regulated, and training standards * should reflect market needs.. . : Agencies providing.serviccs must also have incencives if they are to imple- mcnt policies in a cost-effective way: some of the more important incentives are cmbodied in the'training contracts just described, which prescribe perfor- mance criteria rclating to the numbers of workers placed and their subsequent' earnings. I180 I - AI.Aifl MANKI"IISKT UINlMlI,OYMIN:. RAISING LAItOR I'HODIJUYrIVItY There airc many routes to raising the produc- tivity of labor, not le&ast the improved management of existing enterprises. In this section, we examine two ways in which labor rmobility can raise produc- * tivity: helping individuals make zbetter use of their cxisting skills by moving from a low-productivity, to a higlier-productivity Job and investing in hunman - capital tlhroughi training anid retraining to imprven the skills of the lbor force., Employmcnt services urc primarily related to the first route. In Central und Eastcern Europe, as in most Western economies, thy nmust inicreasingly' go beyond thcir former simple matching function in order to (u) identify and react to imminent layoffs and (b) help individuals assess their capabilities, deter- mine their nced for ne w-skills, and initiatc self-directed job scarches. The cost of providing these services is low, although costceffectiveness varies for differ- ent categories of-vorkers (Jacobson 1991; Johnson,f Dickinson, and Wcst 1985; for a fuller review, see rretwell and Goldberg 1993). Retraining policies are one aspect of skills improvemcnt. The economic return to retraining is controversial, both because of its expense and because of its flow return, particularly in excess supply sftuations.; Because of the structurai nature of a significant part of unemplovsnrent in Central and Eastern Europe, however, the option must be considered. The cquestion,: perhaps, is not if, but rather how and to.what extent retraining can be accomplislhed. Too much training too soon is not warranted, but demand signals clearly show exactly where labor is in excess supply (mining and heavy industry) and where - labor is scarce (the service sector, accounting, information technology).- -Training for unemployed adults is made availablc to approximately- 1 per- cent of the labor force each year in the highly industrialized countries (Scherer 1990), as opposed to about- 0.1 percent in Poland and 0.5 percent- in' Romania. The differences reflect multiple factors: a lack of labor market information,4a lack of requests for retraining, problems in determining what- ' programs to initiate, difficulties in mounting flexible retraining programs, financial constraints, and a philosophy of waiting until demand emerges at the local labor exchange, which may never occur. Research indicates that displaced workers may have particular nceds which affect the design- of retraining policies (oEcD 1984a), and initial anecdotal evidence from Central and Eastern Europe suggests similaritics with OECD trends. Public employmcnt services- in some countries -(Ro'mania and Russia, for example), like those in oscO countries, are involved in organizing, if not themselves providing, retraining to displaced workers. Public employment -service offices which are also involved in administering retraining programs tend to achieve higher returns in terms of wages or placement rates than those which -are not (U.S. General Accounting Office 1991). Generalizations about the costs and benefits of government-sponsored training as a part of manpower policy are hazardous. Particular care is neededV to distinguish betiveen programs which provide little screcning or job counsel- ' 00 ;';0 'i' 0''-''' \' 0 011811'-0' ' 4 ;;'; 0 POLICY DESIGN AND IMPLEMENTATION ing prior to entering rctraining and those which are more exacting. For exam- pie, initial retraining programs in Hungary encountcred high dropout rates, but improved screening and delivery of training is now achieving up to 60 percent placement. A U.S. study (Manpower Demonstration Research Cor- poration 1993) examined the cost-effectiveness of training some 20,000 par- ticipants. The study included control groups and took account of such factors as salary forgone because of the time spent in retraining. The findings of the study show that providing general cducation skills to adults with less than a high school matriculation has a significant impact on earnings, that on-thejob training has a significant impact for both men and women, and that classroom training tends to have a more significant impact for women than for men.6 If training is to make a difference, especially for higher-paid workers, it may have to be morc intensive, or more long term, than that currently offered (Seitchik and Zornitsky 1989). Many adult workers in Central and Eastern Europe may have limited gen- eral education (about eight years in Russia) complemented by narrow skill training. These workers will be faced with job changes, evolving management practices, and advanced and unfamiliar technology. Consideration should be given to retraining policies which include job counseling and assessment, as well as remedial general education, management training, and traditional voca- tional training. In summary, training is expensive and should noE be undertaken lightly or without first investigating other options, varying the type of training for differ- ent clients, and carefully screening clients before entry. Regvuskng Market Forres The major form of intervention in chis context is policy to address unemploy- ment, of which two sets of policies stand out: those which anticipate unem- ployment and those which seek to create jobs. ANTICIPATING urNEmPLOYMENT. Policies to anticipate unemployment have two central elements: labor market information and industrial adjustment policies. Decermining the extent of large-scale lavoffs and developing policies to reduce their impact are among the most critical issues in labor market adjustment in Central and Eastern Europe. Evaluations of worker adjustment programs in Western economics indicate that advance notice of a plant shut- down or large layoff is a useful first step in promoting smooth adjustment (OF-CD 1984a, 1988c). Layoff notices are usually backed by the provision of other relevant guidance and employment services. Advance notice legislation, regulations, and services have been cnacted in most Western countries under- going economic restructuring and have been developed in Central and Eastern Europe in countries such as Hungary and Poland. Industrial adjustment services are often cost-effectivC in Western countries (Employment and Immigration Canada 1984), and initial evaluations in 181 I L.ABOR MARKETS: UNEMIMLOYMENT Poland indicate that similar approaches can be developed in Centml and Eastern Europe. The services involve the transfer of authority to the local level, so as to involve the emplover and the local community. One of the most compelling reasons for introducing such scrvices has been the damage caused to a local community by the disappearance of its sole or dominant employer. Policies seck to cstablish a framework under which (a) public funds are concentrated on the most vulnerable areas and (b) local organiza- tions, trade unions, employers, and local and central governmcnts work together to solve practical labor problems. Onc of the objectives, both for incentive and for social solidarity reasons, is to demonstrate to the worst- affccted areas that public funds, indicative of the broader community's involvement, will be used to buttress local efforts to resolve difficult adjust- mcnt problems {oEcD 1985). Representatives of both the public and the private sectors, including the affected enterprises, should be involved; an example is the Besckgfringpnggse((schaften in Eastern Germany. Howcver, efforts to have the private sector undertake the full responsibiliry for leading and financing industrial adjustment have noE proved successful because of the resource constraints in communities where enterprises are closing their doors. CREATING JOBS. The creation of jobs is economically difficult and politically highly sensitive. Policies center around encouraging self-employment, provid- ing temporary jobs, and promoting local economic development. Euxpnnnnhjop. Throughout Central and Eastern Europe, there is consid- erable interest in creatingjobs, particularly for the unemployed, by developing small businesses. The option of developing micro-enterprises is successfully used in the West by only a small portion of the unemployed (2 to 3 percent; OECD 1988b), and initial experience in Poland reflects the same percentage. This option might, however, be of greater significance in Central and Eastcern Europe because of the poor development of small businesses, although evi- dently the scope for new entrepreneurial activity depends very much on deregulation policies and on the availability of finance. Entrepreneurship programs usually reach only a small segment of the unemployed (individuals who are middle-aged, have a postsecondarv educa- tion, are predominantly male, or who possess professional and technical back- grounds). In the context of Central and Eastern Europe, however, women tend to be better qualified relative to men than in the West, in both their education and work experience, particularly in the service sector. These pro- grams may therefore have a role in encouraging entrepreneurship among women. In the West, however, the survival rates of such firms are often low (50 percent are still operating after thirtv-six months in the United Kingdom), although success can be increased by providing technical assistance and credit (Mangum. Mangum, and Bowen 1992; Purdy 1987). 1183] POLICY DESIGN AND IMI'LEMENT'ATION Entrepreneurship is supported in several countries by capitalization of unemployment benefits (Czechoslovakia, France, Hungary, Poland, United Kingdom, and United States) and by provision of technical assistance to the unemployed through the local labor offices (Hungary, Poland, and Romania).7 Poland and Hungary have had difficulty administering these schemes through local labor offices because of a lack of staff and expertise. There appears to be a need to strengthen private and local nongovernmental organizations so that they can provide more effective assistance to the unemployed who wish to start firms; the role of the labor ministry would be limited to assessing the interests of the unemployed. Tronsidonawprivatre employmet. Schemes of this cype offer wage subsidies to ecisting enterprises to hire the unemployed and give them on-thejob training, with some guarantee that a fraction of the persons hired will be retained at the end of the subsidy. This arrangement may be difficult to promote amnong large firms, which are shedding rather than adding workers. These policies have feceived mixed evaluations in the West (oscD 1982). Te Socialiv Purposeful Jobs Scheme, which has been the main element of active labor policy in the Czech Republic, is of this form. Hungary and Poland have also designed limited programs which pay par of the cost of adding new employees for a limited time, if those employees are retained for a minimum period after the subsidy is removed. Similar job insertion programs have proved successful in Turkey (United Nations Development Programme 1992). Arguably, such subsidies may encourage enterprises to hire unemployed workers entitled to the subsidy for existing jobs rather than for newly created additional jobs. Nor are policies of this type effective in speeding up the adjustment process (oECw 1 988b). Temporary public or jobs. Temporarv job creation. often referred to as public works or public service employment, may be useful in Central and Eastem Europe because such programs can provide labor for environental cleanup and infrasuucture development, while temporariil lowering unem- ployment, reducing social stress, and keeping workers atached to the labor mark-et. The difficulty is that such schemes may perpetuate public funding of what may be perceived as non-productive work. Poland and Hungary have enacted policies to encourage the creation of temporary emplovment, and eastern Germany and the Czech Republic havc instituted extensive programs. Experience in eastern Germany suggests that these programs should be tar- geted to ehe disadvantaged and the long-term unemployed, that training ele- ments should be included where possible, and that there should be concurrent job search requirements (Spicznagel 1992). These programs have also been used in many OECD countries, but their popularitv has waned because they do relatively little to improve an individuars long-run job prospects. If alternative opportunities become available, hovever, public service enployment may serve as a bridge between jobs. The risk is that dependence on public emplov- 11841 LABOR MARKETS: UNEMI'LOYMENT ment can develop, leading to longer tenure in the public employment service job than budgets warrant (OEcD 1984a). Cook (1985) conducted an extensive evaluation which concluded that pub- lic service employment programs in the United States are not appropriate for individuals who lack even the most basic skills necessary for employment. Based on the experience of such programs, public service employment should use carefully designed selection criteria, be prescribed for a limited time to minimize dependence, and imposc a limit on the maximum wage, both to contain coscs and to ensure that take-up is confined to those genuinely unable to find work elsewhere. &ononic devekpment. It should not be forgotten, finally, that the primary ingredient for increasing the demand for labor is economic growth, and the major objecuive of active labor programs is to help ensurc a supply response. Labor programs may also play a role in developing demand. Local labor offices in Central and Eastern Europe wvere historically often little more than passive repositories for information on unskilled or semi-skilled individuals looking for employment. As major restructuring occurs, however, local labor authorities could become more active partners in local economic develop- ment, as in some market economies where labor offices help to screen employees and organize custom-made training programs for firms agreeing to mak-e new investments and to support community development. Examples include the Canadian Gommunity Futures Programme and the Australian Regional Development Programme. Impemenfng the Refwms It should be clear from the multiplicitY of programs discussed (table 8-5) that active labor policies are administratively demanding. They are also, and very obviously, highly political. Implementation of these policies requires signifi- cant development of both institutional and political capaciry. BUILDWNG iNsTrTnONAL CAPACITy. Public institutional capacity for imple- menting active labor policy was narrow and incomplete during the period of central planning: unemployment was nor recognized, enterprises played the dominant role in providing social services, and private services were nonexis- tent. Institutional development is thcrefore needed in three broad areas: the supply and fiance of private alternatives, the broadening of the legal and administative structure to support both private and public services, and the development of personnel. The restrictions discussed earlicr on the operation of private employment services should be lifted and private training organizations allowed to develop. In addition, in countries like Poland the status of nongovernmental organiza- tions remains unclear: in countries like Romania the laYvs regulating their activities are outdated and should be reviewed. These laws should be rewrit- 1185 1 IPOLICY DESIGN AND IMPLElMENTATION ten to ensure that nongovernmental organizations, which are major providcrs of active labor services in many countries, can deliver the services effectively and, given the fiscal constraints, can receive private as well as public funding. Legal and administrative structures raise two sets of issues, one relatcd to centralization and decentralization and one related to the links between the administration of cash benefits and that of active labor policies. Active labor policies, particularly those related to unemployed and dis- placed workers, are generally administered and often financed by ministries of labor or public employment services. Various administrative structures can be used, depending, among other things, on the mix of policies. The trend is toward creating quasi-independent and autonomous governmcnt: bodies, such as Germany has had and as Poland put into place in 1992, as opposed to maintaining the administration within a govcrnment ministry, as Romania has done. The advantage of keeping the administration within a ministry is that the ministry coordinates policy and administrative action; the advantage of adopting the more autonomous approach is that it strengthens nongovern- mental input and cooperation (particularly if it is tripartite) and promotes greater operational tlexibility. A totally autonomous or decentralized approach, however, can complicate the development of national labor policy. The linkages between the administration of cash benefits and active labor policies are contentious and complex. Countries such as Australia, Germany, Romania, and the United Kingdom integrate the administration of active labor market policies and passive policies (cash benefits). Others such as Canada and the United States separate the two; Albania is considering such a policy. It is difficult to identifv an overall trend. Indeed, Canada and the United Kingdom have moved back and forth between integrated and separated approaches. Administering all programs together promotes administrative coordination and assures rhat clients rccciving cash benefits have direct and immediate access to active programs. In addition, as more services are created, the existing network can provide a ready-madc administrative vehicle to orga- nize them, as has happened in Romnania. The disadvantage of such an approach is that it tends to centralize program operation, sometimes reduc- ing flexibility- In addition, during times of rising unemployment, most resources and staff are often shifted to the cash benefit programs at the expense of active programs. In addressing these issues, countries in Central and Eastern Europe should bear in mind two striking features of the Western cxperience: the frequent changes in structure which occur and the rather different cultures of the two services. Labor redeployment and investment policies need to be dynamic and responsive to local economies and are mostly concerned with positive access; passive cash benefits policies are highly regulated, and part of the responsibility is to control fraud, or negative access. [1861 LABOR MARKETS: UNEMPLOYMENT' The adniinistration of active labor policy requircs trained and experienecd staff, a major issue in Central and Eastem Europc, where new policies are being enacted in the face of rapidly rising unemployment. Staffing ratios vary widely, as shown in table 8-6. The differences are explained partly by rhe types of services offered in different countries and partly by their quality. The data should be interpreted with care, however, because they do not always compare like with like. For example, a country like France, in which the public employment service operates adult retraining itself, will tend to havc a higher staff/client ratio than a country like Poland, in which adult training services are contracted out. Nevertheless, in Central and Eastern Europe, limited funds, increasing workloads, and civil service hiring practices have all created serious problems with staff recruitment and training. The types of employees needed to deliver the new labor redeployment policies and admin- ister labor investment policies are very different from those of the old system. BUILDING POJTICAL CAPACITY. Given the high labor force participation rate under communism, unemployment can be expected to cause even more personal hardship in Central and Eastern Europe than in the West, particularly in those countries with no prewar history of being a market economy. As discussed in chapter 13. this makes the politics of unemployment a sensitive, indeed potentially explosive, area. In part, the political capacity to deal with this situation must involve a general buildup of experience with democratic politics. This buildup will involve judgments about the balance between fiscal restraint, economic ratio- nality, and political expedience, all three of which can be in conflict. Part of Table 8-6. Ratio of Labor Staffto Unemplqoyd in Seleed Cont es, 1988 Raoo of staff ConnirY to nanempiyed Swvedcn 1:9 Austria 1:33 Germany, Fed. Rep. of 1:37 France 1:78 Italy 1:88 United Kingdom 1:98 Portugal 1:120 Poland k:ZZ Turkev 1:375' Mexico 1:400- Note: Labor staff wvere chose in public employment services only, including the administration of unemployment benefits. a. Ratio of staff to applicants, no unemploymcnt benefits, limited care services, and active programs. Sovme: Schercr 1990. 1187 I'OLICY DESIGN ANU IMP'LEMENTATION the answer also involves building labor marker institutions. Setting up a Eripar- tite dialog betveen government and representatives of workers and employers is critical in this context. Constraints The major political constraint is thc patechy understanding among the social partners about the need for active labor policies, the different types of policy, and their costs. This can make it difficult for one partncr to implement policy or to defend it in the wider debate about expenditure on the social sectors versus other sectors. The main economic constraines are acute fiscal limitations, the pressure to implement cash benefit programs, a shortage of private resources, and the difficulty of determining where and wvhen to make labor investments in a time of major recession. These constraints frustrate attempts to implement active labor policies at the level found in the Western economies. Enterprises are reluccant to invest in labor because of financial pressures, uncertain nceds, and layoffs. In many cases, enterprises are closing internal retraining facilities, or lowering enrollments, and wurning the facilities over to labor and educational authorities, who also lack funds to operate them. Finally, because of inflation, slow wage decompression, and continuing problems of aceeess to credir, few individuals have resources to invest in retraining or employment promotion initiatives. Institutional capacity constraints are also severe. Central and Eastern Europe has insufficient private sector capacity, inadequate legat and regulatory strucwures to support implementation of private or public programs, and inap- propriate public infrastructure. Policymakers tend to believe in simple and complete solutions, an urge to find the silver bullet, rather than to create a range of policies which can be targeted to different clients. Conclusions: Priorities and Sequencing The early vears of the transition were characterized by a reluctance of enter- prises in most of Central and Eastern Europe to shed labor on a large scale. When output fell, the main adjuscment was on hours worked or on wages rather than on employment. As a result, unemployment in the first instance concentrated on new entrants to the labor market (youths), on women with young children, and on older workers. This phase provided an opportunity for governments to adjust policies before major hard layoffs were made. What should be done? As noted at the start of this chapter, it is unrealistic to aim to eliminate all unemployment. In most countries, significant rates of unemployment are likely to continue for many years and will play an impor- tant role in restraining wage demands, in encouragng work effort, and in facilitating labor mobility. Nevertheless, the economic devastation of indus- 1 188 1 LABOR MARKE'rS: UNEMPLOYMENT tries and communities threatens to impose unacccptable economic, social, and political costs. In the short term, the policy strategy entails financial assistance to the localitv to alleviate these costs; in the long term, it entails measures to improve labor markc flexibilitv in response to changing demand. Mort-terym Polides The overriding short-term priorities arc to monitor emerging unemployment, to anticipate possible enterprise closures and mass lavoffs, and to develop policv aceions which shorten and amcliorate the impact of unemployment through job creation programs. A start should also be made on developing institutions to faciliEtae labor mobilitv in a market economy. This includes parallel development of appropriate wage and emplovment policies (chapter 7) and effective cash benefit programs (chapters 9 and 10). EarYy acton isneeded to antipate uneloymet: • Advance notice by employers of closures or mass layoffs is essential to enablc policymak-ers to design appropriate responses. • Close liaison is nceded with other policies addressing unemplovment. In particular, the design and administration of active policies should be carried out in liaison with the delivery of unemployment benefits. Poliy option shol&e iadra edatav earlystage. Policies to assist industrialiy devastated areas include: - Entrepreneurship and small business assistance * Emplovment subsidies * Public wvorks or public service cmployment and * Identification of opportunities for local economic development. The merits and costs of each will need to be evaluated. For example, if the prospects for economic revival in the long term are good, a strong economic case can be made inr the short run for temporary work on environmental and social infrastructure improvements; if the prospects are poor, employment subsidies may be more cost-ceffective. The choice of instrument will also be influenced bv the politics of unemployment. Socldi-alogis'crzaland etailstrhefiloAg: * Tradc unions and employers should work with government to identifv pol- icy options and implement poliev. * The dialog should go beyond reaction to short-term crisis. Unions and employers can and should play a kev role in the design and delivery of retraining schemes, including in-service retraining, and in the provision of labor market informarion. 1189 1 POLICY DESIGN AND IMPLEMENTATION Medium-tmn Policies Policies with a medium-term dimension are of two sorts. Thev serve, first, to develop institutions, from improved employment exchangcs to retraining schemes, which increase labor mobility and thus enhance the ability of worklers to respond to changes in the demand for labor. Second, they deal with large-scale layoffs which in many cases are an inevitable outgrowth of privatization. Retraining samecs should be establWhed. In the short run, retraining suffers from constraints both on the supply side (lack of skilled trainers) and on the demand side (lack of jobs for trainees). There is no doubt, however, that in the long run a major problem in restructuring will be a skills gap, and that substantial resources will have to be devoted to retraining. Various practices have been employed by Western countries wvith respect to the organization and finance of training. Countries in Central and Eastern Europe will, for budgetar reasons, be interested in schcmes in which some or all of the cost can be shared with emplovers, trainees, or trade tnions. The adniuizrcrvefizmervo* needs to be refined. • Initially, most active labor policy emanates from labor ministries. Once short-run policies have been enacted, however, differcnt administrative structures for ministries of labor and public cmplovment services should be reviewed. The flexibilitv which decentralization makes possible should be balanced with the need to foster labor mobility through national labor mar- kct information and labor cxchange services. • Plans should be made to automate services and to develop a management information system to facilitate the planning and evaluation of different policies. Poruics Aoul be awred to del with Irnge-sclk layffl. These policies should build on experience during the early transition, with threc objectives: to identifv staff affected by restructuring, to develop tailor-made labor adjust- ment plans for displaced workers, and to provide services for individual workers: * All the social partners (reprcsentatives of workers, employers, and govern- ment) should be involved. * Measures should be linked to the privatization program and tailored to diverse industrial scctors and geographic circumstances. - Resources should be allocated to local organizations which would have the major responsibilirv for administering thc measures. - Operations should be coordinared by an appropriate body at the national level, perhaps a subgroup of an overall privatization steering commitmce. The initial shock of emerging unemploymcnt has becn considerable. Indi- vidual citizens and policvmakers are rethinking the speed of reform, partieu- 1 190 1 LABOR MARKEVS: UNEMPLOYMM.NT larly since the institutions for social protcction and labor redeployment arc having difficulty coping with the influx of displaced workers. Experience is showing that it will take time and rcsources to reorient labor institutions toward providing the human capital necessary to support the transformation. The absence of the necessary change in labor policy and institutions will slow down tht: eronomnic reform. The question is how to balance the speed of the overall economic reform with the reform of labor and social programs. The problem is made more difficult because dhe returns to active labor policy are hard to quantify: the costs are clear enough, but the benefits of reduced unemployment include many intangibles. The rcal costs of unem- ployment are nor only the lost output and the cost of income support. Unem- ployment is also a personal rnatter affccting human dignity, imposing stress on family life, and creating many of the problems discussed in chapter 4. When it affects the young, the unskilled, ethnic minorities, and older workers, it falls on those least able to absorb the cost. The challenge is both economic and political. It must be met if restructuring is to proceed. Notes 1. In 1991, Poland spent 1.7 percent of GDP on labor markct programs (0.3 percent for active policies and 1.4 for income support); comparablc figures were 3.3 pcrcent in Sweden (2.0 percent acrive), 3.2 percent in Spain (0.8 percent active), and 1.5 percent in the Unitcd Kingdom (0.5 percent active) (see OED 199 lb). 2. For example, thc staff-to-client ratio in public employment services in Romania was 1:470 in November 1992. compared with an averagc of 1:64 in selected otCw countrics. 3. In Poland, for instance, Lchmann (1993) found that participation in training programs appeared to increase the reemplovment of men, but not of women. 4. Conspicuously, in the Czech Republic unemployment started to fall quite sharply when benefit entitlement was cut in January 1992. 5. Thc distinction between the state (a) as provider of publicly produced services and (b) as the source of finance, and possibly also regulation, for privatelv produced services is cruciaL Sec chapter 2 for a fuller discussion. 6. A possible explanation of the last finding is that women tend to be more highly educated than men (see, for instance, Fong 1993, tablc 7). 7. Sone counties, for example, allow individuals to receivc their entire enritlemenE to unemployment benefits (rwelve months of benefits) in a single lump sum. [191 1 Nine 1[NCOME TRANSFERS: SOCIAL KNSURANCE NICHOLAS BARR A KEY MESSAGE OF ThE PREVIOUS TWO CHAPTERS iS that wages and employment should assist the efficient use of labor. Some other instrument is therefore needed for distributional purposes. Cash benefits are thus central to the cconomic aims of the reforms. ' They are also, and obviously, highly political. If unemployment benefits are coo low or paid too late, or if, more generally, too many people remain too poor for too long, the reforms could founder for lack of political support. The backlash against the reforms in some countries is already clear. This chapter and the next seek a meeting ground betveen the economic pressures to contain costs and the political pressures to pay higher benefits. They contain four main messages: *- The state in Central and Eastern Europe has a continuing and substantial role to play in cash benefits, as it does in the highly industrialized countries (see table 1-3). - The major purpose of the system during the early transition was to address emerging poverty. In particular, during the current fiscal crisis, poverty relief should be given priority over the other aims of cash benefits, such as insurance and income smooching (see the glossary). This emphasis on pov- errv relief is intended not as a value judgment about the proper role of cash benefits, but as a response to the fiscal crisis. As soon as the fiscal situation allows, other objectives will come into play, the balance of which is a mater for each country to decide. * Both to achieve these short-run aims and to ensure dhat cash benefits assist the operation of labor markets, the inherited arrangements throughout Cen- tral and Eastern Europe need to be reshaped. Targeting can be improved by increasing expenditure on unemployment benefits and poverty relief, while cutting spending on some other bencfits. * The savings from the cuts in other benefits could finance much of the additional cost of the increase in unemployment benefits and poverty relief. Throughout the two chapters, following conventional usage, cash benefits are divided into three types: * Social insce is awarded without an income test on the basis of (a) a person's contributions record and (b) the occurrence of a specified event, such as becoming unemployed or reaching a particular age. The essence of 1192 1 INCOME TRAN9EPPRS: SOCIAL INSURANCK social insurancc is that it offers protection against what, at least in principlc, are insurable risks. - Univecrl e,efit,s arc awarded on the basis of a specified event, without regard to a person's income or contributions record.2 Examples include family allowvance and free health care. * Sodiala ssistance is awardcd on the basis of (a) an income test (see the glossary) and (b) the occurrcnce of a specified event, without a contribu- tions test.3 This chapter discusses social insurance. Chapter 10 looks aE family benefits (a substantial part of which are univcrsal benefits) and social assistance. Income transfers should be regarded as an integrated system, so the nvo chapters should be read as a whole. The system should be seen in its broader context. Historically, cash benefits made up a much smaller share of gross domestic product (GDP) in Central and Eastern Europe than in the West, with consumer and producer subsidies and public investment making up a much larger share.4 The impact on welfare of the cancellation of most subsidies and the dramatic fall in public investment is an important part of the backdrop. Poverty relief is a recurring theme. Its definition and measurement pose a series of questions for policymakers. First, how is the poverty line defined? Under an absolute definition, poverty is defined relative to the cost of buying a given quantity of goods and services; Wvith a relative definition, it is compared with the income and consumption of others; with a subjective definition, it is compared with a person's expecctations and perceptions. [t is well known that a "scientific' definition of poverty is a miragc; all definitions of poverty, ultimately, are political (see Atkinson 1987, 1989, chap. 1, 1991a; Barr 1993b, chap. 6; World Bank 1990b, chap. 2, 1992c, chap. 1). Nevertheless, the state cannot avoid the issue merely because there is a conceptual impasse. Policymakers need to consider what is necessary for survival, the fact that people require different amounts, and the need to work out the cost of the minimum consumption basket. There is no easy answer: the poverty line has to be based on the best available data on people's incomes, coupled with a view of political realities. The yardstick by which poverty is assessed raises a separate ser of prob- lems. First, what income should be included? Should homc-produced goods, such as vegetables, be included? In principle they should, but the resulting administrative burden is acute. Second, whose income should be included? A narrow definition includes only individuals and married couples; a household definition includes the income of, say, grandparents sharing the familv home; an extended family definition includes the income of close relatives like grown-up children living elsewhere. Narrower definitions reduce the risk of excluding the genuinely needy but are more expensive. A separate problem is 11931 IPOLICY IJKHION ANI) IMPI4UMKNTATION how to treatt families of different sizes. Should ehc poverty line for a family of four be four times that for a single person, or should it be lower, for instance, becausc small children consume less than adults? Measuring the cxtent of povcrty is difficult cven where a definition of the poverty linc has been agreed upon. Policymakers arc intercsted in howo mZanJy pcople are poor (tihe leadcount measure), in howr mucl their income falls below the poverty line (the poverty gap measure), and in how long they are poor (that is, whether their povcrty is cransitory or long run). All three measures require large amounts of up-co-date information on individuals and families. A final problem is that the meaning of poverty relief is ambiguous. Poverty relief has two possible objecctives: (1) eliminating poverty by bringing every- body above a poverty line or (2) reducing the poverty of those below a given poverty line by increasing thcir income, without necessarily eliminating the poverty gap. The purpose of the first policy is, in principle, to reduce both the headcount mcasure and the poverty gap to zero. The second strategy seeks to reduce the depth of poverty of poor people, without necessarily implying any reduction in their number. Targeting is another recurring theme. As discussed in chapter 6, it has two aspects: • To ensure effective poverty relief, benefits should go to all who need them (that is, there should be no significant gaps in coverage). This aspect of targeting is known as horizontal efficiency. * To contain costs, benefits should go only, or mainly, to those who need them (that is, there should not be excessive leakage of benefits). This aspect is known as vertical efficiency. Most political discussion focuses on vertical efficiency, in that it relates to the cost of benefits, but horizontal efficiency is equally important, since it has a direct bearing on the effectiveness of poverty relief. There is a mistaken view that accurate targeting is possible only by award- ing benefits on the basis of an income test, where the amount of benefit is directly related to individual or family income. Income tests have major costs, however: they are administratively demanding, they can be intrusive and hence stigmatizing, and they can creatc major disincentives to work effort and saving. Moreover, accurate targeting does not always require an income test. The poor can be identified in two ways: through an income test or via indicators of poverty, that is, possession by the individual or family of one or more easily observable characteristics which are highly correlated with pov- erty, for example, poor health, old age, or the presence of children in the family. Social insurance benefits are based on factors such as unemployment, poor health, or old age and thus use indicator targeting. Simnilarly, family allowance, being based on family size, is also well targeted, notwithstanding the absence of an income test. 11941 INCOMHi TRANHPI'KHIU SOCIAIL I NNIRANCIH The difficulties should not be undercstimated: defining a poverty linc is probleimatic, tight turgcting can create a tension between the economic and political sustninability of the reforms, and indicators of poverty may be imper- fect. For all thcse reasons, targeting is a mattcr of considerable subtlety (sce Atkinson 1993). The Inheritance The system of social insurance which countries inherited at the start of the reforms was well establislhed. This was one of its grcut strengths. But the system was also wasteful and poorly adapted to the needs of a market economy. As discussed in chapter 3, the old arrangements comprised a wide-ranging and mature system of social insurance, including sick pay, pensions, and generols family allowances. The system covered the great majority of workers and their families. These benefits, combined with more or less guaranteed employ- ment, gavc workers and their families a considcrable degree of security. Weaknesses The major adverse political inheritance was the viewv that the state and the encerprise were jointly responsible for the well-being of the individual. The major adverse economic inleritances were lack of targeting and weak adminis- tration (for studies of Hungary, Poland, Romania, and the Russian Federation, see World Bank 1992b, 1992d, 1993b, 1993c, respectively; see also Kopits 1992). The lack of targeting manifested itself particularly in the form of ineffective cost containment, holes in the social safety net, and adverse incentives. INEFFEICTIVE COST CONTAINMENT. Expenditure can be excessive because the level of benefits is high or because benefits are easy to obtain; it may also be possible to combine work with receipt of benefits on generous terms. High benefits arise, first, because many benefits are fully related to earn- ings. It is not self-evident that this should be so. Flat-rate unemployment benefits are becomning more common, as in Bulgaria and Poland, and Estonia and Latvia have both flat-rate unemployment benefits and flat-rate pensions. Another possibility is to have a basic, flat-rate pension plus a second-tier carnings-related pension which rises less than proportionately with earnings. Furthermore, most benefits are increased in line with changes in earnings. When real earnings fall, costs decline, but so does the minimum benefit. This reduces the effectiveness of poverty relief. When real earnings rise, however, the use of an earnings index adds to the cost of benefits. Thus, tying benefits [195 1 POLICY DESIGN AND IMPLEMENTATION to earnings hinders poverty relief if real earnings fall and makes cost contain- ment less effeccive if real earnings rise. A second class of problem with cost containment is the ease of access to some benefits. Early legislation tended to define unemploynient broadly. The 1989 Polish law, for instance, awarded benefits to all persons without a job, even if they had no recent attachment to the labor market. Access to pensions is also easy. Normal pensionable age in Central and Eastern Europe (sixty years for men, fifty-five for women) is low by Western standards, and some groups, such as miners, teachers, and ballerinas, are eligible for pensions even earlier.5 These groups can be numerous. As will be discussed shordy, they can generally receive pcnsions while continuing to work, often in their old job. In addition, years of work while receiving a pension count as years of service and add to a person's pension entitlement. These arrangenents, again, are under- standable in their historical context, given pervasive labor shortages, but their cost is high. In Poland in 1990, one-third of expenditure on old-age pensions benefited individuals below the normal pensionable age (World Bank 1993b, chap. 4). Invalidity pensions raise parallel problems. Recipients are numerous for two separate reasons. First, for the reasons discussed in chapter 5, little emphasis was put on safety at work, so that many individuals now have genuine and serious health problems. This situation requires separate remedial action. Second, benefits are relatively easy to obtain, not leasc because the authorities typically have little power to control access. Western European experience suggests that rising unemployment will put increasing pressure on invalidity pensions. Cost containment can be ineffective also because of the case with which receipt of benefits can be combined with work. Old age pensioners can generally work full time, or nearly full time, with no loss of benefits. Similarly, people can qualifv for invalidity pensions even if they havc suffered no loss of carning capaciry. An individual who loses a limb, but whose long-run hcalth and capacitv to work are not affected, will generally receive a continuing, partial invalidity pension while performing his or her old job and receiving a full wage. HOLES IN THE SOCtAL SAFET NEr- Despite high levels of spending, poverty relief can be incompicte for four reasons: data may be lacking on the extent of the problem, some benefits may be too low, there may be gaps in coverage, and some people may not receive the benefits to which they are entitled. The absence of data on people's incomes exacerbates the problem of defin- ing and measuring poverty. Some countries have better data than others, but information can bc seriously deficient. The adequacy of the minimum benefit is questionabic. The problem arises because the minimum level of the major benefits is often tied not to a poverty 1 196 1 INCOME TRANSFERS: SOCIAL INSURANCE line but to the average wage or the minimum wage. If the minimum benefit is tied to the average.wage, the minimum benefit falls if overage wages fall, and real wvages fell significantly throughout Central and Eastern Europe during the early transition. Indeed, the whole purpose of the incomes policies which normally accompanied the early transition was to ensurc that wages were not fully protected against inflation. If the minimum benefit is tied instead to the minimum wage, the issue becomes highly politicized. The minimum wagc is highly political in the best of times, and even more so when subsidies on basic commodities are being reduced. If there are additional knock-on effects for the minimum level of benefits, it becomes even more political. Gaps in covcrage arise, first, through inadequate linkage between benefits. Under the old system, virtually all cash benefits were part of social insurance. The reforms typically produced three sets of benefits: unemployment bene- fits, social insurance benefits, and social assistance, organized by three sepa- rate authorities!' Gaps arise where the three sets of benefits are incompletely linked with one another, which is a particular problem for recipients of unem- ploymcnt benefits. A broad-ranging system of social assistance is necded to cope with these imperfect links, to cope with poverty in familics of diffcrent sizes, and to copc with the narrowing scope of social insurancc. The weakness of social assistance, the second important gap, is one of the central topics of chapter 10. A Lhird gap is incomplete coverage of workers in the private sector. -The problem is no longer one of eligibility (workers in the private sector typicaliv face the same regime as workers in the stare sector), but one of enforcement. In an unknown number of cases, private sector employment remains undeclared, resulting in incomplete or missing contributions records and hence loss of benefit entidement. Non-receipt of entitlement is potentially a further problem. Not everyone who is entitled to benefits may receive them. Take-up can be incomplete either because people do nor apply for benefits, or because they apply and are wrongly refused (see Atkinson 1989, chap. 1) No quantitative evidence exists on take-up in any of the countries in Central and Eastern Europe. Problems have been observed, however, particularly with social assistance, but sometimes also with pensions, when funding sources have dried Up.7 ADVERSE INCENTIVES. Expenditure depends on two sets of factors: the aver- age level of benefits and the number of recipients. Both are significantly influenced by the underlying incentive structirc. Benefits can create adverse incentives, particuarly in respect of work effort. In many countries in Central and Eastern Europe, unemployment benefits pay up to 75 percenc of the workers previous wage; in Ukraine and Belarus early in the transition it was 100 percent for the first three months of unemploy- ment. Similarly, sick pay is often 100 percent of the worker's wage. The resulting tendency to take extended sick leave is aggravated by weak monitor- 11971 POLICY DESIGN AND IMPLEMENTATION ing. The incentive effects of unemplovment benefits have been sEudied exten- sively in the West (for surveys, see Atkinson and Micklewright 1991; L.ayard, Nickelx, and Jackman 1991). The prevailing view is that the ratio of benefits to previous earnings (known as the replacement rate) should not be given undue emphasis as an influence on the level or duration of unemployment. Other factors-for instance, the fact that unemplovment benefits are cut off after, say, nvelve months-are regarded as more important. That research, however, is based on the range of replacement rates typical in Wesrern Europe and the United States, which are between 35 and 70 percent, and therefore cannot be applied uncriticallv to Central and Eastern Europe." Other adverse incentives arisc where the definition of unemployment is broad, wherc the duration of entitlement is unlimited, and where the condition that recipients must be actively seeking work- receives litde attention. The contributions regime also creates adverse incentives. The social insur- ance contribution is generally paid entircl by the employer, the absence of a worker c.ontribution having been regarded as one of the victories of socialism. In the West, contributions are normally shared between worker and employer. If the entire contribution is paid by the employer (and even worse where employers face a soft budget constraint), everyone thinks that benefits are paid by someone else. This is the third-party payment problem, in which no one has an incentive to restrain benefits. The situation is exacdy parallel with fee-for-service medical care financed by insurance. Contributions are typicallv about 40-45 percent of the gross wage, although they can be considerablv higher (81 percent in Ukraine in April 1992), not only interfcring with the competitiveness of enterprises but also depressing the demand for labor and, in particular, given the high cost of bcnefits for mothers with Young children, the demand for female labor. A fuirher problem is that contribuutions are fragmented. Throughout Central and Eastern Europc there was considerable ermarking through multiplc conrribu- tions: some pay slips could have more than twenty separate contributions for different benefits. Such contributions used to be transferred to the general budget, which allowed for sizabl-c redistribution between the insured and the general population. Governments routinely used social insurance resources for other purposes. One ill effect is fiscal inefficiencv. Depending on how contri- bution rates are specified by legislation, for example, some benefits may be overfinanced, while others are underfunded. In addition, separate collecion procedures for each of the funds are administratively costly. WEAK ADMINIsTRRA'ro0N. In the past, benefirs, such as family allowance and pensions, were rmostly long term. Individuals receiving short-term benefits from the public authorities vere few and could therefore receive Rolls Royce treatnent. The main Employment Office in Warsaw at the start of the reforms was paying unemployment benefits to five people. In addition, little emphasis [ 198 1 INCOME TRANSFERS: SOCIAL INSURANCE was put on administrative efficiency. For both reasons, benefit structures tended to be highly complex. This is noE sustainable wvith large-scale unemployment. The second kev administrative characteristic waus the major role played by the enterprise. Enterprises provided information to employees aboiut entitle- ment. assisted with pensions claims, and organized the payment of family allowance and short-term benefits as part of an individual's pay pack-et. The first problem with this arrangement is that administration of benefits by enter- prises is becoming more and more unsustainable as job mobiitv increases, as enterprises increasingly face hard budget constraints, and as large numbers of peoplc work for small-scale employers or become sclf-cmployed. These changes necessitate a major transfer of administration from the enterprise to the public bcnefit authoritics. A second problem is the extent to which t'c social insurance authorities are ignorant of individual records. All but the smallest enterprises pay social insurance contributions as a single lump sum covering all their workcrs. The social insurance authorities Aave no knrowkdge whatever about an individual's vnnibwinos ar=d. Individuals who arc approaching retirement must put together, with the aid of their employer, a dossier of their entire work historv to establish their contributions record. For the same reason, the social insurance authorities generally haveno lknldge of :,tiduaks who reive short-tamn bmeftr andfamiy albwkc. Both problems impose maor limitations on the range of reforms which are administratively feasiblc in the short run. Administrative capacity was, and remains, limitcd. Records are generally of the pencil-and-paper variety. The main method of getting short-term benefits to recipients was through the emplovcr. For benefits such as pen- sions, the main vehicle of payment was, and is, cash sent through the postal svstem. Pernna Prob/tis Vicwed from a Western pcrspective, the old svstem paid insufficient atten- tion to resource constraints and to the types of tradeoffs discussed in chapter 1. A kev aspect of the reforms, therefore, is to improve the efficiency of resource use. As chapter 3 madc clear, however, most of ehe countries in Central and Eastern Europe will ncd a long rime to catch up with living standards in Western Europc Additionally, and in sharp contrast with Maris dtinking, higher standards 3f living will never wholly solve the problem of scarcitv. Resource constraincs wili persist, and institutional capacity con- straints will be eliminated only slowly. For both reasons, the social safety net will not be as effective as soon as people would Wish. Perennuil problems will remain. As experience in the Wcst makes abundantly clear (Adtinson 1992), the twin problems of unemplovment and poverty wil never com- pletcly be solved. 11991 POLICY DESIGN AND IMIPLEMENTATION The Forces Driving Change The economic and political driving forces discussed in chapter 4 apply in a powecrful and verv simple way to cash benefits. On the economic side, price and wage liberalization create two sets of effects: The widening distribution of income is associated with increased unemploy- ment and rising and more visible poverty. In addicion, the administration of benefits becomes more complex: under the former, fairly flat distribution, bencfits could be targeted at specific gr'ps, such as families. With the current, widening distribution, bencfits must be targeted also by level of income. The resulting sysrem has grcater coverage and more complex tareting. Dcclining output is creating a fisa crisis which exposes manv of the weak- nesses of the old svstem. It emphasizes the need to improve targeting, both to relieve poverty more cffectively and to contain costs. Difficulties with tax collection and social insurance contributions expose the administrativc weakness of the old svstem. An important implication of the widening distribution of incomc is the need for a more sophisticated structure of benefits. The social insurance svstem, w.hich in the past also delivered most social assistance (such as pensions to invalids wvith litde or no contributions record), will, as a result of the reforms, no longer be able to do so. Insurance benefits (with benefits bearing an explicit relationship to contributions) must be separated conceptually from noncontributorv benefits such as family allowance and social assistance. -The political driving forces are equally clear. The imperarive of achieving higher living standards creates pressures for increased benefits; and higher benefits are in direct conflict with the need to contain current expenditure in the interests of longer-term grouth. Polev Different cash benefits contribute to the objectives of policy in different ways, depending in part on their construc;ton. Unemplovment benefits and sickness benefits conrribute to the insurance objective by reducing the extent of sharp, unexpected falls in income. If the formula for determining benefits is weighted toward lower-paid individuals, benefits also help to relieve poverty, particu- larlv short-term poverty, and rediszribute income from rich to poor. One of the major purposes of explicit social insurance contributions is to give recipients an entitlement to benefits, thereby fostering social integration. If properly constructed, the benefits minimize adverse incentives to labor supply. Pensions have tvo aspects. The primary purpose of invaliditr and sur- vivors pensions is insurance. Retirement pensions offer insurance, since peo- ple do nor know how long thev will live, and also enable people to redistribute t 200 1 INCOME TRANSFERS. SOCIAL INSURANCE income to themselves over their life cycle, thus contributing to incomc sMoothing. Both types of pension help to relieve poverty, particularly long- tcrm poverty, and may also rcdistribute income from rich to poor. Like other social insurance benefits, they also contribute to social integration. Family allowances have a major objective of income smoothing and also contribute to povertv relief, To the extent that the bcnefit is financed out of progressivc taxation, it also contributes to vertical redistribution. If the benefit is univcrsal, it assists social integration; if it is paid to the mother, it redis- tributes toward women. Social assistance primarily seeks to reliev poverty and also contributes to vertical redistribution. The Strategy The effects of the driving forces include rising unemployment, increased poverty, severe fiscal constraint, and exposure of administrativc limitations. So far as cash benefits are concemed, the resulting policy strategy follows naturally and is entirely consistent with that presented in chaptcr 6. The primary policies concentrate on: * Strengthening povertv relief C Containing costs * Raising administrative capaciq. Additional policics are concerned with: * Improving incentves * Diversifying supply, particularly in connection with privatc pensions. The first two policies are the nvin aspects of targeting discussed at the start of the chapter benefits should go to evcryone who needs them and, at least up to a point, onlv to those who necd them. There is a clear distinction between short- and medium-term policies. While the fiscal crisis lasts. poverry relief should be given priority over the insurance and income-smoothing objectives. Thus fiscal constraints blur the distinction bewveen insurance and non-insurance benefits. As soon as resources permit, a clear relation benveen individual contributions and benefits should be restored; the extent to which the relationship is strictly actuarial is a policy choice. Before turning to a detailed discussion of how this strategy might be trans- lated into policy, it is worth asking whether the social safety net, even if reshaped along the lines suggested below, is affordable. In crying to answer the question. it is important to distinguish public costs from social (that is, economy-wide) costs. Put crudely, if the state ceases to pay a wage to a workier who is producing little or nothing, and instead pays him or her a lower unemployment benefit, there is a net saving. Two cases should be considered: where value added is smaller, but not much smaller, than wages, and where value added is effectively zero. As 1201 1 POLICY DESIGN AND IMPLEMENTATION discussed in chapter 7. if valuc addcd is significant, the cost-minimizing policy night be temporarily to subsidize employment. If redundant workers pro- duced zero value added in their former job and previously earned the average wage, gross savings are then the number of redundant workers times the average wage times the average duration of unemployment. Since unemploy- ment benefits are generally less than the worker's previous wvage, it follolvs (unless the costs of training and other active labor market policics are high) that the total savings to the enterprise sector will be greater than the total costs of unemployment benefits. From the viewpoint of the economy as a wholr., there is a net saving. The problem is that most of the costs fall on government and most of the savings accrue to the enterprise sector, so that more rapid adjustment has budgetary implications. although these are less acute if wages had previously been subsidized out of tax revenues. The general point, however, is valid: public expenditure on the social safcty nct should not be considered in isolation but viewed alongside the resulting direct and indirect savings to the entEcrprise sector. This argument confirms the point that income support, quite apart from its distributional objectives, has a key role to play alongside other labor mnarkcet policies in assisting the ovcrall economic objectives of the reforms. A different aspect of affordability is that replacing untargeted general price subsidies with wvell-rargeted income subsidies also creares some leeway for financing the social safety ne. Maintaining Macroeconomic Balance Maintaining macroeconomic balance is pursued both through efforts to mobil- ize private resources and through policics to contain costs. mOBItZING RESOURCEs. As discussed in chapter 1, most income transfers in the highly industrialized countries are organized by the state. The only signifi- cant cxception, private pensions, is discussed in some detail later in the chaptcr. CONTAINING COSTS. The obicctivc here is co restrict benefit spending with- out undermining povcrty relief. Policies include sharing the costs of sick pay, tightening access to pensions, and improving the targeting of uprating of benefits (that is, increases in benefits in rcspcnse to increases in earnings or prices). Shaintg cost. Sick pay would be more cosc--.ffeccive if workers were made responsible for the initial period (say, one to three days) of absence from work for health-related reasons, with employers responsible thereafter for a spe- cified period (perhaps two to four weeks). Only then would people with health problems become a charge on the social insurancc fund. The social insurance authorities would escablish minimum standards for such arrangemcnts. 71gWteningpension dregbifry. Reducing access to pensions would yield large savings while still offering effective poverty relief to the old and disabled. l 202 1 INCOME TRANSFERS: SOCIAL INSURANCE First, aw arding an invaliditr pension to anyone whose earning capacitv has nor been reduced could be discontinued, wvith compensation for permanent loss of a faculty which does not reduce carning capacity taking the form of a lump- sum payment. Although the policy is clear, implementation is problematic because earning capacitv is difficult to assess. However, it is administratively less difficult to stop paying invaliditr pensions to people who continue in their old job at their old rate of pay, which is a common occurrcnce in Ccntral and Eastern Europe. The proposal is not to withdraw invalidirv pensions gener- ally, but only w here earning capacity has not been adversely affected. A second aspect is pensionable age. The ratio of pensioners to workers is high both because the official pensionable age is low by Western standards and because for significant numbers of people the effectivc age at which they first reccivc a pension is even youngcr. Earlv retirement in Poland absorbs one- third of all expenditure cn old age pensions. Similar problems exist in all the countries of Central and Eastern Europe. The facts are clear. Policy, however, must achievc a difficult balance between different objectives. In the mcdium term, pensionable age should be increased, with cirly retirement only on the basis of an actuarialv reduced pension or actuariallv higher contributions (see rhe glossary). This would remove ardficial incentives to early reirement, improve the equitv of the system as between different groups of workers, and ease administration. Short-term policv is more difficult. The argument for raising the effective pensionable age is the resulting substantial savings in public expenditure. There are three arguments for caution. First, there might not be amn savings; this could happen if people whose rctirement is delaved are paid a higher pension when they finally do retirc. Second, increasing the pensionable age might not be politicallv feasible in the short run. Third, raising the age of retiremcnt, even if it does yield fiscal savings, may have other costs. Western experience shows the discouraging and debiliatng effects of long-run unemployment, especiallv for the voung. A case can there- fore be made for encouraging older workers to retire because this would assist restructuring and open up jobs for younger pcople. Combining work with receipt-of a pension is a third problem arca. Again, thcre is a conflict of objectives. On the one hand, the abilitv to continue working while receiving a mrac or less full pension is costly. This suggests the need for a rctirement test, at least for people below normal retirement age. For example, the pension could be withdrawn from-or at least lowered for- anyone who earns more than a fairly small amount. An effective recirertzenr test of this sort would create savings in two ways. If a person does not rctire. the pension payment is saved; if he or she does retire, a job is released which can be filled by an unemployed person, thereby reducing expenditure on unemplovmcnt benefits. The argument againsr this approach is rhat early retirement allows firms to make older workcrs redundant and rhus assists rcstructuring. This suggests that rather than impose a retirment sat, it is worth 1 203 1 POLICY DESIGN AND INtPLEMENTATION considering a changf-job rt, whereby individuals who retirc but find another job are allowed to keep at least part of their pension. Once more, though the policy is clear, implementation is problematic; Soviet cnterprises wcre adept at organizing fictitious job changes. This sorc of problem can be sidestepped for people who become sclf-cmployed, where a strong case can be made for allowing them to keep some or all of their pension. It is important to clarifv what is being criticized and what is not. The problem is not the outcome-early retiremenr-but the process leading to that outcome4 in particular the absence of anv clear connection between the contri- butions paid by an individual and the bencfits he or she receivcs. The problem can bc resolved in the medium tcrm by strengthening the relationship betwecn contributions and benefits. In the short tcrm, howevcr, there is an acute conflict betveen restructuring and employment for the young, on the one hand, and cost containment, on the other. Bet4rtsrgrduprazvgof6mer (see the glossary). As discussed earlier, bene- fits tied to earnings are problematic. If real earnings fall, they fail to relicve pov- erty; if real earnings rise, they conflict with cost containmcnt- A policy which combines cost containment with effective poverty relief has tvo legs: - TMc minimum level of all the major benefits and of social assistance is fully protected against price increases. - While the need for fiscal stringency persists, benefits above the minimum are increased only to the extcnt that the budgetary situatior permits. The first part ensures effctive poverty relief, the second ensures that it is achieved at minimum cost. As the economic situation improves, real benefits abovc the minimum could be pardv or wholly restored. Although the strategy is clear, the administrative and political difficulties of controlling increases in benefits during times of high inflation should not be minimized. BudingAanWr The reform of cash benefits can support markets (a) bv diversifving the supply of some social insurance benefits and (b) bv improving incentives. DitERvIFTUG SUPPLY. The main benefit for which markes are relevant is private pensions- These are a medium-tcrm issue which is currently the subject of heated debate in Central and Eastern Europe The subjcct is taken up in detail below. IMPROVING INcErwFs. Three arcas stand out: improving the incentive structure of benefits, reducing the burden of payroll contributions, and sharing the social insurance contribution benvecn worker and employer. The structure of bcnefits can be improved, fuist, by reducing the high replacement rate (see the glossary) for unemploymcnt benefits and the 100 204 1 INCOME TRANSFERS: SOCIAL INSURANCE percent replacement rate for sickness benefits. The right to combine full benefits with work for individuals below retirement age should be recxamined for reasons of incentives as well as costs. The ideal qualitative relativitv of the different benefits as earnings decompress and the fiscal situation improves is that the poverty line should be below the minimum unemployment bencfit, which should be below the minimum %wage, w thich should be below the aver- age wage In the short run, the relativitics should be kept under revieW tO create the best balance between the need to relieve poverty and the need to minimize adverse incentives. The level of payroll contributions needs to be reduced and their structure sirnplified. It might be argued thac sith real wages so low, high conmbution rates arc not a major problem. That vicw is mistaken. High employcr contri- butions give incentives against nev employment, encourage worker and employer to collude in fraud (by declaring a lower wvage than the worker actually receives), create incentives to unofficial emplovment, distort the rela- tive price of labor and capital, and tak}e from enterprises the resources thev need to invest in new plant and equipment The employers contribution can be reduced in three ways: by financing through general taxation benefits like family allowance which do not relate to any insurable risk, by reducing bene- fits, and bv sharng the contribution berween work-er and employer. Shared contrbutions would follow the typical pattern in the highly indus- trialized countries. The social insurance contribution should be divided between the emplover and the individual worker, vithithe vorker's contribu- tion appearing as a deduction on his or her pay slip. Although the theoretical importance of the division can be debated, worker contributions give impor- tant political and economic signals. The political signal concerns responsibil- iry and is particularly important during the transitiorn thEt the state is responsi- ble for establishing the gencral framework of social protection, but that the individual, through earnings and contributions, is substantiallv responsible for himself or hersclf. Where contrbutions are paid wholly bv the enterprise, and even morc if the entcrprise faces a soft budget constraint, neither workers nor employers face any incentive to moderate their claims. This is another instance of the third-party payment problem. With a worker's conmbution, any increase in benefits instantlv incrcases the contrbutions deducted from individuals' pay packets. The resulting economic signal is that it is the wter who pays, at least in part, for social insurance benefits. RegalarihngMartFore Market forces need to be regulated through policics to relieve poverty, through the development of an enabling environment for insurance and income smoothing, and through the introduction of a regulatory structure for private providers of benefits. O 705 POLICY DESIGN AND IMPLEMENTATION REUEVING POvEWrY. The policies discussed below are based on threc propo- sitions: * In the short run, for fiscal reasons, poverty relief should be given priority over the objectives of insurancc and income smooching. The major components of cash benefits which should be expanded are unemployment benefits and povercy relief. * Wherever possible. poverty relief should be based on indicators such as age or family size to minimize the need for administrarively demanding income testing. This suggests that the minimum level of the major social insurance benefits should not be below the poverty line. S&egrhntdi unewptymei bkwft. Early legislation tended to exhibit prob- lems requiring substantial arnendmcnt of employment laws to tighten eligi bilitn, to strengthen the incentives for individuals to seek work (for instance, by limiting the lcngth of time for which benefits were paid), to strengthen the checks to ensure that individuals were seeking work, and to simplify adminis- tration. A second set of activities coi;cermed building administrative capacity to cnsure that the system could deliver benefits to increasing numbers of recipients. In Poland, unemployment rose from negligible levels to more than I million during 1990; and there was a proportionately similar increasc in Bulgaria during 1991 (see table 1-1). The system. by and large, coped well with delivering benefits but less well with organizing active labor markle policies. Rat-rate unemployment benefits, such as thosc in Poland and Bulgaria, have short-run advantages: reduced cost, improved incentives to seck work, and ease of administration; i:i thc short run, sick pay could be paid at the same flat rate and certainly at less than 100 percent of the worker's wage- Incentive arguments suggest chat a person should not normally be eligible for unemploy- ment benefits for more than a specific number of months, although such a provision could noe be put into effect until social assistance is able to provide poverty relief for those whose entitlement to the insurance benefit has expired. As the fiscal situation improves, government may choose to retain a svstemn of low, flat-rate unemployment benefits or to increase the flat-rate benefit or to return to benefits relatced to individual earnings. I!pivviagpon ,nff. Poverty existed under the old system, and there is increasing evidence that the transition aggravates it, particularly for the unem- ployed, the elderly, and families. Morc and better information is needed, both to make povcrty relief more effective and to help contain costs. The data should be sufficiemnly detailed to show the changing position of different groups such as children, women, the unemployed, and the eldcrly. Key policy reforms include the protection of minimum benefits, the avoid- ance of gaps in coverage, and the creation of a system of social assiscance. The starting point is to establish and maintain appropriate levels of minimum 12061 INCOME TRANSFERS: SOCIAL INSURANCE benefits. Given the doubts about die level of the minimum benefit discussed above, the minimum level for all major bencfits requires continuing review. The aim should be to set unemployment bencfits and the major social insur- ance benefits at or above an irdividual poverty line; social assistance should be defined relative to afamily poverty line. To the extent possible, the minimum benefit should be fully protected against inflation. Coverage should also be as complete as possible. Unemployment benefits and most social insurance benefits, if the minimum benefit is adequatc, address individual poverty but not necessarily family poverty. Recipients of such benefits should therefore be eligible for social assistance. The adminis- tration of social assistancc must thus be able to copc with large numbers of applicants, necessitating administrativc reform and additional administrative rcsources. Anothcr aspect of coverage is thc protection of employees in the private sector through action to reducc large-scale evasion of contributions. Ca,4=ng the di-stiniaon bkentw mswrnnceadnon-isrance bexiv.# Action of this sort has already occurred in several countries. Although policy in the short erm may have to concentrate scarce resources on protecting the minimum benefit, the relation between contributions and benefits could usefully be strengthened as soon as economic conditions permit. The move to strengthen the relation betveen contributions and benefits increasingly rules out the use of social insurance contributions for non-contributors or to finance in-kind benefits. It thereby removes from social insurance much of the social assis- tance function. The narrower scope of social insurance has alreadv excluded many people who were previously covered, such as disabled people who have no contributions record, or part of the agricultural population who, after the dissolution of cooperatives, are unable or unwilling to pay contributions. Alongside, and connected with, the stronger relation betveen contributions and benefits is the increased self-governance of social insurance funds, whose independent management is responsible for maintaining actuarial balance and representing the interests of the insured."' Though there is general agreement that the relationship between contribu- tions and benefits should be strengthened, the extent to which it is sztzy actu- arial is a policy option. Social insurance has two distinct roles: (a) as a device to address failures in private insurance markets and (b) as a device which allows redistribution from rich to poor within a generation or between generations. The extent to which social insurance embodies redistribution is fundamentally and importantly a value judgment: the lower the weight given to redistribution, the stricter the relationship between contributions and benefits. Where redis- tribution is not a goal, the relationship will be strictly actuarial. Where social insurance incorporates rediscribution (as it typically does in the West), benefits should still be related attAemazin to individual contributions, and contributors and beneficiaries should perceive this to be so. The argument is imporant. Pol- icvmakers may have a pension formula which is redistributive in the sense that [ 207 1 POLICY DESIGN AND IMP'LEMENTAI'ION worker A, who has twice the earnings of worker B over his working life, gets a pension which is higher than B's, but less than twice as high. If either A or B retires early, however, his pcnsion should be actuarially reduced relative to the pension he would have reccived at age sixty-five. The relationship should be strengthened for at least three reasons: to achieve equity (for example, the early retirement provisions for miners dis- criminates against other groups in the work force), to minimize distortions to individual retirement decisions, and to counteract the strong incentive for workers to evade contributions when they do not sce a clear relationship betwveen contributions and benefits. It is important that some of the impetus to enforce contributions comes from incentives rather than administrative activiry, not least because enforcing contributions, particularly in the growing private sector, will be a continuing problem. In the medium tcrm, therefore, a closer relationship between contributions and benefits is a key component of the social insurance strategy. Poverty relief should incrcasingly be based on social assistance and other tax-funded benefits such as family allowance. PROVIDING AN ENABLING ENVIRONMENT FOR INSUtANCE AND INCOME SMOOTH- ING. A central role of the stare for this purpose, as more generally, is to keep prices sufficiently stable to enable financial assets to act as effective stores of value, thereby encouraging voluntary savings and insurance. INTRODUCING A REGULAIMRY sUmcURE. Private insurance in general, and private pensions in particular, depend crucially on well-regulated financial markets generally and a regulatorv structure of the pensions industrv specifi- cally. A key purpose of such regulation is consumer protection. Divenrjing Sapp4y: The Role of Private Pnsions Discussion so far has concentrated mainly on the short run and mainly on addressing problems with the existing system. This section turns to an area writh a more medium-term horizon. State pensions, it is said, pay too little to too many at too high a cost. One suggestion has been partially to replace the state system with private pensions, which would accumulate a fund out of which future pensions would be paid. WHY PRIVATE PENSIONs? This is an area of continuing controversy among economists (see Aaron 1982; Auerbach and Kotlikoff 1990; World Bank 1994). Notwithstanding arguments to the contrary, this is anodier area with no silver bullet, that is, no single, simple, completely effective solution. A number of definitons are important. With pay-as-you-go (PAYG) schemes, this year's pensions are by and large paid out of this vear's contributions. Most stare schemes are organized in this way. Withfi&de*schemes, in contrast, the individual accumulates a fund over his or her working life; upon the worker's retirement, this is generally converted into an annuity, that is, a flow of 1 208 l INCOME TRANKI'ItRS: SOCIAI. INSURANCiE income for life. Funded schemeis thus combinc saving during a person's work- ing life wiuli insurance (the annuity). Most privatc scleies operate in this way; a few state schemes also have fundcd or partially funded coniponents. Two types of funded schemes should be distinguished. Under a deflned ctc rn- bAwdow scheme, a person's pension depcnds only on the size of hiis or her pension accumulation. The risk of varying rates of return to pension assets and eic risk of inflation after retirement are thierefore borne cntirely by the individual. With a defined benieflr scheme, usually run at the level of the firm or industry, the individual's pcnsion is normally based on the number of years of service and his or her final salary. In this case, the employer bears at least part of the risk of different rates of return to pension assets. Sevcral advantages are claimed for private, funded pensions: * To the extent that they take over from state pcnsions, they reduce public spcnding. i They lead to increased savings and hencc to higher cconomic growth, thus making it possible to pay higher pensions or to pay pensions in the face of an aging population. * They help to develop capital markets and, in the context of Central and Eastern Europe. may assist privatization. i They protcct the government from political pressurc since, in a funded scheme, future increases in pensions arc possible only if contributions incrcase in the present. Such claims engender powerful lobbies in favor of private pensions in a num- ber of countrics. BACKGROUND THEORY AND EVIDENCE. Several conclusions provide helpful background to subsequent discussion of expericnce in the highly indus- trialized countries and elsewhere. These relate to the lack of consumer infor- mation, the effects of inflation, the budgetary impact of private pensions, and their effect on savings and economic growth. Consumer ignorance is a major problem. Financial markets are highly com- plex, and consumers are ill-informed of how they work in principle and even less informed of how they operate in practice. Regulation of financial markets generally and of the pensions market in particular is therefore required to protect consumers in an area where they are usually not sufficiendy well- informed to protect their own intcrcsts. Inflation is not an insurable risk for the reasons set out in chapter 2. Nor is the private sector generally able to offcr other indexed assets on which to base pensions. Although there is controversy as to why no private sector financial instruments offer a risk-free real return (that is, a return which is consistently greater than the rate of inflation), the evidence is clear. Bodie's (1990, p. 36) survey points out that "virtually no private pension plans in the U.S. offer automatic inflation protection after retirement." Gordon's (1988, p. 169) - 209 1 POLICY UESIGN AND IMPLEMENTATION cross-national conclusion is that "'indexing of pension benefits after retirement . . .prescnts scrious difficulties in funded employer plans." Private pension schemes in the West have experienced problems with inflationary shocks even in the absence of structural change. It is true that many countries have also experienced problems with their PAYG schemes in the face of inflation; such problems, however, are not the result of inflation per se but rather of unrealistic promises in the past and fiscal deficits in the present. I I Sometinmes these problems can be sidestcpped. Private schemes can cope with inflation during a workers contribution years, and internationally diver- sified funds can rcsist purely domestic inflation. The latter, however, is not necessarily useful in Central and Eastern Europe, given the risk of capital flight if private pension funds are allowed to hold forcign assets. More gener- ally, the greater the extent of a common inflationary shock such as an oil crisis, the less well-placed are funded pensions to resist it. Without intervention by the state or some other benevolent entity, individual pensioners face the entire inflation risk. Etfects on the state budget in the short run are fairly clear-cur; any signifi- cant move tO funding generally iicreaws puhlic spending. The reason is straightforward: under a PAYG scheme, contributions by workers are used to pay the pensions of the elderly and so cannot be put into the workers' pension fund; in a switch to funding, an additional contribution is therefore needed to begin building the fund. Because it is generally not politically possible to impose a double contribution on the current generation of workers. substan- tial budgetary transfers are necessary in the early years of a move to funding. Even in the long run, the budgetary gain is reduced to the extent that the state guarantees a minimum pension or offers any guarantees against inflation or other risks, for example, by issuing indexed government bonds. The effect of funding on savings and growth is arguably the most controver- sial area. The large literature on the experience of countries in the West is inconclusive both theoreticallv and empirically (see Aaron 198Z; Auerbach and Kotlikoff 1990; World Bank 1994). EXPERtENCF IN HIGHLY INDUSTRIALIZED COUNTRIES. As table 1-3 makes cleair state spending on old age security in all the highly industrialized countries is substantial, mainly in dhe form of rNc schemes, and financed by earnings- related social insurance contributions (the Western experience is 'well docu- mented; see OECD 1988a, 1992b on highly industrialized countries; for the OECD experience and possible implications for Central and Eastern Europe, see Holzmann 1991). Stare-funded schemes, which exist in very few of the OECD countries, have not fared well.'2 An international survey concluded that they "offer powerful evidence that this option may only invite squandering capital funds in wasteful, low-yield investments lwhich] should give pause to anyone proposing similar accumulations elsewhere" (Rosa 1982, p. 212). 2101 INCOME TRANSPERS: SOCIAL INSUR.ANCE Private funded schemes ecist in all the highly industrialized countries as a complement to state schemes, often in the form of defned benefit schemes run on occupational lines. Their performance has been sensitive to overall economic developments. In particular, they are sensitive to the effects of unanticipated inflation. Overall, howvever, they have performcd rcasonably wvel1. Given the problems of consumer ignorance and the inflation risk, private pensions in Western Europe can be broadly described as having four charac- teristics. They may be optional, in that the individual can choose to remain entirely within the state scheme. They are supplemental, in that they replace only part of the state pension. They are constrained in nvo ways: individual choice is limited, and the conduct of pension companies is regulated to pro- tect consumers.'-3 Finally, virtually all private pension schemes are subsidized through major tax advantages. In addition, because of the uninsurable inflation risk, the state may give private pensions at least a partial guarantee or may issue indexed government bonds. Public social spending in the West proved robust during the 1980s despite determined attempts, at least in the United Kingdom and United States, to roll back the frontiers of the state. One explanation is that these areas do noE accord well with the conditions necessarv for private markets to work effi- ciently (the major topic of chapter 2). The demographic prospects in most of the highly industrialized countries, coupled with continuing recession, havc prompted searching reviews of public spending. The result so far has been limited reduction in the scale of activity, but no significant change in its structure (see U.K. Department of Social Security 1993). EXPERENCE iN LATIN AMERICA. Most Latin Amrrerican countries have well- established PAYG pension systems, and state pension spending is significant, as table 1-2 shows (for a derailed discussion, see McGreevey 1990 and Mesa-Lago 1990a, 1990b). Most of the scheries have had endemic financ- ing problems of precisely the sort faced bv countries in Central and Eascem Europe, mainly as a result of promiscs which have proved fiscallv unrealistic. These problems, as in Central and Eastern ELrope, have led countries to seek better wavs of financing pensions and, in particular, to advocate funded pensions- State-funded schemes in Latin Arnerica, however, have not per- formed well. In general, pension reserves have not been invested ... in insuuments with the highest economic returns; social insurance institutions have not been designed to play the role of financial intermediaries, their personnel lack experience in this field, and no investment plans have been formu- lated. Capital markets are poorly developed in the region, and inflation has had a pervasive effect on the value of the reserves (Mesa-Lago 1990b,p.i). 12111 POLICY DESIGN AND IMPLEMENTATION Of eight representative countries in the region, onlv Chile has had a significant rcal return. Most of the rest "had negative yiclds as low as -21 percent annually, hencc decapitalizing the reserves" (Mesa-Lago 1990a, pp. i-ii). Expcrience in Chile is worth discussing separatelv because its pension reforms of the early 1980s are a recurring topic in Central and Eastern Europe (for detailed discussion, sce Diamond and ValdEs-Priecto 1994; Gillion and Bonilla 1992; Myers 1992). Emplovecs are required to join an approved scherne; atl such pension plans are privatc, funded and defined contribution (see the glossarv); workers pay 10 percent of their earnings. plus a commis- sion; and there is no employcr or government contribution. Workers can choose which scheme to join and can change schemes. Each pension com- pany manages a fund, the return to which is credited to the accounts of individual contributors, implying no redistrbution from rich to poor. Upon retirement, the -worker either can make a scries of phased withdrawals from his or her accumulation (with maximum w ithEdrawral limited by formula) or can buy an annuitr from an insurancc company. The pension is indexed to price inflation, largcly though not wholly on the basis of government-indexed bonds. A sizable minimum pension, paid by the state, is guaranteed for any worker with twentv vears of contributions, and generous, government-funded transitional arrangements are made for workers transferring from the old PATO svstem to ehe new schcme. In September 1991 the new scheme had 4 million members, but relatively few pcnsions (100,000) had been paid out. Thcsc arrngements are uscfullv assessed under four hcads: their cffect on the incomes of pensioners, their effect on the budget, their impact on savings and growxth, and the form of their administration. affras o the icomes qfpenoners. In a defined contribution scheme, pen- sions depend on the workers accumulation at retirement, which in tum depends on (a) the rate of reurn over his or her contrbution years and (b) his or her contribution density, that is, the number of contributions paid ovcr the vears. The average real rate of rcturn to pension savings in Chile during the 1980s w-as 12.6 percent a year. This is very high, and a lkev question is whether it is sustainable. Chilc implcmented an intensive privatization pro- gram during the 1980s, generating large capital gains; that program is no"' largely complete. On contribution density, matts are more problematic. In 1990, the proportion of members who paid conmbutions regularly was 53 percent. down from 76 percent in 1983. The compliancc rate varied by income level, being 45-55 percent for funds which cater to lower-paid workers, 80-90 percent for those with bettcr-paid members. GlJlion and Bonilla's (1992) average case assumes a 3 percent long-run real rate of return, leading to a replacement rate (see the glossary) of 44 percent. This is low and implies that only about half of all workers will rcceive pensions above the state minimum- A long-run real return of 4.5 percent is needed to reach a 70 percent replacement rate. Both sets of figures assume a complete 121 1 INCOME TRANSFERS: SOCIAL INSURANCE contributions record. With a 3 percent rcal return plus a 60 percent contribu- tions density, 65 percent of workers would receive only the state-guaranteed minimum pcnsion. Thus a contribution rate of 10 percentt may be too small. Several features of the svstem are noteworthy. First because the svstem is based on defined contributions, the entire risk above the minimum pension is bornc by the individual worker. Second, the scheme is individualistic. There is redistribution neither within a generation (there is no redistribution from rich to poor except through the guaranteed minimum pension) nor betvcen generations (pensions arc indexed to prices, noE wvages, so that pcnsioners do nor share in economic growth occurring after their retirement).'4 Third, there are significant gaps in covcrage, both because of non-compliance and because formal employment embraces only about 65 percent of the work force, most of the remainder being outside the scope of the new scheme. Finally, out- comes are highly sensitive to real rates of return and compliance rates. and the schem6s twelvc-vear historv is onlv a smali fraction of its total lifecime.'3 Effetes on die gormerrnbudger. Diamond and Valdes-Priero (1994, p. 257) point to the fiscal costs of thc old pension system and the promises associated with the transition. Such a fiscal sacrifice, they point out, is inevitable if the flow of pavroll tax revenue into privatized mandatorv savings accounts is to be genuine new savings. Pcnsion contrbutions now go into individual accounts rather than into social insurance funds. Government guarantees include the cost of pensions for older people who never transferred to the ncw svstcm, the cost of the transitional contribution for workers w ho switchcd to the newv system, the cost of indexed bonds, and the guarantee of a minimum pension, wz%hich helps to protect contributors against poor performance of thcir chosen fund and pcnsioncrs against bankruptcy of the insurance company paying their annuity. The first tvo costs wil eventually decline; the last two will continue in stcady stare. It is significant that the I.. orm wvas introduced ar a time when the government budget as running a surplus of more than 5 percent of GDP, giving room for the up-front public cxpenditure costs of the new system. Public pension spending in the earlv 1990s wvas variously esti- mated at between 4 and 6 percent of cGP and is likely to remain-at that level for at least another ten years. 4ecn on mvingr and ecnomk grvwrk. The accumulation of new savings. together with high real rates of return, has led to a large accumulation of funds. In June 1992 the totl holdings of pension funds amounted to 35 percent of GDP, about 40 percent of the total being public debt. These facts prompt two questions: What has been the effect on the total volume of savings? Whar has been the effect on economic growth? The answer to the first question is by no means clear. The findings of theoretical and cmpirical rcsearch have been inconclusive. The savings rate in Chile wmas 21 percent in 1980 and 20 percent in 1989, with a major dip in the carly 1980s (Santamaria 1991). The answer to the second is that economic grouth depends nor onlv on the quantity of Z 313 1 POLICY DESIGN AND IMPLEMENTATION savings but also on the effcctiveness with which they arc used. It is widely agreed rhat the pension reform significantly improved thc effectiveness of capital markets in Chilc. The pension funds have become a sourcc of equity capital and long-tcrm finance for private enterpriscs; and they have stimulated the growth of other. institutional investors. Although the matctr cannot bc quantified, there is agreement that such deepening of capital markets has contributed to economic growth. To somc commentators, this is the only substantial benefit of the pension reform which could not have been achieved by redesigning the old PsA system. Gocrnante and admininiron. The pcnsions industry in Chile is oligopolis- tic: three of thirtecn pension funds account for 65 percent of all insured persons; four of the largest companies are controlled by foreign corporations. Both features imply a heavy regulatory cask for the supervisorv body. Admin- istrative costs are much larger than costs in uniform government-managed conventional systems" (Diamond and ValdEs-Prieto 1994, p. 288). Adminis- Erative costs could be as high as almost 3 percent of taxable carnings, thus, if the replacement rate is 50 percent, administrative costs are nearly 6 percent of pensions paid. The comparable figure for the state schemc is 1 percent .of pensions paid in the United Scares and 1.25 perccnt in the United Kingdom. At least part of the difference is the added administrative costs of multiple funds (the Chilean figures are not out of line with the administrative costs of private insurance in the NWest) and the significant expenditure on marketing 'and sales. EXPERIENCE IN ASIhAN ECoNoMIES. Experience in the high-performing Asian economies varics considerablv (for a convenient summary. see Phillips 1992; MacPherson 1992). Taiwan (China) has a svstem of sociJ insurance trans- planted from the China of the 1930s. The only benefit it ofl his for old age is a single lump sum, and the svstem is supplemented by social assistance, mainly for emergencv relief, on the basis of an extended famly means test (that is, a means test based not on the income of the individual or nuclear family. but on the income of the extended family). Hong Kong has no contributory scheme: there is a tax-funded univcrsal benefit, at a level well beloNv subsistence, for the elderly and disabled, supplemented by a very limited scheme of social assistance based on the Poor Law tradition. 'Protecrion from hardship and poverty relies on self-help and on the family. The role of government social securitv is to meet only the most basic nceds of the most dcscrving, in the direst need of financial assistance (MacPherson 1992, p. 57). In 1988, the Republic of Korea introduced a contrbutory pension scheme for all emplovees and the sclf-employed, but no benefits have vet been paid. A svstem of social assistance pays benefits only to people over sixt-five who meet a stringent income and assets test and for whom no one is lcgally responsible. 12141 INCOME TRANSFERS: SOCIAL INSURANCE Singapore has adopted a totally different approach, whereby all workers and cmployers make compulsory conuributions (22.5 and 17.5 percent of wages for workers and employers, respectively, in 1991) into the Ccntral Provident Fund. Members can use their accumulations to buy a house, to pay hospital bills. or to meet living costs in old age. The underlying principle is similar to that of Chile to the extent that it is based on compulsory individual savings; it differs in that (a) members can use the savings for purposes other than income support in old age, and (b) there is only a single, state-organized fund. This is a state, not a private, scheme. Effct on the incomes ofpemisiow3. Poverty in old age is a continuing problem in all t.ie high-performing Asian economies. In Taiwan (China), the pension is only a modest lump sum. In Hong Kong, "most poor people arc old, their numbers are growing, and their situation is worsemning' (MacPherson 1992, p. 57). In Singapore. -the Central Provident Fund has . .. only a marginal impact on poverty among the old" (MacPherson 1992, p. 58); and there are stil significant gaps in coverage, for instance, for the self-employed and for casual workers. Redistribution is minimal. The arrangements in Taiwan (China) are very individualistic the main social insurance schcme covers only the workers themselves, not their dependents, which poses a particular problem for health care. In Hong Kong, except for very limited social assistance, there is no redistribution from rich to poor. In Singapore, there is virtually no public expenditure on income transfers, and "the provident fund approach is one which alloNvs of no redistribution, neither vertical nor horizontal. This ... accords with the dominant features of development in Singapore. The price of rapid economic growth is high" (MacPherson 1992, p. 55). Effws on the gonmw7t budget. There is little to be said. By definition, pension schemes which involve litde or no public spending have litte impact on the government budget. If the gaps in covcrage are significant, howevcr, there may be knock-on effects for alternative benefits such as social assistance. The acetratnk ofdifami(y. Kopits (1993, p. 23) stresses the importnce of the cultural and social context in policy design. "At one end of the spectrum there are socicties where the extended family . . . still operates rather actively as an informal social security schemc, obviating the urgent introduction of large-scale public pensions and assistance schemes." In the Sourh Asian con- text, the Chinese emphasis on family responsibility is a continuing influence. As a result, -powerful family networks of obligation and reciprocity have continued to be of major importance" (MacPherson 1992, p. 51). In Taiwan (China), "about three-quarters of elderly people were living with their children or close kin" (Chan 1992, p. 140). In Hong Kong, "the family ... is still providing the most important 'caring community' for elderly people" (Chow 1992, p. 74). In Singapore, "the family has always been che primary care giver 1 215 1 POLICY DESIGN AND IMPLEMENTATION for its aged members. No evidence has been found in Singapore to suggest that the fhmily. as an institution, is shirking its responsibilities" (Cheung and Vasoo 1992, p. 96). Moreover, 'the government is prepared, if necessary, to institute legal protection for the welfare of elderly people if families appear, in the future, to be abrogating their responsibilities" (Cheung and Vasoo 1992, p. 98). In the Republic of Korea, "about half of older Koreans . . . are dependent on their children for their living expcnses" (Choi 1992, p.. 151). In Thailand, "the extended family household [isl an important internal mechanism for raising the consumption opportunities of low-earnings individuals" (Warnes 1992, p. 196). The fabric of familv support, however, is coming under strain as family size declines and more and more women join the labor force. There is concern in Taiwan (China) about the sustainability of the system as "traditional Chinese assumptions about the role of the extended family are challenged' (Hill and Lee 1992, p. 69). Lack of support of the elderly "is one of the emerging aspects of the ageing problem in Korea" (Choi 1992, p. 15 1). One interprera- tion of these facts is (a) that the Southeast Asian system has been able to work without substantial stare intervention only because of the major role played by the extended family, but (b) that such arrangements are on the decline even in Southcast Asia and are therefore not necessarily a model which can easily be copied. IMPLICATIONS FOR CENTRAL AND EASTERN EUROPE. A fewv conclusions can be asserted fairly strongly; others are more in the narure of a list of decisions which will need to be made. ReAr of ite stare pension is esraeotl. The problem of pension finance in Central and Eastern Europe is the cost of the existing pension regime. How- ever, it is important to avoid the argument ehat "PAYG schemes have problems; therefore the solution is funding:' The word "therefore" does not follow in logic."' In reality, PAW and funding both address the same problem, namely, how to divide national output benvecn workers and pensioners. It is therefore not surprising that neither approach offers a complete solution. With PAYG, the problem manifests itself as political pressures to pay higher pensions; with funding, political pressures arise when inflation reduces the capital of pension funds, eroding the funded basis of pensions, as shown by the Latin American experience. Whatever policv is adopted, private pensions are no short-run substitute for dealing directly with the excessive expenditure of the state scheme. Reform shouldbe as simp(e as possible. The management of privare pension funds is complex. So, more generally, is the operation of financial markets. Both sets of activities require (a) the necessary operational expertise and experience and (b) the expertise to construct an appropriate regulatory reg- ime. These activities require planning and opcrational skills which are not yet l 216 1 INCOME TRANSFERS: SOCIAL INSURANCE common in Central and Eastern Europe. and they require such skills on a very substantial scale. The severe institutional capacitv constraints, and the many demands made on institutional capaciEt by other aspects of the reform pro- gram, make simplicity essential. Pni'alze pensions nfqzda a re.ulatory rigime. The management of pension funds raises complex technical issues which arc poorly understood by con- sumers even in the West. Regulation of pension funds, like other financial insticurions, is therefore taken for granted, although the effectiveness of such regulation is under continuing review, for instance, in the United Kingdom in the wiake of the Maxwuell imbroglio and in the United States after the savings and loan scandal.17 Private pesons rqukresoame protrmnn agai st fnion. The inflation risk, which is problem enough in the West, is cven greater during fundamental structural change in an economv with no experience of financial markets. For both reasons, uncertaintv about the prospects of pcnsion funds during the transition will be high, raising potential problems of capital flight. Thus a strong case can be made for extending at least a partial guarantee from the state, correspondingly reducing the potential budgetary savings. Either this could be a direcr guarantee, or the state could issue indexed bonds in which funds could hold a significant fraction of pension savings. Tle argument for offering some protection is twofold: horizontal equitv suggests that pen- sioners should not face substantially more inflation risk than -wage carners, and the collapse of private pension schemes during the infancy of a market economy puts at risk the political consensus underpinning the reforms. As a practical matter, the polirical pressures for somc sort of guarantee wili be strong; and Western experience suggests that the pressures will be even stronger for government to help any pension fund which runs into difficulties. Refim raqus gkeypolriy daiu. How important are social solidarity goals? Should the state schcme be residual or substantial? Should it embodv minimal or substantial redistribution? Should the risk of privae pensions be faced by the individual alone (implying a dcefined contrburion scheme) or shared with employers (implying a defined benefit scheme) or shared more broadly (implying at least some state guarantee)? How restrictive should the regulatorv regime be? First, what restrictions should be put on individual choice: in ascending order of freedom, should citizens be obliged to belong to their employer's scheme? Should they be allowed to choose between authorized pension funds? Or should thev be allowed to manage their owvn pension portfolio? Second, what restrictions should be put on the conduct of pension funds, in particular their choice of asscrs? Should a peinsion fund be allowed to hold some (or all) of its portfolio in foreign assets? Should it be allowed to hold risky domestic assets? In all thesc cases, how will compliance be monitored and enforced? 12171 POLICY DESIGN AND IhMPLEMENTATION Howv extcnsivc will state guarantees be? Will the minimum pension be guaranteed? What type and volume of indexed assets wtill the stare issue? And what help, if any, will be given to pension funds which do poorly? All three questions face a major tension berween political pressures and cost contain- ment; in addition, the third question mav raise a significant issue of moral hazard. The more generous is the treatment of funds which face difficulties, the weaker are the incentives for managers to act prudentlv. Private pensions, in conclusion, should not be thought of as a solution to the short-run budgetary crisis. Their real advantages are tvofold. First, the long-term improvement in the operation of capital mark-ets is significant. Second. the introduction of private schemes might make it politically easier to allow privileged groups to keep their higher pensions, but only on the basis of higher contributions. Other advantages include increased individual choice and an eventual budgeary saving. InpkMmdngzk eRtrxs To implement the reforms, both institutional and politcal capacitv require development. BUILDING iNnS'rmIONAL CAPACITY. Strengthened institutional capacity will be needed, borh because of the incrcased number of recipients and becausc a -wider distribution of income necessitates targeting benefits not just by group, but also bv the income level of individuals and families. Legislative changes should rakc account of administrative constraints. As chapter 13 makes very clcar, individuals with implementation experience should be involved from the strt of the design stage in all policv areas The first, and overriding, priority in the short run is to ensure that unem- ployment benefits and social assistance can cope wich potentiallv large num- bers of unemploved people. The unemployment benefit should be simplified as much as possible for administrative reasons, and sufficient pcrsonnel and adeqcate equipment, such as calculators and computers, are needed to admin- ister it. AlH the countries in Central and Eastern Europe have started, or intend to start, computerizing the calculation and delivery of unemployment benefits and employment services. The effecrive implementation of such develop- ments, which requires substantial investment, is rightly accorded high prior- irv- Staff should be adequately trained and derailed regulations available to guide staff on how the law should be implemented. A further administrative prioritv is action to minimize defaults and delays on contributions. This is obviously problematic in the growing private sector, but such problems in the state secor are becoming cndemic and even critical in some countries, particularly the Baltics and some other former Soviet republics. In the medium term, a single, coherent administrative structure is needed to replace the present fragmented system of cash benefits. Four aspccts stand 12181 INCOME TRANSFERS: SOCIAL INSURANCE out: moving the administration of benefits from enterprises, developing a system which can track the social insurance contributions of individuals, improving relations with the public, and devising more cost-effeccive methods of delivering benefits. Againi, these areas all require heavv investment. The reform process will necessitate a move from enterprise-based to individual-based benefits and contributions. At present, entcrprises adminis- ter most short-term benefits, and the social insurance/pension authorities generally know nothing about individual recipients. This creates confusion abouE the respective roles of wages and benefits; workEers need to understand thar wages are determined mainly by productivity, not by distributional goals. In addition, administration imposes a substantial compliance cost on enter- prises, mhich will harm their competitiveness, especially in an international context. In Western Europe, the social insurancelpension authorities organize the great bulk of benefit payments. On the contributions side, if the social insurancelpension authorities are to administer benefits, they need to know about individual contributions. This is noE at present generallv the case. Automating contrbutions and benefits would lead to nvo sorts of savings: administration per se would be cheaper, and policy options, particularly for containing costs through better targeting, would be possible which are not possible with manual systems. One example is the capacity to raise the basic pension fulty in line with inflation and pensions above the minimum by a smaller amounr. Relations with the public become more important as contact with individual beneficiaries (as opposed to enterprises) increases. Offices should examine how they provide information to current and potential beneficiaries. The information should be easily understandable by people who are nor parzcu- lary well educated or used to being responsible for their own claims. Forms should be easy to understand to reduce the time staff need to spend helping people with their claims. The authorities should gear up to give such addi- tional supporr and, where possible, should simplify procedures. BUILDiNG POLITICAL CAPACrr. The political issues raised by social insurance, familv benefits, and social assistance are very similar. Discussion of the need to build political capacitv is therefore deferred until chapter 10. CIMiw The widening distribution of income increases the need for income transfers. The major economic constraints are the fiscal crisis, which reduces the ability of the economy to provide income transfers, and gaps in the legislation and regplation necessarv to underpin a market system, particularly in connection with financial institutions and private pensions. A political constraint of particular relevance to cash benefits is that the time scale of rcform is long term, but the pressures of democratic politics arc short 1Z19l POLICY DESIGN AND IMPLEMENTATION term. People want a perceptible increase in their standard of living, and they want it soon. Thus the demand for increased benefits is sErong, as is the resistncc to policies which reduce them. The prcssures toward decentraliza- tion are also relevant, in that fragmented svstems of cash bencfits can lead to a fragmented labor market (if some benefits cannot be transferred across differ- ent regions) and may also creatc perverse incentives. Major institutional constraints arise, first because the private sector attracts the best people, partly becausc the backlash against government has reduced morale in the public sector and partly because the fiscal crisis has reduced public sector pay. The resul is a declining number of skilled civil servants. The second institutional constraint is a lack of implementation skills. In part this is connected with the first constraint, but it is also a result of the tendency to regard policv and administration as separate activities, carried out by sepa- rate groups of people. People with administrative experience are rarely involved when policy is formed and legislation drafted, leading to legislation which is unnecessarily complicated to administer. Conclusions: Priorities and Sequencing The enormous macroeconomic shock and consequent fiscal crisis mean .har conventional social insurance arrangements, with an explicit relationship between contributions and benefits, are likely to be unsustainable in some countries during the early transition, blurring the distinction between insur- ance and non-insurance benefits. Thus short-term policy, which concentrates on surviving the early transition by focusing on poverty relief, is clearly dis- tinct from medium-term developments, in which income transfers are more obviously a part of the structural reforms. Shoretanm Puiat Three sets of policies follow directly from the strategy discussed earlier in this chapter. Increasing unemployment and poverty require urgent action on pov- ercy relief, the fiscal crisis makes cost containment imperative, and action is needed in the short run, as well as in the medium term, to ensure that the necessary benefits are paidL Povny rel siould take prcdace for ficat rwsons over ocher objrtie of inma supporrsuch as insurance and icome smooning: * Urgent priorities are (a) to strgthen the system of unemployment benefits and, as discussed in chapter 10, (b) to develop a system of social assistance capable of delivcring poverty relief to potentially large numbers of individ- uals and families. - Expenditure should be concentrated on protecting the minimum level of benefits. Depending on the severity of fiscal constraints, a case can be made for paying unemployment benefits and pensions at a flat rate. 1 220 1 INCOME TRANSFERS: SOCIAL INSURANCE • Unemploymcnt benefits and the major social insurance and pension benefits should be at least equal to the poverty line for an individual, social assis- tance should be defined relative to a family poverty line, and the minimum benefit should, if possible, be fully protecced against inflation. In choosing a poverty line, political pressures and fiscal realities are in direcc conflict. Meaesrs to aotam costs arr wal, notwithstanding their kigh politucal visiblity: * In the short run, benefits above the minimum should be protected only to the extent that resources permit. • Invalidity pensions should no longer be paid to individuals whose earning capacity has not been affected. • The right to receive a pension whilc continuing in one's old job should be withdrawn as rapidly as political raities allowv. To assist restructuring and to protect young people from long-term unemploymcnt, it might be appro- priate to allow people who find a new job or who become self-employed to keep part of their pension. • Private pensions should noc be introduced for short-run reasons. They create no short-run fiscal savings and are no short-run substirute for dealing direcctly ith controlling expenditure on state pensions. A&wisiurauir capaciy must he adequate in the short nxn to ensure Mat anep ky- menat hene fican cope wiAi potualty arfge numbers of app/iorns: * Unemployment benefits should bc simplified as much as possible, staff should be adequately trained, and detailed regulations should be available to guide staff on how the law should be implemented. - Large-scale income testing may exceed short-run administrative capacity. Where possible, therefore, benefits should not be based on income but rather on indicators of poverty such as family size, unemployment, or age. Meium-aerm Pofid Policies with a medium-term dimension relate to actions which should start in the short run but will take effect in the medium term. Adwiniuraritr capacty reqnie cominirig anion. The shortage of implemen- cation skills implies that policymakers should not be over optimistic about the speed and scale of major reform. Nevercheless, administrative reform is viral, and nct just because of the administrative savings which would result, impor- tant though they are. A modernized administration strengthens the capaciry to collect contributions, speeds up the deliverv of benefits by reducing the lag berween applying for a benefit and its first payment, opens up options for containing costs which are not possible with manual methods, and increases the flexibility of policy. Thus: Work al;eady under way on decoupling the delivery of benefits from enter- prises should continue. [2211 POLICY DESIGN AND IMPLEMENTATrION * An early start should be made on the planning necessary to incrcase admin- istrative capacity through a coordinated process of policy development and upgraded delivery, including computerization. * Such increased administrativc capacity is needed not least to make it possi- ble to introduce individual social insurance records. - Methods of delivcring benefits morc cost-effectively than sending cash through the postal system should be introduced. The strucwr of benefits s/maid he refined. In particular, as fiscal and administra- tive constraints start to relax, the system should evolve toward one with a more explicit relation betwecn contributions and benefits: * Pensionable age should be raised over time. One way of phasing in such a change is to raise the retirement age by one year every second year. Fiscal pressures suggest an early starting date for such action; political pressures and a desire to minimize unemployment among younger workers suggest a more cautious approach. - Social insurance contributions should be shared between worker and employer,.with the worker's contribution appearing on his or hcr pay slip. - To avoid incentives against employing women, the cost of maternity and family benefits should, so far as possible, not fall on the employer. * As soon as economically and administrarively feasible, the relationship between social insurance benefits and individual contributions should be strcngthened. As part of this process, growing administrative capacity will allow greater reliance on income-testcd poverty relief. The combined result would be to restore the distinction between insurance and non-insurance benefits. Priatepasion rzquire corninniguwork on deign and imp/mneaturio. There arc two firm recommendations: * Private pensions should not be introduced until the necessaly regulatory structure has been put in place. The design and implementation of such a regulatory regime is the first step toward developing private pensions. * Private pensions should offer future pensioners at least some protection against inflation. This is particularly the case in Central and Eastern Europe, where restructuring poses a serious inflation risk. One mechanism for achieving this objective is through indcxed government bonds. Beyond that, policymakers have a choice about the mix of public and private pensions: * A mainstream Western European system would have three tiers and would be very much a partnership berween the public and private sectors. The foundation of the system would continue to be a PAYG social insurance pension, with a wider role than mere subsistence, although limited by 1 222 1 INCOMIC T'ANSFI'RS: SOCIAL INSUIlANCIC appropriate ceilings for contributions and benefits. The state system would be complemcnted by a mandatory system of appropriately regulated privatc pensions, Icaving open the qucstion of whcther they would be defined contribution or defined benefit schemes. Tax incentives could also be used to encouragc voluntary private, defined contribution schemes, subject to the same regulatory regime as all financial institutions. A more individualistic system would have two tiers. These would be a minimal state PAYc pension, whose major purpose would be to provide a minimum guarantee for private pensions. Pensions for most people would be provided by one or more funded, regulated, defined contribution schemes, probably organized in the private sector. In the three-ticr system the separate components address different pur- poses of pensions: the state scheme is concerned with poverty relief and vertical equity; the second tier, by allowing people to redistribute income to themselves across the life cycle, facilitates income smoothing; and the third allows for the expression of individual preferences. The scheme accords a significant role to social solidarity, and risks are shared fairly broadly. Ii' pen- sioners are to share in economic growth occurring after their retirement, the state pension could be indexed to carnings. The two-tier approach gives Icss weight to social solidarity. Apart from the minimum pension, there is no redistribution from rich to poor, nor any redistribution betwecn generations; indexation, if provided at all, would be to price inflation. The choice between the two approaches depends primarily on (a) objectives, (D) policical arrangements, (c) the economic environment, and (d) the social context. On the first, Chile and a number of the high-perfdrming Asian econ- omies had a single objective, economic growth, which was given priority over all other objectives including social solidarity. On the second, government in the high-performing Asian economies is authoritarian; and the same was true in Chile at the time its reforms were introduced. On the third, those countries face fewer constraints than the countries of Central and Eastern Europe: they have long-established market systems, a sophisticated banking system, highly devel- oped capital markets, and relatively stable prices; they need no substantial restructuring. In addition, the Chilean reform was introduced at a time of sub- stantial budgetary surplus. Finally, the importance of the extended family in the high-performing Asian economies has already been noted. Suc:h family struc- tures exist in the Central Asian republics of the former U.S.S.R., but not in the other countries of Central and Eastern Europe. Notes 1. The term social security is avoided becausc of its ambiguiLy. In the United Statcs, it refers to rectirement pensions; in the United Kingdom, it rEers to the entire system of cash benefits; and in mainland Europe (in accordance wit., the usage of the 12231 POLICY DRSIGN AND IMI'LEMENTAl'ION International Labour Organisation), it refers to all cash benefits plus hcalth care. The term cash benefits is thereforc uscd throutghout. 2. Thcre is no convenient shorthand for this type of bencfit: they are often referred to as universal (Gordon 1988, p. 37). althoug;i in reality they are not, sincc they depend on the occurrencc of the specified contingency. 3. Thesc are the pure cases. In rcalitv the categories can become blurred: both social insurance and universal bencfits may be pardy incomc tested by being included in taxable income. 4. Kopits (1991) found that in Central and Eastern Europe, subsidies comprised as much as 22 percent of GDPr, whilc cash bcnefits comprised oniv 10 percent. In the European Union, the comparable figures werc 6 and 16 percent; sec also Kopits 1992. S. The exception is Poland, wvhcre pensionable age is sixty-fivc for men and sixty for womcn. 6. Some countries have avoided this problem. In Albania and Latvia, unemploy- ment benefits wcre incorporated from the start in the social insurance arrangements. 7. During the summer of 1992, with rapid inflation and a consequent shortage of cash, President Yeltsin, visiting a number of Siberian towns, was reputed to have had a plancload of cash, specifically for paying wages and pensions, as pant of his entourage. 8. The figurcs in Layard, Nickell, and Jackman (1991) rangc from a notional 2 percent in Itaiy to 90 perccnt in Denmark. Aftr Italy, the lowest is the United Kingdom (36 percent). A number of countries are above 60 percent, but oniv Den- mark, Finland, Spain, and Sweden are abovc 70 percent. 9. In economic theoretical terms, the incidencc of the contribution depends on the relative factor and product demand and supplv elasticitics and is independenrt of where the contribution is legally imposed. In theory, therefore, it does not mattcer how the contribution is shared benvecn worker and employcr. This result does not, hovever, necessarily hold in the short run, nor in situations where markets arc not competitive. For further discussion, see Stigjitz 1988, chap. 17. 10. In Hungary in Mav 1993, national eleceions were held for self-govcrning bodies for social insurance. Seven trade unior. groups put forward lists of candidates, and it was diifficult to distinguish ttween geneml elections and thc social insurance clcc- tions. Those elected feel a strong mandatc to respond only to their constituencv. 11. Other things-particularly national outptut and the number of pensioncrs - remaining constant, PAyr schemes arc not affected by inflation. With eamings of S1.000 the yield of a 10 percent pcnsion contribution is $100. If prices double, so, generally, will nominal earnings. The yield of the 10 perccnt contribution is now 6200; nominal pensions can therefore be doubled without changing the rate of contribution. In real terms nothing has changed. 12. The earnings-rclated component, but not the flat-rate pension. in Japan and Sweden is run on funded lines. 13. A U.K. reform in 1988 allowed individuals to manage their own pensions portfolio; vcry few people have taken up the option. Individual Retirement Accounts in the United States, though only a small pan. of private pension provision, similarly allowv individual control. 14. In principle, the converse is also true, namcly, pensioners are insulated from negative growth. This may not be the casc, howevcr, if negative growth is associated with inflationar pressures, as it currently is in Central and Eastern Furope. 15. Based on life expectancy, a first-generation wvorker who joined in 1981 will contribute to 2026, after which he and his surviving spouse will receive pensions for a further twenty years. The scheme's twelve-vear history accounts for less than 20 percent of this period. 1224 I INCOME TRANSFERS: SOCIAL INSURANCE 16. "Oncc upon a time therc was a king who wished to hirc a troubadour. The first performed so badly that he hircd the second without even bothering to heat him sing' (Holzmann 1991, p. 75). 17. The results of an investigation by the U.K. Securities and Investments Board of a 1988 rcform under which individuals w*erc allowed to make their own pcnsion arrangements were disquieting, sce, for instance, "Nine in Ten Pension Deals Sus- pect," Indrependent (Ladon), December 17, 1993, p. 27. A British governmcnt enquiry (U.K. Pension Law Review Committcc 1993, p. 10) found that "the prcscnt law . . . has a number of shortconmings. These include considerablc complexity and a lack of structure and organisation. The law allows such wide powers and discretions to be left in the hands of the employer and the trustees chat the interests of scheme members are not always sufficiently protected.... There is no form of compensation to cover loss through misappropriation of assets . .. [leavingj membcrs at risk of hardship. Finally, there is no regulatory bodv." Sec also U.K. House of Commons Sclect Com- miutce on Social Security 1992 and Nobles 1994. For disturbing claims about the vulnerabilitv of privatc pcnsions in the United States, see Bardett and Steele 1992, chap. 9- 1 225 1 Ten INCOME TRANSFERS FAMILY SUPPORT AND POVERTY RELIEF SANDOR SIPOS CHGPrEr 9 DISTINGUISHED THREE TYPES OF INCOME TRANSFERS: social insurance, universal benefits. and social assistance. Social insurance awards benefits for particular contingencies on the basis of past contributions, universal benefits operate without a contributions teSt or an income rest. and social assistance awards benefits on the basis of an income test. Social insurance addrcsses income losses which, at least in principle, are insurable This chapter looks at the companion income transfers: family benefits, which are aimed at mothers and children and are generally awarded without an income test, and social assisrance. wvhich is aimed at poor people generally. Neither set of benefits relates to risks which are even remotely insurable. The discussion of poverty relief through incomne transfers should bc seen alongsidc other policics ro prevent poverty, notably, developing the human capial of the poor and pro- viding them with carning opportunities, issues which are discussed in chaptecrs 7, 8, and 1 1. An important omission is any detailed discussion of housing. Family benefts in Central and Eastern Europe are generally high as a percentage of average wages in comparison with the highly industrialized countries. Two lines of argument exist for reducing their lcvcl and scope: to assist the move to a market cconomy in which wage differentials play an increasing role and to help address the fiscal crisis. Family allowances are controversial. The institution is importnt in Western Europe but has a much smaller role. if any, in some other highly industralized countries. such as the United States, and in Lacin America. This chapter takes as its starting point the Western European conviction that childrcn are not merely a private utilitv but also a public concern. Thus family policy addresses not only poverty relief bur, at least to some extent, also horizontal equity, for example, between families of different sizes- This concern leads to the recommendation that family allowances should be reduced as a percentage of wages, but not abolished. Povcrty relief, in contrast, should be expandecd. As discussed in chapter 4, one of the effects of the transition has becn to increase the number of poor peoplc. at least in the short run; and, as discussed in chapter 9, social insur- ance benefits will increasingly be related fairly direcdy to individual contribu- dons, thus reducing their scope as a device for povertv relief. The need for poverry relief to expand during a time of fiscal stringency means that benefits 1 226 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF will have to be carefully targeted. Poverty relief has nvo possible objectives: to eliminate povertv by bringing the incomes of all poor people up to a povertv line (policv type A) or to ameliorate the poverty of those below a given poverty line by increasing their income, without necessarily completelv elim- inating the povercv gap (policv tvpe B). Most social assistance schemes in the United States were designed with the second objective in mind; those in Wcstem European countries tend morc to type A policies (see L$dcmel 1992; Northrop 1991). The Inheritance The major characteristics of familv benefits and povcrty relicf Irar a direct rclationship to the inheritance. When income differentials are salil, benefits can be targeted at groups rather than individuals; it is thus natural that there should have been a system of fairiy large family benefits to inect the income needs of families of different sizes. Since povertv did not officially exist, it is not surprising that the svstem of poverty relief was rudimentarv and aimed mainly at groups with permanent major health problems and ar the frail elderly. Strengtk The purposes of family benefits are significandy different from those of pov- errv relief. It is therefore helpful to discuss rhem separateIy. FAmUILY sEanrrs. Family support in Central and Eastem Europe was wide- ranging before the transition. In-kind benefits included the provision (usuallv free) of creche facilities. kindergartens, day care centers, school meals, and the like. Cash benefits included: * Familv allowanccs (a monthly payment. tax free and normally not income teswd; see the glossary), paid until the child reached a cerain age * A birth grant (a single payment at the time of birth) * Maternitv leave, often on full pay and usually for three to six months * Parental or child care benefits (a monthly payment for 6vhich the mother was eligible after her entidemcnt to maternit leave expired, until the child reached a given age, varying bcEveen eighteen months and three vears) * Paid leave for the care of a sick child - Various tax allowances and credics c A death grant. Under the old systeM, the distribution of carnings was fairly flat, with differences in family size accommodated by generous family benefits. This arrangement had significant advantages. It prevented many families from fall- ing into povertr. It empowered households as consumers as opposed to pas- sive recipients of in-kind provisions.' It alowed women to participatc in thc 1 227 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF labor force or to stay at home with some income and job security or to opt for part-time work (see Cornia and Sipos 1991). It promoted gender equality, which later became an explicit policy goal (see Ferge 1993; Fong 1993; Fong and Paul 1992; Nemcnyi 1990). As an increasing bodv of cmpirical literature shows, a Final advantage is chat these benefits were generally well Eargeted, in that thev reached most of the pcople who were poor or at risk of being poor. Sipos (1992) shows that in Central and Eastern Europe young people comprised 30 percent of the popu- lation but 40 percent of the poor. Zmi (1991, p. 183) finds that social expenditure in Hungary in 1989 provided 82 percent of the income of large families with the poorest 5 percent of incomes but only 22 percent for families in the top 5 percent. Ravallion, van de Wal'e; and Gautam (1993) conclude that family allowances reduced povcrty in Hungary in the late 1980s and were xvell targeted, but that if they been focuscd on younger and larger families, they could have been even better targeted. Jarvis and Micklewright (1993) argue that makling family allowances universal in Hungary in 1990 improved targcting. Similar conclusions have been draw%n for Czechoslovakia (Dlouhy 1991), Poland (Topinska 1991; World Bank 1993b), Yugoslavia (Vukoti& Cotic 1991), and for the whole region, except for the Russian Federation (Zimakova 1992). An extensive research project found that family allowances are strongly pro-poor in absolute terms in all [Central and Eastern Europeanl countries exccpt Russia. This means that poor households receive more of them not only in rclative terms . . . but also in absolute amounts. Family allowances arc the only income source in Eastem European countries that is both important and strongly focused on the poor. They achieve a significant reduction in inequality, lowcring the overall Gini coefficient by approximately 3 percentage points in Hungary and CSFR [Czechoslovakial and about half a point in Bulgaria, Poland, and Russia. For comparison they reducc income inequalicv by 1.3 percentage Gini points in France (where they arc comparable in sizc to Central European countries) and by 0.8 points in the U.K. [Milanovid 1992, p. 151 povEr RwsEF. The main strength of poverty relief is that it was delivered to gnuups of people (families, the elderly) through more or less guaranteed employment and a comprehensive set of cash and in-kind benefits, rather than to krdmidaks through income-tested social assistance. Poverty relief thus tookl place befor large sections of the population fell into poverty. Although pov- erty, contrarv to official orthodox,v was not fully eliminated, it was not a mass phenomenon (Milanovi6 1991; Sipos 1992). Notwithstanding these strengths, this preventive approach became unsustainable in the face of the slowdown in growth which occurred in the 1980s. 1 228 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF The significant weaknesses of both family benefits and the svstem of poverty relief are in many ways the other side of ehe coin of their strengths. FAMILY BENEFITS. The serious weaknesses of family benefits parallel those of the social insurance system. Ineffectiwectoainme. Table 10-1 shows the high cost of family benefits which, in the mid-1980s, cost ouer tvice as much as the OECD (Organization for Economic Cooperation and Development) average of 1.2 percent of gross domestic product (GDP)_Z Table 10-2 show s the extent tO which familv bene- fits in 1980 wvere a high fraction of eamings in Central and Eastern Europe in comparison with those in Western Europe. A decade later, carly in the transi- tion, the familv allouancc for cach child was 8 percent of the average monthly ,age in Poland and II percent for each child in a two-child farrilv in Czechoslovakia. Across the OECD, the average level of support from all falily benefies was 7.5 percene of average earnings pa-family. In some countries, benefits were also paid for a dependent spouse. As a result, familv allowrances played part of the role wvhich in industrial countries is plaved bv wages. rhe pattern in Western Europe is to pay such benefits at a lower rate, comple- mented by income-tested family support (see Commission of the European Communities 1991). Materenmi benefits were generallv at or close to 100 percent of the mother's previous wage (in Czechoslovakia. the figure was 90 percent; in Hungary. 65- 100 percent; and in Romania, 50-94 percent). Again, this is high compared wvith Western countrics (usuallv 50-85 percent of the mothe(s wage) but simnilar to the figure in many Latin American countries (Argentina, Brazil, the old Chilean svsrem, Costa Rica. Mexico, and Uruguay; see Mesa-Lago 1991). Table 10-1. Pubic Eoerniunr on Family Support as a Parcentage of GDP x OECD Cornuvs and &vtral ad Easan Eampe, 980-88 Gugp 1980-84arrnhgr 1985 -average oEMt 1.2 - Poorer coututries 0.6 Social welfare countrics 1.5 Cental and Eatn Europc 2.5 2.5 Czechoslovakia 3.3 3.2 Hungary 2.3 2.7 Poland Z.2 1.8 -Not a2Vilabkc Nere: Fanily suppor includes famil allouunccs and parental orchild cabenefits. a. Poorer OECD countries include Greece, Ireland, Porwgal. Spain. and Turkev &arre: Rutkowska 1991,pp. 10.21. [ 229 1 POLICY DESIGN AND IMPLEMENTATION Table 10-2. Family Allowancesfor wro Childnw as a Perrentage ofdrrrage Earnings, by Counnly in EFesterw and Western Earope, 1980 Regiov and counajy Parent FRwn FlUrDpe Hungary 22.2 Bulpria 20.0 Czcchoslovakia 19.6 Poland 7.0 German Democratic Republic 3.9 Wemnv E&rm+e - Austria 16.9 Belgium 10.7 Nethertands 9.0 Sw;neden 8.7 United Kingdom 8.2 Switcrland 6.9 Germany, Fcd. Rep. of 6.6 France 6.5 Nornyv 6.4 Itly 5.4 Denmark 3.0 Nate: Thc figures for Denmark. Gcrmany. Nor%ay. and Sweden refer to 1981: the figurc for Poland. to 1984. Saminy: Intenational Labour Organisation 1989. p. 55. The high level of family benefits was understandable in the past, when thc distribution of earnings was flat and differences in family size were accommo- dated by gencrous family benefits. This policy becomnes increasingy inap- propriate as the economic reforms take effect, and wages become the main sourcc of family support. Hoks in the soda?safety net. The effectiveness of family benefits in relieving poverty had significant deficiencies: inadequate coverage of marginal groups. particularli chose working outside the stare sector; lack of rcfined targeting; inadequacies in respect of gender considerations; and, on occasion, ethnic discrimination. Gaps in coverage were a particular problem for maternitv benefits and family allowances. Matcrnicy benefits depcnd on a contributions record in almost all the highly industrialized countries and throughout Latin America (where twenty-one of the twenty-two countries had some sort of maternity benefits; sec Mesa-Lago 1991). In Central and Eastcrn Europc, however, large agricultural populations and the self-employed vere excluded or received significantly lower benefits. Decdlining agricultural populations and gradual cxtension of coverage improved matters, but gaps remainred in some coun- tries, for example, Poland and Romania. 1 230 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF Familv allowances had even greater gaps. Whereas social insurance is intended to offer insurance against risk, an important purpose of family allowunces is to help a family redistribute income across the life cycle. Pre- ciselv because having children is not in any sense an insurable risk, family allowvances in most Western European countries are universal (that is, paid w%ithout a contributions record or an income test; see Commission of the European Communities 1991). In Latin America only the richer countries (Argentina, Brazil, Chile, and Uruguay) provide some family allowance, usu- ally for those covered by social insurance (Mcsa-Lago 1990, table 19). In Central and Eastern Europe, family allowvances -were normally part of social insurance and thus excluded families outside formal employment. In some countries, for instance Poland, family allowances were related to salary and hence were regressive (see Wiktorow and Mierzewski.199 1); in others, such as the former Soviet republics, means-tested benefits supplemented or replaced bencfits based on social insurance. During the 1980s, coverage of family allowances gradually broadened, but the first country to introduce a universal allowance, Hungary, did so only in 1990. L sack of refined targeting was pervasive. First, family allowances were not differentiated according to the age of the child, and older children in second- ary and higher education were eligible for a range of uncoordinated benefits. Such arrangements simplificd administration but had major disadvantages for relieving poverrv and containing costs. Second, given aging populations and acure labor shortages, benefts were often disproportionately higher for larger families. This type of pro-natalist policy can be criticized on several grounds: it is expensive, it has only a small and temporary effect on birth rates (Andorka 1991; Chernozemski 1991), and, given the high correlation between povertr and family size (Milanovi6 1992; Sipos 1992), high benefits become an indispensable element in the budgets of many large families. In the shorr run, pro-natalist family bencfits may be the least bad way of keeping large families above the povertv line. As the distribution of earnings widens, however, the approach will need to be reviewed. The idea of extended child care benefits. first introduced in Hungary in 1968 as an extension to maternity leave, is well founded, but its design could be improved. The introduction of the scheme was prompted in part by fears that contemporary moves to a more market-oriented economy (the New Economic Mechanism) would cause substantial female uremploymcnt. Most countries in Central and Eastern Europe and many in Western Europe quickly followed Hungary's lead. The scheme has undoubted appeal because it cncourages more flexible participation of women in tEhe labor force and enhances early child development. In most countries of Central and Eastern Europe, however, it,was introduced as a social insurance benefit, based on an appropriate work historv and differentiated according to previous earnings. [231 1 POLICY DESIGN AND IMPLEMENTATION These featurcs werc not consistent with social justice and the necds of chil- dren. It seems morc appropriate to pay wvomen seeking to withdraw from the labor market for an extended period a flat-rate benefit for raising a child. Gender considerations were not always adequately taken into account. Family allowances were usually paid to the head of the family, that is, the faiher. Given women's high participation in the labor force, this was unnecessary and made the scheme vulnerable to abuse (for example, by alcoholic fathers). At the same time, the cligibility of fathers for matcrnity or child care allowances was generally more rcstricted in Central and Eastern Europe than in the West. Ethnic discrimination arose in some countries. Pro-natalist policies paid a high bencfit for the third child, but benefits sometimes declined sharply thereafter because vcrv large families usually bclongcd to minorities: gypsies in many countries or Turks in Bulgaria (Chernozemski 1991; Kroupova and Huslar 1991). Advrri icMncdvn. A vast literature treats the effects of family benefits and social assistance on the supply of labor (see Burtless 1986; Moffitt 1992)- Its application to Central and Eastern Europc is unclear, however, not least given very high rates of female participation in the labor force. The only benefit for which there is evidence of a reduced supply of labor is parental or child care allowances, which support extended maternity leave: unskilled vomen uscd the benefit fully; those with higher earnings resumed work carlier than required (Zimakova 1992). Since the objective of ectended maternity leave is to allow very young children and thcir parents to spend more time together, this outcome was not necessarily a disadvantage. Weak.admihninraron. Most ,'amily benefits w%ere admirnistered by enterprises, raising the same set of problems as with social insurance. The problcms were compounded in some countries by the multiple forms of family benefits (for example, in 1992, Ukraine had about sixtv forms of largely overlapping family benefits). POVEmFY RELIEF. The approach to poverty relief during the communist era assumed that social assistance was not needed. Nevertheless, poverty per- sisEed. Most of the poverty lincs in table 10-3 are officially calculated subsis- tEcnce or social minima. In contrast with countries in the European Union, where a guaranteed minimum income reflects some sort of subsistence level, in Central and Eastern Europe these indicators seldom served as a threshold for policy intervention (see Commission of the European Communities 199 1; the United States is unusual among the countries of the OECD in that its main income-tested benefit-Aid to Families with Dependent Children-is not paid to families at the poverty line). Despite persistent poverty. social assistance was highly rcsidual. The svs- tem was fragmcnted and given low prioriry. Most benefits designed for tempo- rary income support were discretionary, resulting in arbitrarv decisions, a high 1 2321 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF Table 10-3. Pocer Indiazmor and Rates & Central and Eatem Eumpe, Beinningand 5nd of the Period, 1958-91 FTpenadYzre euftodas PoMny/ine Pnrrage apermeige asapenfarage of papuA/der nGentryandyror ofpoey line of atvrage wr iupovny BRulgadla 1978-89, subsistcnce minimum - 65-53 1978-89, social minimum 34-42 82-67 Czrdudovakie 1958-S8. subsistence minimum 60 42 6-0 19588S, social minimum 50 55-56 11-7 1976-90, social minimum 60 42-56 6 Havgary 1967-82. subsistence minimum 35-37 45-55P I D-7 1967-82. social minimum 29-31 5466W 14 1983-90. subsistence minimum 30-38 40-58b 7-10 1983-90. social minimum 25-32 48-70b IS 1981-89. subsistencc minimum 50-60 - 14-17 1981-90. subsistenc minimum 60 36c 14.33 Ramai 1991. subsistence minimum - 13 199 . social minimum _ - 42 U.S.&R. 1967, subsistencc minimum 56 58 16(urban) 359 (rural) 1967. social minimum 36 76 1980-90. subsisteice minimum 49d 72-59 (urban) 24-Z 90-67 (rural) YsWaia 197"89. subsistence minimum 54' 28-32 (urban)' 17-24 - Not available. Nore The numbcr before dhe dash is die value at the bcginning of dic period, and the number aftcr the dash is the valuc at its end. a. Prccntage of avcrage houschold income. b. Minimum and maximum figures for the period. c. 1987. d. 1985. c. 1989. f. 1982-86. Snre: Sipos 1992, p. 56. level of stigma, and low rake-up rates (sce the glossary). Thus a high percent- age of individuals in need failed to receive benefits. Poverty was regarded as a pathology, with high personal responsibility, rather than as a lack of income. Social assistance was therefore targetcd at social problems, often without an adequate means test or proper assessment by a social worker. 1 233 1 POLICY DESIGN AND IMIPLEMENTATION Organizations outsidc govcrnment were invited to provide neither comple- mencarv sources of care nor financial assistancc to state channcls. The few charitablc nongovernmental organizations (see the glossary) which were allowed were mainly church organizarions. They operated in a hostile environ- ment because of ideological constraints on charities and political suspicion of civilian initiatives. The administration of social assistance was poorly staffed and usually local. Most countries had few social workers, and those in place were not adequately trained. Ignorance was reflected in a resticted range of policy instruments: gaps included overnight shelters and tEcmporary work opportunities. The Forces Driving Change Rising poverty, one of the main short-run outcomes of the process of transfor- mation, has become one of the central political forces. Brief discussion of the overall forces driving change is therefore followed by a more detailed discus- sion of available evidence about the extent of poverty under the old system and during the early years of the reforms. Eonomic and Political Forces Armong the major driving forces discussed in chapter 4 are the widening income distribution in gneral and increasing povertr in particular. The transi- dion ins. olves large and unusual dislocations, such as mass lavoffs. abolition of cooperatives, and the sudden decline of single-industry towns, and has not always been peaceful, requiring additional assistance. Social insurance will not suffice, not least because its scope is being narrowed, so that many people previously covered are now excluded. Thus social assistance has a central and growing role as the benefit of last resort. At the same time, rhe fiscal crisis narrows the scope for income transfers. Social policv has to bc redefined. Better targeting is needed both to avoid gaps in coverag. (horizontal efficiency) and to contain costs (vertical efficiency). Social assistance, being income tested, is at least in principle highly effective in this context, although policy development is necessarv to prevent adminis- trative costs from absorbing much of the savings resulting from tighter targeting. Empirical Evidece on the Exnent of Poven Table 10-3 shows the extent of poverty prior to the transition relative to an absolute povertv line. The figures measurc the income of households or individuals compared with a minimum basket, often called the subsistence or social minimum. which reflects an off:iCIl perception of povertv (on the merits and shortcomings of these calculatioas, see aMkinson and Micklewright 1992; Milanovi6 1991; Sipos 1992). In most countries of Central and Eastem 1 234 1 INCOME TRANSFERS: FANMiLY SUPPORT AND POVERTY RELIEF Europe, povertv declined significantly between 1960 and 1980. In the 1980s. as growth started to slow, poverty rates stagnated or started to rise again, with the exception of the U.S.S.R., where poverty rates continued to fall until the end of the decade.3 Povertv rates varied considerably both between and within countries. Although not a mass phenomenon, poverty vas too large for the prevailing residual poverty relief regimes and wvas aggravatEcd by the wage and price liberalizarion which occurred in the early transition. In Poland, according to official statistics, real income per head fell more than 41 percent bewveen 1989 and 1991, and the poverty rate (the number of poor peoplc) doubled from 17 to 34 percent (sec table 10-4). These figures are almost certainly too high both because of the statistical problems dis- cussed in chapter 4 and because of the specifics of the Polish situation.4 Nevertheless, the direction of change is clear, and the effects on child poverty were sharp: Because the increase in poverty wras greater among large-size families, the change in the percentage of children who arc poor is even greater than the change in the percentage of the poor households or the popula- tion. In 1989, about 17.5 percent of children under six years of age lived in poor households; this increased to more than 50 percent in 1991. Poverty incidence among children of workers and mLed households tripled. IMilanovic 1993, p. 151 Milanovic also found that the poverty gap (the total cost of bringing the income of all poor households up to the povcrty line) almost trip!ed between 1989 and 1991, from 1.4 percenc of cGP to 4.6 percent. Thus the poor are more numerous than before and, subject to caveats about the statistical data, are becoming poorer. In Hungary, the experience was somewhat different the increase in poverty rates took place without an increase in the povertv gap. According to house- hold surveys, the incidence of povercv increased from 10 percent in 1990 to Table 104. PontyandR&atIncome in Poknd, 1989-91 (pcrcencage change) Deraw in -Caodrs of reolf Pove&y rate hossholdrs capita ome 1989 1991 Workers 33.3 15.8 38.1 Mixed households 41.0 7.9 217.2 F2rmcrs 51.6 17.2 39.4 Pensioncrs 11.6 36.2 33.0 Total 41.5 17.3 34.4 Sourre: Milanovic 1993. 235 1 POLICY DESIGN AND IMPLEMENTATION 15 percent in 1991, and to 27 percent in 1992 (Andorka, Kolosi, and Vukovich 1992; Ferge 1993; VKSH 1992). Using a narrower definition, poverty increased from 8 percent to nearly 16 percent between 1989 and 1992 (KSH 1993a). Even if the impact of hiddcn incomes and activities in the informal sector is considered, the poverty rate was estimated to be in thc range of 20- 25 percent, more than double the level beforc the transition. Ncvertheless, mainly because of offsetting social policv measures, the poverty gap did not widen substantially (see Sik and T6th 1992). The changes, nonetheless, arc profound. The average income of the richest 10 percent rose from 4.9 times that of the poorest 10 percent in 1987 to 6.0 in 1992 (Andorka, Kolosi, and Vukovich 1992). Again, the number of children and the incidence of poverty are highly correlated. In 1992, only 9 percemn of people Nwithout children lived below the poverty line, rising to 21 percent of two-child hcuseholds, and 49 percent of families with four or more childrcn. More than 15 percent of children in poor families lived on less than 70 percent of the natrowly defined povertv line (KsH 1993a). The incidence of poverty was also high among the unemploved (nearly 50 percent) and gypsics. In 1992, about tvo-thirds of gypsies aged sixteen or older were poor (and even more if children are coun- ted; Ferge 1993). In Russia, about 12 percent of the population was poor in 1990; by Septem- ber 1992, the figure had risen to 37 percent (although the data are not strictly comparable due to differences in methodology). Once more, the great major- ity of poor households vere families wich children (Popkin 1992; Popkin, Mozhina, and Baturin 1992; Sipos 1992). In the first quarter of 1993, 42 percent of all families with children under sixteen vears of age were below the povertr line, rising to 72 percent of families with three or more children (Radio Free Europe/Radio Liberty, Daily Repor 99, May 26, 1993). Women were traditionally overrepresented among poor and vulnerable households in the former U.S.S.R. This trend apparently intensified during periods of rapid inflation for households dependent on cash benefits and with low earnings (see Fong 1993). In contrast, in late 1992, only 19 pcrcent of elderlv households were belowv the povcrtv line. In the case of Russia, not only the povertv rate but also the poverty gap was large. In September 1992, the average shortfall below the poverty line was about 34 percent (World Bank 1993c). Less is known about poverty trends elsewhere. In Bulgaria in 1991. the povertv rate was about 34 percent; in Romania, it was betveen 13 and 42 percent, depcnding on the choice of povertv line {Barbu, Gheorghe, and Puwak.1992; Sipos 1992). Although evidence is still fragmented, the main patterns confirm the analy- sis presentcd in chapter 4: the distribution of income is widening. and povert is spreading, especially among children, young adults, the unemploved, and disadvantaged minorities (see also Burrows 1994). Problems which were mar- ginal prior to the transition are becoming a common experience. 1 236 1 INCOME T1RANSPI!RS: F'AMI LY SUPPORTI' ANI) OVIC'ItTl'Y RLICI'I. Policy This section starts with a brief discussion of the overall strategy. After discuss- ing poverty relief elsewhere, it turns to the reasons why family benefits and social assistance should be continuing parts of the economic landscapt. The overall strategy set our in chapter 9 applies equally here. It is necessary at this stage, however, to remind ourselves of the distinction made at the start of this chapter between type A policies, which aim to prevcnt poverty, and type B policies, wlhich aim to ameliorate the inost extreme poverty by reduc- ing but not climinating the poverty gap. The choice between the tvo strate- gies is critical in addressing the tension between fiscal constraints and political imperatives. Not many countries in Central and Eastern Europe can afford true type A policies, and some definitely cannot afford them. A likely outcomc in many countries is a mixed regime. The correct floor for policy A during the early transition was a parsimoniously defined subsistence minimum. Policy B requires several decisions: How much of the poverty gap should be reduced? Should all groups be helped equally, or should policy focus on particular groups, such as the elderly, mothers, and young children? Should policy focus on particular needs, such as nutrition, health, or education? The traditional methods of family support and poverty relief are by no means above criticism. The arguments, which are not new, assert that bene- fits create adverse incentives, both because taxation is necessary to pay fur them and because their existence reduces people's incentives to be self- sufficient; benefits, particularly benefits in kind, have high administrative costs; and benefit administrations have a vested interest in expanding the schemes- Many commentators, therefore, advocate poverty relief in cash: they empowver consumer choice; they facilitate the markeet mechanism; and they rce':uce administrative costs. Son,e commentators argue further that there should be no specific bencfit administration; benefits, instead, should be integrated with personal income taxation. Such negative income tax schemes (sometimes known as a guaran- teed minimum income) work in the following way: each individual or family receives a given income from the state (the guaranteed income) and then pays tax on all other income.5 The siZe of the guarantee can vary w^ith familv size and can be higher for specific groups such as pensioners or the disabled. The system is administered by the tax authorities (for the classic statements, see Friedman 1962; Friedman and Friedman 1979). Depending on the size of the guaranteed income, both type A and type B interventions could be delivered via negative income taxes, which could replace all other benefits. The idea has support from all parts of rhe politica spectrum: from the right, who see it as a wav of breaking w.hat they regard as the stranglehold of in-kind benefits, and from the left, who see the guaranteed income as a right of citizenship, awarded without the stigma of an income test. It is therefore important to ask whether I 237 1 POLICY DESIGN AND IMPLEMENTATION family support and social assistance are necessary or whether the new market econorfieq should eliminatc them altogether. After a brief description of sys- tcms elsewhere, this chapter turns to this basic question. The Straty Most Western European countries pursue type A policies (this section draws on Esping-Andersen 1990; Esping-Andersen and Mickliewright 1991; L$demel 1992; L0dcmel and Schulte 1992). Hoevevcr, their approach to poverty relief varies substantially. In the Nordic countries, an employment-oriented policy has kept the num- ber of poor small. Social assistance is residual, largely the rcsponsibility of local governments, and discrctionary inasmuch as national lcgislation needs to be interpreted by local govcrnmencs and social wvorkers. Povertv is perceived not only as a lack of income but also as a social pathology. Poverty relief is therefore delivered via cash benefits coupled with the active, often discretion- ary, involvement of social workers. In continental Europe (Austria, Belgium, Germany, and the Netherlands), social insurance, based on a contributions rccord, is distinguished sharply from social assistance, financed from general taxation. Ir. these countries, poverty relief is seen largely as income maintenance. it is usually a legal entitlement but is administered and financed locallv with little caseworker discretion. Bcnefit administrators outnumber social workers. The British system of social assistance is nationally organized as part of the administration of social insurance (though it is separately financed). The focus is on income maintenance. Benefit administrators pay social assistance to a large clientele on the basis of well-defined rights, with little discretion. Social w*orkers are not involved in income maintenance; rather, they focus on special problem cases at the local level. The Latin or Southern European countries (France, Italy. and Spain) are latecomers and, with the cxception of France, have no general schemes for the poor. Greece and Portugal, despite persistent poverty, have no sizable social assistance schemes. In consequence, local welfare organizations such as the church and other charitics play an important role. Exiting schcmes are characterized by a categorical approach which defincs groups of people, such as the elderly who receive litle or no pension and the disabled, as benefici- arics of social assistance (sec Tavaza and others 1990). In 1988, France introduced a national system of assistance (the rnrre minimum d onreim) which limits caseworker discretion and emphasizes reintegrating the poor into society by making income maintenance conditional on participation in rcin- tegration programs. In the United States, social assistance is fragmented, with programs geared to help different categories of poor people, such as individuals without healtch insurance and childrcn in povertv, or to meet particular needs. such as food 1 238 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIr,F and medical attention. Critics argue that the system is too expensive, is open to abuse, and does not reduce poverty because it fosters an attitude of depen- dency (see Friedman 1962; Friedman and Friedman 1979; Murray 1984). Others show that U.S. poverty relief programs are all typc B. Bcnefits are set at levels which only ameliorate povercy after the fact but do not bring recip- ients above the poverty line (Northrop 1991). Most developing countries pursue type B policies focused on prioritized needs. In some countries, the priority is food; in others, it is primary health care or education (sec Ahmad, Drezc, and Hills 1991). In some Asian cconomics-mainly those where Confucian traditions play a prominent role, such as Korea, Taiwan (China), and to a certain cxtent mainland China- social assistance tends to focus on health, education, and some limited nutri- tional interventon (see Leipziger and others 1992; Yeun 1986). In Latin America, pervasive poverty is hardly mitigated by social assistance. The poor are rarely covered by any form of social insurance and receive vc y limited support from the stace and charitab!c organizations (often the Catholic Church; McGreevey 1990; Mcsa-Lago 1991; Psacharopoulos 1990; Psa- charopoulos and others 1992). wHY FAMILY BENEFITs? Although most of the highly industrialized and higher-income developing economies have a broad range of family benefits, some benefits are absent in some countries: Austratia, New Zealand, and the United States, for example, have no system of universal family allowance. It is thereforc necessary to ask why these benefits should continue norwiLthstand- ing fiscal constrans. Historical forces are nor an overriding argument, but neieher should they be ignored. Family benefits Cxist throughout Central and Eastern Europe as adjuncts to vage seting and constitute an unusually large part of fauily incomc. Unlike price subsidies and many in-kind benefits, they do not cause major dis- tortions apart from the impact of their cost on tax rates. For the reasons set our in chaprer 2, an ovenvhelming case can be made for undertaking substantial pri- vatization and for phasing out most price subsidies to gain the efficiency advan- tages of market allocation. The same arguments do not apply to family benefits, at least not with the same sense of urgency. Indecd, when radical cancellation of producer and consumer subsidies and some state-provided services is on the: agenda, and when falling output makes it impossible to raise wages or to com- pensate fully for the cancellation of subsidies and serviecs, family benefits can- not be eliminated without cxacerbating the impact of the transition on family incomes. In addition, the abolition of family benefits in such circumstances, even if government thinks it desirable, is likely to meet strong political resis- tance or to invite disillusionment in democratic institutions. Income smoothing introduces a second set of arguments: family benefits stabilize the consumption of beneficiaries during difficulc times. It is true that 1 239 1 POLICY DESIGN AND IMPLEMENTATION hunger is an cffcicnt incentive to seek employment (if jobs arc availablc). However, hungry cmployees are rarely productive, let alone innovative; both qualities are badly needed in Central and Eastern Europe. Children cannot wait until bettcr timcs to grow physically and develop their abilities. Poor nutrition during their early years can permanently stunt their intellectual development. If they drop out of school for financial reasons, they lose the most productive years of cognitive development. The lack of income smoothing can casily become irreversible at a personal level (for a fuller discussion, see Cornia and Sipos 1991). Income smoothing thus has major implications for human capital formation, quite apart from its obvious moral and political dimensions. Poverty relief raises a third set of issues. Sincc poverty is highly correlated with family size, family benefits, being awarded on an easilv observable indicator of poverty, are: well targeted. This proposition is supported by convincing evidencc from the early transition. It reaains to bc seen over what time horizon the correlation benteen povcrty and family size might loosen, or when cost-effective and casy ro administcr means-tcsting tech- niques might become feasible in Central and Eastem Europe. If and when either of thesc developments occurs, the case for using family benefits to relieve poverry will correspondingly weaken (although the other arguments will remain). Public choice, the fourth element in the discussion, is the link between the historical context, on the one hand, and the tax burden of paying for family benefits, on the other. Family benefits are a significant tax burden and so, like any item financed from taation, are subject to public control in a democratic society. Thus family benefits must rCflCct public preferences. Valucs vary across nations and cultures, depending on prevailing attitudes toward chil- dren, families, the role of women, and so forth. Societies which perceive children more as a private than as a public benefit are less sensitive to horizon- tal equity, and the public is less willing to share the costs of child rearing. Countries whcre womcn's rights are a major issue are likely to cmphasize benefits for single mothers. A drive for gender equality is usually reflected in equal access to family benefits-maternity and parental or child care benefits for fathers and family allowances for mothers. A quest for higher participation of woomen in the labor force usually leads to morc child care facilities. Finally, pro-natalist incentives, regardless of their motive and efficiency, also fall into the category of public choicc. 'The connection of family benefits to negative income tax is often over- looked. The United Kingdom's switch in the late 1970s from child tax allowances to universal, tax-free child benefits was, in effect, a partial move toward an income guarantee scheme.6 The conclusion to which these arguments lead is that there is no universal recipe for the optimal level or form of familv benefits. The appropriate choice 1 240 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF will depcnd on a compromisc bcetwcn pablic choice and economic sus- tainability. rwo statements can be risked, however: * During the transition, a relatively high level of family bcnefits should remain for reasons related to history. poverty relief, income smoothing, and public choice. • Although the public expects higher wages to pay for an increasing share of child rearing when economic growth resumes, the pendulum probably wil not swing toward toral abolirion of family benefits. A sensc of horizontal equity seems to bc prcsent in most countries of Central and Eastcrn Europe. Against this backdrop, it is probably more useful to concentrate on increas- ing the efficiencv of family benefits through betcer targeting and streamlin- ing than to focus on persuading the public chat such benefits should be eliminated. wHn soa. AsssTrANcE? The case for social assistance is even less ambig- uous. The case is not thar social assistance is better targcetd than &mnly benefits, but rather that it has important additional aims. Labor marker policy and social insurance rest in important ways on social assistance. Entitlement to unemployment benefits generally expires after a fixed period, varying by country becween six and eighteen months. Given the shortage of jobs during the early transition, many people remained unein- ployed longer Ehan the maximum duration (in the case of older workers, perhaps permanently). An imporant function of social assistance, therefore, while maximizing incentives to find a new job, is to provide povcrty relief for the truly needy. This is partly to enhance equity, partly to sustain politic-i support for the reforms, and pardy to avoid the social costs-increased crime and erosion of human capital-which would otherwise occur. The level of and access to benefits are much more controversial issues and, as discussed ear- lier, vary widely in different countries. The choice among particular models and their mixes is again affected by public preferences, but the necd for social assistance is not questioned. An additional and forceful argumcnt in favor of social assistancc is its ability to take account of family size. In reformed social insurance schemes, benefit is generally awarded on an individual basis rather than being fully related to family size. This is a rational development, in that a closer relationship between contributions and benefits contributes both to efficiencv and to hori- zontal cquity, even if some redistribution occurs in most schemes. However. households differ greatly in size and composition. Social assistance is the instrument with which to take account of any of these diffcrences which other benefits fail to accommodate. A third purpose of social assistance is as the social safety net of last resort, providing highly targeted poverty relief. 1 241 1 POLICY DESIGN AND IMPLEMENTATION WHY NOT A NEGATiVE INCOME TAX? It is necessar, finally, to consider the case for and against a negative income tax. Onc way of thinking about such syscems is that they pay everyone a guaranteed income equal to the poverty line, recouped through the tax system from those who do not necd it. The problem with the idca is nor its logic, whose simple clarity is part of its great appeal, but the empirical fact that in almost all counries the distribution of income is heavily skewred toward lowver incomes (there are many poor people and few rich ones). The heavy lower tail of the pre-transfer income distribu- tion necessitates high tax rates to pay for the benefit; and tax rates that high are unsustainable because thev discourage w'ork effort. The incxorable logic of the point is important. Atkinson (1983, p. 275) illustrates it in terms of a typical Western European income distribution. If the guaranteed income for an average family is x percent of average income, and if income tax currently raises y percent of averagc income for purposes other than income support, the average income tax ratc must be x + y. With plausible values for x and y (say. 35 and 15 percent), the averag rate of income tax, ignoring all indirecc taxes, is 50 percent. Although it is, up to a point, possible to finesse the issue by introducing more complex schemes (see Parkler 1989), the underlying point remains valid. For these reasbns, negative income taxation has been introduced in the West only on a small scale. In the context of Central and Eastern Europe, in addition, (a) the avcrage tax rate would have to be significantly higher,7 and (b) large parts of the population would remain outside the income tax net. Moves from child tax allowances toward a universal family allowance would be a parial stcp along the road. Mainaining Maroacnomic Ra4vc There is an obvious nced for policies to contain costs. But possibilities for mobilizing additional resources should not be overlooked. MOBILtZING RESOURCES. There are pressing needs and ncev opportunities for mobilizing additional resources. The pressing need is co address the increase in poverrty The new opportunities are of three sorts: the phasing out of consumer and producer subsidies creates substancial savings; in addition, new democracies offer increasing opportunities to raise funds from private sources through nongovernmental organizations such as charities, self-help groups, and the like, and the reforms open up more flexible arrangcments between central and local government. The abolition of subsidies hits vulnerable groups thc hardest. Their aboli- tion should thcrefore be coordinated with an increase in social 3ssistance budgets and a buildup of the administrative capacitv necessary to deliver services. The attractive part of this logic is that sincc a gencral, untargeted subsidv is being replaced by a targeted benefit, only part of the resources 1242 1 INCOME T1UANSFERS: FAMILY SUPPORT AND POVERTY RELIEF released by the abolition of subsidies is needed to reduce poverty; dhe rest could be used to reduce budget deficits. In extraordinarv situations, social solidarity usually strengthens. Central and Eastern Europe suffers a handicap in this respect. The church and non- governmental organizations, and charities generally, rcquire resources to restore their capacities, an area which often requires considerable political tact.8 Policy needs both to encourage and to rcgulate nongovcrnmental activ- itv. Traditions are verv important in this field. It is not by chance that coun- tries with charitable traditions (Croatia, the Czech Republic, Hungary, Poland, and the Slovak Republic) have dozens of soup kitchens, while poorer countrics likc Albania have none. In addition to providing a conducive envi- ronment, govemmcnts can actively encourage international nongovermental organizations and other charities to help. However. qualirt control is impor- tant in the light of potential abuse, for cxarnple, scandals connecced with the foreign adoption of children in Romania or the contracring out nf orphanages by militant reUgious groups in Albania undcr conditions which threaten thc children's intcercsts. Thus both the traditional charities and new nongovern- mcntal organizations require immediare legislative and regulatory changes. Regulation of nonprofit activities should be high on the legislative agenda. The central-local mix in financing and providing social assistance is a sub- ject of heated debate throughout Central and Eastern Europe. Local initia- tives, such as public works and feeding programs for the elderly or for chil- dren, could be crucial in expanding the resources available for social assistance. Local governments, charities, and nongovernmental organizations arc better suited than the state to providc some aspects of social assistancc they are closer to the problems, and they can devise morc flexible responses than the central government. 'T'he existencc of a variet of providers could empower individuals to use the most appropriatc forms of social assistance. Social assiscance benefits should, to the extcnt possible, be self-targeting, for instance, by offering low-quality goods such as used clothes or low remunera- tion for public works. The stigma associated with relying on social assistance is also a self-targeting device, although more controversial than the others since it might reduce take-up to an unacceptable extent. cONmAINING cos. So far as family benefits are concerned, cost contain- ment involves (a) reducing the real value of univcrsal family allowances, (b) eliminating these benefits for a dependent wifc, and (c) rationalizing the duration of ccrtain family benefits. Rcducing the real value of family allowances per child does not imply that the benefit is an unwvanted luxury at present levels of development in Central and Eastern Europe. Rather, it relates to the changing rolc of wages and other income and to retargeting public transfers. The emerging structure of marker- determined wages will cover a larger part of the costs of chid rearing than was 1 Z43 1 POJLICY DESIGN AND IMPLEMENTATION the case under the old regime. In an ideal transition this would be a painicss process, with family allowances falling as real wages rise. The problem is that during the actual transition, and especially during the stabilization phase, real wages fall, which precludes the painless route. Income smoothing arguments suggest that family benefits need to be incrased. That, howevcr, would be the wrong route, given fiscal constraints. The policy which makes sense would reduce the real value of family allowances (but not necessarily of other family benefits), reflecting the changing role of wages at the higher end of the wage structure. At the lower end of the wage spcctrum, universal family benefits would be supplemented, but not replaced, by income-tested family support. The process should be gradual. Its phasing should rake account of changes in the wmage structure and of the development of adminisuative and other target- ing capabilities. Family allowances to dependent wives should be eliminated altogether. The practice makes little sense and is paternalistic. The resulting savings would be better used for labor market policies designed to help women find a job or for child care services designed to assist the pardicipation of women in the labor force. If the purpose of the transfer is to acknowledge child rearing as an alternative to gainful employment, then the transfer shot ild be made condi- tional on the presence of children and the costs of the scheme should be monitored closely.9 Reducing the duration of some benefits offers additional savings. Family allowances in some countries can be paid for a child up to twenty-six years of agc who is in continuing, full-time education. The problem of young adults in education is bctter addressed, however, by an explicit system of student support involving grants and loans designed to encourage participation in higher education, increase self-reliance, and improve incentives. Student loans (discussed further in chapter 11) are another example of a state- organized device to facilitate income smoothing. Sequencing is important. During the early transition, when wages werc low and insufficiently differenti- ated by educational levcl, loan repayments werc likely to be problcmatic. Student support which does not have to bc repaid should remain, ar least in parc. The duration of other family benefits (for example, materniry and child care allowances) could also be reviewed. Containing expenditure is also relevant tO social assistance. The topic arises in discussion of the effects of different financing mechanisms (in the context of incenrives) and of the level at which the benefit is pitched (in the context of poverty rclief). BaiYg Ma, te Family support and poverty relief can assist the working of a market svstem by improving incentives and by increasing labor productivity. 12441 INCOME TRANSFERS: FAMILY SUPPORrT AND POVERTY RELIEF IMPROVING INCENTtVES. Incentives can be improved through careful design of both the structure and financing of benefits. Bwefits. Smooth links between wages and different types of benefits are essential not only for poverty rclief, but also for reasons related to incentives. Social assistance should be harmonized with social insurance benefits and wages. Thus unemployed recipients of social assistance shoutd be subject to the same requirements to seek work as are recipients of unemplcimenc bene- fits. Also for reasons rclated to incentives, the working poor stould be poten- tiaily eligible for social assistance, at least during the early tansition. This is especially relevant for the ijcreasing numbers of self-employed. Self- employment is risky, particularly during a time of rapid change; yet it is an important ingredient in the success of the transirion and should be encour- aged. Allowing the self-employed to be eligible for social assistance would reduce the risks they face. The administrative problems should not be mini- mized, however the income of self-employed peoplc is difficult to assess, mak-ing means testing very difficult (see Atkinson 199 Ib). Universal family benefits improve labor supply incentives, particularly with a compressed vage structure. If benefits are income tested, families lose up to SI of benefit for every exa SI they earn (this is the so-called poverty trap); the poverty trap creates major labor supply disincentives. If, in addition, the distribution of wvages is compressed, many familics will havc incomes just above or just below the poverty line; a family might therefore be litle better off working than if it were rcceiving a means-tested benefit- If rhe difference between the means-tested benefit and the prospective wage is small, the familv might prefer activity in the houschold or the informal sector to formal cmployment (the unemployment trap). Making family benefirs universal, albeit at a lower level, helps to avoid problems related to both the poverty trap and the unemployment trap. S&arng wra. The division of costs between different levels of govcrnment has incentive effects which are crucial both to running services efficiently and flexibly and to controlling expenditure. Although discussed here in the con- text of social assistance, the matter has much wider relevance. The issue is that local involvement in social assistance can increase available resources or improve the efficiency of their use, but it can also create difficulties. The problem is at its mosc acute where local government administers a benefit paid out of an open-ended transfer from the central government In such cases, local governmnent, which is often politically opposed to the central govem- ment, has little or no incentive to restrain expenditure and faces strong local electoral pressure tO pay generous benefics. The resuk is a recipe for explod- ing costs (this is another example of the third-parry payment problem dis- cussed in chapter 2). The problem is somewhar less acute where social assis- tancc is centrally funded and centrally administered, for example, through local offices of the relevant central ministrv. This approach, however, in- [245 1 POLICY DESIGN AND IMIPLEMENTATION creases administrative costs, and administrative capacitr is frequendy inad- quate for such an arrangement; and without additional measures, it would not wholly guard against exploding costs. Two standard methods-matching grants and block grants-are used to build in caps to avoid uncontrolled spending. The first can be applied only to local governments; the second, both to local government and to local offices of a ecntral institution. Marching grants work best where local government controls a significant tax base and has the capacity to collect taxes. The central government could then offer to cofinance local social assistance schemnes, on condition that appropriate quality control was exercised locally. The flaw in this solution is that it is usually the better-off local governments which can afford to pay their share of soeial assistancc costs, whereas the needy cannot. For this reason, matching grants could be applied only selectively and only in some of the better-off countrics. A departure from the standard matching grant solution, buE still within its domain, would recognize nonfinancial inputs from local communities, such as labor and logisfical support for public works. This type of solution might be more useful to lower-income countries in the region. Block grants can be applied both to local governments and to local officcs of the central government. Their advantage is that they avoid the adverse incen- tives of matching grants, since they leave local government facing the full cost of any significant increase in spcnding on poverty relief. Their disadvantage is that the central government needs considerable knowledge of the distribution of poverty across the counuy in order to determine the size of the block grant for each area. Such information is difficult to obtain, especially in countrics with litde or no experiencc of household surveys and where administrative statistics are not reliable. Nevertheless, block grants are the preferred option, with special emphasis on improving the data on which their distribution is based and on devising and implementing systems of quality control. An added attraction of block grants is that they divide responsibility benween central and local government: local governments or local offices can use thcse resources relatively flexibly within the limits of legislation and avail- able resources, and the central government does not have to worry about third-party payment incentives which can cause costs to explode. Thc rolc of the central government is to considcr the appropriate level of spending on poverty relief. In countries where the local tax base is weak, which for the time being is the case throughout Central and Eastern Europe, the extCnt of poverty relief depends largely on the size of block grants. RAisING LAUOR PRODUcTIVITY. Reform policies should bear in mind that fam- ily benefits can be useful in maintaining the productivity of labor, increasing the participation of women in the labor force (see Fong and Paul 1992), and increasing individual choice. Fanily benefits affect labor productivity in differ- [Z46 1 INCOME rRANSFERS: FAMILY SUPPORr AND POVERTY 4ELIEF en ways, both through their effects on productivity per se and through their effects on labor force participation. Beneficial effects on labor productivity arise if paying a family allowance encourages children to pursue their education beyond the minimum age for leaving school. Although loans and grants were proposed for higher educa- tion, such solutions are not feasible for secondary education (students four- tecn to eightecn years old). Family allowances can help to reduce dhe extent of dropping out. In rural Albania, for example, which has no family allowances, the drastic decline in living standards, together with the privatiz- ation of land, has led to a sharp drop in secondary school enrollment and incrcased truancy from elemcntary schools because of the newly redis- covered practice of using children in the fields. Under these circumstances, conditioning family allowances on school attendance until the age of sixteen or eighteen might be a useful device, especially in highiy 3gricultural countries. Effects on labor force participation arise because the structure and fnance of family support form part of labor-market policy (see Fong 1993 and the discussion in chapters 6 and 7). In particular, support like child care facilitices could help to maintain the participation of women in the labor force. This might not sound like an important policy at a time of rising unemploymenc. However, the demographic prospects, particularly an aging population, sug- gest that high particiation of women in the labor force will soon be back on die agenda, as it clearly is already in most of the highly industrialized coun- tries. Undoing some child care services would be counterproductive from this perspective. Additionally, and separately, family benefits help workers, espe- eiaily women, to withdraw temporarily from the labor market and subse- quendy to retum to full- or par-timke work. This increases individual and family choice. Reglal ning Market Forces: Poverty ReTWef In the shorr run, poverty relief is a central focus of the reforms. The issucs raised by family benefits and social assistance are somewhat differcnt, and so are discussed scparately. FAMILY BENEFITS. Family benefirs arc not designed for povercy relief per sc. They do, however, substantially relievc poverty (a) because they accrue disproporcionately to poor people and (b) because their share in family budgets is high. Family allowance should therefore c retained as a universal benefic. Scope exists, however, for improved targeting. As discussed earlier, this does not necessitate income testing. Universal family allowances should be retained because they are well targeted ac fairly low administrative cost. That does not, however, mcan that no improvemcnt is possible. [247 1 POLICY DESIGN AND IMPLEMENTATION C2ild tax allowances. Tax allowances and tax crcdits require discussion as background: * A tax allowance (for example, allowing $250 of tax-free income for each child) is a deduction from taxable income. Such an allowance is worth nothing to a family below the income tax threshold, is worth $50 to a family whose marginal tax rate is 20 percent, and is worth $125 to a family whose marginal tax ratc is 50 percent. Since income tax rates generally rise with income, child tax allowances are thus worth more to richer families and are worth nothing to the poorest families. The more progressive the tax system, the more the rich benefit from any tax allowamnce. A tax credit, in contrast, is a deduction not from taxable incomc, but from a person's tax bill of, say. S250 for each child in the family. A tax credit is gencrally worth the same to cverybne. Tax credits can be arranged so that even thc poor benefit, so long as the systern allows for negative tax payments (the payment of S250 per child to someone whose income is so low chat he or she pays no income tax). Tax credits, however, facc practical problems. Taxes are paid annuallyr thus credits would normally also be paid annually, which would cause problems for the poor. The payment of tax credits monthly is possible, but administratively cumbersome. I in contrast, a tax-free familv allowance, which is not income tested, is worth the same to all income groups and raises no signirlcant administrative problems. Thus child tax allowances are an expensive and poorly targeted form of family support. lining family bmefis. Making family bcnefits taxable is a promising approach to improved targeting. If family allowance is taxable, a poor family would receive the benefit (say, £250) in its entirety; a family facing a marginal tax rate of 20 percent w-ould receive a net benefit of $200; and a family with a 50 percent tax rate would receive a net benefit of $125. Thus a larger share of total expnditurc goes to lower-income groups. Attractive though the idea sounds, it needs to be adopted with care: - It has the desired rcsult onlv if the personal income tax is progressive, that is, if marginal tax rates are higher at higher incomes. - If the assessment unit for income tax is the individual rather than the family, as is often the case, subjecting family benefits to income tax can be problematic (see Jarvis and Micklewright 1993). * There are significant administrative problems in taxing family benefits. If the benefit is taxed monthly, the agent paying the benefit needs to know the recipient's marginal tax rate each rime a paymcnt is made; with diverse sources of income, this is administratively complex. Alternatively, families could receive the gross benefit each month and pay tax at the end of the year. This is easier administratively, and it would work well for the beter off by reducing their net benefit. For lower-income families, however, the need in 1 248 1 INCOME TRANSFEtS: FAMILY SUPPORT AND POVERTY RELIEF some cases to make additional tax payments at the end of the year could cause serious problems. - Administrative difficulties are compounded by the fact that personal income taxation is a new institution in most of Central and Eastern Europe, so that administrative experience is still building up. For these and other reasons, family benefits in many of the highly indus- trialized countries are not subject to incomc tax (although Hungary is consid- ering the possibility of taxing family allowances beginning in 1994). AtRatigfimily allwances toffamiy size or the ag of thMe ildn. This type of policy could improve poverty relief but raises issues of both design and imple- mentation. If the costs of child care are high, family allowances should proba- bly fall with age; where child care costs are not generally borne by the family, family allowances should rise with age because older children consume more food, clothing, and so forth than vounger children. In both cascs, it would be administratively helpful to have relatively large age brackets (such as under six, six to fourteen, and fifteen to eighteen) to avoid the need for frequent reclassification. SOCIAL ASSISTANCE. The design of a workable system of social assistance is complcx. Policymakers have to decide on the level of benefits, on the division between benefits in cash and in kind, on the specifics of design and implemen- tation, and on the sequencing of reform. 7he cld of benefit. Setting the level of social assistance benefis confronts hcad on dhe tension between resource constraints and rising poverty. Ideally, benefits should be set at or above the poverty line, that is, a type A policy (as discussed at the start of this chaptcr a type A policy seeks to eliminate povcrty; a type B policy seeks to ameliorate it). This should be less than the minimum unemployment benefit or minimum pension or minimum wage to maximize incentives to seek work. With low minimum wages and a com- pressed wage distribution, however, a meaningful margin between social assis- tance and the rest is difficult to determine. Although the calculation of poverty lines could be improved, in many countries rninimum wages are set at or below the poverty linc- The core of the problem is the remaining vestiges of socialist wage determination, under which an avcrage wage for an individual earncr could not pay the subsistence minimum of even the smallest family. This is still true in most of Central and Eastern Europe. Under these condi- tions, it is doubtful whether a parsimoniously redcfined poverty linc could create the meaningful margin which is missing from the equation. Either the level of social assistance is at the same level as the minimum wage, with advcrse effects on incentives, or it has to be below the povcrty line-a type B policy-which does nor eliminare poverty but only amelioratcs it. Having said that, it is worthwhile to reiterate earlier arguments. Hungry people are not efficient workcrs, and hungry job seckers arc not efficient job 1249 1 POLICY DESIGN AND IMPLEMENTATION seekers either. Competitive economies requirc a competitive labor force, and social assistance recipients should have a chance to maintain or improve, by retraining, their productivity. An inappropriate social assistancc system gener- ates a downward spiral from which few, if any, can return to the world of work. The poor can easily become marginalized during a long spell on inadequate social assistance, risking not onlv a lack of income but also exclusion and the related dangers of developing behavioral patterns which perpetuate their exclusion. The symmetry with the discussion of long-term unemployment in chapters 7 and 8 is clear. To avoid this outcome, poverty relief policies should be strengthened in at least threc ways: through a wider choice of instruments, through a well- designed system of social assiseance capable of dealing w ith large numbers of recipients, and through smooth linkagcs vrith social insurance benefits and assistance for the working poor. CA&ih rsus kind. The choice of instrumenEs is crucial (this secEion draws heavily on Hughes 1993 and Jimenez 1993). Many opeions (see table 10-5), an analvtical framework (chapter 2), and a wide arrav of international cxperi- ence are available. Cash benefits are generally preferable to benefits in kind if the objective is poverty rerief. Thev are more cost-effective (in-kind programs are more diffi- cukt to administer), and they provide recipients with rcsources which they can use freely. Cash benefits help to create and maintain markets and consumer discretion. In-kind programs, in contrast, can inhibit private production of the commodities concerned. Since new democracies aim to increase liberty and reduce patcrnalistic scAlutions and stigma, a strong case can be made for letting the poor choose by granting them cash benefts. Cash is generally more effective (a) the greater the fraction of Ehe popula- tion it is intended to help, (b) the easier it is to trade the commodity being redistributed, (c) the more fungible is the commodiry in family income (that Table 10-5. Insrmtn of SoilAssistancand TherReI7deff the Markeg lIsmment PAcder p,ce Examples Cash transfers Generally private Markcc prices Framilv allowanec. tradcrs soaal pcnsions, cash assistnce In-kind transfers Direct public Govcrnmcnt, state- Free or highlv Public education, provision owncd enterprise subsidized (below public health, government cost) public udlitics Vouchers Private traders Market prices Food stamps. housing, hcalth Producer subsidies Private traders Markct prices Socili funds Administrative Private taders, state- Subsidized prices Food, housing, price controls owned cnterprises utilities Sa.: Jimencz 1993. I 250 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF is, the casier it is to redirect spending), (d) the better the information con- sumers havc about the commodity, (e) the greater the extent to which the commodity is available at marker prices, and (0 the lower is institutional capacity to organize in-kind redistribution. Bencfits in kind also have a role, particularly if the aim is to stimulate the con- sumption of certain typcs of goods or services among previously identified groups. As discussed at length in chaptcr Z, the issuc of cash versus in-kind benefits requires careful analysis. Cases where distribution in kind might be appropriatc include commodities which the private market supplies poorly, if at all: an example is primary education because of imperfect consumer informa- tion and the lack of complementary markets, such as for student loans; another is vaccination against communicable diseascs (because of externalities). In addi- tion, some in-kind benefits can be self-selective. If the poor consume identifia- ble bundles different from the rich, self-selection can be cfficient. Carefully tar- geced noncash benefits can combine good coverage with cost-effectiveness. Considerable care is needed, howevcr, when designing in-kind programs. Such programs generally have two aims: to alleviate absolute shortages, by giv- ing out food directly, or to constrain the consumption of the poor to types of consumprion which policymakers regard as appropriate. On the former aim, the consensus on famine relief (Ravallion 1987, 1991) tends toward income trans- fers rather than direct transfers of food, although a case may be made for limited direct transfers of food during the transition if shortages become acute. Food scamp programs and the like, however, may not be successful if their aim is to constrain the consumption of the poor. The group aimed at is large; the com- modity is easily traded, even if the law specifies otherwise; family income may be diverted to other uses from the food on which it would otherwise be spent; and significant resources are needed to administer the program. Two possible arguments remain. One is that, in political economy terms, it may be easier to redistribute benefits in kind than in cash. The argument has to be recognized, but its strength should not be overestimated. The other argument is a strong one: in very specific circumstances, direct in-kind trans- fers are both well targeted and nontransferable, particularly where there is a captive target group. Examples include pregnant women and infants (nutri- tional programs such as free orange juice a. maternity clinics, medical checkups) and schoolchildren (free milk, meab, and health checks). Such programs are aimed at a precise and largely captive group, and they are not readily tradable. More generally, targeted family support, particularly for nutri- tional and medical purposes, can be a useful complement to cash benefits in addressing emerging poverty (for a further discussion, see Grosh 1994). The degnand impplmeurauon ofasy sm of socialassistant. Putting into place a workable systmn of social assistance is the major priority alongside unern- ployment benefits. The system should have the following broad characteris- tics: it should be universal (eligibility should nor depend on whether a person 1 251 1 POLICY DESIGN AND IMPLEMENTATION is in the work force); it should provide an acceptable level of income (the cxact level of which will depcnd on whethcr a type A or a type B policy is being pursued); it should be flexible; it should be simple to understand and administer; and, to the maximum extent consistent with political realites, it should have a national framework.'0 On the last point, the legislative frame- work (eligibility criteria and the introduction of block grants to localities) should be national; implementation could be local. 'f'he links to other benefits are important. Recipients of social insurancc benefits should also be'eligible for social assistance. For example, a person who reccives a widow's pension and a family allowancc paid for a dependent child should receive social assistance if the combined household incoome is less than the level of social assistance. The gap could be met in cash, or specific benefits such as financial suppore for the education of the child, school meals, and rent subsidy could be provided to ensure that certain prionty needs are met. Especially with a type B poverty line, a cash payment designed to bring family income up to the poverty line would not be sufficient to cover the cost of ehcsc important nceds. Hcre, again, policymakers have to make difficult and politically contentious choices. The design of such a systcrn requires a set of sequenced decisions: - What categorical tests, if any, will there be (will benefits depend on criteria other than income, such as agc or cmployment status)? - How will the poverty line be set? This requires decisions about the basket of goods to be covered and about how familics of different sizes are created. - What range of benefits will be offered (the mix of cash and in-kind benefits)? - How will mcans testing be organized? This involves a series of decisions: What income is relevant to determining bcnefits (for example, how will home- grown food be assessed)? Whose income is relevant (will the income of an elderly parent sharing the family home be included)? How much income, if any, will be ignored for the purpose of detcrmining the benefit? And how rnuch benefit will be lost for each dollar of income above any disrcgardcd income? - Who will operate the benefit? Will it be a new operation (which will increase administrative costs and complicate the system for the claimant), or will it be an addition to the currcnt administration (which reduces administra- tive costs but adds to the complexity for benefir offices)? * What are the legislative requirements, procedural instructions, and staff recruitment and training needs? Thc design should lead to implcmentation as soon as possible. Seqncing. In this area, as clsewhere, sequencing is crucial. Phasing out general subsidies produces savings, part of which could finance social assis- tance. But the phasing out of subsidies and the introduction of social assis- 1 ZSZ I INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF cance should be harmonized. The standard mistakes are cutting subsidies without increasing the allocation of social assistancc or thc institutional capac- ity to deliver services. For example, the abolition of hostels for commuting workers subsidized by the enterprise or from taxation is a major reason for the increase in homeessness in Central and Eastern Europe. Measures which take this burden off enterprise and state budgets should be coordinarer with measures which relocatc the workers affected or establish night sheite f (or the destitute. An across-the-board abolition of pricc subsidies without ade- quate mechanisms for targeting and institutions for social assistance (means testing for cash benefits, food stamp schcmes, soup kitchens, and so forth) would cause much avoidable hardship. Removing social assistance functions from social insurance also requires effective sequencing. As discussed in chapter 9, the reform of social insurance is likely over time to reduce redistribution within the system, thcreby shifting to social assistance the burden of caring for vulnerable groups. Moving the finance and delivery of social assistance benefits our of social insurance pro- grams would greatly improvc the transparency of both schemes. Any such change requires adequate funding for social assistance and the developmcnt of an effective alternative delivery mechanism. The latter usually requires the transfcr of institutions or the development of new administrativc capabilities. Imp mentang Se .Re_fnns Efforcs to reform the system of family support and poverty relief will fail unless the serious constraints imposed by a lack of institutional and political capacity are addressed. BUILDING INSTffUTIONAL cAPAcrry. The necd to build institutional capacity poses a major challenge. As with social insurance, the emergence of large numbers of small-scale employers and widespread self-employmcnt means that the administrarion of benefits should be moved from the enterprise to the benefit authorities. A poorly developed system of social assistance should be upgraded quickly to respond cffectively to the rapidly expanding number of claims. The critical bocdenecks relate to (a) a lack of capacity to admin.stcr a means test to large numbers of people and (b) a lack of personal counseling. During the commu- nist era, poverty relief was a residual area, with poverty regarded as a pathol- ogy afflicting the individual concerned. A nctworkz of social workers is largely nonexistent, with a few cxceptions such as Croatia, Slovenia, and, up to a point, Hungary. In most of Central and Eastern Europe, local governments or local offices of labor ministries were staffed with pcople of general clerical education. Specialized training to enable benefit officers and social workers to delivcr services more efficiendy is a mattcr of somc urgency. To fill these gaps, and to run an extended system, reform is necded in at Icast threc arcas. First, the regulatory framework generally requires strcngth- [ 253 I POLICY DESIGN AND IMPLEMENTATION ening to guidc thc dctermination of benefits. A second changc is the necd carefully to distinguish the role of social worker from that of bencfit officer. Social work (helping familics with problems) requires high skills. The assess- ment of benefits can, for the most part. be carried out by officers with rclatively litdc training. It is by no means clear that the two functions should be carried out by the same pcople; the balancc between the two professions should up to a point depend on the traditions of each country. Third, the assessment procedure should be streamlined, given the largc numbers of people who are likely to claim social assistance once their entitlemcnt to unemployrnent benefits has cxpired. Appropriate training could greatly improve the ability of all levels of government-from ministries down to the local level-to control the quality of the welfare apparatus. This is crucial for the running of orphanages, nursing homcs, night shelters, and other welfare institutions, where the administra- ticn-whether or not it provides the service itself-should set, publish, and enforce standards. BUILDING POLMCAL CAPACITY. The objective is to maintain support for the overall reforms in the face of the overarching tensivn between maintaining current standards of living, on the onc hand, and rielasing resources for investment, on the other. In addressing poverty, it should be remembered that the poor are citizens and are part of the electorate. Support for the most needy, beyond solidarity, is a tool to avoid a breakdown in the social fabric both in its political aspects (riots) and in its civil manifestations (crime, delin- quency, and drug abusc). Although reintegrating the marginalized poor should be an aim of social assistance, for which certain incentives could be applied, depriving the "undeserving' poor of access to social assistance could inflict a varicty of costs on socicty. Maintaining a certain level of social protection is essential to secure support from rhe most vocal groups. That can hardly cvcr be done without sacrifices in the form of leakages of benefits to persons who are not truly necdy bur who might otherwise lose intcrest in lending support to poverty rclief. This espc- cially applies to family benefits. In general. this is a twilight zone where policymakers should strike an appropriate balance between targeting bcnefits very tightly on the poor (for fiscal reasons) and ensuring broader coverage (for political reasons; see Cornia and Stewart 1992). At a more practical level, building political support has two main aspects: adopting policies which rcspond to public opinion and taking action to change public opinion. On the first, the state earnings-related pcnsion is regarded as very important in most of the former U.S.S.R.; it should thercfore be made clear that policy which, in cffect, gives everyone something close to the minimum pension is a temporary expedient. Similarly, public opinion in the former socialist countries tends to favor family benefits, and any attempt to 1 254 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF reduce their level should take account of these public prefcrences. To achieve that, and to avoid inflicting unduc hardship upon the poorest segments of society, at least some of the savings from reducing family benefits must be divcrted to increased cxpcnditurc on social assistancc or to new mcans-tcsted family support. Policy should also seck to address people's strongest fears. As an example, in some countries inflation has largely wiped out people's savings, and many of the elderly fear that thev will not be able to afford a funeral. A death grant sufficient to pay for a simple funeral would yield significant politi- cal dividends among both the elderly and their middle-aged children. The benefit wot'ld not be costly, both because it is a single payment and because the claim for a death grant automatically gives the authorities the information they need to discontinue the dead personrs pension or to reduce it to that of a surviving spouse. The grant therefore has administrative, cost saving, and political advantages. The second aspect of building political support is action to shape public opinion. Political acccptnce from this perspective requires public under- standing of the issues, in parricular the tradeoffs discusscd in chaptcr 1. A major misconception (common enough also in the West) is that die standard of living of pcnsioners, or that of famnilies with young childrcn, can be increased by giing them more money, that the government has lots of money, and that the government can always prmt more money. It is important to help the electorat understand that what matters is not monev but national output, and that if pcnsioncrs receive a larger share of national output, then less is left to pay workers' wagcs or to invest in ways which lead to larger national output in the futurc. Such public education is an important guard against populist political pressures. Conclusions: Priorities and Sequencing Declining real wages and dislocation of large numbers of peoplc have led to a sharp rise in povertv. Povcrtv alleviation is a clear impcrativc, both for politi- cal reasons and for maintaining human capital; it is particularly important in countries which inherited a vcry low standard of living or where the stabiliza- tion or supply shocks have becn particularly sevcre. Shon-tem Poeas Short-term policics should scek to strengthen or develop a system of social assistance capable of delivering poverty relief to potentially large numbers of claimants, to ensure the necessary administrative capaciry, and to promote practical measures to targct benefits righrJy in the interests of cost containment. 1 255 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF even makeshift) capacity to conduct poverty surveys. In countries with no social assistance administration prior to the transition, the development of administrative statistics is equally important. Measwrw to cntain cost, though wita, rquirra more ban usuallyfine balance of ecoomitc and pieal considrations, given the se, visibilty, an political sw- dinty of cash benefitprograms: * In addition to its administrative advantages, using indicators of poverty to target benefits is likely to bc more cost-cffcctivc and efficient, at least initially, than introducing means testing prcmawrely. In countries where incomes in the informal sector and remittances from abroad are important, this method could be supplemented by allowing authorities or individual caseworkers a measure of discretion in the aiward of benefits, subject to suitable regulation. A As wage differentials widen and administrative capacity increases, universal family allowances could be scaled down and supplcmcnted by means-testcd schemes. Medium-tan Policies Policies with a medium-term dimension should focus on consolidating social assistance as a complement to a reformed system of social insurance and other forms of income transfers. Kev coisemust Le mae: - Decisions are needed about the desired mix of tvpe A and type B policies and, in the case of family allowances, about horizontal equity objectives. * Thcse issues and their cost implications should be made explicit in the political process and should form part of public debate. d4dmiu&radrr cpacity iwqurars noiiuiig acdm - Administrativc costs should be kept down by simple, standardized procedures. - When the appropriate administrative and financial institutions are in place, integrating social assistance and family allowances with the pcrsonal income tax system could be considered but should not bc regardcd as the only option. In any case, a backup scheme is needed to respond to individual circumstances. Such a scheme could be based on a series of rules or could operate within a framework of caseworker discrection. - Poverty monitoring should be improved by integrating the conduct of statis- tical surveys with systems designed to collect informarion from caseworkers and data necessary for administration. Z2571 POLICY DESIGN AND IMPLEMENTATION The structure of betefits should seek to coorate pov relief with other cash benefits: * Where income levels permit type A policies, ehc cmphasis should be placed on coordinating social insurancc, social assistance, and other cash benefits relative to a well-defined poverty line and in a way which minimizes adverse incentives. * In countriCs With typc B policies, family allowances should bc differentiated by income level and could possibly bc withdra-wn for higher-incomc groups. Thefinance ofpotry relief couldbe divasiffed: * In the longer term, morc local and privatc agcncies such as nongovernmen- tal organizations, charities, and self-help groups could be involved both in financing but especially in delivering social assistance. * Regional disparities should continue to be addressed by differentiated cen- tml allocations in ways -which do not underminc the motivation for increased local responsibility. In the longer term, the poverty relief function of cash and in-kind benefits should be replaced to the cxtent possible by policics aimed at developing the human capital of the poor and providing them with opportunities to carn income. The sorts of reforms outlined in this and the previous chapter have a series of advantages. Through bctter targeting, they improve povcrty retief and simultancously contair costs. The system is flexible and can be adapted to objectives besides poverty relief, such as income smoothing, in the lightr of the economic and political conditions emerging in each country. By freeing the labor market to perform its proper function of helping workers move to jobs in which chey are more efficient, the reform of cash benefits constitutes an integral part of the overall reform process. Notes 1. As discussed in chaptLr 3, the carly communist principlcs favored colleceivc ovcr individual consumption. The distribution of bencfits in kind derived from this view. Thus a movc toward cash benefits which empowered individual consumer choice was a major departurc from the early principlcs (sce Rupp 1997: Zimakova 1992). It is therefore no accident that the scopc of cash benefits was greater in countrics whcre somec market-oriented reforms took root or wherc the civil society was stronger, such as Czechoslovakia, Hungary, and Poland, and developed onlv partially and bclatedlv in countries which adhered to a more orthodox vision of the socialist society, such as Albania and the U.S.S.R. 2. These data &ce difficultics additional to the gcneral problems of scarce and unreliable data discussed in chapter 4 and should thcrcfore be interpreted with care. First, the diffcrence betccen thc oECD countries and Ccntral and Eastern Europc is I 258 1 INCOME TRANSFERS: FAMILY SUPPORT AND POVERTY RELIEF partly the result of demographic factors: only Australia, Portugal, and Spain among OEcD members have morc than 30 percent of thc population under ninctecn years old; among countrics in Central and Eastern Europe, only Hungary has lcss than 30 percent of the population under nincteen years of agc. Second. the comparison is biased because countrics with lown family bencfits, such as Albania and the former U.S.S.R. (bclowr I percent of GoP), arc usualty excluded from the avcrages for Ccntral and Eastern Europe. Finally. the outcomc is influenccd by factors other than the gencrosity of family bcnefits. For instance, between 1960 and 1984. expcnditure on family benefits in the OECD countries rcmained a broadly constant fraction of cDP but fell sharply as a fraction of social spending, from 17.3 to 8.9 percent, becausc other programs, notably pensions, wcrc expanded. 3. Akhough long lincs and misery plaved a role in creating dissatisfaction in the communist rcgimes, rising povertv alonc cannot explain the sudden demise of the system. A morc likely explanation is the widening gap betveen expectations and reality for a large majority of peopic. The economic stagnation and downturn in the 1980s made it clear that the regime would not be able to deliver its promises and that thc economv was cntering a dow nw ard spiral. 4. The sharp decline in real wvages in Poland in 1990 should bc secn in the context of the explosion in nominal uages in 1988-89 w hen prices were still largely controlled, leading to massivc shortages and finally hyperinflation. It is argued that the higher 1989 real wvages were not translated into higher welfare because of shortages and forced savings; thesc forccd savings were then washed away bv inflation which ensued from wage increases (s=e Balcerowicz 1993a; Upton and Sachs 1990). 5. To illustrate with a simple cxample, supposc that the income guarantcc is $1,000 a year per person in the family and that all other income is taxed at 50 percent. A family of four with zero carnings thus has a total annual net income of S4,000. A family of four with camings of $5,000. receives a guaranteed incomc of $4,000 and pays a tax of S2,500 (that is, 50 pcrcent of its earnings of $5,000); its total annual net income is therefore $7,500. A family of four with carnings of $10,000, receives a guarantec income of S4,000 and pays a mx of S5,000 (50 percent of its earnings of $10,000); its total annual net incorne is therefore S9,000. For a furdtr discussion of negativc income tax and details of the large literature on the topic. see Barr 1993b. chap. I 1. 6. The definition and differen charactcristics of (a) child tax allowances and (b) tax- free child bencfits are discussed bclow in the section on rCgulating market forces. 7. In 1993, Lithuania introduced a svstem of social assistance based on a ncgativc incomc tax. Predictably, the scheme required high tax rates. 8. In almiost all Central and Eastcrn Europe. restitution of church property has caused problcms for existing social wclfare oreducational inscicutions. Many properties which used to belong to the church now house institutions which have nowherc cise to go; their rclocation would require considerable public cxpenditure which, during the current fiscal cris, is not a realistic possibilitvy 9. This has becn done in the newv Social Law in Hungary,v which offers a benefit for mothers with a work history who raisc three or more children for a fie-year period when the youngesr child is bectween three and cight vears of age (see Magyar Kazlany 1993). 10. Thc history of the British Poor Law,. particularly during the period between the first and second world wars, is instructive as a case study of the problems of financing social assistance locally; the history of the U.S. 1935 Social Sccuritv Act is an cxample of how to reimpose some central control on a local system (see Barr 1993b, chap. 2). [ 259 l Eleven EDUCATION AND TRAINING BRUNO LAPORTE * JULIAN SCHWEITZER VIrUALLY ALL COUNMES IN CEWrRAL AND EAsrELm, EUROPE have marure cduca- tion and training systcms, oftcn with a rich scholarly heritagc which predates communism.' Scholars in the region have often demonstrated their excel- lence. paricularly in the basic sciences. It could be argued, therefore, that reforming the education and training system is nor a high priority because so many urgcnt matters are demanding the attention of cash-strapped policy- makers and that restructuring can thcrcfore wait. Why would such a policy of ncegcct be a critical mistake? At lcast sincc the development of human capital tiory in the 1960s (Becker 1964), cconomists have realized that high levels of education and training are crucial determinants of a country's economic success. This has been confirmed most recendy by two studies (World Bank 1991, 1994). The lattEcr examined the determinants of success of the East Asian 'tiges and identified their high levels of education, from basic educa- tion to rcscarch, as one of the kev facwors disrLnguishing them from their peers. But quite apart from economic compctitivensci. thcre is another reason to emphasize education and training now. Failure to invest in the education of young people will generate large downstam costs for the statc and the individual because the poorly educated make up a large proportion of persons who are unemployed and living in povcrty, and they consume a disproportion- ate share of public services and public expenditurcs (World Bank 1990a). This is not to downplay the imporunce ot the social and culural purposcs of education- The education and training system clearly plays a vital role in supporting the cvolution of a social conact which emphasizes freedom of expression, equity, and the responsiilities, rights, and obligarions of individ- uals. The study of at, music, and culrure supports the prcscrvation and evolution of cultural values and artistic life. Indeed. it can be argued that the whole idea of a nation resrs on a bedrock of common values, the transmission, evolution, and protection of which are important purposes of the education system. A key function of education is social integration. This is unusually important in countries in Ccntral and Eastern Europe. many of which have significamn cEhdc and religious minorities and communal tensions. The resulE- ing bcnefits constitutc an important rason why virtually all countries provide free primary schooling. The economic, social, and cultural purposcs of cduca- tion., morecover, arc mutually supporting. For examplc. active participaxion in 1 260 1 EDUCATION AND T'RAINING economic developmcnt presupposes that individuals understand societal values. An understanding and appreciation of the arts and humanities may help young people to develop value systems which arc cssential for equitablc social and economic development. More efficient management of the education and training system (an economic objective) may dictate a degrce of decentraliza- tion, which in turn supports creativity and divcrsity (a social objective). Given the focus of this book, this chaptcr is concerned mainly with the economic objectives and challenges facing the education and training systems of countries in Central and Eastern Europe. From an economic perspective, the function of education and training is to equip peoplc to participate activcly in the formation of wealth. The success of the education and training system can, in principle, although subject to major measurement problems, be mea- sured bv the rares of rcturn to investment in human capita. Of course, the countries of Ccntral and Eastern Europe have different cultures and social structurcs, and no single blueprint could possiblv match these varied conditions. A discussion of reforms in education and training Must therefore be approached with some humiliv. The Inheritance The postcommunist governments of the countries of Central and Eastern Europe inherited mature education and training systems which are a legacy of central planning and political control (see table 11-1 for enrollment data). Largelv transformed after the Second World War into models of the Soviet system, education and training systems continued throughout the communist period to stress basic literacy and vocational training for the so-callcd produc- tive sectors at the cxpense of creativity, diversity, and "unproductive' and ideologically unsafe topics in thc social sciences. With some variations, the communist education and training system had the Lijowing components: * The svstem of kindergarrens and preschool education was well developed. * Near-universal basic education was provided to both boys and girls up to grade eight (ages thirteen and fourteen) in state-run elementary schools. * Secondary edueation in academic, technical, and vocational streams was provided to fourtcen- to eightlen-year-olds. Academic secondary education prepared a small cohort of students for higher education. Vocational schools, often specialized into narrow occupational streams and frequently attached to enterprises, prepared skilled and semi-skilled workers for industry and agriculture. * A rclatively undevelopcd system of adult education and training was largely confined to on-the-job training in enterprises. * Higher education comprised universitv education and some professional training for a relatively small postsecondary cohort. Research was not carried 1 26! 1 P'OLICY DFSIGN AND IMI'LEMENTATION Tablc 11-1. Gross brvlmnent Ratios in CnvI and Fasem &rope, 1985-89 Coarn'vy and/leve of ed,cadvm 1985 1986 1987 1988 1989 Alania Primary 103 101 10o 99 99 Secondarv 72 73 76 77 80 Higher 7 7 8 8 8 B/lgara Primarv 102 104 104 104 97 Secondary 302 75 76 75 75 Higher 19 71 23 25 26 Cst6boslovkia Primary 99 98 96 94 92 Scconday 84 81 82 85 87 Higher 16 16 16 18 18 Primary 98 98 97 96 94 Secondary 72 70 70 71 76 Higher 16 15 15 15 15 Poland Primary 101 101 101 100 99 Sccondarv 78 80 80 81 81 1-ighcr 17 17 18 20 20 RAmmia Primary 98 97 97 96 95 Sccondary 75 74 79 85 88 Highcr 11 11 10 9 9 N(oe: The scrics on primary school enrollment arc cstimates of childrcn of all ages enrolled in primary school. Figures are exprcssed as the ratio of pupils to the population of children in the countryss school-age goup. Many countrics. but not all, consider the age for primary school to bc six to eleven years. For some countrics with universal primary education. the gross cnrollment ratio may exceed 100 percent because somc pupils are younger or oldcr than the country's standard age for primary schooL The dat on secondary school cnrollment are calculated in thc same way. The definition of secondan, school age also differs among countries; it is most cornmonl considered to be twelvc to sevcnteen years. The higher cducation cnrollment rado is calculated by dividing thc number of scudcnts enrolled in all posisecondary schools and universities by the population twcntv to Nventry-four vcars old. Pupils attcnding vocational schools. adult education prograMs. tvo-ycar colleges, nd distancc cducation arc included. &xre: World Bank 199Za. ouE on any scale in universities. being generally the preserve of research institutes controlled by industrial ministries or academies of sciencc. Strngks The most positive bequest of the communist education and training system was the high quality of basic education. Even taking into consideration somc distortion in rhe data, countries in Central and Eastern Europe achieved high I 26 1 EDUCATION AND TRAINING levels of literacy compared with countries of similar gross domestic product (CGDP) and even compared witli somc countrics in the Organization for Eco- nomic Cooperation and Development (OECD). Despite similar caveats con- cerning the comparability of data, evidence from Hungary and Slovenia shows relatively high lcvels of achievement in school mathematics and science.2 Close central control and standardization of teacher training, school curricula, and cextbooks may have ensured rcasonable equity of access, near-univcrsal literacy and basic numeracy, and high standards for a limited range of cogni- tive objectives in a few subjects, such as mathematics and sciencc, which the state considered economically important. Special schools for gifted childrcn produced very high standards in mathematics, sciences, languages, sports, and the performing arts. Standards in some medical specialties wvere at world- class levels. Social values may also have played a part in promoting a culture of high educational standards. In gcneral, girls had equal access to education at all levels. Many countries enjoyed a tradicion of scholarship dating back to the period before communism. Universitics such as Cliarles (Prague) and Jagello- nian (Cracow) were created in medieval times, and academies of science and humanities were founded in the nineecenth century. Weakh essea Among the negative bcquests, ccntral planning and political control of pro- fessors and teachers often stifled culwral and academic freedom, limited indi- vidual choice and diversity, encouraged dogmatic teaching, and limited the flow of information, particularly in the humanitics and social sciences. The cducation and training systcm w as an ideological and cconomic rool of the state-ideological to ensure conformity with Marxism and to stifle local cul- ture and national identity, and economic to cnsure a match betveen economic requirements and trained staff. The major problems which resulted werc political interference in educa- tion, excessive specialization, deficient incentives to efficiency, duplication of facilities, early decisions about children's specialist study, uncqual access ro the best schools and universities, poorly organized research, and a neglect of adult education. Political interference was pervasive. At all levels in the system. but particu- larly in universities, many teachers were appointed for their political beliefs, or at least their lack of opposition to the system, rather than for their academic achievements. Academic standards suffered. The social sciences and the humanities cndured particular neglect and distorcion. Subjccts like economics, management sciences, lawv, sociologv, and psychology were either ignored or devalued. The consequences are serious for the economic reforms. Privatiza- tion is held up by the lack of accountants and lasvyers; the scarcity of skilled managers hampers rhe grow th of the private sector. Central and commercial 1 2631 POLICY DF.SIGN AND IMP'LEMEN'TATION banking is constrained by shortages of financial specialists. Since social scien- tists were discouraged from studying poverty, crime, and other "negative" social issues, institutions to assist disadvantaged sections of society are now weak at a time of gr%.at social stress. Central planning led to excessive spccialization and limited choice for the individual. Even though central planning in its extreme forms was abandoned from the 1960s onward in many countries, its legacy-manpower planning- survived. Industrial ministries determined the so-called requirements for sklilled and unskilled workcrs based on production targets for thcir enterprises. As discussed in chapter 7, distortions in the labor market encouraged enter- prises to hoard labor, while at the same timc discouraging workers from entering "unproductive' sectors such as teaching or medicine. Incentives to efficiency were absent in the institutions of education and training, as in other economic units. Assessment and examination systems did not provide information which could be used to improve the qualitr of educa- ion. The emphasis was on testing factual knowledge, using unreliab[c Lech- niques which did not permit: cngitudinal analysis (comparison of standards year by year) or comparison betveen schools. Nor were there any incentives to improve financial efficiency. Financing at all levels came entirely from the state and was based on rigid cost-plus norms which allocated funds for teachers, buoks, and cquipment based on historical data. Finally, given vir- tually full employment and distorted wage structures, there was no labor marker measure of the success of diffcrcnt training institutions or university programs. Fragmentation and duplication of scarce resources were widespread as enterprises and ministries competed to devclop their own facilitics. The curriculum of technical and vocational secondary schools was usually con- trolled by the relevant sectoral ministry, and these schools were often attached to enterprises. In contrast, and with inevitable attendant confusion, the academic curriculum was controlled by the Ministrv of Education. Highly specialized universities reporced to different government agencies, with little cross fertitlization among academic disciplines or flexibilitv to introduce newv subjects. For example, although closely locatcd in the same town, the three utlversicies in Debrecen, Hungary, rcported to diffcrent ministries and did not share resources (they have since joined together into a larger uzmeitzas). The practice of placing childrcn into specialized vocational and tecc. nical training at an early agc-around fourteen, before they are marure enough to choose their own career-was pervasive. In Hungary and Poland, about 75 percent of secondary schoolchildren were in vocational or technical streams in 1990-91. and the proportion was even higher in Romania. In practice, many of these children received limited general education beyond grade eight. By contrast, in Western Europe, specialization rarely begins before sixteen years 12641 EDUCAT'ION AND rRAINING of age, and continuing education designed to reinforce cognitive skills and communication is increasingly emphasized. The pattern in East Asia is simi- lar. Specialization in Central and Eastern Europe was excessive throughout the system. In Poland, for example, some 300 occupational skills were taught until recently in secondary technical schools, reflecting the typical specializa- tion of a command economy. By contrast, in Germany, about sixteen broad occupational programs are offered at the apprentice level for sixteen- to eightcen-year-olds. Access to poscsecondary and higher education was inequitable. As in other sectors, the proclaimed intent of the communist planners-that educa- tion and training should improve the lot of the ordinary -worker and peasant-was not realized. One measure of the failure wvas the limited access to postsecondary and higher education. Students were all too often the sons and daughters of parrv officials and intellectuals, who used their influence to secure a place in elite academic secondary schools and universities. Students who were cracked into secondary vocational education found it almost impossible to cnter universitv and a white-collar occupation. In addition, middle-level technicians and managers secking training had few alternatives to traditional univcrsity programs. A separate source of incquity was that the socialist education and training system often failed children with special needs. Childrcn at the bottom of the range of ability, with disabilitics or from disadvantaged backgrounds, rarely received the specialized assistance they required. Research was poorly organized. Although standards of science and mathe- matics wvere quite high at the school level, this did not necessarily translatc into cxcellencc in research and development or increased productivity. Few universities had a capacity for research, which was often isolated from the teaching process in rcsearch institutes, academies, or enterpriscs controllcd by sectoral ministries.3 Research and development were distorted in favor of hcavy industry and the militarv; potentially more productive research in basic sciences, agriculture, and the envirornmen was neglected. A cardinal -weak- ness was the failurc to offer ncv interdisciplinary subjects such as materials science and biotechnology. Adult education, essential for mobilirv in a market economy, was neglected because workers were expccted to remain in their first occupation throughout their working lives. Individuals were rarely, if evcr, encouraged to take -espon- sibilirv for thcir training needs and career development. EnErprises provided on-the-job training for their workers, but individuals who wished or needed to retrain for a different occupation found few opportunities to do so. In addition, much on-the-job training had little purpose. Wage levcls in enter- prises were often rigidly determined by qualifications and training, inducing firms to provide much spurious training so that workers could meet thc required qualifications. 12651 POLICY DESIGN AND IMPLEMENTATION The Forces Driving Change Economic, political, social, and cultural forces are all driving the reform pro- cess. On the onc hand, countries desire to cradicate all vestiges of the old ideology and to reasscrt national and cultural values. On the other hand, however, the emerging market cconomy and thc perilous state of government finances arc exerting enormous pressures on the system of cducation anu training. Polincal, Socal, and Cu/tural Feorre Changes in political ideology and a resurgence of nationalism and ethnic tensions arc having a major impact on Ccntral and Eastern Europe. Perhaps the first imperative is to cradicate Marxist dogma from school and university curricula and to reassert local cultural values over Soviet hegemony. After a half century of living in a closed society. therc is a desire to travcl, to learn about other cultures and economic systems, and to participatc in the eo- tiomic success of Western Europe. It is no coincidcnce, for cxample, that a fund set up by the Hungarian government to assist innovation in higher education is called the Catching up with European Higher Education Fund.4 The initial euphoria after the revolutions of the late 1980s has given way to the realization that the task of reform is inmensc and costly. Repiacing tEaching materials may takc years because tinances arc so scarce that coun- trics such as Albania and Romania cannot eve i hcar school buildings in winter or undertake basic maintenance. Preparing new curricula and assessment svstems requir-s new skills and additionai resources; retraining and replacing teachers arc long and cosdy processes. In many countries, authorities must take tiousands of tEcachers of Russian and rctrain them to teach Wcstern languages. Purges of communist appointees have takcn place at universities in the Czech Republic and in Eastern Germany, among other countrics. How- CvCr, hiring new universitv teachers, particularly in topics which are now in demand in the labor markcEt, is proving difficult because of the shortage of qualified professionals, low academic salaries, and poor conditions for research. In Hungary, grants are being offcred for young scientists to carry ouE research in an attempt to prevcnt a brain drain of the next generation of university academics. The rcsurgence of nationalism and regionalism throughout Ccntrml and Eastern Europe is placing additional strain on the education and training svstem. Throughout the region, minorities arc demanding more educational autonomy. particularly in the use of minority languages. Administrativc and financial burdens are gronving as authoritics struggle to provide the additional teachers and educational matcrials which bilingual educational systems requirc. In iiddition. decentralization of school education produces stress as local govcrnmcnts taki on ncw financial, administrativc, and-technical rcspon- sibilities with limited p icr expertisc and resources. 1 266 1 EDUCATION AND TRAINING &onoanic Foirrs The main thrust of this chapter is to consider the economic forces and their consequences. For the education and training system. as elsewhcre, the movc to a markcet economy involves the liberalization of (a) demand, (b) supply, and (c) prices and wages. The liberalization of demand is leading to calls for more relevant cducation and skills training: I ditiduals are starting to rcspond to market signals. As salary diffcrcntials widen, individuals are beginning to scck skills which allow them to move into higher-paying jobs. For workers displaced by enterprise restructuring, new skills may increase their chances of finding altcrnativc employmcnt. * DEnr'aprsa are beginning to operate in a compctitive environment. Investing in human capital through the provision of prc-service and in-scrvice training may enhanec productiviry and profits, although hard budget c.nnstraints are initialy producing contradictorv pressures. * The state needs to respond to the demand for new knowledge and skills critical to the transition. For instance, emphasis necds to be placed on topics such as the environment and cntrepreneurship, which were previ- ously completelv ignored. The liberalization of supply is generating more divcrse forms of education. ownership of educational institutions, and supply of cducational materials: Local grwmmnmns are progressively assuming more responsibility for the provision and financing of preschool and basic education. Givcn the limited basis of local taxation, however. the central governmcnt continues to play a significant financing role in redistributing tax revenues from richer to poorer districts, as well as a rcgulatory role in sctting norms and standards to ensure quality and cquity of access. * lnsd.ricmns, in particular at the level of higher education, are being granted more autonomy. New legal frameworks wcre introduced early in the transi- tion which preempted any return to more centralized administration and allowed institutions more control over policies and rcsources. P iwtprmvWr are starting to cmerge, as offering cducation and training services becomes profitable. Skcills training providcd by private organiza- tions and nongovernmental associations is beginning to expand in some countries.5 In addition, private schools are being cstablished. The liberalization of prices and wages has led initially to declining output and a widening distribution of income, which is affccting the capacity of individuals and the state to finance educational services: * Prices of cducational inputs are increasing. This is particularly the casc for textbooks wvhose pricc has increascd significantly in real terms.6 | 267 | POLICY DESIGN AND IMPLEMENTATION - The fiscal situation has precipitated a crisis in the public financing of educa- tion and training in some countries (see table 1 1-2). For example, whilc GoP was itself falling in Poland, the share of cducation expenditurcs in GrP also declined, suggesting a steep decrease in real spending between 1990 and 1992. In Bulgaria, Hungary, and Rumania, education expenditures appear to havc been protected to some extent, although spending is falling in real terms. With the exception of Hungary, however, the share of education spending as a percentage of GDP is lowv in comparison with developing coun- tries of similar incomcs and oECD countries. Training expenditures havc also been affected as enterprises, incrcasingly faced with hard budget constraints, move quickly to phase out their education and training programs. - At a timc of sharply declining income pcr capita, families are having to contribute incrcasing amounts for education. Parent-teacher associations are raising significant rcsources to cover items such as textbooks and educa- tional materials. Private training centers and somc institues of higher edu- cation are charging fees. Policy In discussing the reform surategy, it is necessary first to consider the vcry different economic function which the system now has to perform in a marke economy. As discussed in chapters 7 and 8, the education and training system now has to prepare young people for lifetime occupational mobility, since workers can expect to move between jobs and occupations as market condi- tions change (OEcD 1990c). This will place a premium on workers with mar- kcEabic skills, who can troubleshoot, anticipate problems, work in teams, and develop new production proccsses and services, that is, workers with good analyrical and communications skills (Berrvman and Bailey 1992). Thcsc workers will also be in demand in the new industries which countries hopc to attract. The Serafrg Thus a principal strategic objectivc of the education and training system in transitional cconomies is to prepare crainable, adaptable, and innovative peo- Tablc 11-2. Ependftwr on Educaion as a Paremtage of GDP in Slar Couritas S Corraldand Ewae Eurpe. 1990-9Z Comany 1990 1991 1992 Bulgria 5.2 5.7 5.4 Hun}ry 5.6 6.2 6.4 Poland 4.6 3.8 3.1 Romania 3.t 3.7 3.9 Lava: Unpublished data fromrn ministries of finance and the World Bank. 1 268 1 K:DUCATION AND TRAINING pie who havc the flexibilitv to shift occupations. To ensure an intelligenc and innovative work force, the educaEion and training system must encourage innovation, questioning, and the developmcnt of highcr-ordcr cognitive skills, rather than obedience, conformity, and memorization skills. This will require flexible and responsive institutions. The emphasis in the curriculurn needs to shift from teaching facts and skills in an cssentially static workplacc with little mobility beteen occupations to teaching students how to think and usc knowledge in a dynamic labor market. This signals a fundamental move from a teaching system dcsigned to serve the needs of the statc to onc bascd on the developmental needs of the individual. Prcparing trainable, adaptable. and innovative pcople will requirc funda- mcntal changes in the behavior of the main actors in the systcm: the state, the insticutions, the teachers, and the consumers (studcnts, parcnts, and employers). As in other scctors, this will requirc a careful balancing of policie: aimcd at preserving macroeconomic stability through targecing resources, containing costs, and mobilizing additional financial rcsources; building mar- kets by promoting consumer choice, improving incentives. and introducing competition among providers of education and training services; regulating markers bv maintaining educational standards and ensuring equitablc access to scrvices; and strengthening instiwtional capacity to implemcnt the reforms. Afainraining Maoconomic Balance Restoring macroeconomic balance has two important implications for the education and training system: public rcsources need to be uscd more effi- ciently, in part by concentrating them on priority arcas; and the state can no longer assume the cntire financial burden of education and training, implying a need to mobilize additional private resources. CONTAINING COS WHILE IMPROVING EcnvENss. During thc fiscal crisis, public finrnsces need to be righdy targeted on the basis of xplicit prioritics. This section argues that the prioriry areas should include policies to maintain standards in basic education, restructure secondarv education, improve adult training, ani intervene selectively in postsecondary and higher education. These priorities should bc buttrcssed by policics aimed at using educational inputs more cfficiently. Maintaining standards in basic educaion. This objective, though casily over- looked, is essential. Extensive rcsearch has revealed the high rates of return to basic cducation (Psacharopoulos 1993). Indeed, public invCstmcnt in this area has some of the highest returns of anv investment, public or privatc. The yicids arc long term, however. and politicians are tempted to downplay their importance. This would be a major error sincc basic education provides the foundation for all skills development. Protecting basic education implies (a) defending poor districts against ineq- uitable financing mechanisms arising out of decentralization; (b) cnsuring 1 269 1 POLICY E#SIGN AND JMPLEMENTATION adequate public financing for educational inputs which have been shown to be highly efficient in enhancing learning, particularly books, materials, student assessment, and tracher training; and (c) rcsisting any pressures for expcndi- ture on policies, such as reducing class sizes, which havc a much lower impact on student Icaming (World Bank 1990a). Indeed, in some instances, class sizes could bc increased without risking qualitv. At the same time, it may be possible to reduce the size of the teaching force, thereby freeing resources for paying higher salaries or investing in rcaching materials. Restturing stondry educaton. This is perhaps the major structural chal- lenge for the education and training system. Much secondarv education is now provided by a quasi-dual system, which unfortunately bears littlc resemblance to the parent Gcrman model. The largc majority of secondary students who undertakc occupational training, usuallv frorn the age of fourteen onward, arc in apprentice training programs in which the school provides acadcmic educa- tion and enterprises providc occupational training (this is the dual systcm). The remainder of the secondarv vocational cohort is enrolled in secondarv industrial or agricultural technical schools which arc intended to providc a higher levcl of tcchnical training. Reforms currently under wav in a number of countries in Central and EastEcrn Europe seek to addrcss the following issues: carly and narrow special- ization; weak general education because specialized training crowds out cssen- tial components of the school curriculum; inflexibility of school-based voca- tional training systems in dealing with rapidly changing labor markets (Adams, Middleton, and Ziderman 1992); and the poor financial state or even bank- ruptcy of many enterprises, which renders much training by enterprises irrelc- vant or impossible. ThC strategy for these reform efforts is twofold: (a) to establish a secondary curriculum for the age group up to sixtcen years focusing on science and technology, broad occupational disciplines, languages, and social studics and (b) to develop a model for thc sixteen-plus age group which allows for choice betwvcen academic and technical streams.7 Thc technical scream covers the study of broad occupational clusters, including business studies and services, with continuing emphasis on communications and mathematical and com- purer skills. Epainrug adult dcation. Adult training-defined here to include school leavcrs-includes further education, on-the-job training, training for vorkers who wish to upgrade their skills to improve cm :cr prospects, and training for displaccd workers. Becausc adults will necd tO change jobs and upgrade thcir skills frcquently during their working life, adult training assumcs considcrable importance. The statc has an important role in providing incentives to cncour- age thc provision of training, but the statc should nor be the sole source of funding. TMe enterprisc and individuals themselves should be encouraged to take rcsponsibility for thcir own training needs, and the state can play an | ?,70 EDUCATION AND TRAINING important role in encouraging training through appropriate tax incentives. T'ax incentives will not be sufficient, howevcr: small firms rarcly havc the capacity to carry out training even though training may be crucial to their survival in a competitive marker, and the privarc sector cannot be cxpected to provide much training for disadvantaged groups in the labor markcE, for instance, the unemployed, school dropouts, and the handicapped. Thc capacity to underrake occupational training will be nceded in both the public and private sectors. Countries such as Hungary and Romania are creat- ing national and regional training boards to fund and coordinatcE training by pub- lic and private institutions. In Hungarv, national and regional training boards comprising representatives of government, tradc unions, and employers, and jointlv fundcd by th': state and the private sector, contract with public and pri- vate training institutions to deliver training for dislocated workers, school leavers. and other groups. Development of these new institutions has becn complicated by difficultics in strengthening the appropriatc relations betwecn the groups reprcsented on training boards, including trade unions. which are highly fragmented. Despite these initial difficulties, results arc quite promising-8 In addition to encouraging cooperation among the social partncrs (govern- meint, labor, and employer organizations), the satc has an imporcant rolc co play in (a) dcevloping occupational training standards and accreditation; (b) ensuring an appropriatc mix of financing by the statEc, individuals, and firms which reflects their new roles in the market cconomy and protcecs weaker groups such as persons with disabilities; and (c) cnsuring stndards and cffi- ciencv by evaluating and providing information. Res igajeeducaimr. Universitics and ocher institutions of higher edu- cation have a critical role. Fust, they must develop the highr-level skills and knowledgc to assist the transition to a market cconomy. Second, they play a cen- tral role in the production and dissemination of scientific knowledge and innova- tion through high-lcvcl rescarch and training. Finally, they providc a forum for debating ideas and promoting social and cultural va!ues which arc particularly important in the contcxt of countries undergoing fundamental changc. Many countries in Central and Eastcrn Europe have an ancicnt tradition of higher edu- cation and scholarship, which provides a solid foundation on which to build. Resistance to reforms may, howcver, alter the traditional structurcs on which the svscrn is founded. This resistance may come both from supportcrs of the com- munist model of higher education or from those who arc nostalgic about the elidst system prior to communism. Thcsc conutadictory currents have alrcady mani- fested themscives in debates ovcr the duration and structure of cducation (fivc- year diploma courses similar to those in most of Westen Europc versus shorter modular programs modeled on North American svstems). Higher cducarion is now being restructured in many countries to improve access, choice, and rcievance and to diversifv sources of funding. The main 1271 1 POLICY DESIGN AND IMPLEMENTATION prioritics for reform include expanding cnrollment (currently as low as 10 perccnt of the age cohort in Romania compared with 20-30 percent in oECD countries), introducing new programs, and diversifying ownership and finance. In Poland. changcs in admissions policies in some university depart- ments have been introduced to incrcasc cnrollment. In Hungary, the previ- ously mentioned Catching up with European Higher Education Fund is bcing used to finance new universirv programs on a competitive basis in accordance with government priorities. In many countries, private universities and spe- cializcd institutcs (for example, in managcmcnt) have bcen crcatcd. This is an encouraging trend. since the private returns to cducation are high, and state subsidies should be directcd first and foremost to basic education. Decisions to invest public funds in efforts to expand the higher education system would need to be accompanied by significant reforms: * Impr, efficicncy (studcntlceacher ratios as low as 3:1 wcre common in 1990). Methods under considcration includc compulsory rctirement (thc Czech Republic) and cxperiments w%ith normative financing bascd on studentl teacher ratios (Hungary). - Incrcase diversity. choice, and relevancc by adding new subjects in sci- ence, technology, and the social sciences and bv developing links with thc evolving privatc sector. This is thc primary objective of the Hungarian Catch- ing up with European Higher Education Fund. In addition. it is essential to increase access for older students, which rcquires designing altcrnative path- wavs which allow school leavers and adults without the necessarv formal entrance qualifications to enter higher cducation. - Improve flcxibilirt by introducing shorter. modular programs and devel- oping vocational education at the posesecondary level. The restructuring and modernization of industries, the development of small- and medium-scale enterprises. and the emergencc of a scrvice sector are generating a demand for highly qualified technicians and middle-level managers which cannot be met at the secondarv level and is not being met through traditional university programs. In countrics like Poland, the long tradition of higher-evcl voca- tional training has been considerably weakened over the last fortv years,9 and new initiatives aimed at creating technician training institutions outside the universitr are under way. * Develop productivc relationships in rsesarch and developmcnt between higher education, research. and industrv. Under socialism, much basic and applied research was carried out in rescarch institutes under the control of industrial ministrics, entcrprises, or academics of scicnces. The univcrsitics vcre rnostly confincd to teaching. Many of these rescarch institutes are now obsolete or bankrupt because their parent minisnies can no longer afford to fund thcm, and many have alrcady closed. At the samc time, universities have difficulty recruiting the best researchers bccause of salarv constraints and poor access to rescarch funds and facilities. 1 272 1 EDUCATION AND TRAINING Alainraining the quality of input. Reforming the structure of the different components of the education and training system is only part of thc story. Action to maintain the quality of inputs is critical to the success of the structural reform. Teachers arc key agents in bringing about reforms of the education and training system, since without their cooperation, nothing will change. The role of the teacher and the school principal is changing dramatically from deliverer of received wisdom to manager of resources, guidc and tutor. This change will require far-rcaching rcforms of the tcaching profcssion. The suc- cessful introduction of new curricula and teaching materials. new mcthods of assessment, and decentralized school managemcnt all depcnd entircly on thc quality and motivation of the teacher. The challcngcs include introducing new subject areas into the curricula, which may result in uncmploymcnt for somc teachers whose skills arc no longcr requircd; rewriting existing curricula, which w ill requirc cxtcnsive retraining of tcachers so thac they can teach the ncv materials; direct access to libraries and Information technology, which will need new skills: and decentralized mansgemcnt, which will rcquirc new skills of school principals, among others. Thus rcsources should bc targetcd to-ward rcforming pre-service training to reorient new teachers to changcs in curriculum and rcaching practice and toward providing extensive retraining for cxisting rcachers. Retraining of tcachers is particularly crucial since the goal is to change long-entrenched attitudes as well as to introduce new techniques. T-he quality and availability of books and educational materials are equally important. Given the magnitude of the change required in die system and the rimc i rakes co retrain tcachers and influencc their behavior. cnsuring access to appropriate teaching materials might. in fact, bc the highest priority. During times of fiscal crisis. cutting public recurrent expenditures on education other than salarics is tempting. The cffect is usualiv felt in rhe classroom as teXt- books and materials disappear. This has an immcdiate impact on the quality of cducation, particularly for the poor. who hate littic disposable incomc with which to make up anv imbalances. I is a truism to satEc that children will not become properly litcrate unlcss they have access to a diverse supply of books. Yet this is exactly the case even in middlc-income countries, such as Brazil, which havc negiccted to supply this esscntial commoditv in the classroom. Most OECD countries assign the scate responsibilitv for providing frec of chargc basic school textbooks for primary and secondary cducation. The main justification for this approach is that tcxtbooks arc considcred essential to thc cducational process: without them, equality of opportunitr is not possibic, and targeting frec materials spccifically toward poor children may bc adminis- tratively difficult. In Ccntral and Eastcrn Europe. the decline in budgetary rcsources has led some education ministries to dcfault on their obligation to providc frec access to textbooks. In Poland. for instance, parents musr pur- chase all tcxtbooks with the exccption of books for special schools for hand- 2 273 ! POLICY DESIGN AND IMPLEMENTATION icapped children and ethnic minorities. Given the significant decline in per- sonal income during the carly 1990s and the increase in the price of text- books, this policv should be closely monitored. At a minimum, the state should provide financial support for poor parents to purchase books, as is the case, for example, in France. Using inputs of physicc( and human capircl effideily. Finally, available data suggest that in most countries, cducational ir.pUS of human resources and physical capacity are not being used efficicntly. StudenE/teachcr ratios in the carly transition were verv low in all countrics of Central and Eastern Europc."' Sincc cxpenditures on teachers' salaries make up a largc proportion of the education budget in all countries, improvcd use of teachers can rcsult in significant savings which can be redeploved clsewhcre in the cducation sys- tEcn. The remcdv would include altering three main contributing factors: light teaching loads,"I undue specialization of subjects offered, and singlc-subject teachers. Reforming the tcaching profession as well as streamlining the curric- ula, in particular in technical and vocational education, "ill lead to changes in the demand for teachers with particular skills. This calls for careful analysis of possible alternatives offered to teachers, such as professional upgrading, retraining for another assignment in teaching, rctirement (including compen- satcd carlv rerirement), and compensation for moving into alternative employment. So far as the usc of physical capacity is concerned. higher cducation in Central and Eastern Europe is charactrized by a multiplicitv of poorly funded, poorly cquipped, and often unproductive teaching and research facili- ties.)2 Certain institutions could bc closed, wvhcn thcre is no demand for the programs offered or when qualitv is not up to standard. [n Hungar,y incentives arc being offered to encourage small, specialized institutions to consolidate into largcr and more comprehensivc establishments offering a wide rangc of disciplincs. MOBILIZING ROURCES. Public financing of education and training has manv economic justifications (sce, for instance, Barr 1993b. chap. 13). The main arguments may be summarized as follows. First, benefits flow not only to individuals but also to sociery at large. A highlv educated and trained work forcc contributes to improved productivity and economic performance. Lack of cducation is closcly correlated with poverty (World Bank 1990a). Second. cconomies of scale can be achieved through public provision of education for largc segments of the population. Third, in the absence of comprehensive information about thc qualitv and cost of education, consumers cannot always make rational decisions about thcir education, let alone about thc value of their education in the future. For thcsc reasons, the state always plays a significant role in the financing of cducation. Given the co mpeting claims on tax revcnues, howevcr, thc statc I 274 1 EDUCATION AND TRAINING cannot and should not assumc the whole financial burden. A new alliance is needed becween the state, the employer, and the individual to share the financial burdcn of education and training (Laprtce 1993). Since education is not homogeneous, the role of the state will bc differcnt for diffcrent levels of education. Both primary and secondary education have largc externalities (explained in chapter 2), and the public has an interest in cnsuring that the right quantity and quality of education is produced at the right price. The govcrnment needs to ensure an adcquate supply of education (cither directly or through the privatc sector), control quality, and enforce mnandatorv school attcndancec. Since imperfect information leads to underconsumption, particularly by the lowest socioeconomic groups4 a subsidy needs to be applied either to prices (frce education) or to incomes (education vouchers). So far as higher education is conccrned, it is widely acknowledged that the proportion of bencfits internalized by individuals rises with the lcvcl of educa- Lion Jn market cconomics, where the structure of wages is at least partiallv re-^attd to worker productivity,. the discrepancy between the privatc and social rcturns to investment in higher cducation is large. This is particularly the case in publiciv funded systems, where a large fraction of the cost is borne bv the state and a large fraction of the benefits accrues to ind.viduals in the form of higher wages. It is therefore desirable to shift part of the fnancial burden to individuals and private employers. As the structure of wages is liberalized. it should be possible to introduce fees in higher education. Countries including Bulgaria, the CZC0LJ Republic. Hungarv, and Poland are moving in this direc- tion. Cost recoverv in higher education should be introduced alongside stu- dent loan schemes. Substantial reliancc on tax funding till lcad eithcr to rationing of highcr education and training through limitEcd access or to a poor- qualitv system. At the same timc, limited taxpayer funding, if not carefulIv targeted, will constrain access to higher education by lowcr-incomc students. In the case of skill-specific training, thc COStS (which can be large) could be borne to a grcat extent by entcrprises, which cnjoy substantial benefits in the form of a morc productive labor forcc, and by individuals, who are revarded with higher wages. Although they benefit from investment in human capital, firms may underinvest for one of two reasons. First, the new owners and managers may not be aware of the bencfits of having a skillcd and flcxible uwork force in their enterpriscs. Second, chey may bclicvc that skilled labor can bc acquired more cheaply by poaching staff from othcr entcrpriscs than by training their current stff (an exampic of the frce-rider problem discusscd in chapter 2). Correcting this market failure requires stact intcrvention, and many countries (Brazil and Korea, for cxample) therefore use payroll taxes to mobilizc resources for training. Onc of the strongest arguments in favor of a payroll tax is that it can be used as an instrument for restructuring the labor force.'3 However, payroll levies 1 275 1 POLICY DESIGN AND IMPLEMENTATION tend to increase the price of labor and thus may inhibit employment growth and international competitiveness. In the case of countries in Ccntral and Eastern Europe, the tax burden on cnterprises is already high. It might there- fore bc desirable to introduce a trainirg tax along the French model, which is paid only by enterprises which do not provide training at the samc nonceary level as the taX. Of cqual importance, individuals will invest in training if they perceive substantial cconomic benefits from doing so. In the German apprenticeship system, for instance, the apprentice accepts lower waUges in return for training provided by entcrprises, which leads to higher wages in the future. Buili-ng Markers Market forces can be used to improve the performance of the education and training system through increased consumer choicc, through a more divcrse supply of educational services, and through improved incentives to use resources efficientivl INCREASING CONSUMER CHOIa. Education and trining institutions need to become responsive to consumers by increasing their divcrsity and flexibility. In higher education, for instancc, a vider varierv of courses is necdcd to meet diverse cultural, social, and educational objectives. Similarly, vocational train- ing instiwutions catering to the necds of adult populations (age cighteen and over) must provide flexibic entrv and exit programs tailored to sazisfv the needs of particular target groups. Increasing choice and divcrsirv also rcquires fundamcntal changes in the way curricula and textbooks arc organized. Although the state would normally dectcrminc the corc curriculum and set standards. part of the curriculum should be left to the discretion of regional or local authorities, to takc account of regional and ethnic diversity. Similarly, schools should be allowed to choose from a list of textbooks authorizcd by the Ministrv of Education. Increased choice will also necessitate changes in funding arrangements. A survey of financing in higher education (OECD 1990a) concludes that diversirv and variety are thc most important charactcristics of higher education at the end of the tWentiCth centurv. The concCpt of global funding for higher education as a whole may havc been appropriatc in circumstances where universities and colleges were engaged in a rclatively narrow rangc of activ- itics evaluated on the basis of similar criteria. Since this is no longer thc case, the higher education budget should nowv be divided into separate categories and different allocation criteria establishcd for each program item. Ensuring maximum flexibilitv in the usc of the budgct at the institutional level is critical. Finally, the rolc of information in the strategy to reform the cducation and training system is also crucial. Information must be available at all levcls: to 1 776 1 EDUCATION AND TRAINING parcnts so that thc can makc informed choices about schooling and training; to students so that thev can select higher education, training, and carecrs; to emplovers so that they can participate in the formation of policy and the delivery of cducation and training; to the unemployed so that they can make informed choices about training and .earer opportunitics; and to the public at largc, since the education and training sysLCm will continue to be largely financed through taxes. DIVERSIFYING SUPPLY. Although cducation services partially or rotallyfinnced bv the state may be justified for many economic reasons, such services do not need to be entirely produced in the public sector. (he central distinction bewveen public funding and public production was discussed in chapter 2.) In many countrics of Central and Eastern Europe. cducation and training are being provided increasingly by the private sector. Private institutions operate under differcnt arrangements. with varying degrees of state subsidy. In Poland, for example, manv institutions classified as "non-public" schools offer primarv and secondary education.l4 Privatc training institutions for languages, management, infomiatics, and so forth have cmerged in all Central and East- ern European countries. Providing public subsidies far privatc schools offcrs some advantages. It increascs the number of educational scrvices available; promotes competition, thcreby rcducing costs; gives parents and studcnts a wider choice of schools and programs; and gives the state a measure of influence to regulate quality. Diversified ownership of the production and disuibution of tecxbooks and educational materials is particuarly important to ensure wide choice and high quality. This in turn requires far-rcaching reforms. For cfficicncy rea- sons, the traditional monopoly of the statc needs to be challenged, and a market characterizcd bv competition and frce choice, with a wide varicrv of textbooks and materials available for purchase, should be established. For equity and efficicncy rcasons, however, the sate rmay need to continuc to subsidizc primary and secondary texts and materials. but these subsidies should bc transferred from the producers to the consumers (schools and individuals). IMPROVING iNCENrvEs. Education and training are a scrvice which has a cost. transmits a bencfit to its recipients through enhanced knoWledge 3nd productivity, and can bc bought and sold. No matter how they arc financed. education and training institutions must respond to the necds of their clients, maintain standards, and deliver services cost-effectivelv. This implies greater institutional autonomy, improved management practices. and the crcation of an CffectiVe veEting mechanism With means to ensure that improvemcnts happen when needed. The statc also plays a crucial role here in crcating a policv environmcnt which favors improved managemcnt and cfficiency. Barnes and Barr (1988) suggcst that the govcrnment should allow higher 2 277 l POLICY DESIGN AND IMPLUMENTATriON education institutions to managc themselves within a framework which safc- guards acadcmic freedom but subjects thcm to scrutiny to prcvent conceal- ment of poor tcaching or low academic standards. Incentives are important, first, for the institutions which provide educa- tional services, on whose behavior funding sources and mechanisms havc a powerful influence. The OECD (1990a, p. 55) survey of financing in higher education notes the growing interest in che introduction of market incen- tives: 'The move towards market mechanisms is taking two main forms: one is that public funding agencies are becoming more selectivC, somCtimes taking the form of buying services from highcr education institutions; the other is that universities and colleges arc being cncouragcd to seck an increasing proportion of their finance from non-traditional sources." In Ccntral and Eastern European countries, supply-driven block grants were the norm until reccntly.v5 Over time. shifting a greater proportion of public funding toward demand-drivcn formulac should encourage greater market rcsponsiveness. Idcas being tried out in a number of countrics includc capication formulae which pay institutions by the number of stu- dents enrolled, formulae which penalize institutions for allowing excessive student repetition, and norms which ensurc efficicnt student/tcachcr ratios. In addition, contracting arrangements benvcen funding bodies and institutions of higher cducation should bc encouragcd not only for rescarch contracts but also for mainstrcam teaching activities. This has started to happcn. In 1991, the Polish National Committee for Scientific Rescarch initiated a comnpetitive pcer review systcm for allocating funds for rescarch, under the guidance of the commissions for basic and applied research. Hungary has adopted a similar approach for basic research under the Hungarian Research Fund (oTzA) and introduced compctition for applied rescarch under the auspices of the Officc of Tcchnology Developmcnt. Hungary has also introduced compecition in the funding of highcr educa- tion. This should assist institutions to bc morc responsive to thc nceds of the cconomy, as expressed by funding bodies, and to providc beter value for moneyv Incentives are also rclevant to cducation staff. Teachcr salaries arc rcla- tively low in Central and Eastern Europe, and tEcachcrs often depcnd on a complementr job to survive.'6 The living scandards of primary and sec- ondary education teachers should be protected to the extent possible, since they should not have to moonlight or cngagc extcnsively in private sector activties to survive. Protccting living standards is feasible only if cfficiency is maximized in the ways described earlier. As wages arc liberalizcd, the level of salaries for professionals in the education system needs graduallv to be restored to attract and retain a well-qualified and highly motivated teaching force. Salary incrcascs could be contingcnt on tEcachers participating in retraining and achieving certain standards of performance. 2 78 l EDUCATION AND TRAINING Regyilating AMarket Forrs Where the state is no longer the sole provider of cducation and training services, it has two key regulatory roles: seEting and maintaining national standards and ensuring equitabic access to basic cducation scrviccs. INTRODUCING A RECULAlTRY STRUCrURE. The state has a key role in monitor- ing the performance of institutions and maincaining standards of academic achievement. Crighton (1993, p. 1) argues that, "as cducational systems in Central and Eastern Europe decentralise and diversify, it becomes paradox- ically more nccessary for the State to set, monitor, and if necessar insist on the maincenance of standards." A key aspcct is the introduction of national systems of assessment and cxaminations which monitor quality, permit com- parison benveen equivalent institutions, and deliver feedback to instituiions and consumers. A national svstem of assessment will increasc acCOuntabilitv: if cducational results are poor, the public will demand reform. Alongside these measures aimcd at maintaining overall academic sandards, it is necessary also to regulate private providers of education and training. The proliferation of such providers is a welcome developmcnt which assists the reform process considerably. However, the state needs to protect citizcns against abuse. In order to ensure that thc training providcd is worthwhile, governments should encourage thc accreditation of training providers and certification of training programs against national standards. National ccrtifica- tion systems reduce uncertaintv among prospectivc students and their subsc- quent emplovers about qualifications, permit mobilitv within the councry. encouragc personal development, and discourage the provision of low-quality programs. Participation by employcrs in thesc schemes should be volunary to prcvcnt additional rigiditics from being introduced into the labor marker. Importanly. ccrtification and accreditation schemcs do not need to be run by the government. Private associations can set up their own accreditation svs- tems to ensure standards, as is the case, for cxampic, for privatc English language schools in thc United Kingdom. ENSURING ACCESS. One of the most important functions of the statC is to cnsure equitablc access to cducation, which is a fundamental right of individ- uals. This, in turn, requires statc intcrvention to ensurc that the coscs and benefits of education are equally distributed among regions, socioeconomic groups, and cthnic groups. Two interventions arc particularlv rdelvant for countries in Central and Eastcrn Europc. The move toward decentralization of education services carries the risk of unequal expenditure across educational districts. Local govcrnmenrs clcarly have a comparative advantage in providing basic social services such as kin- dcrgarten and primary education. Given the significant diffcrences in the tax base of individual localities, however, central government has a vital role in I 279 1 POLICY DESIGN AND IMPLEMENTATION funding to ensure reasonable equity and minimum standards across the countrn. So far as hiher education is concerned, the shift towvard greater private financing advocatEcd in hihs chaptcr implies thc introduction of loan schemes and measures such as scholarships to ensure access for the economically disadvanaged. An approach increasingly adopted in the West (see Barr 1993a) is to have income-coningent loan schemes,. in which repayment takes the form of a gitvcn percentage of the smdent's subsequent earnngs. One way of implcmenting such a scheme is to add the loan repayment to the graduates social insurance contributions. Payments stp once the loan has bcen repaid. This strategv is particularly appealing for cconomies in Central and Eastemn Europe. First, studencs pay part of the cost of their ducation themselves, which is both efficient and fair, and replaces parental contributions. Sccond, 't circumvents the unwillingness of commercial banks to mnake long-term loans without a govrnment guaranxite*to individuals lacking collateraL Td it reduces the public, cost of higher education, making it easier to cxpand the systm and improve its quality, Although the magor task fimpmentng educationalrforms involves bUild- ing institutional capacit, the area is also politicaly highly charged. BUlMING r rnSTuTO aL P cArAcrn Eiducation and taining cover a wide. range: of activites, and reform is nceded of both their strucnre and finance. For both reasons, the demands on managemcnt and administration are heavy. M:awagi comple refim& The reforms suggested in this chapter require strong leadership and management at the central, regionaL, and imnsituional levels. Staff in the education sector in. Central and Eastem Europe need to acquire specific skills and knowledge: to work in a mixd, decentralized envi- ronment. particularly planning, mana financial, and computer skius. To promote greaer effeccivness and flexibt triing should be provided to both senior manageial -stff and to middle management in administrative officcs wit:h broad institutional respoasibll.: Political reforms during the caly transiton dist tled many instiiuions which had had a prominent role under central planning. Several important functions have all but disappeared, and this undernines the capacity of uinsttu- tions to function in a new-economic and social contex First, the concept of planning in education and taining should be rehabilitated and redfined. Few units at the central or regional lecvls now have the capacity or authorty to collect, synthesize, and present data about the education systim. Basic com- puter planning models, which can simulat the impact of alternative policies -on enrollment, stffing, and infascructur, are not readily avaiable, and this limits the capacity of policymakers to make decisions. Second, educational - [,80 1 EDUCATION AND TRAINING rescarch needs to be redeveloped and strengthened. As a result of political changes since the fall of the communist regimes. many education research institutes have closed. PolicV devclopment in education must be supported by a strong research capacity, and countries in Central and Eastern Europe need to organize this crucial function. It is also essential to improve the information on-which to base decisions. Management informaton svstems comprising financial, materal and human inputs and? cspecially, outcomes such as student learning and success in the labor markct need to be improved. Educational management informanon systems should be accessible at the national, regional. and uistitutional levels to assi education policvmakers and managers to make more informed deci- sions, tO monitor the impact of policies, and to direct resources m ways which improve the quality of education. They would also facilitate communication with educaiont smtems in other European countric-, which in turn could encourage innovation and change.- Finally, objctive criteria and transparent proccsscs for allocating resources. should be introduced In most counmes in Central and Eastern Europe, hisorical budget allocations, expcnditure patrnms, and crude norms for staff- ing and physical resources are the donimin factors in allocation decisions, wvhich are besr described as the result of elaboratc bargaining. Manages have been conditioned to believc that the more resources garnered during the year, the beticr off the instiujon will be in nexct yar's budget, regardless of the, qualiy of output achieved or the efficiencv of service deliverec ThMe main' task for most countries is to formnulate budgets in the context of rhcemacro- economic framework where the purpose of the oudays and the expecned results arc cxplicitly umderstood. :raig and nra=gig m. Most countries are moving :-Wry fasc toward decentralizing ccrain education services. In Hungav, local gov- erments are responsibl for kindergartn and primary education, butc the financing is shared with the central goverment, which provides per student grants depending upon the level of education. In Poland, preschool educa- tion is already the responsibility of local governments, and primary education is progressively being transfecrred to -local gverments. B&ause local gov- erments have limited capaclry to raise revenues, the financial resources devoted to important services such as preschoot education and child- care have decreased. This is a serious setback for a previously wel-developed system. Attending preschool has an important positive ffcCt on later school achievement, particularly for disadvantged children (Mevers 1992) and the lac:k of child carc negatively affects the participation of womcn in the labor for,c-. Some important principles need to be applied to decentralizna on policies. First, local governments clearly have a comparative advantage ovcr the central goverrnment in providing basic social services such as kindergrten and pri-- 1 281 1 ~~~~~~~~- . *. - .. . . , - . -:.. POLICY DESIGN AND IMPLEUENTATION mazv education. Theq ar: in a bttr position to assess preferences and target resources. Second, as just discussed, differcnces in the taxable capaciky of individual local governments to raise revenue give the central government a vital fundIng role tO play in ensuring reasonable access and minirum staa- dards across the countrv. Thrd, many g rnments will ish to mainmin a core curriculum throughout die country to assist social integaton and to cnsurc educatonal sandards. Fourth, the centra government nDsOa& to address the weak technical and implementation capacity of many local govern ments by providing tainingand technical assistance. fsea=*g fd7. mpJemenon of these policies wvl depend o a con- siderable extent on the cfficincy of resoue use. Thi education and rinng system cannot afford to 'sc precious resources on icffctive or irrelevant prog Particula during a fis is, it wil bc wcll-nigh irnpossile to pers6iade miniur'es- of fiance to ppmvide financial resources for the sor without demonstrable improvcmcnts in efficiency. Measuring efficincy in education and tranimg is problematic, how sinc measuring inputs, out- puts. and the relation becween dtem is difficult Inputs can be quantified in measures such as the number of students and teachers., cumiculum hours, teaching loads, and uni of mai s. But he are only proxes for what goes on in the classroom and do noe provide inrormation about de quairy of the teaching and leing proces which is mich more difficok to measure. Output mcasures of smdent achievemcnm arm technically difficult and have tO be intecrpreted carefuly if used to compar imsitutions and prograns;.it is ev more difficult to reluc raching inputs to cducationa tainment, gnhen the difcfret social, psychological, and educational profiles of studcnts in the classroom. Fialy, even though the causa licnk betwee inestme in educa- ion and economic growth is now well established at the mroeconomic level (World Bank 1990a), it is mcthodologically extrerely difficult tO esDtis such links at the microcconomic lcvel- These problemos are partcularly acute in die counries of Cetral and East- ern Europe, which lack mana ent informnaion systes to measure educa- tional inpurs propirly or assessment and evalution systems to.measure stu- - dent acievement. Neher do they have sufflcnt historical dat on the labor market to measure the rlationslhps between'erings and education. Not- withstnfing the technical problens and institutional difficties associaed with measuring efficiency, quntum advnces a ssential.to track the impact of the reform efforr.. BUvIDING PoLmtz cAMAcrry. Contentious issues include the developent of new curricula, the provision of new textbooks,and teachers' pay. On the. first, hc plitica[ imperative of 'out iththe old" applies to cdion as - - other parts of the system. One of the prob;ems ficing policynaks there- fore, is how to protcctthose parts of the old system which worked irll and, at. ;.z8z. .I. EDUCATION AND TRAINING the samn time, to head off demands for reforms wrhich experience elsewhere suggests are unlikely to work well. The provision of new, non-Marxis textbooks has already begun and should be left largely to the private sector, both as a signal of political freedom and for reasons of economic efficiencv. Education authorities should buv books for those parts of the svstem for which schoolbookls should bcprovidcd to chil- dren free. A difficult polical decision is how to divide the educanton budget so as to prevent the demands of teachers'salarics from crowding out spending on texbooks. The. issue of teachers' pav durng a time of fiscal crisis has no * - simple answer - In facing the political dimensions of all thesc issues, governments should remembcr that in a democracy Cm shirp contrsrwkh the old system), parents are a powerfil part of dte electoraic. Education ministcers should thereforc be prepared to communicate direcdy with parents (for example, using television) to ecplain thc problems and the governmenits proposecd policics to address them. In the matter of tachers' pay, for examplc the govemmenes grecates- allies are lkely to be parent: Conclusions: Prionrties and Sequencing The central message of this chapter is that improving the quality of education * : : and trainig is vkat for the future economic healcb of counties i Central and Easter Europa iis wi require involvement and investment rom dhe differ- ent actors in a markcr economvn the state, private business, and individuals..- Nosingle blueprintrexists for restrucrng the education and training syscem- and countries in Cntral and Eastaen Europe are by no means alone in facing the necd for reformSxnr debates-for emple, abou th nar of the relationship betwecn education and the labor market-are occurrng in many- market economies. The following represents a cross section of-short- and medmme-term policies which should be appropriate in most of Central and :asZten Europa-, So-znwrPold : : Stzz:{ui{:;X bt=-v~~~~ ~ ~~~~~~~~of Af V &andmfr &pr=ihcoandhadicedadouw slouMbe ma&at3rdasa0 mar4 ofgf pdodity. Basic education is the foundation on,which skills and knowledge for thew orkplace are built A failure. to. invest in basic human capital wil result in major costs to the smte later on. as the poorly educated consume dispropor- - tionacely more state services. In addition, a semi-itcrate work force cannot compete in a global markert Since the population in primary education is static or dectining in much of Central and Eastern Europe, quality can be mainutined : ~;; : 0 in basic education without any significant increas i cpendiu Areas of focus include: 1 283. 1.: POLICY DESIGN AND IMPLEMENTATION - Reforming curricula * Ensuring the availabilirt of in-service teacher training * Providing an adequate supply of books and educational miaterials. Sendary eduction needs,t bereuncrwrd to anna aflexhk and tainable work f,ne, capable of rrsponing to te rapiid dages anug place in tAe bkorn marte The emphasis should be on: Increasing enrollment in academic and technical streams which Icad to matriculation * Reorganizing technical and vocational education around broad clusters of occupanons . Delaying specialization and transfcring pre-employment training outside the formal school svstem * Devcloping appropriate curricula and associated teaching materials and books R Redeploying and retraining teachersm Rum shoud be hilcd at tAe poaseamda leel A diversified systcm of postsecondary and higher education. capablc-of providig opportunities to a wide range of abilities and levels and able to provide the economy with high- level knowledge and skls, is an essential component of every successful markec economvy Rcformsinclude: - Creating alternatives to long-duration university programs G Giving universkiis autorromyar hilc at the sanc time providing them with tncentives to introduce new spcializaions and to improve the efficiency -with which they use resources - Modemizing libranres and information serVIces. :hferWM-wM Polide *; - Polices with a mcdiui-term dimension are of thrce broad types: those con- - cerned mainly with unproving the quality and mix of education and training, those aimed at ifnproving the cfficicncy with which ta mix is delivered, and those concerned mainly with instIutional capactv Sdukkafon adnVhrinfgshoudherqmbwdo mxke ftedrjfir-da o 4pgmd or Agean cmpete achanging kibor n-.W. The emphasis should be on: - - Developing a pirtnership between public and private financing and1 the provision of ruaining D Dccentralizing the sstecm to ensure that itC respond to local needs * Ensuringstandards through regulation and provision of information.- E2841 EDUCATION AND TRAINING Plmeoud&y and high/er educatonr s4oud be epanSd to me dmand- The focus should be on: * Changing curricula and admissions procedures to allow for more flexible access : Recovering costs through fees and other income-generatng actvitics - Introducing sudent loan svstems * Providing incentives to promote prvate sector involvement. -Tecwedncadnshouddlergakzdx. This is crucial since the teacher is the k-ey player in the cducation and training system. Reforms include-. a Consolidating teacher education instiutions and strengchening education departments in the umversities * Developing an education inspeccorare * Developing instiutions and incentives to ensure an adequate and continu- nmg provision of rvicteacher training. 7k educa&w and ruining srrnk shol be dmnl&ed in the -md A' Without accompanying reforms of local goverment and the tac system, how- ever, rapid deccentalization may backfire- In the absence of appropriate me ch- anisms ro equalize funding across regions and to ensure mminum standards, decentralization mav lead to a decline in the quantirt or cpaliry of services. Preschool education in manv countries has already suffered in this wvav. The focus should therefore be on; Ensuring equity of public funding across regions Developing and enforcing normns and standards roviding technical assistance and taining to local government. Paki shoW .&u9or * warn ofpi*au pMUidr not lee n order -m divnr~ *fiwnce of iC; ecd on and draing niefscalisis. Th is can be accomplished br R Removing obstacles o licensing privatE providers * Providing imcentives through the tax system and in other wavs such as. offering access to idle faclities and equipment - Subcontracting training and reuraining services for groups such as the . unemployed. Regrda: and iufonaarm Sitms nquk r develpenwto' prtt asumws 'afd pVOte nid ac by woawse and 'np4'#. Priorities include estblishing: A national svstem of assessment and cxaminatiorns * Accreditation of private providers - An information system on providers and irk performance. *~~~~~~~~~~~~ ;-85-1. POLICY DESIGN AND IMPLEMENTATION Notes 1- The discussion in this chaptecr focuss on thosc countries which werc nor part of the U-S.S.R. Readers may, howvvere be able to draw some parallels with the sicuation in the former U.S.S.R. 2- Educational Testing Service 1992. Rccent Sovict research on the use of mathe- maEical and scientific knowledge among thirten-yar-olds in ninEtcn oECD and for- ;;*. mer communist counties quoted by Hecneman (1993) highlights an intersting differ- ence betcwen the two groups. The thrce former communist countries in the sample (Hungarv Slovenia- and te U.S.S.) rank highest on the avrnss ofsbut i : - significantly lower on the integration and application of those fiacs t newv situaio ITe rankig in the oec counties is typically the reverse. These differences do not necessarly rcflcct a good or bad education, but deep differences in the role playvd by education in market and centraly plannd economics. 3. Ancedoul evidencc for the split bcewn educaion and research comes from one of the authors, who in 1989 asked a prominent biomedical researchcr from a Hungarian rcsearch instituc whether he taught students. The rcsearcher rcplicd that ves, he had caught smdent but only in the United Sataes, whcre he had been a visng fcloaw He had never taught students in Hungarv. 4. This name, chosen by Hungara officials, connotes a svstem which was scpa- rated from and is now irving to rejoin Westcen Europe. 5:. Poland maintined a tradition of private; tang throughout the communisr period, and privae training as flourished se In-Poland in 199 at least forty enterpise of rcasonable size compcted in this markcer Orgaizations- such as the Chamber of Craftsmen, the Skill Devlopmnt Cntre (zmzzn and the Federation of Scientific and Technical Associaons (NoT) managed hundreds of trainingprograms- 6.- Betwee 1988 and 1991. the prce of tetbooks in Poland incrased by a hactor of 26 at the prmary and secondary levels and by a fartor of 30 to 40 at the tei level, with similarG increase occurring in all the countriis of Central and Eastern Europe. 7. -A rclativelv new trend in some niw counties is to introducc technology educa- tion into the curiculum The intcnt is to enable students to acquire a generl under- stnding of dcsign, production, and marketing processcs. 8 For cxample, initi rCsIdts in Hungary for ERx (Regional Labor Developmentr Center) show a placcnct rate of 60 percent for graduatcs in a rCgion 'with a 20 percent unemplovmcnt rate. The unit cost is only iv percent higher than inemploy- ment benefits for the corresponding period. 9. As Mtusted by the closing in 1973 of the Waveler and WoEwand High : . . - Tecchical School, which wuas founded before the Second World War :10 n 199D-91. studentdteacher ratios in secondary educaton were 18:1 in Poland, 17:1 in Bulgaria, and 14:1 in Hungary. - 11. In 1990-91, the number of teaching hours was eighteen hours per week in Poland, which is low compared with other European countries where rwenty-five hours per week is more norm2al 12. In 199. Bulgaia (a countrv of 9 million people) had thirty hifgr education - .. :minstitutions and forty-five postecondary oducaton insttutons spread overvtwenty-five diffrnt cities. In addition, some 175 acadenmvbased research centers varied in size. from 4 to more than 1,000 enployees. 13. In 1992, enterprscs paid the foilowing in Poland, a-Z percent payrof ax toward the Labor Fund, part of which is dedicated to retraining the unemployed; in [286 - EDUCATION AND TRAINING Romania. a 4 pcrocct payroll tax, which is used partly for unemployment compensa- tion and pardy for rctraining the unemployed in Hungrv, a 1.5 percent payrol tax camarked for taining and anodher 5 percent payroll ta earmarked for the Solidarity Fund. which fiances both unemplovment compensation and proactve emplovmcnt program. Howr, expenditures on unemployment benefits have crowded out: epnditures on training. 14- Non-pubIic7 schools in Poland can be divided in two groups, depending on whether or not they receive sta: subsidies privae schools, which rcciv no subsidy, and social schools, which receive subsidics equivalcnt to 50 percent of the avcragc unzt cosrin public schools. 15. In 1990. funding formulae were based on salaries in the case of Polnd andd courses offered in the case of Czechoslovakia. 16. In Poland in 1988. average wages and salaics in the educaton scctor werc the lowest in the entire socaized economv. Tem index was 71.3 in educationi 98.3 in agriculturc. 103.6 in manufacuring and 179.1 in mining and energy (Poland. Gus 1989). Z2871 Twelve' HEALITHI AND JH[EALTN CARE ALEXANDER S. PREKER RICHARD G. A. FEACHEM To EvrTrAztE ITHEIR HLALTH SERVICES, governments in the former socialist stares of Central and Eastern Europe are cxperimenting with a new wonder drug called marker mechanisms. This is rathcr like the doctor who gives penicillin to a patient who has a known allergy to it but will die without it- It is necessary to understand the associated dangers so that appropriate measures nay be tk-en to prevent thc treatnent from killing the patient. Marker forces have of course existed in Central and Eastern Europe for a long time in the form of the underground economy, and thev are a nornal part of the health sector in most of the highly industrialized countries. So by themselves markect forces in the health sector are nothing new. In most Western countries, however, the trend over.the past century has been toward an increasing role for government becausc of known market imperfections in the health sector. In Central and Eastern Europe, by contrast, mark-er forces are being introduced to deal wiEh the svstemic failure of excessive rather than kisufficient goverrrnent involvement.; - This chapter presents a conceptual framework for understanding why the - .ahealth sector performs poorly in Central and Eastern Europe (excessive state intcrvention), the prescribed treatment (market forces), the allergy (marker imperfections), and the remedy (a new public/private partnership in the. financng and provision of health care). The chapter looks at policies relating to health and. a closely related but distinct topic, at the organization of health care. - The Lnheritance It would. be seseless for governments in Central and Eastern Europe to attempt to fix things which are not broken or to focus excessively on problems for which tier are no known solutions (for studies of the different countries, see Preker 1990; Feachem and Preker .1991; World Bank 1991a; World Health Organization 1991; umwlc/wHo 1992). They should, therefore, con- * duct a rapid assesment of the stenirhs, weaknesses, and perennial problems which their health sectors inhcritcd, so that tley can begin to redress the most urgnt needs. Alhough each country has irs owmn unique history, somc of the common threads presented belowv are readil apparent. 0 1 ~2881.-.. HEALTH AND HEALTH CARE Strengths The first major lesson to be learned from the sociatist experience is that4 under dic right set of circumstances, stare involvement in the health sector is desirable and may at times be essential. Rapid economic growth, expansion in the social seccors (income transfcrs, hcalth, education, and culture), and more readily available food, shelter, and employment led to significant improve-C ments in living standards and health status in many of the socialist states during rhe earlv years of central planning.1 In comparison with earlier periods of physical destruction, economic hardship, starvation, and homelessness in countries like the Baltic states, Poland,. and the U.S.S.R., the 1950s-w;rc characterized by improv:ments in human well-being and health status despite the obvious price of political oppression and loss:of personal frecdom. Entitlement by the ctnirc regional populaiCon to a full range of -healkh services was one of the remarkable achievements of the socialist regime and its health care system. No other region in the. world, not even Europe or China, has ever succeeded in providing such extensive coverage of compre- hensive health care to a population of similar size. Since equity in access to affordable health services appears to be one of the most inportant deterni- nants of healti status at uppcr income levels, preserving this positive legacy should be a high priority. By the early 1970s, countries such as Czechoslovakia and Hungary had very mature hcalth systems. Comparcd wvith developing countries with similar per capita gross domestic product, or even compared with the highly indus- tialized countries, the health sectors of Central and Eastern Europe were well endowed in basic physical infrastructure, trained staff, and education pro- grams. Stcructrally integrated networks of hospitals, clinics, and other clinical .fTilities, based on the Soviet health care model, secured universal access to curative health services throughout the region. Patients had their firs point of contact with the lower tiers of the health svstem through individual outpaient departments of hospitals, polyclinics, diagnostic departments, emergency ser- vices, communitv health centers, rural health centers, and industrial health services. Doctors working in thesc settngs actcd,as garekeepers, teating - what they could and referring more difficult cases to higher levels of care. Universitv hospitals and national specialist- insticutes capable of providing advanced technological interventions formed the tip of this pyramid. A highly structured system of hygiene and epidemiology stations :formed a similarly sophisticated and integrated network of public health services which concen- trated on the control of infectious, occupational, and environmentally related diseases. These positive bequests from the former socialisr regime are sum- marized in table 12-1.. --Because the previous sysrnfalled to produce many of its predicted eco- nomic and social benefits, radical reformers during the tansition have been : - 12891 POLICY DESIGN AND tMPLEMENTATION Table 12-t. Posidie Bequesasfrm the SrialistRegimes in Ceutral and Easwren arope EnitmCnt . fntire rcgional population Burden of financing Evenly distribuced Access Fewv financial barricrs Range of services Comprchersive Network of fhcilitics StrueUrlv integratcd Resoureebase Exctcnsive infrastrucurc. quick to condemn, and even have been tempted to discard, almost everything that existed during the past. As a resut, ere is no c a sious risk that, at least in the hcalth sector, some of the countries in Central and Eastern Europe may throw out the baby with the bathwater. Not onlv would this waste valuable assets such as excellent vaccination programs and maternal and child health services, but it could also deprive a significant part of the population of: basic healdt care at a time when unemployment and deterioratng standards of living are having a negative impact on health. Unfortunately, despit these positive aibutces, the nationa health services in Central and Eastern Europe were remarkably ineffective in promoting good -health or preventing illness and disabiitv from known and avoidable causes. The second major lesson to be learned from the socialist experence is, therefore, that relying too heavily on a state monopoly in a centrally planned and supply-driven health sector lowers the efficiency and quality of care. This -musc be quickly corrected if health services in the region are to be successfulry integrated nto the emerging market economies. Interestingly, the health sectors in Western countries such as the United Kingdom, whecre governents have assumed a similar monopolistic and cen- tralized dorninance in the financing, ownership, and provision of hcalth ser- vices, suffer from many of the same problems as those observed in Central and Eastern Europe. Thus, even though govcnment involvement may be necessary to secuing some positive atributes in the health sector, it is not in itself a sufficient ingredient in securing others, such as good health. There are two major sets of problems: poor health status and lorw-quality health services, as,summarized in table 12-2. POOR HEALTH srATUS. The single tongest predictor of a nation's health status is noc the character of its health services but its per capita GDP (Schicber 1989; World Bank 1993d). The relationship betwecn c;rPper capita and life expectancy at birth is strong, especially at lowver levels of income (figure 12-1). 1 290 1 HEALTH AND HEALTH CARE Both the northern and southern countries of Central and Eastern Europe, together with the Central Asian republics of the former U.S.S.R., occupy positions in figure 12-1 which suggest that ovcrall, they are a little morc healthy than their income level would predicr. This is especially the case for the southern counries of Central and Eastemr Europe. If, howevcr, a measurc of adult health is taken, such as risk of death between fifteen and sixty years for males, a diffcrent picture ernerges (see figure 12-2). The southern coun- tries of Central and Eastern Europe and the Central Asian republics have male adult mortality risks close: to those predicted by their GDP per capita. The northern countries of Central and Eastern Europe, by contrast, are more wealthy.and less healthy. They have a male adult mortality risk of around 29 percent when, at their-level of income, the predicted figure is 21 percent. In both figurcs .12-1 and 12-2, the national wealth and health status of Central and Eastern Europe is broadly similar to that of Latin America and the Caibbean. At the same timne, the relationship betwcen life expectancy and national wealth is wveak at higher levels of income. Wlkinson (1992) suggess that among industrial countries income a&ffinvalv, not the. kvel of income, are a better prodiccor of health status, with more equitably distributed wealth being Table 12-2. Legfa ofPoorHeulh and lneffiierHeath &n:ic: n Csia andE ze Eu-pe Keiypmhlem1m Health scsus dHigh mortalityespealy in adult men;high morbidity unhealthy- lifescyles and environsncn- Policymaking and managent - IInecffect inrsecoral coordinaion; low priorirt :- given o hcalth and god healtb car; lack of responsivencss to local nceds; weak management. - . : X - - - - mdd~~~~neling.and evaluation. .- Structmre Rigid and overly cntlized structurc; too much' emnphasis ptacd on instntuional care neglect of. public health and primary ar; distortons in th mix of public and privatc financing Function Lack of functional integraton; incffective. inefficient, and low-qualitv servics Resources Arbiary statistical norms (physical ad human); . i = unmbalanceswih surpluses and shortages; cxcssivc usc Training . Narrow and excessive specializtion and isolaton; and rescarch and development graduate cducation isolated firom universkities rcsearch isolated from teaching; noncomptimiv.e funding Fnncing Undcrfinaniingcompared with capitlization;. adversehientives - . - ... : - .; -- -. ., . - ..--9:, POLICY DESIGN AND IMPLEMENTATION Figure 12-1. Lift Expectanq by GDPper Capita and Rgion, 1990 Life cxpectancy at birth (years) 90. 80 60 _ JN+ E j; 50 40 1 I - 1 .0 5 10. is 0 25 GDP per capira (thousands of US. dollars) NIew: GOP per capita is in 1991 US. dollars convened from local currcnci's at purchasing power-parity rather than the cxchange race. The linc is drawn from the data poincs for every individual councr, the regional pooled mcas arc shown as a singic point for each rgon. The regions are defined as follotts: CA. Central Asian republics of the former U.SS.R. * (hAzerbailan, Kyrgistan, Tajikistan, Turkmenistan. and Uzbckistan); CHI, China; EME, Estab- * lishcd market economnies (Austraia. Canada, Japan, New Zealand. United States, and Westrn Europe); IND, India; LAC. Latin America and the Caribbca; MEC. Middlk Eastcrn crescent (from Morocco in the wtst to Paldstan in the cast, including Nerrh Africa and the Middle East); NCEE, Northern Ccntral and Eastern Europc (Belarus, Czech Republic. Estonia, Hungary. Kazakhstrn. Latvia, Lithuania, Moldova, Poland, Russian Fcderation, Svak= Republic. - Ukrainc); OAI, Othcr Asia and islands (all of Asia cxcept for China, India, Japan, and Pakistan, plus the Pacific Islands); SCEE, Southern Cenral and Eastcrn Europc (Armcnia,- Bulgaria. Ceorgia. Ronania, and Yugoslavia); and SSA, Sub-Saharan Africa. Sxm- Data supplied- bv Christopher Murray and collcagues. Ccnter for Population and Development Studies, Harvard Univcrsi, Cambridge, Mass. associated with greater longevit. In light of this, the poor status of adult hcalth in the northern countries of Central and Easten Europe is noteworthy in view of their historv of a relatively compressed incomc distribution and - supposed absence of poverty. Therc is, therefore, a real risk that the move to a market economv will make health status decline in some countries as pov- ertv increases among some subgroups of the population. Although health status in Central and Eastern Europe today is reasonable in relation to the wealth of the region (except for that of adult males in the northern countries), an cxamiution of trends over the last five decades tells a very different storv. and poses a considerable challenge for policmnakers (Fea- 1.292 1 HEALTH AND HEALTH CARE Figure 12-2. Risk of Death for Ma/es betveen FIfteeu and Ffify-abe Yesm of.4ige, by GDP per Capitra andRegon, 1990 Risk of mortality (percent). 60 W~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 40 + ~+ NCEE LAC 20' + MEC E C I 10III 5. 10 15 20 25 G DP per capita (thousands of US. dollars) gmr The risk of death mcsres for evr 100 maleswho are aive at fifteen ycars of age the number who ivill be dead by sixty. The horizontal axis is in 1991. U.S. dollars converted from local currencies at purchasing powe) r parity rther than the exchange rat The line is drawn from the- data points for event individual countrv. The regional pooled means are shown as a single point far each region. The regions are defined as follows: CA. Central Asian republics of the, former U.S.S.R. (Azerbaijan, Kyrgistan. Tajilcistan, Turkrcnisan, and Uzbekistan); CHI, China; EMEY Estab- lished market economies (Australia, Canada, Japan, New Zcaland; United States, and Western Europe); IND$ India: LAC, Latin Amnerica and the Caribbean; MEC, Middle Eastern crescent (from Morocco indiewet ,to Pakistanin the east.iiclu ding North Africa anddtheMiddle East); E. Northern Cetral and Easter Europe (Belarus, Czech Rpublic, Estonia. Hungar''. Kazakhstan. Latvia. Lithuania, Moldova., Poland, Russian Federation, - Slovak Republic. Ukraine); OAT, Ocher Asia and islands (all'of Asik except forChina. India. Japan, and Pakistan. : plus the Pacific Islands); SCEE, Southem Central and Eastn E P Georgia. Romania, and Yugoslavia); and SSA, Sub-Saharan Africa. * ~~~~Soww:Dt uple yChitpe Murra and colleagues. Center for Population and Devckopment Studies, Harvard Univcrsity~ Cambridge, Mass. chem 1994). After recovering from the war years, the region enjoyed 'a health status which overlapped that of the West. Life expectancy, atbirth was higher in Czechoslovakia than iin Austria throughout the 1950s (Bobak and Feachem :1992). Furthermore, in the decade from the early 1950s. improvments in hoalt sntatus ourcpased toseci most Wt estern countries exceptjapan. Infant moralicty rates fell by nearly half in the communist countries, and life expec- tancy at birt c increased by around five years. By contrast life eXpetanCY pver this periodLt increased by two and; a.. half yes in: the Federal Republic of : [293 Y POLICY DESIGN AND IMPLEMENTATION Germanv and one year in -the Unitcd Stares (Eberstadt 1993). Bv the mid-1960s, only one or tVo years separated average life expeccancy in Central and Eastcrn Europe from that in the advanced capitalist countries, and the gap ,was closing. From the mid-1960s, the relauive rrends changed dramatically. Health sta- tus in Central and Eastern Europe stagnated or deeriorated, while in the highly industrialized countries, it improved steadily. Between the mid-1960s and the late 1980s, life expectancy at age one fell for mates dhroughout Central and Eastern Europe (the greatest fall-three and a half years-was -in Hungary) and rose by less than one and a hatf vears for females.z Over the samc period, age-standardized male mortality rates in Bulgaria, Czechoslovakia, Hungary, and Poland rose 2-13 percent, while in the Netherlands, Sweden, Switzerland. and the Unitcd Kingdom, they f:ll 12-27 percent. The witening gap in life expectancy and mortality betwecn Eastand West was parcicularly strking in middle-aged adults ln the communist coun- cies, death rates for males aged formy-five to forty-nine years micrased betwcen 7 percent (German Democratic Republic) and 131 percent (Hun- gary) becwecn 1965 and 1989, while they decreased in the highly indus- trialized coiuntries (Ebcrsradt 1993). The risk of death for men between fifteen and fifty-nine years of age it the late 1980s was higher in Hungarv than in Zimbabwe and higher in Czechoslovakia than in Vet Nam (Fcachem and others 1992). A substantal proportion of this divergnce is attributablc to an epidem-ic of cardiovascular disease and, parcularly, of ischemnic heart disease in middle-aged males. (Other leading causes of death and morbidity include cancer, respiatory disease, and accidents.) By the rnid-i980s. mortality ratcs from ischemic heart dismse in men aged forty-five to fift-four years were twice as high in Czechosloakia'as in Austia, while in the 1950s they had been the same (Bobak and Feachem 1992). Superinmposed on these longer-term trends of declining health are the effects of the transitiun. Although the dat are somewhat ftagmenied and the precise causal rclationships difficult to cstablish, the results in some counmes are dramatic- Thc increase in crudc death rates in the Russian Federation "assumes truly apocalyptic connottions. Plt increased by: 33 e33pr ... between 1989 and rhe firsr seven months of 1993 (umcmltmc 1993, p. 20, flg.7).-- -. It is no consolation to the countries in Central and Eastern Europe to know that their overall heith status iS similar to that in Malaysia, Sri Lanka, Uruguay. and Venezuela, simce it is not with tese countries that they must compce. They need human-capital capable of competing cffcctively widh the countries of the European Union. At present, the gap in health staus between- the former socialist economies and the highly indusrialed countries-is wide and growing, especially in the cohorts of workingagc. The gap in health status shown in table 12-3 is due oaly to differences in mortality. These mormlity [294 1 HEALTH AND HEALTH CARE Table 12-3 HAA Sar i e CenmIa'nland Ean Eupe and E& ird MarkerRoi,miq, 1990 C-vmzfab FarshrAd Heatkeuar &SW-EWZD ,nsnamaies6} - Atbinh Avcrgc .72 . . 76 Range 69-73 74-79 Arfifteenycse . 59 -62 1Bcteen birch and fivc wazs Aera=ge 1.1 Rangr- e1.336 0. - 6-13 Between fiftcen mand ffy-ine CaS: Males. 28 15 Females 7i .7 t Albania. Bdaus, Bipria. Czech Republic. Hungary Lithuania, Moldo. Poland. Romania. Russian FedestimSbkk Republc, Ukraine, rcrYugos-avia. b . Austrla Ausia. Bclgiu. Canda Dcnam-k. Finhnd, Fmnr-a Fcdarad Rempublic of G- ;crnny. - Gr Ircland, Ita, Japan, NcEhcdaerNd w N ealand, Norny, Portugl. Spain, f _.:~Sakdn, S hrmnd, Unied l;ingdorm, Unied SWUM_5- Sow= Calculated rom World Bank 1993d. able A4. excesses place a burden on dhe economics of Central and Eastern Europe because of the lost investment in human capital (ndividuals who dic in middle age have reccived publicly funded education and other services), medical expenditure made prior to their deaths, and the more geneal opportnity cost of lost lives. An even greate burden is ikely to be imsd-by the hge morbidity differential which underlies the mortalit differentia. Lost produc- tuvi due to high rates of sickness in die labor force and lost investment due. to the high costs of caring for the chronica-llyl and theirfamilies put the. formerlv sociast economies at a string disadvantage when competing with thcir hcalthier rivals. ; Repairing the damagm caused by the last thire decades of communist nrle and closing the gap in health status must, therefore, be a central objective for human resources policy, throughout the region. Tiis will be neither easy nor quick. If they could achieve rates of overall decline in moralitv similar to char-' of Chile ovcr the past tvo decades (roughly 2 percent a year), i wouldcaJkec aStErnM Germany twelvc vears to catch up with wescern Germany, and Hun- :gry vould need tventv-three years to rejoim Austria (Eberstadt 1993). For many rears, either thse trends went undetected or information about ter was suppressed for political reasons. The general philosophy-tar citi- zens are passive recipients of stae-run health services rather than active participants ui a process of improving life-styles and reducing environmental risks-contributedtotheproblem.::` 1 29-51 POLICY DESIGN AND IMPLEMENTATION LOW-QUAITY HEALTH sERvicEs. During the early years of communism, the health sector (as parc of die so-called non-productive sector) was accorded a : lower prioritv thian the indusrial sectors. As a result, the cnormous potential benefits of an interseCcoral approach to health and healch services planning undcr the former five-year plans were largely losL Thcse problems in poli- cynaking at the ctra level were compounded bv poor flows of information in .thc tracking and evaluation of health trcnds and lack of authorit in dei- sionmaking at local levels (a result of the inability to decentralize). The main resuling problems were poorly targcted invcstmcn,. inadequate integration : - between the differet parrs of the systm, excessive specialization, a narrow base for financing, and grossly deficient incentives to efficiencv. PoorlY targeted invcstment had, by the early 1970s. led- to a massivc but lopsided buildup in acute care hospitals and excessive spcialization at the expense of public health services and primary care. The rigid and over- -entralized Soviet-syle national health services which evolved from this pro- cess contained both significant overlaps and significant gaps because different minimnsres al tried to provide services for their own enterpise-based workers. The private sector'was excluded from ncarly all actvities. The differenE components of a compkx network of services 'were not functionally integrated. Standards were determined by arbitrary sttistical norms, leading to my imbalances. Surpluses and shortages devloped due both to vanrations in local patters of use and to polidcal patronage. Thc compulsory caccuTnent areas and the role of prinary care doctors as gate- :keepers were unpopular with patcents who rightly felt char they were wastng - - -- their time waiting inline to be told that the services they needed were not avaiable at that level of care. Nor surprisingly, they were willing to pay subsmntial gratuitics to be referred quickly up the line or to use .services outside their official caechment area- In the poorer countries, such as Romania and across the southern crescent of the former U.S.S.R., this shopping- around was often unproductive because neighboring areas with higher lcvcls of Care, mote often thanr no't had similar shortages. Instead of providing comprehensive and functionally:integrated services, the system created many inldirect bamers to access through corruption and adverse incentives.. - Excessive specializaion led to the absence of a broad cducation and to thce development of narrow skills which are now difficult to adapt to the more complex demands of a market economv. For instance, -girls would en-er technical training in nursing at the age of fourteen. depriving them of a broader educationa. base. Sincc mcdicine was considered a technical skillf, doctors and othcr health carc providers received training provided by mmiistrics of healtLh Medical educarion was, therefore, isolated from the education provided in general universities by ministries of education. Trainng of public health spe- ciaists, healti economists, hlth srvice managrs, general practiiioners, nurses, and manv other heilth care personnel was seriouslv neglected. Under - . ...>,...................12961.......... HEALTH AND HEALTH CARE the Ceaucescu regime in Romania, the nursing profession was virtually abol- ished, leaving the country wtith a serious deficit of traind nurses by Western European standards. Research -as isolated from tcacing and financed through noncompetitive grnts- International isolation in rauin4 research, and technology was pandemic throughout the rcgion, especially in Albania, Bulgria. and Romania These problems of the hcalth care system echo those of the rest of the educational svstcm, and the similarities are stiking Health services were fianced almostc xclusively through general revenues. Although an equitable and possibly efficicnt source of financig, such depen- dence left the health sector vulnerable to political agenda. It also failed to send a dcear signal to patients and health care providers that healdt care is not free even when provided without direc charge at the point of deliverv. Under-the-: able user fees in the form of gratuies or blac monbecame widespread throughout the region. In countries like Hungary, up to 20 percent of health care expenditure is estimted to have taken the form of out-of-pocket pay- ments. The rccurrent budget required to opate the resuting overcapi-alizcd and underfunded health services outripped the financial resources of most countries;- Inretives to efficiencv werc virta nonexistent either to morivate panents to maintami good hcelth and use scarcc rcsources judiciously or to ncourage health care workers and instions tO provide high-qualt car Doctors work-ing on salarics had an incentivc to minize thcir work- load by refering complcx problems up the line- Dirctors of hospitals, similarly, had a' strong incentive to avoid perforning expcnsivc diagnoses and treatments- themselves and to refer dfficult cascs to higher lvcels of care. The less work,: the less strain on thcir global budget As a result, queues and wvaistnlists Were common even though thc number of doctors and beds per capsta was. higher than inmost Wecstrn countrics. : The ird major lesson to be learned from the past is that some problems arc an unavoidable parc of the human predicament and may simply have to be- accepted. iNo health sector reforms or cxpendiure wi entirclv climinate the problems of aging, biological defects, povertyv and social miser These exis- ted both before and during the forer socialist regimes. just as they do i markce economics today. Uni-versal entitlemnt and fre access to health services mav have allcviaed some of the associated hardships, but thcl did nor climinate them altogethcr. The Forces Driving Change eTh currcnt reforms in Cental and Eastern Europe fundamentally redefine the role of the satc in the health sector, as celswhere. This includes a call for. (2971 POLICY DESIGN AND IMPLEMENTATION more efficient alocation of resources dtrough marker mechanisms, greater individual freedom through democratic processes, and stronger institutional capacity of health svstems through decentralized devolution of responsibiliy and management. The polar extremes of those driving forces which are most rclevanct o the health sector are summarized in table 12-4. The tran=sitio from a centrallv planned command economv and s x'ialist political svstem to a marker-oriented economv and democratic political svstem is accompanied by a swing of the pcndulum of olicy choices. Some countries, such as Poland and the Czech Rcpublic, have opted for a "big bang" approach to restructuring, while othcrs are following a more grad- ual path. In all instances, however, an elixir of rapid libealizion of demand, supply, prices, and wvages. combined with the fiscal constraints of stabilization progm. provides a pocenr and at times toxic, brcr failing health s- viccs. In most countries, the health sector was not prepared for the resulting problems discussed belowv: an overshoot in economic iberalization, the rqec- tion of constraints on freedom, and a resulting instituional collapse The mounting backlash aginsc these negative effEs of thc transition is nowr threatening to destabilizc the -whole reform process. hlis presents a parncu- larlv difficult short-term problem for poEicymakers in the region, who have to Table 12-4. DyivfrFaonzr&teR4bnnJWem en For markw -mo:s ForW-A-Mmd cd oddaaeuiFc * frivbgfinu ~~~~~~~rzrEdiwqnvsw pa&imhyavtu Ps fa aa ,. Idcology C:ofciMr : b- Indivildwr Political process Autocratic Pluralit - Govcm c Toczkrian. Democr:tic - Economicmodde Sociaist Capi2lis: Command Market State -a-.c-6ire Ownership and financing. Public Private Prices and nges Predetcrmined C;OmITvCe - Production Supply dcrivn Demand driven Labor markCes Resticwd Mobilec Incentivestrucwurs Burelucratic Menrocr.ti- Non-t:ive Performance Economic cquilibrium Static Dynamic Policy and lepl Five-yearpns pIncremnal .: Structur- Ccntralied Deenatlized Function Simple aid uniform Complex and diverse Pcrsonnel Superspecialzed Broad skills - Z98 1 HEALTH AND HEALTH CARE address the strengths, weaknesses, and perennial problems of the past as well as chose of the transition. The first major driving force is the rendencv for economic liberalization in the health sector to go coo far too fast. The remouval of centalized scate control over the healti sector and the rapid introduction of unregulated com- petitive markets have alreadv led to sigificant market failure. In the Czech Republic, ownership of most health care faciliies was quickly transfcrred to local communities. Substantial parts of the former national healh service have been privatized, cespecially in the case of pharmaceutical products, medical equipment, supplies, ancillarv services, and ambulatory hcalth services (pri- vate offices, clinics, pharmacies, and diagnostic centers). Many health care providers such as ge-neral practitioners, consultant specialists, dentists, and pharmaciss vworking outside the hospital subsector no longer see thcmselves as public employvees but rather as entrepreneurs in private practice. Patients se themselves as consumers of health care, demanding services in return for their . axes or social insuranc. contrbutions. Unforunately, instead of engen- dering a partneship between the public and new private sector, unrestrained privatzamon within an ecessively relaxed regulatory fiamework has led to unscrupulous profiteering and pillaging by health care providers and unchecked use by patients (both problems are caused in parr, though nor wholly, by the third-parry payment incentives discussed in chapter 2). With the sudden hlberalizadon of prices and wages, the cost of critical supplies and pharmaceuticals has eCxloded. In Poland, for example, public expcndicure on pharmaceuticals incrcased from 12 percent of health care. ependkiure to more than 30 percent almost overnight. The unbalanced shift mn incentives from a normative-based sysEm to a performance-based system has cxacerbated the problem of cosr containment3 In the Czech Republic, the original annual budget of the newly created health insurance fimd was: more or less exhausted within six months of its inception at the begining of 1992 and had tob1pe replenished; expenditure in the fisc six months of 1993 was almost as much as in the whole of 1992. In Hungary, the proposed rcplacement of global hospital budgets with performance-related, diagnostic- relarctd groups (see the glossary) is likelv to have the same effect if nor accompanied bv strict rnechanims to cap the budget: In countnes li cAlbania, large-scale Iavoffs in he industrial sectors have led to significant dislocations, housing shortges, farmily disruption, and unemplov- menr as firms begin to shed labor to become more efficient and Erv to avoid bankruptcy during the recession. These social disruptions have increased the demnand for hcalth care ara rime when resources are exremcly limited.. 'A second driving force, the sudden rejcction of constraints on freedom of choice, has led patients and health care providers throughout the region to shop around indiscriminately. wasting valuable resources and increasing the pressure on an alreadv ovcrused halIth servic. In Poland. the obsession with [2Z991 . . . -0 ..................................... . POLICY DESIGN AND IMPLEMIENTATtON steering committees and popular consultation has led to ineffctive policv- making and management. Critical pieces of legislation renmin deadlocked in Parliament for months, even though many of the proposed reforms could easilv have been introduced through regulation. In Hungary and surrounding counries4 rqejction of past socialist ideals and excessive confidence in individ- lua autonomy and self-sufficiency have almost completely replaced all concern for collective protection and equiry. Gypsies, migrant populaicons such as immigrt workers, and minoritv groups such as AIDS patients are now threat- cned wiith loss of entitlement and of access to adcquate health care. The third driving force, the reection of the communist modeL has led to a massivC collapse in the prevaing centraly planned institutional framework for health services which had previously been provided through the public sector and vhich has not been replaced bv privatc or nongovernmental sectors. The abolition of fiveyear plans has lcft many ministrics without a clear strategy fbr the future and w%ithout an institutional capacity to develop new policies- Purges of the nomenclature and a witch hunt for previous card-caring communists have decapiated the minstries of health and manv health carc institutions in the Czech Rcpublic. Poland, and the Slovak- Republic. leavinga dearth of exprienced senior staff. Medical doctors with titde training or exerience in management have assumed key administrativc posts m headlh muuinismes, hospials. and other institutions, creating a policy vacuum in which poorly prepared and contradictory reform proposals are oftcn prcsencd to Parliament at the samc timc. Impertnt decisions abett the budg& allocation process and major capital investments are now heavily influenced by vcsted interests such as the medical profession, pharmaccutical companies, and equipment manufactrers and importers. As a result, the invesunent needs of hospitls and clinics mav be increasing unnecessariBy, not least becausc main- tenance and repairs are being neglecced. Excessive decentralization and;a breakdown in refcrral nctworks in coun- tries such as Bulgaria,- the C-wch Republic, Hungarv. and the Slovak Republic have led to potentially expezswve overlaps, as every communir hospital wants its own neurosurgical unit and the latest technological equipmenL A splinter- inlg of the former centrally organized wholesale and rctail distribution svsrems has added to the crisis caused by, rapidly rismg prices. The result has bee serious shortages of pharmaceuticals and critical supplies in much of the former U.S.S.R.. where many of rhe distributional links which formcrlt led to Moscow have now. been cuL Sevcre supply shortges are, of course, experi- enced also in countries ravaged by *war. Policy Governments in Central and Eastern Europe are firnding that reforming their - heaith sectors during a period oF major socioeconomic adjustmenc is vastly 1 300 I HEALTH AND HEALTH CARE different from reforming them in a more stable environment. Frequent changes in leadership in Poland during the earlv vears of the reforms, hvper- inflation in Larvia, and purges in the civil service in the Slovak Republic make it difficult for government Eo introduce sustainable health care reforms Reforming the health sector is also different from reforming ocher parts of the econoray because health services cannot shut their doors while they are undergoing significant restructring and reform; As a resul, the massive ll.v- offs and liquidation of assets in easern Gcrmanv folowing reunification did nor excend to the health scor. Health sector reforms, therefoe, carrv with rhem special opportunes and risks. Policvmakers in Central and Eastern Europe have an opportunirt to redesign their health services and health financing systems, while drawing on tie best of Western experience and avoiding knowvn pitfas such as the escala- : tion of costs in the United States, waiting liss in the United Kingd, and excessive prescription of drugs in GCrmany. Yet, they nr the risk that lower sandards of living, weaker commitment by governments t mami .ng essential services, and restrictions in public exenditure on health carc wi weaken ithe healdi sector's role as a critical [ink in the social safetv net. For insance, the privatization of familv docrors' offices in Russia, under consid- - ration im 1993, could worse the shortage of doctors in regions outside Moscow. Continued underfunding of immunization programs or maternal and child clinics could worsen the already high infant and maternal morality rats. The Snagy In an effort to be consistent iwich the underlyini thrust of the transformation process, many governments in Central and Eastern EuropC arc trying tO introduce healh and social policies which simultneously support the broader aims of associated political, economic,- and insirutional reforms, as well as obectives which are specific to the health seor islf. The underlying thrust ;of the transformtion is to increase the overall well-beig of the popion by restoring individual freedom, increasing liing sandards, and creang a strong safew net for-those who are unable t take advantge of thcse benefits without: additional assistnce. In the case of health and health care, as elsewhere, tis. includes inccntives for individuals to become more self-sufficient, competitive markets to improve efficiency, and decentralization of management to improve the responsiveness of insttutons ro local needs. Illness limits peoplesautonorny, reduces theirparcipation inemployment, and increases their dependence on health-services. Thus poor health has a direct ngaive impact on labor mobiliry, productivity, and public expenditure- Unrestrained demand for health sevices and explosive incrases in prices, if left unchecked, could triggr a vicious cycle, of poor economic performance and deteriorating standards of living which would' jeopardize other measurcs tk-en to improve health. The current sense of urgency, therefore, stems not [3011 POLICY DESIGN AND IMPLEMENTATION only from ethical motives to improve healdt and the quality of human capital but also from a desire to undcrpin the emerging markecr economies with sound fiscal policies and institutonal reforms. Most countries in Central and Eastern Europe have begun to formulate policies which address these bmad objectives. They can be grouped, under three major categories: ' The first st of polcies is directed at improving health. without which seif- sufficiency and individual freedom cannot be restored. This includes mca- surcs to raise standards of living, to promot healthier life-fstles, to protect the environment and to improve the effectivcness of preventive and cura- tive health services. The second set of policies focuses on health care and is directed at restoring macroeconomic balance, building new and more efficien-t markets, and controlling for market failure, without which economic growth and produce- : tvity wil not be restored. In the health sector, this includes mcasures (a) to maintain macroeconomic balnce through cost-containment policies and the introduction of non-budgetary sources of health care financing; (b) to build markets so as to incrcase consumer choice, divcrsify supply, and improve labor productvicv and (c) to regulate market forces to improve risk pooling, and ensure quality control. The third set of policies is directed at imnproving the political and institu- tional capacity of the health sector to implement relevant. reforms. This includes mneasures to introduce new legislation, to strengthen the physical and administrative ifrastructre of insttutions, and to rorient the training of personnel:- Variations in the evohling health systems which are observed troughout the regon can be explained largely on the basis of differences in how policy- makers combine these options (World Bank 1993d). IMPruVifgReaftA The fist and most imporunt reforms being introduced in the health sector in Central and Eastern Europe, like th Cos the Gap Program in Hungmv, aim to reduce the difference in health satus bewn the countries in the region and the highly industiaed counmes with which they will compete in the fturre: The determinants of the heaith gap berween Central and Eastern Europe and Wcstem Europe are not wel understood. A plausible breakdown would abute 30 percent of the gap to ences in wealt and associated socio- economic factors. 50 percent to known life-stvle risk factors, 10 percent to environmental pollution and occupational risks, and 10 percent to deficiencies in the preventive and curative health care services. Good health depends not only on income per head but also on the dismbu- tion of that income. The risk factors causing disease arc experienced pariicu- 1 30Z 1 HEALTH AND.HEALTH CARE larly by the poor and less educated, and it is they who must be reached by incentives and cducational programs. Unhealthy jobs are taken by workers with no other options, typically thc lcast skiled and Icast cducated. It is the poorest. who live, in the shadows of belching chimneys. Closing the gap in health status, therefore, requires a concern for equitv and an emphasis on reaching the most disadvantaged sections of the population. Fortunately, so far, no country in Centrl and Eastem Europe has withdrawn universal entitle- ment or equitv in accCss to serviccs, although the health insurance programs. rccendy intioduced in thcCzch Rcpublic, Hungary, Russia, and the Stovak Republic could alter this situation.. Although policies to incrase standards of living and econoriuc growth rec extremely important, they lie, for the most part,Toutside the hcalth sector.: Policymakers in Central and Eastern Europe are, nevertheless, trying to avoid any actions in the heatih sector which woutd conmtbutc unnccssarily to the fiscal dcficit or to inflationary pressures during the transition, sincc this would indirecdy hurt health; by rerding economic recovery and imprbvcmenrs in - living standards. At the same ime, they are conentraing their attcntion on thosc factors which have a more direct impact on healtkhr lifie-stys, pollution and occupational risks, and preventive health care.: c.CwHANGING u-rrn. Thc lrgest single conutn to the health gap is the high and rising ratc of cardiovascular disease among adults- cspecially adult men. Risk factors for cardiovascular disease include cess consumption of alcohol, smoking, obesity, lack of physical exercisC, and poor diet (hi in - animal fat, salt, and cholestero- low in frits and fresh vegetables). All these factors are more prevalent in Centralaand Easten Europe:than in-thehighly industialized countries, and the most important factor, smoking, is much more prevalent. Surpringly, no country in the region has introduced effective polcies to reduce these risk factors. Such policies would include: * Tation-basd disincntives to consumption of alcohol, tobacco4 and unheathy foods * Legislation on alcohol, tobacco advertmsing, and food labeling - Public education programs to inform and sensitize:the population about diet, physical exercise, and dangerous behavior. REDUCING.POLLUTION AND occuPIoNAL-RImSs. Environmental -poUution is widespread in Ccntral and Eastern Europe, and brnging it down to an effi- cicnt level, which takes account of both the costs of poRution and the benefits of the polluting activity, is a priority for government action. This is for more rcasons than the ncgative imnpact -on health. The most serious problems are dust and gases in: the air, lead in the water and soil, and nitrates and hcavy metals in the wcatcr. Air pollution is paricularly damaging. Black spots are prevalent throughout the region. and at the junction of the Czech Rcpublic, 13031 POLICY DESIGN AND IMPLEMENTATION Germany, and Poland is the so-called Black Triangle, where about 6.5 million people are exposed to cxtremely polluted air. In the Czech Republic, air polluidon may explain about 9 percent of the gap in health status with Austria (Wklorld Bank 1993d). Occupational risks are w%idesprcad and varied. Under the communisc regime, worker organizations, managerment, and the state conspied to allow appallingly unsafe and unhealtiy working conditions to be maintained. This conspiracv was shrouded in an elaborate system of inspec- tion, certification, and regulation which w-as corrupt and ineffeccive.4: Most governments in Central and Eastem Europe realize that rectiing this legacy will not be cheap or casy. As a result, effectivc inspection and regula- tion, and incentives for investing in anti-pollution technology and occupational safety.. have not vet been introduced. In the future, such- measures must be applied everdy, and preferably throughout the region, to prevent compliant industries from being disadvantaged in the rnarkeplace Worker organiza- tions, such as Solidarit in Poland. could play a central role in helping to-. develop a wider public consensus. SUPPOrtING PRVEVE HEaL-H SERVICES. n some respects, preventive health services werc performintg wcU under the previous regimes. In particular, most countnies offered good services for pregnant women and babies, high rates of iMMunizauon among children, and effectivc programs for controlling infectious diseses, such as typhoid and tuberculosis. Immunization coverage rates in countries such as the Baltic states, Bulgaria, Czechoslovakia, Hun- gor, and Potand were among the highesr in the world, and diseases such as poliomyelitis and measles were reduced to-very low levels. Maintaining thcse achievements, and building upon them by adding rnew vaccines such as hepatitis B, has not ver become a hikh enough poriorit for manv countrics. Control of some coInmnunicable diseases is now threatened in the former U.S S*R by problems in the production, purchase, and deliverv of vaccines Without more effective acrion, Illncsses such as tuberculosis, which is on the rise in Westem Europc, will pose a great threat to the poorer countries in Central and Eastern Europe.- Improving cducation and services for women and thcir babies is an effective way to increase health status and avoid unnecessary medical expenditure. In contrast with past achievements in providing effective immunization scrviccs, family planning under the communist regime was grossly inadequate through- out Central and Eastern Europe, leading to many unwanted pregnancies, frequent and expensive hospital abortions. and dangerous back-sweet termia- tions of pregnancies (Johnson, Horga, and Andronache 1993). IMPROvIG THE QIIuLxrY OF aCUAn1V iEATN SERVICES. Altiough the direct impacc of curative healdi services on life epctancy and morbiditr may be much less than the effects of public health mcasures such -as those descnrbed above, -policies in this area are nevertheless important for several reasons; [3041 HEALTH AND HEALTH CARE Well-being can be mcasurcd in terms of quality as well as length of life. Since modern medicine is constantly finding new ways to relieve suffering, the curative services cannot be ignored simply because they do relatively little to increase life expectancv. For instance, victims of accidents may suffer perma- nent disabilities and loss of productive employment when thcir fractures are not set properly. Furthermore, the way curative health scrvices arc financed has an impor- tant effect on the financial resources avaiable to other arcas of the health sector, such as preventive scrvices, and to income support programs, which, in turn, indirectly affect stndards of living and health. Although international guidelines exist for the cost-effectiveness of some basic interventions, such as the treatmenr of diarrhca or various forms of immunization (World Bank 1993d), policymakers in Central and Eastern Europe are finding that thev- must often develop solutions specifically for their own country Hungary and Poland are already reviewing the costs and outcomes of such policies. Based. on these reviews, they are drawing up 'baskcts" of affordable health care which match thc financial resources available to the health sector. fag2inirg MAzc owmid BaA,c, Given that perhaps one-third of the health gap berween Central and Eastern Europe and Western Europe is due to differences in wealth and associated socioeconomic factors, many goverments are according verv high prioritv to poicies in the health sector which support measures to restore macro- economic balance. These policics are of two broad forms: (1) policies to contain pubEic ecpenditure on health care in an efform to relieve the fiscal imbalance and avoid crowding out the newly growing, but fragilc, private sector and (D) policies to mobilize non-budgeary resources for health care financing to rejuvenate the sector. In both cases, various techniques are being used successfully. CON1ANIG cosrs. In the past, it wVas relatively casy for governments to maintain tight control over health care expenditure. Since the sector was financed exclusively through the state budget, expenditure caps could be: - enforced bv indexing budgets at or below the rate of inflation (global budgets in the case of hospitals and clinics; saries or capirarion fees in the case of doctors and other health care workers). Hard budget caps, such as global budgets for hospitals and budget envelopes for doctor services, continue to be used throughout most of the region as well as in many Western European countries (Culyer 1989). This has markedly reduced health care expenditure both in real terms and relative to GDP in some countries. For example, in Poland caps led to an annual drop in health care expendiurc of approximately 10 percent in rcal terms between 1990 and 1992. As countries begin to introduce diversified sources of health financing- and 'more complex performanc-based reimbursement for health care providers,-- f: ; - . - -- ; !L -~1305 POLICY DESIGN AND IMPLEMENTAriON controlling hcalth care expcnditure through budget caps is becoming more. and more difficuit. For instance, diffcrent variants of the deccntralized Ger- man health insurance model (sickness funds), under which doctors and insti- tutions are paid according to the number of examinations and procedures they perform, are becoming extremely popular.throughout the region. Gcrman policymakers control health care expenditurc under this model through a complex process of managed price fixing. Negotiaued agreements bcvtcen the government, the sickness funds, and the medical profession, rather than market forces, determine prices. Undesired incrcases in the number of exam- inations or procedures are,. in this way, offset by downward adjustments in prices. Even using such complex methods, many Western European countries have difficulty controlling health care expenditure (Abel Smith 1992). The Czech Republic introduced a similar model in 1992 which replaced salaries by carte blanche fec-for-scrvice payments, before having adequate informa- nion systems to track costs or establishing a process for negotiating prices. The entirelv predictable rcsult was that within a few months, the authorities had completely lost control of health expenditure. MOBILIZING RES0ouRCES. During the early stages of the transition, the bcalth sector in most countries had enough internal rcserves to withstand significant budget curs Wvithout seriously compromising the quality of care provided. In the face of continued budgetary restaint and explosive increases in.prices. especially in the case of imported pharmaceuticals and equipment, this is no longer truce Countries likle Bulgaria, the Czech Republic, Hungary, the Slovak Republic, and .several countries of: the former U.S.S.R. have, therefore, turncd tO public-and to a small extent private-health insurance and direct charges to shorc up the dwindling state budget. This silver bullet solution of health insurance did not mobilize financial resources for the health sector for two reasons: (1) the health insurance contributions in countries like Hungary usually replaced rather than supple- mented budgetary sources of health finance, and (2) rising unernployment and a groiving infornal sector in countries like the Slovak Republic reduced com- pliance and eroded the original contributions base. As a substitute for the state budget, social insurance for health care is, therefore, no panacea as an addi- tional source of finance. When the government is forced to bail out an insol- vent health insurance fund, as in the. Czech Republic, shifting health care financing from the state budgct to national health insurance may even damage. other efforts to contain public expenditure. Medical doctors in countries which have not-introduced health insurance are looking wvith envy ar the incomes of .their Western European. neighbors, while ignoring the negative expertences of other countries in Central and Eastern Europe. They continue to lobbv their Parliaments for German-style health insurance. In the poorer countries of the region, such as Bulgaria, the. - 1 3061 HEALTH AND HEALTH CARE Slovak Republic, and the southern crescent of the formcr U.S.S.R., a rapid collapse in the colilction of contributions would have a devastating effect on cquity and the quality of care provided. In many of these countries, govern- ments are realizing that state budget support for the health sector is unavoid- able and that giving up cost controls under the assumption that health insur- ance will regulate itself is courting disastcr. B- i(dingManfrts Governments in Central and Eastern Europe. are finding that it. is neither desirable nor possible to insulate the health sector from the market forces sweeping the. region. Many are turning to radically new health policy. para- digms which can be grouped under three headings: (1) policies to libealize demand by increasing consumer choice and redefining the.-role of govern- ments, patients, health care providers, and entcerprises as actve partners. in the health scctor; (2) policies to diversify supply by establishing a new enabling environment for nongovcmmental and private sector activities in t- . ownership, production, and financing of health care; and (3) policies to improve incenaves in a-new comperitve mar.ket for health care. The individ- ual elements of these policies are summarized in table 12-5 and described in greater deai in the following sections. The strategy to use market forces in the health sector is double edged: on the one hand, it offers a chance for new approaches to improving health and the performance of health serviccs; on the other, it carries an inunense risk of reopening the Pandora's box of well-known market imperfections discussed in chapter 2. The budgetary crisis:which occurred in Poland in 1992 becauseof a: Table 12-5. Poricy Opiwtzo IpAxe MafrkeFatF frtMe Heatkh Seto Polic are Exmnrpotky opdons Heath paraig : Consumer choice Sute vs. individual Parnecrship -Govrcnmnts Monopolisc vs. minimalist Stewardship - Patients Rcipients vs. consumers Active pankipants Providers Employces vs. vested interests Preferred providers Enterprises Mini-states vs. capitalists Responsibleagents Diversified supply Planningvs. marketplace Managcd competition Economicgoods Public vs. private Mixrd gDods Ownership . State vs. providers Publiclprivatn mix Production Planned vs. supply and demand Publidpriiate mix' Firnancing Taxationvs.insurancc . Public/private mi; Incentives Normnative vs. input and output Outconm-based Incentive structre Burcaucracy vs. personal gain Efficinevn. Cost-effcctiveness Quality and satisfiction 1 307 1 POLICY DESIGN AND IMPLEMEKTATIOM sudden increase in the price of pharmaceuticals and the recent breakdown in the supply network in Russia are only the tip of the iceberg. Because of such market failures, many Western countries have recently begun to use managed competition, or managed care, to create a restrained, but competitive, environment in which the advantages of market forces can be exploited, while the undesirable effects are controlled (Enthoven 1988). Governmenrs in Central and Eastemr Europe are discovering that market forces arc an excllent way to improve efficiency, but only if accompanicd bv regulation, some public production, and targeted subsidies to mninimizr the associated abuses and deficiencics (Evans 19b4!. INCREAStNG CONSUMER (bOICE. As a first step, mnany countries are improving consumer choice by redefining the role of governments, paiients, health care providers, and enterprises in the health sector. In the past, both statc and individualist extemes led to many unsatisfactory outcomes. The cormnunist era provides ample cvidence that vwellc-bing and health are poorly served vhen consumer choice is toUlly suppressed. At the same time, expeience from Wester countries over the past centry provides equally good evidence that excessive reliance on consu:ner sovereignty has its own shortcomings. The changes require redefinition of the role of government, of patients, of health care professionals, and of enrerprises. The central government in the Czech Republic, Hungaury and-Poland has alreadv relinquished much of its previous monopoly by transferring the owner- ship of most health care facilitics and the responsibilirt* for providing services to local authorities and the privae sector. Likewise, responsibility for financ- ing health care is being ansferred from the state budget of the central government to decentralized and semi-autonomous health insurancc funds. Instead of withdrawving completey from the hcalth sector, however, govern- ments in these countries are assuming a new and important role as regulators or stewards of the emerging nongovernmental and private sector activities. Whatever the policy developments in a particular country, governments in all cases remain responsible for puting policies and programs into place in order to procect equiry and the quality of care as patients are becoming more active participants in securing hcaldh. This is especially true since patients are not well informed about the cost-effctiveness of most treaunents, and supply shortages would cause severe distortions in the marker value of treatment without such intervention. All the key players are adapting quickly to the new context by responding to pricc signals in a competitLve environmenrL Patients are becoming actcv; consumers of health care, in contrast with their passive role under the old system. En the Czech Republic, patients have gained in d freedom to choose their doctor and mode of treatment. The remaining bawriers are cre ated by geographical and resource constraints. -1 3081I HEALTH ANtD HEALTH CARE Health professionals, too, are. responding to price signals. In Hungary, health care providers are negotiating the place of work or mode of practice with local governments and the health insurance fund. In most countries, enterprises and governments arc choosing the extent to which they participate in health care activities. Although many doctors sit in Parliament and on influential legislative connittees, there has been littlc self-regulation of the health care professions. Even in Poland, where syndicate activities started&. early under Solidarity during the 1980s, self-regulation is not effectve because responsibity' for conducting professional activities and enforcing professional standards is vested in single professional.organizations such as the Physicians Chamber, Nurses Chamber, or Pharmacists Chamber. The strict interrnal controls neccssary to prevcnt abuses such as supplicr-induced denmand espe- .cially whcrepayrnent is on a fe-for-service basis. are often missimg- - During the socialist years, theboundaries bentecn the enterprise and the state were blurretk both were responsible for the welfare of workers, and borh provided ectensive and elaborate networks of healt- services, social pro-: grams, and education. In some countries, such as the former Soviec republics, industrial subsectors like mines ralways, police and militamr provided health. services-for up toJ1-15.percent of the pop'ilation, financed largely through. dkctSbr indirect public subsidies. As enterprises become preoccupied with making a profit and :avoiding bankruptcy, they are seeking to witdravw from their position as mistaes vithin states. The potential, sudden colUapse in hcalth services of these sectors would equire massive and expcnsive restruc- wuring; this is a time bomb which fewv goverrtnents have taken adequate steps to defuse. Nor have they sought to ensure thar enterprises assume a new role as responsible emplovers who provide safe workplaces and protect the envi-.. ronment in line wih internaional stwldards.';.. DIVERSIFYING SUPPLY. Government. are finding that diversification of supply requires major changes in the way dtey treat health care as an economic good. It also requires major changes in onnership and financing. - Health care as an economic good. As discussed in chapter 2. private goods exhibit excludabilicy (an individual can be prevented from consuming a good until he or she has paid for it), rivilness (consumption by; one individual prevents consumption bv another), .and rejecability (an individual can choose to forgo consumption). True public gDods have significant elments of non- excludability, non-rivalness, and noni-rejectabilityv Mixed goods have some but not all of the characteristics of private goods. A-breakdown occurs in efficiency, equity, and sustinability when public goods or goods vwith signifi- cant externalities are allocated through competitive markets. The reverse - hi c -when private goods are allocated by central planning-is onc of Central and Eastern Europe needs litle reminding: all have expen- enced low-quality health care, blak money. queues, and the,like.. 1 309.1' S 0 f R ~ ~~~~ ~~ ~~~~~~- - 61..- ^. - - -.A POLICY DESIGN AND IMPLEMENTATION Governments in Ccntral and Eastern Europe are finding that health care is not a homogen ous private good which can be uniformly submitted to market forces Policymakers have to answvcr a number of major questions: * Which sector, public or private, should pntdic the service in question? * Which sector shouldfimna the servicc? In particular, what chargcs. if any, should be made to patients? Should patient choice be constrained, for example, by requirng family doctors to act as gatekeepers for treatnent by specialists or by restricting drug subsidies to a range of basic drugs? Different types of health activity involve different packages of these elements. Public health services, such as sanitation services, control and prevention of conmrnunicable diseases, and hcalth promotion, and other activiies, such as research and development and professional education, have significant public goods characteristics. Yet some of the elements which make up these services-such as clean water, collection of refuse, - immunizations, public hcalth campaigns, individual research projects, and postgraduate training- may have sufficient characteristics of private or mixed goods to be subjected to market forces. Some of these clements arc, therefore, usualy sold as public utilities rather than given away as public goods. Hungary, for example, has recendy introduced a controlled intemal market by estblshing a competitive process for funding research. Nongovenmental organizations are being con- tractcd to conduct public health campaigns in Poland. And private phar- maccutical companies are being provided with micentives to produce desired 'vaccines in Russiat In the case of such public or near-public goods, production can thus be public or priva,, consumers typically do nor pay charges, and consumpton is rclatively unconstrained.> Hospital care, including expensive diagnostic and therapeutic care, - although in principle a private good and hence marketble, has.nor been privatizcd anywhere in the rcgion. Such action would lead to politically unac- ceptable inequiv and allocative inefficiency if lcef to markcet forces alonc In this case, production was hiswrically mainly public, althoug that is changing, consumer chas historically were mainly unofficial, though again thar is changing; and consumer choice was constrained bv ambulatory clinics acting as gatekeepers. Ambulatory care and long-term residential care were generally treated as pnvrate goods even under communism bccause it was difficult, if not impossi- ¶ ble, to prevent their salc in the informal economv. Following the collapse of the socialist regimes in the Czech Republic, Hungarv, and Poland, the new democratic goveranments were quickto introduce legislation which allowed the private production of medical drugs and supplies and the services of general practitioners and pharmacists. In sch cases, supply is becoming increasingly private, and the role of consumer charges is growing. [3101 HEALTH AND HEALTH CARE One of the great challenges facing govcrnments in Ccntral and Eastcrn. Europe is to decide where to draw the boundarv betwen different types of health carc goods and services, especially in the case of mixed-goods, which are open to a fair amount of interpretation. The choice made in the Czech Republic, which now charges fees for access ro private clinics and hospitals, is quite differcnt from that of the Slovak Republic, which -still provides free access to public clinics and hospitals. A second challenge is to develop cffcc- tive policics for dealing with the various types of abuse as they arise. Govemr- ments throughout the region have so far been unsuccessful in. introducing effective policics to deal with grawities, bribes, and the emerging informal. health sector economv. Ower andfiumce. Many countries in Central and Easern Europe are also introducing major changes in the ownership and sources of firancing for . health care. In fact, much of the suikin' variability in the health systems in both Westem countrics and Central and Eastem Europe-can be explained by the mix of public and private producton of health care. Table 126 presents- this mix: the columns show different tyes of financing of health care, and the rows show the diffcrent types of ownership. Interestingly, none of the health svstms in the highly industialied coun- ties or'in Central and Easter Europe falls wholly into;a single cell. For - example, the systems in the United Kingdom and the Nordic countrics are primarily in cell A, but also. have components ofB and C, and J to L, in their. public sectors Their private sectors include a range from D to L_ Canada and .Ausralia arc mainly in B and C, but likewise mclude D to L in their pnvaec sectors- In Canada,. J.to L are prohibited bv law for standard services in the public sector; but direct chages arc levied for above-standard services, phar- maceuticals, and many other goods and services provided through ambulatory care. The systems in some contnental European counties are mainly in cells D to F,-but include A to C through the public scor for tageted scrvices -Table 12-6. TypotyofOwnmadpemSourwokfPacingforHeah Car' Sowre offl*ndnifg Government Statutorv RcpyaEcd Compct-iv- GCeneral rec l insurance Pvartc isurnc Out-of-pockect :; - : : - ~~~~~~~~ ~ ~~usa recs-; Purly public A D G J. Private nonprofit B . E H K Prvt for- profit C ; F . I &vnr -Adapted from Rcinhardl 1989. [.311 1 POLICY DESIGN AND IMPLEMENTATION and populations. Australia. Canada, France, Germany, and the United Statrs are similar in their use of health insurance but very different in the ow%nership of health care services. Although health care in most of Central and Eastern Europe is currentlv concentratcd in cell A. about 10 to 15 percent of the private sector-and black market actvitv takes place in celtsJ, K, and L. As the countries move to-ward health care svstems w.ith a more diverse publiciprivate mix, they are already beginning to occupy other cells in this schema, espe- dialy cells D. E. and K. given the tendency to move from general revenue financing to that of national socia insurancc. The source of financing for the health sector in the highly industrialized countries and Central and Easmt Europe falls simultancously into two broad categones: direct charges and thd-pa prepaynnts. Dircvt chaes are made in the form of official user fees or unofficial gratuities paid directly to health care providers when services are rcnderedPs Third-party prepayments are made through taxes, social insurance payroll levies, and earmarked health nsurance contributions paid by individuals, families, and employers to inter- mediaries (the stac budget, social insurance funds, or private healh insurance companies) before services are rendered by health care providers (hospitals, clinics, doctors. and pharmacies). In the West, most prepayment schemes are subsidized either direcdy through dccmed contmbutions covcring the non- contributing population (the poor, unemplovyd and elderly) or indirectly through Eax crcdits. Lik-ewise, th:e new health insurance schemes in the Czech Retpublic, Hungary, and Russia also rely on direct subsidics to cover the non- active parts of their population. IMPROVING INCENTIVs. Governments are quickly discovering how to lidtthe enie our of the bottle in a marker economy by improving the smucture of incentives. Incentive structures in the health sector are, of coursc, nothing new in Westen countries. Positive incentives include profits, subsidies, pro- fessional recognition, and special sutaus; Negaivc incentives include losscs, fines, professional disapproval, and exclusion. As part of the health sector are being privatized, and wage differentials are increasing, such incentives are beginning to have an effect. The incentive effect of dtird-party reimbursement of services supplied on a fe efor-service basis are highly conducive to exploding coss Westem coun- tries such as the United Stares, where similar problems arc observed, have tried to deal with the problem through regulation and. countervailing incen- tives, for instance, by encouraging health care providers t join together in preferred provider organizations, which offer a predetermined basket of care for a fbied price (sec Sandier 1989 and, for general discussion of the under- lying principles, see Barr 1992, sec. VI[BD. : Hungarvy recent changes in the mechanism used to pay health care providers (capitation paymnents for family doctors,c feefor-service pavments 13121 L ,' '; *,' Sb' _ Ol.t . *4 _ X -.',.= '. ,<'''.'. ; -;' ', HEALTH AND HEALTH CARE for specialists, and diagnosis-related groups for hospitals; see the glossary) have had a much greater imnpact on the character of service delivery than earlier changes in ownership and thc introduction of contributory health insur- ance. A well-run prepayment scheme can offer good covc:rage and compre- hensive care, as vell as low administrative costs and good control of expendi- ture. A poody run scheme can be expensive to manage while providing poor coverage and incomplete care. There is therefore, no ideal model for the countnes in Central and Eastern Europe to follow. The underlying principle for govemments which want to introduce such incentives is, therefore, simple: use them carefully because they will almost certinly be more poverful than expected. Govemments which use incentives skillfully as thermostats to rurn desired behavior on and off can gready- improve both efficiency and equity. For instance, outcome-based incentives reward providers who improve the health of their patients, notjust those who see more patients each hour. The idea is that the reimbursemcnt regime should be based on outcomes nor on inputs, giving doctors an incentive to improve the health of their patients instead of merely rewarding them for the amount of treatment provided irrespective of its cost-eectiveness7 Governments which use incentives poorlv wll quickly find themselves facing escalating costs due to supplier-induced demand and reduced efficiency as rcsources are moved into narrowly defined areas of low priority. The cost explosion in the Czech Republic was cntirely predictable and could have been prevented though the introduction of appropriace incentives such as preferred provider organzations and of adequate mcchantisms to cap the budget The incentive structure cetainy increased the productivity and income of doctors but led.to few gains in the quality and cost-effcctiveness of their interventions. Market imperfections in health care are pervasrve: : Consumer information is highly imperfect. crcating serious problems of quality controL : * Workers have only lirnited power to insist on safe working conditions, and, without appropriate sanctions or regulations, employers have litle incentive to improve safery. * Major problems with extecrnalitics mcan thar, although cnvironmental cleanup is in the interests of society as a 'whole, individual firms have no incentive to produce in a less polltaing way. * Privare insurance is unable to cover some important mnedical risks. T Third-parry reimbursemcnt, partcularly in a fee-for-service environment, creates incentives which can Icad to uncontrolled escalation of costs. In addition, and separately, in a marker system the poor are likely to be excluded from mecdicalcrbecause of its cosL 1313 1 POLICY DESIGN AND IMPLEMENTATtON Examples of the ill effects whcn thcse problems are ignored arc legion. At least 35 million Americans have inadequate medical insurance covcrage; costs are difficult to contain; and the massive dumping of low-quality drugs and the importing of defective mcdical cquipment have already occurred in Poland and other countries in Central and Eastern Europe because the government does nor-or cannot-enforce adequate standards for quality controL INTMODUaNG A REUIAMRY SMUCU Becausc the problems are so perva- wsrc, policies to regulate market forces have eo be an integral part of measures used to harness market forces. Thus they emerged repeatedly in ehe discus- sion of the previous sections and are recapitulated here only briefly. State intervention, apart from income transfers, is of three types: regulation, finance, and public production. Regulation is necessary in a variety of forms: * Quality control is made necessary by imperfecc information. The govern-. ment has a stewardship role which includes controlling the quality of medi- cal services generally, ensuring that professional standards are upheld. and maintaining regulatory regimes. for the testing. production, and sale of drugs. C Containing medical expenditure in the ways described is necessary because of the third-parry paymcnt problem. Regulation of medical spending can be imposed at the level of the total system, as in the United Kingdom, or at the level of the hospital, as in Canada, or at the level of the individual provider. as in Camda or Germany.. * Environmental action is necded because of the externality problem; such policics need to be stimulated both by appropriatc incentives and by appro- priate regulatory structUres. * Safety at work requires regulation anzd enforcement to ensure minimum standards. Public funding of medical care is necessary for tvo -very different scts of - reasons: to ensure the provision of public goods and to ensure wide-ranging access: * Public health activities such as vaccination programs and public health education are generally largely, if not wvholly, publicly funded. *The non-actiEve populations with low income require subsidies, particularly: the elderly. The poor also require subsidies. : Dru, particularly limited drug formularics. are generally subsidized. o Health finance, more generally, is f*oequendy government run (tax funding) or government mandated (social insurance), to address failures in the pri- vate health insurance market and to ensurc adequate access for the ponr. 1 3141 HEALTH AND HEALTH CARE Public production has various aspects: Public cducation is needed to counter imperfcct information. Examples include programs to inform the population about diet, physical cxercise, and the ill effects of alcohol, narcotic drugs, smoking, and the like. Other public health activitics, such as mainaining clean water, need to be sponsored by the government, even if some or all of the production is in the private sector. * Medical education and medical -rescarch, having significant pub:ic good attinbutes, also involve some govcrnmcnt activi:t. * Public clinics mav be necessarv to ensure that hcalth care is available in rural areas and slums. EXPERIENCE ELSEWHRE. Three additional observations. from the highly industialized countries have a direct beaing on future health policies in Central and Eastem Europe. PowbIifziduim.gw uheiherhrouht*A,zadm or soc alizwwfaw,s A ajorsounrof hathfinaa&zgir the OECD nawdo,s. Countries like the United States which rely to any great extent on private risk-rated health insurance (cells G, H, and I in table 12-6) appear to have much greater problems (a) with ensuring equality of access-because of uniinsurablc risks and the poor-and (b) with containing costs-because of the third-parcy payment problem-than countries which rely on other sources of health finance. -A the same time, countries lhke Sweden and the United Kingdom which relv heavily on public ownership - (cells A, D, G, and J) appear to have much greater problems with cfficiencv and productiviry than countries which rely more heavilv on nonprofit and private owvnership Health care financing mechanisms wvhich relv on general revenues or national health insurance, combined with some direct charges and nonprofit or private ownership, wvould appear to be a much beter choice for Central and Eastern Europe than private health insurance -and pubric ownership. Drha7geu7ro eft-owrnnoteffeatearsamaWorsourceoffce. Providing financial protection against the unpredictable risk of illness and the high-cost of modem health is the main reason why pooling risk through third-party prepayment schemes has become the cornerstone of health finance over the course of the twentieth century. Direct charges, although they may play arn important role in financng less expensive care. and discretionary services, providc neither adequatc protection against the risk of catastophic illness nor -sufficient source of financing for expensive health care, typical of modem health systems- As a result of these factors, direct charges contribute less than 20 percent of the financial rcsources available to the health soctor in most Western countries. Governments in Central and Easterm Europe must balaner- the epected benefits of introducing copayments as a disincentive aganst excesslve use and as a source- of additional revenue against their negave - _13151 POLICY DESIGN AND IMPLEMENTATION impact on vulnerable populations during the transition. So far, none has for- malized the gratuities or black paymcnts which are charactcristic throughout the region. No srem isperfec. Significant tradcoffs between efficiency and equity are associated with each of these mechanisms. Greater equity may be achived through the risk-pooling characteristic of prepayment schemes. Greater effi- ciency may be achieved through the market forces associated with direct charges. Governments in Central and Easern Europel. like those in the highly industrialized countries, are finding that neither model by itself is ideal. The main message is that in the cse of medical care, a carefullv designed blend of market forces and governent interventon is needed. As market forces are introduced in Ccntral and Eastern Europe, problems with cost containment, quality assurance, and equity are begining to appear.-To coun- ter these effects, many governments are now rewriting the social contract for the health sector based on policies which (a) protect highly vulnerable popula- dions, such as mothers, children, and the elderly, through targeted entitlement to specially designed services (b) secure affordable access r a basic basket of cos-cffective health services for the whole population; and (c) distrbute the financial burden of illness across the population as a whole. Ismplaiwug tic Reors Alongside policies to improve health and those to incrcase the cost- effectiveness and equitable distrbution of health care, a third set of policies seeks to improve the political and institutional capacity of the health seccor to implement relevant reforms. This effort includes introducing ncw legislation, strengthening the physical and administrative infristructure of institutions, and reorienting the training of personnel. Most governments have introduced a new legal framework for the legen- mate entry of the private sector (private ownership and provision of health services), syndicate activities by the medical profession and other professional groups, and decentralized decisionmaking. Poland has passed the Health Care Institutions Bil legalizing private practice, Hungary and the Czech Republic have transfered owncrship from the central government to local commu- nities, and Russia has vested Oblasts with almost autonomous power over their health services, similar to the Canadian provmces or the states in Austra- lia.8 The Phiysicians Chambers in Potand was the first professional body to gain the status of a self-regulating medical syndicate, with responsibility for: setting professional standards and negotiating collctively. Many countries are passing new regulations to control the qualiUt of pharmaceuticals and medical equipment. Although countries such as Russia and other former Soviet republics are sull struggling Vith critical imports of pharmaceLical products and other nondurable goods, the Czech Republic, Hungary, and Poland are concentrat- [ 3161 HEALTH AND HEALTH CARE ing on building an infrastructure for the health sector. This includes new diagnostic and therapeutic equipment to improve clinical interventions, com- puter svstcms to improve cost control and management, and limited public uorks to consolidatc outmoded and inefficicnt physical facilities. Since catch- ing up with standards in Western Europe would cost billions of dollars, gov- - ernments are finding that itris critical to establish dlear priorities. Without such priorities, every community hospital will attract gifts of CAT scanners or other expcnsive high-technology equipment from bilateral donors without having the recurrent budget to operatEc them effectively. As many countries in C-ncral and Eastem Europe are decentralizing and privatizing their health services, they are finding that clinical and nonclinical personnel need much broader training in such fields as health policy, manage- ment, health economics, chronic discase epidemiology, computer science, and medical sociology than was either necessarv or possible in the past. Modem management skils and data analysis are required to cone wich the complcxirv of many of the new health insurance svstems. The success of many of these reforms villl lie in a fundamental new orientaion in the educa-- tion system and applied research in the health secto-_ Conclusions: Priorities and Sequencing In most of Central and Eastem Europe, a cotlapse in the public entcrprse sector, irnflation, and unemployment have reduced the real income of large segments of the population and created a fiscal crisis. The resulting poverty deprives the population of exacdy the healthy living arrangements, diets, and lifie-styles which are necessarv for good health. At the samc time, reduced tax revenues make it impossible for governments to -maintain their historical commitment to public expenditure progamms like health care, just ar the time when thev are most needed. Of necessity, therefore, most governments are cautiouslv introducing reform in the health sector in two phases. S-on-4enx Po/in -'' The first phase (up to two years) concentratcs on urgent measures which need to be, taken or avoided to survive the early transition. The following actions' are not intended to be exhaustive but rather to focus on critical measures which must bc taken bv government to avoid a collapse of the health sector and to strengthen its role as part of the social safety neLt *: - Polyshoul &ar conF&ig dervy of basic hea sri and cosr-eOc-n: : aca a catcam. This includes: Ensuring that the share of GDP devoted to the hcalth sector is maintained: during the transition, either through the state budget or through some form of national health insurance. 1 317i POLICY DESIGN AND IMPLEMENTATION Providing immediatc relief of critical shortages in areas where the health system is collapsing. Of particular importance is action to guarantee the continuing availabiltv of essential vaccines, drugs, and supplies. - Allocating an adequate budget for services designed to protect vulncrable populations. These include maternal and child clinics, immunization pro- grams. and social services for the elderly. Selecting and implementing cost-effective correcctive interventions, espc- cially for cardiolcerebrovascular and related discases, accidents, and pulmo- nary diseases. This includes maintaining properlv equipped and staffcd ambulance services, emergency rooms, and intensive care units. Measr to coain cosshoudf ocwpa&niwarfy on avoibgado,s liklym ltad m caMst apksion. This entails: Introducing hard budget caps, such as global budgets for hospitals and salaries, or capiation payments, for doctors and other health care wvorkers. Such action is vital to contain costs during the transition. Other forms of reimbursement, such as fee-for-service pavments and iteniized retrospec- tivc payments, are difficult to control and, unless accompanied bv wide- ranging and sophisticated rcgulation, will lead to exploding costs. Avoidimg the foors gold of using health insurance as a way to mobilize additional financial resources for the health sector. The introduction of such a mechanism would be premature. During the early transiton, the potential contributions base was shinking because of rising unemployment and a growing informal sector, in addition, an adequatc mechanism for collecting ontributions suitable for a svstem of health carc finanice based on social insurance has vye to be put in place in most countries. Meufum -mm Po&ade Policies with a medium-term' dimension could be started immediately. or in the near fucure, if the short-cerm issues just descnrbed are addressed at the same time. Since their impact will be maily in thc medium term, posicy- makers must ensure thac measures taken to restructure health services do not destabilie and lead to a collapse of the sector during the transition. Exces- sively rapid decentralization and changes in the financing mechanisms could have just such an effect, particularly if they are introduced before the ins- tional capacity necessary to implement such changes has been built up. Many of dhest, therefore, are being left for a second phase of the reform process. Tle actions listed below are of four broad sorts: those which relate mainly to improving the quality and mix. of actions to improvc health, those aimed at improving the efficiencv with which those serviccs are delivercd, those which relate mainly to health finance, and those intended to improve institutional capacity. [-318 1 HEALTH AND HEALTH CARE m and mor erim approa. no public ealth ond disas prennon shotd beitmduced. Actions include: * Mobilizing greater communit participation in health promotion and pre- vention programs. * Launching national campaigns to.promote healthier eating habits, to reduce alcohol and substance abusc;- to discourage smoking, and to encourage greater physical activitvy * Providing safe alternatives to abortion through improved family planning programs * Coordinating an intersectoral approach to occupational and behavior-relatd illness and accidents. !mbahwz beu pubic hAlt, Prin-ny cm, hisftuknai care, anzd -mmm- iysrvcenquireonraion. The emphasis should be on: * Setdng up or improving training programs in primary care, public health, and conmunirt services * Increasing the iiake of students into these programs and restrcting the intake into specialist training * Raising the income of primary care, public health, and comnmunity service workers relative to other clinical specialties * Increasing the relative weight of investment in-prmary care, public health, and community service facilities and programs relative to hospital-based care Setting up professional bodies to improve the status of individuals who choose a career path in these areas. Eiffadecxy shoudbe impmrrd with particular focus on: * Containing costs through regulatory mechanisms and hard budget caps * Stimulating productivity through performance-based reimbursement for the health sector, such as capitanon payments for general practitioners, case- mix adjusted budgets for hospitals, outcome-based reimbursement for spe- cialist services, and changes in ownership (transfers to local government or privatizaton) * Encouraging competiton among providers. A' new pblic/pivaz mcc shaoube esrahhedin the provis of hea* swes. This would involve: * Creating a legal framework which facilitates appropriate private sector activ- ities in the healh sector - * Seting up accessible loan facilities for doctors, dentists, laboratory techni- cians, and other health workers who want to set up private practice or private clinics * Removing subsidies from the public production of pharmaceutical products. medical equipment, and supplies 1319 1 POLICY DESIGN AND IMPLENMENTATION - Introducing publicly mandated financing of privately owned health care facilities. Thesonrresof health care finarcingshouldbedivr/ifed by: * Introducing national or government-mandated contributory health insurance * Adding copayments to some goods and services Excludingabove-standard scrvices from publicly financed programs * Eliminating public subsidies such as tax credits from nonessential services and private health insurance. Intitutonal capacity shouwd he strgthed :khtnugh (kqis rn; csolida- -ion, rebiliftadon, audrneratnofhaskicnfrrse n; modemnwof of equ;omn;- : :pg'mdngthe traiinng ofpersonne; and improved qualiteoyrtrnnvusyzn. Again, this list is not intended to be exhaustive but rather to focus on early action wvhich can be taken to strengthen and reconstructchci health sector.. Even in the medium term, few governments are planning to expand dramati- cally the physical infrasEructure of their health sectors'. Such, investmenc is being postponed until there are signs of significanc economic recovcry, which, in some countries, may be several years away. Notes 1. Being interrelated, it is extremcly difficulE.to attribute improvemcnts in health status to anv one of thcse factors. 2. Lifc expcctancy at age one rather than at birth is used because infant morality :(mortality before age onc year) was not accuratel mclsured in some countries in the region and because the relatively poor performance of the communist counmes is particutarly evident for mortarity beyond one year of age. 3. A normative-based system would finance hospitals on the basis, for mstance, of the number of beds; a performance-based svstem of reimbursemcnt would pay hospi- tals in away related to the number of patients treated. Thc incentives given bv the tWo methods arc clcarlv differenu the former cncourages hospitals to have lots of-beds., but to keep them empty; the latter encourages hospitals to givc large amounts of trcat- mene, whether or not it improves health. 4. For cxample, as discussed in chapter 5, an adversc report;by a safent inspector could be interpreted as sabotage of the plan. 5. As discussed in chapter 2, retrospective reimbursement for medical providers who operate on a fee-for-scrvice basis crcates incentives to ovcrsupply; if uncontrolled they can casilv lead to exploding medical costs. 6. User fees arc also refcrred to looselv and inconsistentlv as tariffs, copavmnets,. deductibles. dcr moderaner (France), and cost recovery They are usually lcgal chargcs used to supplement incomt from third-party prepayment schcmes in both industrial and developing countrics. Gratuitics are also referred to as black money, under-the-table bribes, tips, and tokens. They are oftcn illegal charges used to supple- ment doctors' salaries. 1320 1 HEALTH AND HIAI.TH CARR 7. Many Wcstm countrisc are expermenting with funding regimes which give providers the incentive to keep patients hctkhy. Health maintenance orpnizations (see thc glossary) arc one example. Along similar lines, reforns in the United Kingdom. in the early 1990s alloued some family doctors to act as the funding agency for certain types of hospital trrcament agiin giving thcm incentives to keep their patients heakhy. 8. Russia is divided into eiglhty-four Oblosts. [1321 1 . . . .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~i Thirfeen -DRI[VI[NG CHANGE: POLITICS AND ADMINNISTRATION IAIN CRAWFORD * ALAN THOMPSON Therc is nothing more difficult to arrange, more doubtful of success, and more d&ngcrous to carry through than initiating changes in a state's constitution. The innovator makes enemies of all those who prospered under the old order, and only lukewarm support is forthcoming from chose who would prosper under Ehe new.-[Machiavelli 1513J Stbility is not everything, but without stability there is nothing. [Schilerl SUCCESSFUL REFORMS ARE WHAT THE PEOPLE ExpEcr. That was why they. defied the tanks. It is nonv a question of how soon they can expect refornns to improve thcir individual wdfare. Thc real problem was the popular assump- tion that their lives would be lke those in the West within weeks, months, or at the worst a year or two. Now. that these illusions have been punctured, it is important that they be replaced by realistic hopes and that the economies can be seen to improve measurably as-quickly as possible. People must believe that the short-term sacrifices are just and that they will be worthwhile in the longrun.. Suppose, then, that all the rdevanr minises decide to adopt the recom- mendations in the previous chapters. Would success of Ehe reforms be guaran- teed? The answer is, not necessarily unless broader political and administra- tive problems have been solved. The reforms will nor succeed without sufficient support, not just for the general idea of reform but also for a significant proportion of the specific measures necessarv to put that gencral idea into effect- The government, for instance, has to convince Partiament of the need for pension reform. L. this, as in other matters, Parliament will be acutely conscious of the views of the electorate. The major politicaj problem, as the quote from Machiavelli makes cicar, is that government has to cope not only-with individuals and groups who are activcly hostile to the refo.p", but a1so with the apathy of people who would support the reforms if they had any faith in their ultimate success. Without such support, government may fail to: deliver a policy for political reasons; such as the refusal of Parliament to p'ass a stringent budget law. Even if government has the political support. it may fail to- deliver the policv 32Z I- DRIVING CHANGE: POLITICS AND ADMINISTRATION because of administrative shortcomings, such as an inability to implement a promised increase in pensions fast enough. The first is fundamentally a matter of political communication; the second is a matter of building an effective public administration. In addition to convincing the electorate and Parliament about the rightncss of their policies, departmental ministers have also to convince their ministerial colleagues. All die policies advocated in earlier chapters have major cost implications. Dcliberately there has been little discussion of how a budget, cnormously constrained by the fiscal crisis, should be divided among compet- ing claims on resources. Those decisions will have to be taken by ministers in the countres concerned. Yet departmental policies do not operate in a vac- uum- They are determined in large measure by interactions between depart- ments and by competing political priorities: : Each spending department will compete for scarce resources of finance, of administration, and of legislativc time. M The overall limit on public spending will be decided by the interaction of* the spending departmcnts and the Ministry. of Finance. The total resources available will be a mattr of economic circumstances and of * govemment decisions about general levels of taxation, a high-taxing, high- spending economy (for example, the Scandinavian countries in table 1-3) or one with lower taxes and, consequenly, a smaller public sector (for x example,Japan). * Both the total of public spending and its division among departments are affcted by how departmental policies interact with overall government objectives. The governmnent has to balance the demands of social policy with other demands such as infrastructurc, the environment, industrial investment, and defense; it has to form viewvs about the pace of reform (for example, about how much unemployment is politically tolerable); and it has to rake account of its electoral popularity given the proximity or otherwise of the next election. - Alongside such questions about the ste of the government sector are sepa- rate but related questions about its stnhc4'rn. Important decisions are needed about the dividing line between the market and the sctae. As discussed in chapter Z, market imperfections are a particular problem in the social sectors. - Government thus has to makc choices, which are political as well as cco- nomic, about such questions as whether the-governmcnt should alleviate ; unemployment through selective subsidies to enterprises; how large the role of private pensions should be;- the extent to which health care should be privately produced, even if it is largely publicly funded; and what the state's; role should be in retraining displaced workers. In. the social sectors, in particu- lar, decisions have tO be made not only about the volume of spending, but also about how and by whom the various services are to be produced. Some of [323i POLICY DESIGN AND IMPLEM ENTATION these decisions will end up being made not for economic, but very much for political reasons. These topics-political communication, strong public administration, and the competing claims of differcnt spending prioritics-though clcarlv far tran- scending the specifics of the sociat sectors, have a critical bearing on social policy. The success of social sector reform depends on the abiliry of govern- ment to garner sufficient political support for the overall rcforms. It also rests on the ability of the public service to implcment the administrative aspects of change. In addition, the success of reform in any parcicular part of the social seccors, such as health care, will depend on the success of the relevant.: department in its ncgotiations with other dpartmnents, particularly the Miis- :s: try of Finance. The Objective: Political Stability A primary prerequisite for all these tasks is political stability. Without it, none. of them can be carried out effectively for long. Political stability is not, of course, an absolute condicion, nor can alL Westen democracies claim to have consistendy enjoyed it' Stability, in this context, is not a condition where change cannot take place, but rather a sitruation in which the governmcnt and the governed arc responsive to each other, and citizens have general confi- dence in the institiuons of the state. Given the specd and extnt of the changes, the first transitional govern- ments could not have hoped to achieve political stability immediately. nTe early period of transition, which combined economic and political reform, Was (and in some places remains) revolutionary. Revolution is dangerous, unpredictable, often violent, and, as history tels us, uncertain of success. Balcerowicz (1993a) has described this as a period of "cxtraordinary politics," which he sees. as a time when politicians have high political capital, and the electorate is ready to.acccpt radical economic measures. This honevmoon, however, is short-lived and impossible to repear, and the "normal politics" which follow in the second phase require normal political bchavtor. This may be seen as an argument for concentrating radical and dramatic change in the early days of reform, but that histonrc moment is over in most countries, and the daily grind of normal politics has arrived This process may seem to the general public to be rather boring compared with the heady days of the early. revolution, but this is the essence of stable, safe, democratic govemment. In stable political systems change is usually incremental. Even the govern- ments of Ronald Reagan in- the United States and Margaret Thatcher in the United Kingdom, which were seen as fairly radical, werc far from revolution- ary. AU the emerging democracies should aim to reach a plateau from which further development is.incremental. Thus a prime objective of all policy - advisers, international aid agencies, foreign governments, and politicians -324 1 DRIVING CHANGE: POLITICS AND ADMINISTRATION themselves should be to reinforce political stability. without which there can be no confidence in the institutions of the state. Without political stability, democracy itself is precarious. Without confidence, both domestic and inter- national, the reforms are seriously hampered, investment is not forthcoming, and the potential for chaos cannot be ignored. Crick (1992) makes a powerful claim for the "science"' of politics. He sees politics as the component essential to the organization of a stable sociery.2 Without a system of political organiza- tion littd else of an organized nature can alke place. Political stabilitv is the prime objective, first, because of the potential conscquences of its absence, both for the countries themselves and for the rest of the W*orld. Some states possess considerable stocks of nuclear and chemical weapons, the accidental or deliberate use of which would have catastrophic global conscqucnces.. Nev disarmament agreements have been signed, bur earlier agreements stil have to be implemented. Many transitional states produce nuclear power with units of questionable safetv. For the rca- sons discussed in chaptcr 5, environmental and pollution control was inade- quate under previous regimes, and the consequences of an environmental disaster in a situation with littlc r no political authority could be catastrophic- -Te replacement of the old rcgimes has already led to civil and intemational wars. Some have been the result of ethnic, religious, or nationalist disputes which had been botded up by the previous totalitarian governments. They clearly illustrte some ofthe dangers inherent in the lack ofsironggovernment. - Events in the statcs which formerly comprised Yugoslavia provide a terrible example of the consequences of instbiliry. Nationalism is a clear threat to poli-- Ecians seeking reform in Central and Eastern Europe, not least because the pro- motion of nationaist issues or the targetig of an "enemy withi" is a tempting diversionary tactic for politicians unable ro meet inflated expectations. Political stabilir is of prirme importance also becausc economic reform becomes much morc difficult without it once the first flush of public enthust- * asm has passed. The primary function of government is to govern and provide a safe and securc environment within which ciizens can live their lives. In the new democracies governments must estblish the rule of law and prove that they can enforce it. Reformns which establish property rights and depend on ownership as an economic motivation cannot worklunlss state agencies are both wling aable to protcet the citizen and his or her property. Enterprise will not take placc unless the entrepreneur can be sure that his propcrty will be safe both from criminal thrcat and from future expropriation by the state. The same is true for foreign investment. Constraints and Potential Pitfalls'. Serious political and administrative constraints eaist, some inherited from the -rcommunist egimes, others exposed by or caused by the transiion process. - 3Z5 I POLICY DESIGN AND IMPLEMENTATION Polical Cotraints Political problems can usefully bc divided into four kinds: those resulting, directly or indirecdy, from the inheritance; those resulting from political pres- sures; those resulting from a lack of clarity about the constitutional rules under which the political game is played; and those resulting from a lack of experi- enced professional playcrs of the political game. Alongside these, one additional (and almost universally underestimated) constraint is that politicians who entered politics committed to long-term economic and social reform in practice find themselves spending 90 percent of their time fire-fighting. that is, dcaling with short-run cises. Many of the early reform policies were designed on the run. This is not unusual. In estab- lished democracies, politicians constantlv havc their carefully prepared plans blown apart by events beyond their control. Postwar British Prime Ministcr Harold Macmillan (known as Supermac for his skillful political lcadership) identified 'events" as the only aspect of politics which rcally frightened him. THE INHERLTANCL The gcneral inheritance was discussed in chapters 3 and 5. Two aspects of the political inheritance stand ouc a top-down approach to government and single-party rule. A further aspect-a consequence of the transition-is the effects, particularly in Russia, of the loss of empire. Top-down gvv&mzt. Government was an entirely top-down exercise. The supreme authority decreed, and the communist parcy machincry dissemunatcd and implemented, policy at the local, national, and even international level. Two-way communication was neither necessary nor encouraged. Feedback is not a requiremCnt of an authoritarian, top-down system. It is, .however, a principal requirement of z government which is ultimately answerable to an electorate and dependent on public support. That said, some two-way com- munication did takc place under the old system, at Iclast at a local level, in that individuals with grievances, such as a missing pension payment; could often get help from their "elected" representative, who would ensurc thar his or her assistance received due recognition in the press. Party officials in rural areas, having to live with the cffects of their policies, similarly responded. tO loCal needs. The individual representative's power, howevcr, was very limited. Single-party rule rendercd any prctense of democratic elections pointless. The single-party system is the most potentially corrptivC of genuine democ- racy. In Western counties, politicians compete for power within their partiest as thev did ir. cne old communist system, burt unlike that system. the parties themselves compete against each other for electoral support. This leads to the constant generation of new ideas and policies and to accountability to the clectorat Undcr single-party rule, such competition is nonexent. - Tiewed of empir. In die former U.S.S.R. and particularly in Russia, empire is an enormouslt important part of the political inheritance. Historically, large cmpires, notably the Roman and British, have gone into slow dedine or have J13Z61 DRtVING CHANG-E. POLITICS AND-ADMINISTRATION collapsed over a period of years. The collapse of the Soviet empire has been dramatic and, for its citizens, taumatic. If throwing off the imperialist power is one of the most compelling driving forces for change in Central and Eastern Europe, the Baltics, and the Asian republics, what of Russia? Soviet imperial- ism predates communism. The people of Russia have lived at the center of an enpire for a very long rime. Since the late 1940s they havc been citizens of one of the two most powerful states in the history of the world. They have always had a strong sense of patriotism which was heavily reinforced by the experiences of the Second World (Great Patriotic) War. Unti very recently, 1they had demonstrated a powerful sense of national pridc, carefully fostered by propaganda. The shock waves emanating from the collapse of empire began with the loss of the European satellites and intensified with the brcakup of _the US.STR Thefact that the old regimt has nor been repced by strong govcrnment has left a tremendous void. The siuation in Russia is vcnr differcnt from that in postvar Germany and Japan. where a sense of national guilt contributed to a determinaion to bury the past and create a new future. In the circumstances of Russia, there is bound to be a sense of national grief-a crucial element of the political inheri- tance of current govcrnment and one which will have to be taken into account vell into the future. This grief has at least-nvo sets of political implications: Russia, whHe rcmaining a nuclear power with a penmanenr seat on the Security Council of the Unitcd Nations, has lost inernational prestige and influence and must find a new role on the world stage. Hence foreign policy wvill be an important factor in domestc politics, albeit not:as important as economic and political reforn. Foreign governments and intemational organi- zations should be particularlv aware of this fxcor. The Political signals will be confused: on the one hand, criticism of the West for not doing enough to help, and, on the other, resentment at bEing the recipiens of charirvy * Vhereas the populations of countries like Hungarv. Poland, and the Czech and Slovak republics can comfort themselves with their new-found national self-determination, this is not true of the population of Russia, who may be much more inclined to look nostgically to the davs of the old regime. It may be that, although the change of regime is common to all, the lack of liberation effects will reduce the mass psychology which Balcerowvicz cites as a factor in the level of readincss to accept radical economic measures. As Western politicians quickly discover, the public memory is oftcn, but selec- tively, short. The recollection of being part of the powerful super state will remain. wvith the population when memories of its shortcomings have faded, especially if the pain of transition persists for too long. POLITICAL PRESSURES. Although the relative strengths of the effects differ, the politics of all the reforming countries are heavily influenced by four sets of - forces: a distrust of govemment, pressures to decentralize, inflated expecta- 13271 POLICY DESIGN AND IMPLEMENTATION tions about the speed of change. and pressures o avoid excessive unemploymcnt. oisrtfgovtxmev. Attitudes can be measured and will vary ovcr time as issues come and go. Distrust of goverment is likely to be less severe in countries such as the Czech Republic which have a history of democratic culture or where repression ws in large measure imposed by the U.SS.R_ In such cases, the new democtic governments should experience less difficulty in dcvdoping mutual trust with their citizens. Where dte repression 'was sevCrc and imposed by their owit govrnmen, such as Romania and Russia distrut wll bc harder tm overcomc. The problem will be even more serous in countries with substantial ethnic minoriiues, such as Azebaijan, Georgia Moldova, ndthe former Yugoslavia. Pnezwm to deawmE. Centrifugal forcms arise most acutely in the form of naionalist aspirations. Ihe reaction against.strong central control lcd to die denand for power to be devolved away.from the centra government to an eenrt which could make some states nearly ungovernable. National an'd ethiic minorities dcmand a- degree of autonomy or even completc indepcn- dence. Local regions, twns, and even villages are demanding powers. over their own affirs. This is often a rcspouse to the breakdown of authority of thc cenal governmt as much as a desire for local autonomy. Umwb* .'mewjvu. Govemments run serious risks when thcy alow epctations to takc roor -which cannot be fuWlfled. This has been a problem sincc tie first day, when tie new leaders stood on the Berlin Wall and failed to acnmowledge that things were going to get very much 'worse before they got beter. Sincc then, politic have had the impossible task of trying to saisfy vastly overbkiwn public ectations?.3 WhRe this is true for longer-term expectations, it is also true for expectations on a day-to-dy basis. Western politicians who arc about to ainnounce some. policy (an annual budget for exanple) wil cncourage dhe press t speculate that thc news is going to be very bad. This tends to ensure dtih the not-quite-so-ad. ncws is bettcr received than it otherwise would have been. Since public confidcncc is an important factor in producing economic upturns, this approach can be impor- tant for cconomic success. When democracy itself i v ie, t tS n more imporanp L Thpo(ria Should it be changed? Is it being administered accuratcely and on time? Arc. there local or regional issues which have to be addrcssed? Is the financing correct? What trends arc cvident for the.development of policy in thc future? For all this to be possible. a great deal of information must be passed back to administrators and policymakers at the center. Continuousrinformation is essential and provides the link which ensures that the policy is developed and improved; not just changed withour considering what has gone before. This should bc a continuing process and is vital if administration and policy are to bc developed in a structured way during the transition. It is also vital for the- future if the administration is to keep pace with, and take advantage of, developments in management as they occur. No administration in the West is a static structure; all are subject to constant change. The new administrations * should allow for this constant change and development. Conclusions It is helpful to separate conclusions about .the political process from political and administrative policy actions. The Political Process During dhe revolutionary phase of the early transition, much policy, of neces- sity, Nvas verv short run. It was concemed (a) with trying to make change irreversiblc and (b) with trying to prevent a complete breakdown of the system, bv. ensuring the cominuing'payment of unemployment benefits and pensions and of doctors' and teachers' salarics. In most countries, however, the revolutionary period is past. Normal politics should follow the revolutionary.phase, and normal. political rules will apply. The process is cyclical, generally following two cycles: the formal and the electoral. The first is anw '1, the fiscal and parliamentary year.- : Budgets are sct, and legislation planneid and enacted. Each stage must be ;explained and feedback noted. Politicians need to "scir their policies and ' explain their actions, particularly in the later stages of the electoral cycle. It is better to make-the most radical changes earlv in this cycle so that the benefits can become clear before thc electorate is asked to judgc them. The combined political and administrative cvclical process is as follows: Publiclv float :the idea and monitor the response, which may involve a formal consultative process 1 3491 POLICY DESIGN AND IMPLEMENTATION - Prepare detailed policy proposals, where possible taking into account the views of interest groups * Campaign for the policy, get ministcrs and prominent supporters on the radio and television and in the press, and win the argument with opponents (this is not casy if, for example, the issue is a refusal to increase teachers' salaries, but government must explain why this is necessary; nor everyone will agree, but it is important to measurc the strength of the opposition) * Tcst at all times that support exists within the party for the policy, since splits are often more damaging in themselves than the issue which initiatcd them - Enact the legislation; widespread public debatec will continue during the parliamentary debates, triggered by the enactment procedure ; Implemcnt the policy * Listen to the fecdback. The feedback will come from many sources, very importantly the civil service, parry supporters, and the clectorate. This is true at ll stages, from the floating of ideas, throughout the consultative process, and in checking the final outcome. The feedback from checking the outcome is often the starting point for a new policy initiative. Thus the process is cyclical and perpetual. Shunr-refm Policis The following policies will have an impact in the short run:r * Because of institutional capacicy constraints, policy design should be as simple as possible. * Administrative needs should bc given considerable weight. In paticular, individuals with implementation skills should be involved from the start of. the process of designing policy and drafting laws and regulations. * Politicians should spend a significant amount of timc persuading the public of the desirabilitv of the government's -policies. Democratic government * involves permanent campaigning, and that must be done by the politicians themselves. * Feedback from the electorate to politicians is essential to cnsure that politi- cians are well informed about what the electorate wants and are aware of the. main sources of support for and opposition to their policy proposals. The electorate for these purposes is not.just the inteliigentsia, who are a minor- ity, but the broad body of the populaEton. * Politicians should defuse rather than encourage unrealistic expectations. Medixm-aem Policies The following policics have a medium-term dimension: * The machinery of government should give the democratically elected cexc- utive the power to implement the policies on which it.stood for clection.: 1350 1 DRIVING CHANGE: POLITICS ANI) ADMINISTRATION - As political parties develop their own discrete identities, governments should incrcasingly adherc broadly to thC policics on which they were clected. * Greater emphasis is needed on monitoring the outcomes of policies. The latter changes may at this stage be long-term goals in some countries. rather than goals which can bc attained immediately. They shomld, nevcrthe- less, remain firmly on the agenda. As the policy chapters ot tnI. oook make. clear, there are many feasible short-run policies* which help the reform process and also protect groups who are most vulnerablc to some of its early fallout. Equally, howvccr, the transition will be long drawn ouL. The good news is that the countries of Central and Eastern Europe have moved out of their culde- sac and onto a path which offcrs a genuine prospect of economic growth and incrcased individual freedom. It may be a long road. At least it is now the right: road. Notes 1. Italy has had relativcv unstable govcrnrment and comparative prosperiry, but levels of corruption and organized crime have led to ovenrhelming public support for constitutional reform. 2. Crick (1992, pp. 174-76) argues that tobc truly stable a political system has to meet thirteen conditions. 3. It isc not only in Ccntral and Eastcrn Europc that expectations are allowed to gct out of hand. A classic cxampic of unrealistic cxpecctations fucled by politicians in the West was the chorus of parliamcntarians. each advocating increased cxpcnditurc on his or her pet project, all to be fundcd from the peace dividend:' D-4. In Germany., for instance, a-arty must win at Iast 5 percent of the toul votcs cast before ic can have a sear in the legislature. The purpose of such a threshold is to ensurc that the legislaturc docs not have too many partics, the idea being that this makes ic easier to form stable coalitions. S. Proportional represcntation can take many forms, each w%ith its own pros and cons. The Czech Republic adopted a pure list svstem (see the glossary) against the advice of a presidential constitutional commission. The major disadvantage of'such a system is that it cuts the link betecen the member of Parliament and his or her constituency, thus losing the direcc accountability of thc individual representative. ' 6. An examplc of logrolling would be if the c Xnsioners' parliamentrv reprcsenta- tives agreed to support continued defense spending. so long as the parliamentarians vwith constituencies hcavilv depcndenc on defense contracts agrcd to oppose pension reform. 7. As an cxarnple of the administrative vacuum which can exist at the center, the. central authoritics in some countries wvere unable to estimate total cxpenditure on cash benefits or health care, because they hid littkl information about benefits at the regional or enterprise lcvel.'In 1992, the central Ministrv of Social Protecrion in Russia. for example..had no figures on total spending on cash benefits. S. As an example. legislation tried to impose sanctions on smugglers. This was pointless, since the only wav of identifving a smugglcr is to catch him. The legislation * . ill have no effcct on the smuggler who remains undetected. 13511 POLICY DESIGN AND IMPLEMENTATION 9. E:xamples of the sorts of complexity which arise whcn administrative issues arc overlooked includc carly systems of unemploymcnt compensation, where benefits wcre (a) related to previous carnings and (b) had to be recalculated frcquently and whcrc (c) the law made no provision for rounding benefits to the nearcst convenicnt currency unit. all in a situation (d) where benefit offices gcnerally had no calculators, Iet alone computers. 352 Glossarry Araatial benuaflt. insurance against an event, such as illness or old age, which bears a strict relationship to the probability that thc insured individual will become ill or dic at a given age. If benefits are actuarial, then individuals, on avcrage and in the long run,. receive benefits broadly equal to their own past contributions. Am- ity. The payment of an income of Sx per year for life, oftcen given. in exchange for a singte, lump-sum payment at the time the individual retires. Capitadon iayment. A fixed sum paid to docrors per patient per year. The sum can be higher for particular groups, such as the elderly. The essenee of capitation payments is Ehat payment is ar related to the amount of trcatment a doctor prescribes, in sharp contrast withfW--jbr--sffvpameEts . Cash bwefia. Incomc support for individuals in the form of cash, in contrast with beneftts in kind like free health care. In the contcxt of Central and Eastern. Europe and the former U.S.S.R., they comprise unemploymcnt and related benefits, socal insrauce benefits, and soclassisance. The term social security is avoided because of its ambiguity. In the United States, social security refers to retirement pensions; in the United Kingdom, it refcrs to rhe entre system of cash benerits; and in mainland Europe (in accordance w ith usage of the Intcrnational Labour Organisation), it refers to all cash bencfits plus health care. The term cash benefits has been used throughout this book. Ceraral aid Earn Eape. For the purposes of this book, (a) all the for- merly communist countries of Europc plus (b) the former U.S.S.R. apart from its AsianlMuslim republics. The trm thus embraces Albania, the Baltics (Estonia, Latvia,, and Lithuania), Belarus, Bulgaria, the Czech Republic, Hun- gary, Moldova, Poland, Romania, the Russian Fedcration, the Slovak Rcpub- lic, the successor states to the former Yugoslavia, and the Ukraine. Armenia and Georgia are excluded because, for most of the period since 1989. internal wars havc pushed economic transformation into the background. For cach country, we have used the name current during the period being discussed. - Thus Czechoslovakia refers to the countrv before it was divided, while the (353J GLOSSARY Czechl Republic and the Slovak Republic-or the formcr Czcchoslovakia- refcr to the countrics after that time. Coxsmer.subsidy. SFEpdce subsidy. Coast-seffecdveness. Producing a givcn output in the cheapest way. Coundi for Mutual &onomir Assistants. The trading system for the former communist bloc; in effect, an international system for trading goods at agreed- on prices and in agreed-on quantities. Deffined benefit scheme. Usually run at the level of the firm or industry, a scheme in which the individual's pension is based on the number of years of scrvice and his or her final salary. Thus the risk of different rates of rewurn to pension assets is borne largely by the employer. Defined eontribuon sdcme. Scheme in which the individuals pension depends only on the size of his or hcr pension accumulation. Under a defined contribution schemc, the risk of varvyig rates of rcturn to pension assets and the risk of inflation after rctiremcnt are borne entirely by the individual. Diposirs rlated ap. A method of financing hospital care by paying the hospital a prospectivc sum for each patient treated, where the prospective sum is related to the condition with which the patient is diagnosed. &nnpngr&tedbaex4ikr Benefits paid as a percentage of previous earnings; thus individuals with higher previous earnings reccivc higher benefits. Eamometia. Thc usc of statistical methods to quantifv economic relation- ships. An econometric study of labor supply, for example, would attempt to show how much labor supply is reduced in response to a tax increase. SaE ALSo laborstpply dti,wenves. EroLLment ratio. The percentage of a given agc group attending differcnt levels of education. Eunvpen Unioe. Formerly the European Community. a regional alliance dedicated to integrating the cconomics of'member countries. Membership in 1994 comprised Belgium, Denmark, France, thc Republic of Germany, Greece. Ireland, Italy. Luxembourg, the Netherlands, Portugal, Spain, and the United Kingdom. Famiy 'alhnvazr. A monthly payment, usually tax free and normallv not subject to an hicomezet, paid until the child reaches a certain age. Fee-for-srnvice paymtr.: Payments detcrmined on the basis of how much treatment doctors give the patient, in contrast, for instance, with capirazion paymnLcL- 1 354 1 GLOSSARY Finr-paor-ze-post. An electoral system in which the winner in any parlia- mentary constituency is the candidate who receives more votes than any of the other candidates, as opposed to proportiional npratnaan. Both the United Kingdom and the United States have first-past-the-post systems for parliamentary (congressional) elections. Flat-rat bnuefits. Bcnefits paid at a fixed monthly rate (though they may be higher for larger families) which arc not related to previous income. Thus, for a given farnily type, all recipients reccive the same benefits. Ru-al poely. Policy concerned with thc level of public spending and the balancc betwecn governmcnt spending and tax rvevnues. Government, by and large, can finance its activity through (a) taxation, (b) bond-sales, and (c) expanding the supply of monev. If government spending exceeds its tax revenues, the resulting budget deficit can bc financed either through bond, sales (this possibility is gencrally.very limited in Central and Eastern Europe) or through monetry expansion. Budget deficits can thus contribute to infla- tionary pressure. SEE ALSOmonetayporulicy. Fundpeons. Paid out of an accumulated fund, in contrast with pay-as you-go schemes. Grvsr adbesrcpmda. The value of all goods and scrvices produced in an economy m a year. G- u matiaprwzadu The value of goods and services produced in the so- called material sectors, used by the countries of Central and Eastern Europe beforc the transition as the principal measure of economic activity. In contrast to the similar concept of gross national product, it does not covcr all economic activity, because some services (education and culture, health care, -adminis- tration) are omitted from the definition. HeadmustA Measures povcrty by the number of people whose income falls. below a given povCrty line; that is, it measures how many people are poor, as opposed to the povery gap measure, which assesses how mud their income falls below the poverty line. Health maistmance wganiadnm. A firm" of doctors, which charges individ- uals or families an annual premium, in return for a comprehensivc range of medical services. The essence of a hcalth maintenance organization is that it merges the function of doctor and insurancc company and thus faces medical providers with the cost of the treatment they provide, thereby reducingn :- party paymen -ci i:. Human capitaL The skills and attributes embodied in an individual, in-partr because of his or her education and training. :. 0 . 0 n . f :~1355 G LOSSA RY Human rsurres. Policies and programs relating to cmploymcnt and unem- ploymcnt, income support, education and training, and health care. These areas are referred to colleccively as the social sectors. Implidt fax raft. A tax which ariscs when a family in receipt of an ina- testdbeaefit carns extra income and as a consequencc loses somc or all of its benefits. If benefit is lost dollar for dollar with carnings. the implicit tax rare is 100 percent. Income smoothiffg. The aim of income smooching is to make it easier for individuals, in cffcct, to redistribute to themselves at different stagcs in their life cycle,- for example, from their higher-earning middle years to their younger years (when their earnings are lower and family responsibilities greater) and to their retirement Vears. Family allwances and old age pensions contribute in important ways to incomc smoothing. fincome-rrdhbenefits. Benefits paid only to peopic whosc incomc falls below a certain leVCI. SEE ASo wnean-atesdbeneiz. income naswsfrn. SEE cask brefi. In-dAd bmefit. Direct transfers to individuals of commodities, such as hcalth care and education. Laborsuppfydisincanives. An incentive not to vork or to work less. Suppose an individual has the option of working longr hours and earning an cxcra SIO; if he does so, he has to pay an extra $6 in tax; as a result of this high taxation he may choose not to work the extra hours. In such a case, high taxation is said to crcate a labor supply disinccntive. SEE ALso econeJ7ia. - t Lisrsyim. An clectoral system in which a political party lists its candidates in numerical order and then sends to Parliamcnt the first x people on the list, where x is determined by the party's share of the total votc. SEE ALsOfs-paSt- the-post and prvpornofa(pr7rsentauion. Macareonomc fidey. 'he efficient division of national resources between human resources, on the one hand, and activities such as physical investment and consumer spending, on the other; thus it is concerned with such qucs- tions as the appropriate fraction of gross domestic product to spend on health care. SEE ALSO micwaomk efficiency. Maret faiture. An economic technical term dcscribing a situation in which privare markets, for systematic tcchnical reasons, produce either inefficiently or not at all. The efficicncy of markets rcsts on a number of key assumptions, including the cxistencc of compctition and, importatly, perfcct information on the part of buycrs and sellers. Wherc anv of the assumptions fail, a possible outcomc is market failurc. A key examplc for the social soctors is tEha, 1 356 1 GLOSSARY because insurers are imperfectly informed, unemployment, inflation. and importnt medical risks are uninsurable in private markets. Maternit leare. In most countries, a woman who is a member of the labor force may stay at home in late pregnancy and carly motherhood at a (usually high) fraction of her previous wage. Means-tested beefits. Benefits paid only to individuals whose pre-benefit income and wealth are below a given amount. The tcrm thus embraces both income teaing and wealth tesing. Mimecontomic iency. Concerns the division of totl health care resources into different types of medical intervention, the division of education spcnding into different cypes of education, training, and retraining, and so forth. S£E ALSO macvwwo~mcefflaenety. Moetaryy por. Concerns the control of the moncy supply, availabilitv of crcdit, and the setting of interest rates. Rapid monetary growth and low real interest rates (char is, marker interest rates which are lower dhan the inflation rate) can contribute to inflationary pressure. SEE ALSO jiStpoliy. Atongovnnmenraloiganiad,6s. Nonprofit institutions which frequendty carry out tasks similar to those of government, such as the Red Cross, charitable organizations, and nonprofit hcalth care facilities. Organkado fir EFonomic Coperation and Drment (ooEM). Refers to the highly industrialized countries. Membe;rs:- Australia, Austria, Belgium, Can- ada, Dcnmark, Fmiand, France, Germany, Greecc, Iccand, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal. Spain, Sweden, Switzerland, Turkey, United Kingdom, United States. Pay-as-you-go (PArd) pensions. Pensions paid out of current revenues, as opposed to funded schemes. Pov&rty gap. A mcasure of total poverty which cstimates the amount by which people in aggregate fall blow the poverty line, thar is, a measurc of how much it would cost to bring evervbody's income up tO an agreed povcrty line. The povertv gap as a measure of total poverty is to be distinguished from' the e&omit measure. Poary mr1 A kev objective of eas benefir during thc tmnsition. Poverty relief secks cither to eradicate poverty by bringing everybody abovc a povcrty line or to ameliorate the povcrty of those below a givcn povcrty line bv incrcasing their income w ithout necessarily completely eliminating thc pov- crty gap. Poveny trap. Situation in which individuals or families earning an extra SI lose SI or more in income-tested benefits, making them absolutelv worse off. SEE ALSO pm it&rrate. I [357] GLOSSARY Pricesubsiy. A rcduction in the price of goods bought, and thus one of tvo wvays to raise a family's standard of living. The other is to increase its income (income transers). The arguments in favor of incomc transfers rather than price subsidies are that income transfcrs (a) are more easily targeted and (b) gencr- ally cause frwer inefficiencies than price subsidies. Pnvaca*e and rnaciv mestsr. As an example, unemploymtet beefnts are intended to provide povrtry nl4for unemploycd individuals; as such it is a reactive policy. Proactive policy includes, for instance, measures to increase the individual's chances of finding a new job. PopWfial rprmenataon. An electoral system in which a party receives parliamentary seats broadly proportional to the tota number of votes it receivcs, as opposed to Jint-past-rk-past. Under a pure list system, a party receives all its parliamentry scats this way. It is also possible to have a system under wvhich some parliamentarv scats are on a first-past-the-post basis and some are on a list basis. The latter, broadly, is the case in Germanv. Publicraftn. Publicly funded-income transfers. -P -lac,, rate. The ratio of income whcn receiving berefits to nect Income- when working. High replacement rates, it is argued, give unemployed individ- uals an inccntive to remain unemploved. Re.r cwai-g. The process of introducing a market system, togcthcr withcth legislation, regulatory structure, and other background institutions (such as a - : vwell-designed svstem of cash benefits) necessary to assist its operation. S fd'ass beaefl. Benefits paid to individuals who suffer a loss of income during short-term sickness or injury. Soial assistance begi. Also refcrred to as welfare. Thev are usually fnanced out-of general taxation and paid to needy individuals on the basis of a test of income or wealth. Socialepemndars. Expenditurcon the social sectors. Soi insrance. Cash benefits organized by the state through compulsory contributions- The main benefits are unemployment benefits, sickness and matenity benefits. and retirement, invalidit,. and survivors' pensions. SelsftJry netr. Narrolvy ddened, comprises cas bowjkaimed at providing povrynlkf. More broadly, the social safety net includes all soad l tpea r. Socisecmo. A collectivc term covering policies and programs rclating to- emplovment and unemploymcnt,: income supporr, education and training, and health carc. :3581: GLOSSARY Sodatswzwry. SEE cask bCef*r. S0owWe/rfar pngrams. SEE sodahJaSirnnCe bmeflts.: Socal u'o. Care provided for individuals and families who are not able to carc for themsclvcs, such as the frail elderly, invalids, and individuals with emotional problems. Szabhiraio. The use of mwearypolqy and flwapoIky to control the growth of the money supply and the balance betwecn public rcvenue and expendi- ture, in the interests of containing inflation. ;S,gva. A reaction of people who fccl shame because they receive income in the form of (usually) incwme-asdbenefits, rather than from somc more conge- nial source (such as carnings or insurance benefits). Subsisrnc. A level of consumption. sufficient to keep an individual or farnily ' - alive and healthy. Take-up. Tihe number of pcoplc recciving a particular benefit as a proportion of those potenially eligible. Targeing. The action of aiming policy at a specific group or groups. Target- ing efficiency has rvo aspects: horizontal cfficiency, which refers to the abiliry of the systcm to cover all potentially eligible individuals (to avoid gaps in coverage), and vertical efficiency, which refers to the ability of the system, by and large, to cover only the eligible group (to avoid the leakage of benefits to ineligible groups). TayArni.. A scientific" approach to management used in the U.S.S.R. (and to a Icsser cxtent in the rest of Central and Eastern Europe) prior to 1960, in which workers were simply treated like another machine. Tar rhnhoh The amount of incomc exempt from taxion. Under a system - of personal income taxation, individuals pay no tx on a given amount of their income, known as the tax threshold. - Third-p.aV payenr in.ntis.- A situation in which, for example, the insur- ance company pays all, or most, of an individual's medical bill; as a rcsult, neithcr paticnt nor doctor has an inccntive to economize. The rcsult can easily be an uncontrolled cscalation in medical spending. Unmpkqmnmt bnfits.. Cash benefits paid to an individual who has lost his or her job. A condition for reccipt of the bencfit is normalv that thc individual- mustactivelyseekanewvjob. Univesl bheufin. Benefits paid on the basis of relevant criteria without a mans tan, for- example, when a family akbraiwff is paid to all familics with childrcn, irrespective of their income. 159 I GLOSSARY. Uprmntg. The process by which benefits arm increased to take account (wholly or in part) of changes in carnings or in prices. 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Poa/and: ome,oSupper aNd srSc&alSafJi My drixng sThTriofr. Washington. D.C. * 1993c. 'Russia: Social Protection duringTransidton and Iyond:' World Bank. Hurnan Resources Division. Country Departments Ill and IV. Europe and Central Asia Rcjoons. Washington. D.C. * 1993d. WJ. DdboprerntRepor 1993: Intmsrgia Alea h. York: Oxford University Press. * 1994. Awrizg the 0ld Af Cdii Jidy.Op6om fir a &hin YIMi!. tNew Yoac Oxford University Prcss. World Health Organization. 1991. "Albania: Health Sector Review and a Proposal for Assis- tancc." Draft report. World Health Organization, Regional Offiee for Europe. Copenhagen. Yeun, Ha-Cheong. 1986. -Soal Welfare Policies in the Republic of Korea.7 Imurnaon al&ial Smw7 Revi 39:2, pp. 153-62. - Zim Maria. 199 1. "Economic Reforms and Safety Nets in Hungry Limits to Prowcdion. In Cornia and Sipos 1991. Zimakova. Tatiana. 199Z. Social Policy in Central and Eastern Europe: From Socialism to Markc, 1960-927 Study sponsored by utncu/Kc, Firenze, and the University of Michipn. Ann Arbor. 13731 .~~ ~ ~ ~ ~ . , Contiribuiors -i.lasrBonr(England) is a member of the Deportment of Economics, London School of Economics and Political Scince, where his main field of research is the economics of the welfare stace. Hc was a full-time consulant to the Human Resources Operations Division, Central and Southern Europe Dcpartnments, World Bank, from Scptember 1990 to August 1992. During chosc two ycars, hc workcd in Bulgaria, Czcchoslovakia, Hungary. Poland, Romania, the Russian Federation, and Yugoslavia. labs C'wfrd (Scodand) is the hcad of Public Relations, London School of Economics and Political Scicnce, and former candidatcefor thc U.K. Parliamcnt. He has substan- tial practical expcricnce organizing political and pressurc group campaigns. -w Ewvi' (England) is professor in the Faculty of Economics at the London Business Schoot and co-director of the Post-Communist Reform Programmc at thc Ccntrc for Economic Pcrformance, London School.of Economics and Political Science. Hc is a consultant to the World Bank and a longtimc scholar of socialist cconomics, especially. the former Yugoslavia. Ritard G. -. Feacm (Engand) is dcan of thc London School of Hygicne and Tropical Medicine and a formcr staff memnber of the World Bank. Hc is an epidemiolo- gist who has worked in thc Czech Republic, Hungary, and the Slovak Republic for the World Bank anrd European Commission. He chaired the advisory committee for WYorld - 1MDqtd*mnRADt 1993: bnrssgbi Health. DavidPFtrwe (Canada) is a senior cmploymcnt and training specialist in the Hurnan --- Resources Operations Division, Central and Southern Europe Dcpartmcnts,.World Bank. Hc has worked extensively on active labor market policy in Albania, Poland. and Ronania during tdic past.four years Prior to that, hc was involved in work force development in corporate, local and national government, and academic settings in Africa. the Middle East, and North America. .:&adsGm Gwmd*a (Poland) is a mcmbEr of the Dcparemcnt of Economics, London School of Economics and Political Science, where-his main ficlds of tescarch are economic growth and comparative cconomic systems. Since Scptember 1989. he has becn coonomic adviser to successive financc ministers in Poland. As a mcmber of the Balccrowicz Group, he advised the Polish government on -the elaboration and imple- mentation of the 1990-91 reform. He also advised the Russian govemmcnt on lierl ization policies at the end of 1991. Raph ; .Harni (United States) is chief of the Human-Resources Scctor Operations- Division, Central and Southern -Europe W Departments. World Bank. a position he assumed when the division w established. Hc is an economist whose' profcssional' work, for die Ford. Foundation in Latin America and Africa utntil 1979 and at the World Bank since then, has focused on eduication and training and, morc recendy. - .[375f : . - - - 7 CONTRIBUTORS social protoction and health. In his current capacity, he has been activdly involved since 1989 in labor market and social policy discussions in all of Central and Eastcrn Europe apart from the formcr U.S.S. R. R;Nelhv,dmw (England) is a member of the Department of Economics, LIndon School of Economics ond Political Science, and was a full-time consultant to the Economic Development Institute of the World Dank from August 1992 to August 1993. He has written widely on theoretical and empirical aspects of labor markets. Bruno Lape' (France) is a principal human resources specialist in the Huan: Resources Operations Division, Central and Southern Europe Departments. World Bank. He has. worked extensively on educ2tion, trnining, and employment issues in Europe, the Middk East, tnd North Africa. Sincc 1989 he has focused on transitional economies, in pafticular Bulgaria; Poland, anddthe former Yugoslavia. I.kx ,r A (1lenrn 'kCanada) is a senior health economist in the Human-. Resources Operations Division, Central and Southcm Europe Departrments, World Bank. and a mmnber of the team which wrote hlWdfr xWR0prn 1993: hnvsa iii lkah. Hc has worked in the former Czechoslovskin, Hungry;, and Poland, and was a pecr revicwe for health sector work in Estonia, the Russian Fedcration, and Ukraine. Afkha fbAuos. (Poland) is an economist in the Human Resources Division, Country Derment IV, Europe and Central Asia Recon, World Bsnk, and a mermbor of the core team writing W)'d. DcmIoxvrt Romrt 1995. Labor And Ddopmt. - Before jomning the Bank, he worked at de Warsaw School of Economics on economic uansi- ion in Poland and other Centrl and Eastern European countries. He w=s a British Council Scholar at the Ccntre. for Labour Ecionomnics, London School of Econorics and Political Science, from August 1989 to June 1990. While at the Bank. hc has worked on labor and social policy isses in vious countries, includingBelarus, China, Esconia, Latvia. Lithuan4 and Ukraine. iie SAureiw (Eglnand) is a former principal social sector specialist in the Eupc and C6 iRegion of-the World Bankd current ief of the Hu anur Operations Division Counury Dpartmnt Ill, Latin America Region. He has wrked in, among other countries, Hungry, Poland, and Romania. S ,a&mas (Hungary) is an economist in the Human Resources Operauons Division. Ccntral and Southem Europe Deprtmrs, World Bank, on leave from the-lnsttute; of World Economics of the Iunprian Academy of Sciences. Before joiring the Bank,. he worked as lng-trm consultant to uNicuvI.crc, Florce,c Italy, on human resoures aspaets of the transition in Central and Eastern Europe. He has worked on social policy issues in Albania, .B1arus. Bulpria, Cratia, Hungary, Moldova, Poland, the Russian Federation, and Ukraine. A- y Thvmpsn (England) is a senior officil in the U.K. Department of Social Sccurity on cash benefits poSicy and administration. Hc uas a consultant on World Bank missions to Poland, Czichoslovakia and Russia between 1989 and 1993. Since S:p- tcernber 1993, he has been a Ul-timc consultant to the World Bank, working in Ccntral amd Eastern Europe and the former U.S.S.R.. Igor Toer (Cwech Republic) is a professor of labor law and social scurity a Charles - Universi.y Prague. Hc was frst deputy federal ministcr of labor and socia affairs in thc first postcommunist roracne in Czechoslovakia and chief auth- of theiritial Czech socialtsecurity reform prograrn. Hei5salso a consultant to he World Bank and : has worked in Albania. Bulgaria, Estonia Lithuania and the Slovak Republic. r 376 1 Accountability, political and udministra- Administrative issues: in active labor tive. 102, 279, 331-32, 348 market policies,. 165, 185-90; in cash Activc labor market policics: advantages bcnefit policy. 198-99, 220: in educa- and disadvanmages of, 148, 160-61, tion policy, 280-82; in family bcnefits. 190; attitudes toward, 188-89, cor- 232, 248-49; in health care, 316-17; pueerization of, 177, 190; cash bene- need in drafting legislation to consider, fits and, 161, 176, 186, 189, 24 1; cost 342, 344: in overall reform strategy, of,-160, 176-77; decentralization of, 118-19; in pension administration, 186, 190: und difficulty in dcalingwith. 214, 217; in social assistancc,1245, mass unemploymcnt -148, 174,.190: 251-53, 256, 258; in wage and during early transition, 165; financing mployment policy, 156-57. of, 175-76; impact on labor mobility Adult cducation, 261, 265, 270-71, 284. -and productivity of,- 1 61i, 163, 181 - - Advancc noticc of layoffs, 182-83, 189 8 4 -2; improving incentives ihrougi, Adverse selection, 40-41 179-S1; increasing individual choicc Akerlof, Georgc, 50 n3, 150-- * - - in,I 77: in:prereform Central and East- .Albania: absence of family allowances in, em Europe, 163-66; political and - 247; active labor market policy in, administrativc issues rcgarding. 165, 176, 186; education in, 266; health - 185-90; privatec mployment services care in, 299; nongovemental organi- in, 178: reform of, .169-73, 188-91; -ations in, 243; social insurancc in. -sharesof oo devoted to, 180; trget- 224 shares ~~~~~~~Alcoholism, 68.'303 ing of, 162, 176-77; time limits for = Atinson, AnthonyB 73 80 82, 133, participation in, 176; types of, 162- 63; unions and enterpriscs and, 167, - 1 75, 189. &EUO kAC VmUs qfcwor s = Backlash against reforms. 21,87 * Administration: accountability of, 348; Balccrowicz, Lcszek, 7, 22,77, 82, 1 01, centrnl versus local, 344-46; computer- 1 20 n 1, 259 n4, 324, 327 ization of, 347; constraints arising from Bankruptcv law, 171 cxsting, 104. 334-36; enforcement of Barnes, John, 277 lawvs and regulations by, I 00; inade-. Barr,- Nicholas, 39, 42, 45, 49 n t, 82.. quate capacity of, Z2-23; incentivcs 193, 259 n5, 274, 277, 280, 312 facing, 46-47: incrcasing effectiveness Basic education, 261, 262-63, 269-70, of. 31-32; need for simplicitv in, 7, 26,. 275, 283 31, 119,218,221,343-44,350: objec- Bcckcr, Gary, 46, 260 tives of, 343-44; policy advisory role Belarus± attitudes toward unemployment of. 334-35,340; political implications in. 3`9: electoral arrangements in, of effcctiveness of, 345; staffing and 331; aninimum wage in, 153; unem- support.of, 346-47;tendency to under- ployment benefits in, 197 value implementation skill in, 105: Bcrgion, A. 58.62, 63, 66, 73, 80. trining for, 106,-280, 346-47 Birth grants.- 227 - 1377 1 | - f -- - - - ~~~~~~~- - - - I NO DR X "Black holes" for policy, 27 276; in healthi curc, 299-300, 308-09; Black nmarket for labor, 136 importance in ovcrall reforn strategy Block grants, 246, 2S6, 278 of, 83, 115; incrcasing during trnsi- Bodic, 7Zvi, 209 tion, 24, 78; in labor markets, 1S I- Buchanan, James M., 46 52; in private pensions, 209 Bulgaria: death rates in, 1: cducution in, Civic Forum,r334 268, 286 n 1 2; excess wage tax in, Civil service. e Administration' 145; mimimuni wage in, 145; output Clinton, Bill, 333 decline in, 73, 90;.povcrty ratc in, Coasc,. Ronald H., 38 236; privacizaEion in, 151; unemploy- Coltcctive, subordination of individuals nient in, 206 to, 58 Bureaucracy. &c Administration Collective bargaining, 135, 15$, 166 - Business organizations, rolc in activc Communirv economic development, labor market policies of, 167 166,185 Conpctitidon: emergence during cransi- - Capitalization of unemployment benefits,- tion of, 78, 83; in labor markets, 151- 184, 191 n7 - 52; managed,.308; role in incrcasing Capital markets, 36, 63, 84. 143, 175,0 efficiency of, 33, 36, 83 209 Computerization: in active labor narket Cashi benefits: active! labor market poli- policies, 177, 190; in administration, cies and, 161, 176, 186, 189, 24 1, 347; decentralization and, 345; in edu- 245: administrative issucs regarding, cation, 281,284-85; of uncrnploy-- 198-99, 220: affcrdability of, 201; mcnt benefits, 218 cost containment for, 27: decentraliza- Constitutional issues, 22 84-86, 99- tion of, 220; gaps in coverage of. 197; 100, 330-32, 341-42 and fostering social intcgraion, 200; Consumcr choice. SeiChoice, individual impact of widening income distribu- Containing costs. Set Costcontainment tion on, 200; incentivccffects of, 161; Cook,.RobertR:, 185 minimun levels of, 196, 220; mini- Coricelli, Fabrizio, 145 mum wcag and, 197, 205; in pre- Cost containment: in active labor market' - reform Central and Eastern Europc, policies, 176-77; in cash benefits sys- 61,71; rolc of enterprises in andminis- ti, 27-in education; Z69-74; in fam- tering, 73; strategvyfor reform of, 201 - ily bcncfits' 229, 24344; in health 02; targeting of, 201; types of, 192; care, 299, 305-06, 314, 318; in over- versus in-kind benefits, 161, 237, 250- all reform strategy, 114; for pcnsions,::. : - 0 258 0 - - .202; in social assistancc. 243L44 257; Central and Eastern Europe, prcreform. in social insuhin&cc 195-96, 202, 221- - . Senams of counties Cuncil forMutual Economic Assis- Centralized wagc bargaining, 155, 156,91. 94 Change,=forces driving: 77, 266-68; eco- Crick, Bernard, 325, 351 n2-: nomic, 20-21, 78-84; political, 21, Crighton.J., 279 84&87 Czechoslovakia, former: active labor Charities. SeNongovcrnmcntal market policies in, 169; education in, organizations 287 nIS; external debt of, 68; fimily Child carc, 227, 231, 232,.247-48, 281 i benefits in, 229; health carc iii, 289.: Childrcn: hcalth care for, 304.318; in 293. 294; hidden unemplovmcnt in, - poverty, 81, 236. &lcolBasic-: 135; housing in, 61; incomc distribu- education Aon in, 73, 1ZS; inflation in, 10; labor Chile, private pcnsions in, 212-14 hoarddig in, 65; lcvel of social spend- China, 75 n2 ing in, 15, output decline in, 90; sub- Choice. individual: in active labor market sidies in, 61 - - policies, 177; cash benefits as means .Czech Rcpublic: administrativc pay to prcscrve, 250; inmeducation, 272, -increases in. 95: bankruptcy lawi in, 13781 INDEX Czech Republic (coatimfrd) ciency in, 264, 272, 274, 282; family 171; centralized wage bargaining in, responsibility in. 268; financing of, 264, 171; cducation in, 266, 272; clectoral 268, 274-76, 278, 280-81, 284-85; system in, 351 nS; health care in, 44, forces driving change in, 266-68; 104, 299, 303-04, 306,308,310-13, impact of fiscal crisis on, 268; impor- 316, 317; political partics in, 101, tance for economic growth of, 5; 334; privatization in, 151; Socially improving flexibility of, 272; incentives Purposeful Jobs Scheme in, 184; for individuals to seek, 128-29, 267, unemploymcnt bencfit policy in, 171 277-78; increasing consumer choice in, 272, 276, 285; and labor mobility, 268; Data problems, 82, 88 n3, 177. 196, of teachers, 285; political issues in, 256, 280, 282 263, 282-83; in prcrcformn Central and Death grants, 227, 255 Eastem Europe, 61, 71, 128-29, 261- Death rates, 291, 294 65; private providers in, 84, 267, 277- Debt, external, 68-69, 90. &ra ao names 79, 285; reform of, 268-69, 283-85; ofcounfrPis rcgulation of, 279-80, 284, 285; role of Decentralization: of active labor markct enterprises in providing, 267, 275; role policies, 186, 190; of cash benefits sys- in social intcgration of, 260; specializa- tem, 220; computerization and, 345; tion in 264-65, 284; standards in, 26, dangers of, 21, 97-98, 332; as force 269-70, 273, 279, 283-85; subsidies driving change, 86-87; of education, for, 275, 277; for women, 72, 263. See 267, 269, 279-81, 284-85; of health ato Adult education; Basic education; care, 300; impact on labor mobility of, Higher cducation; Medical education; 167; lack of capacity to accomplish, names rfcoanru, Prcschool edutation; 105-06; nationalism and, 328; of social Secondary cducation; Training, Voca- assistance, 243; tendency to ovcrshoot tional education of, 88; types of, 332 Efficiency: absence of concept of, 62; Decline in output. Se Output decline conditions necessary to achieve, 34- Defined benefit and defincd contribution 41; dimensions of. 32-33; in educa- schemes, 209, 212 tion and training, 45, 264, 272, 274, Demilitarization, 330 282; of enterprises, 158; in factr mar- Democracy: as forcc driving changc, 84- kets, 43; in health care, 43-44,290, 85; labor markets under, 137. 166; 297,319; horizontal and vertical (dis- lack of cxperience with, 7, 100-03, tribucional), 1 14, 117, 194, 234; mac- 332-33; need for public sclf-discipline roeconomic vcrsus microeconomic, in, 100; power of government in, 100 30; of markers in housing, 43; of pov- Desai, Padma, 67 ertv relief, 194; role of inacntives and Disability insurance. See Invalidity competition in increasing, 30, 33,36; pensions static versus dynamic, 33 Drugs, 299, 314 Electoral systems, 84, 99-100, 331-32 Elemcntary cducation. S4 Basic East Asia: education and training in, 260; education human resources devclopment in, 4; ElIman, Michael, 54, 57, 58, 60-64, 68, levels of social spending in, 17, 20; 75 n2 social assistance in, 239; social insur- Employment policies. SffJob brokcring; ance in, 2 14-16 Job counseling and assessment; Job Economic restructuring, 9, 13, 87, 93- creation; Job safety; job security; 95, 115-16 Minimum wagc; Wage and cmplov- Education: access to, 117, 263, 265, Z79; ment policies administrative issues in, 280-82; com- Employment scrvices, 166, 175, 178, puterization in, 281, 284-85; cost con- 181, 185, 186 tainment in, 269-74; decentralization Employmcnt subsidies, 150, 184, 202, of, 267, 269, 279-81, 28485; eff- 330 [379 1 INDPX Enterprises: administration of social 274-76, 275, 281, 284-85; of health benefits by, 13-14, 73. 104, 176,199, care, 297, 30647, 311-12, 314-15, 219, 221, 232; attempts to maintain 320; of social assistance, 245-46, 256, employmcnt by, 146; giganticism of, 258; of social insurancc, 198, 204-O5, 61, 94; improvingefficiency in, 158; 207-08, 218-19, 2Z2, 224 n9 incentives facing, 143, 158, overstaff- First-past-the-post clcctoral systems, 331 ing by, 65, 126; provision of education Fiscal crisis: causcs of, 91; as constraint and trainingby, 267, 275; provision of on rcform, 21; exposure of systemic health carc by, 309; role in active labor weaknesses by, 200; impact on educa- market policies of, 175; role in social- tion of, 268; implications for the social ist economy of, 59; shift to effective sectors of, 93 private control of, 151; soft budget Fischer, Stanley, 63, 67, 91 constraints facing, 13, 54; support for Flat-race uncmployment bencfits, 195, loss-making, 147, 148-50, 157, 171, 206 202; wage setting by, 135; worker Frec-rider problem, 38, 275 involvement in managemcnt of. 123, Frenvell, David. 181 137, 139 Funded pension schemes, 208-09, 210, Entitlements. See Cash benefits 216 Environment, 303,330 Equity. Se Horizontal equity Gautam, Madhur, 228 Estrin, Saul, 54, 75 n3,91, 140 GcIb, Alan, 63,91 Etnic discrimination, 232 Gender issues. &Se Women Extensive growth, 53-54 German Democratic Republic, 80 External debt, 68-69, 90. See alo names Germanv: active labor mirket policies in, of cowxtries 174; eleccoral system of, 88 n4, 351 Externalities, 38 n4; health carc in, 306; industrial adjustment services in, 183; job crc- Factor markets, efficiency of, 43 ation in, 184; social spending in, 17; Family, extended, 215 vocazional training in, 265, 276 Familv benefits: administrative issues Giganticism of socialist enterprises. 61, regarding, 232, 248-49; attitudes 94 toward, 240, 254-55; cost contain- Gillion, Colin, 212 mcnt for, 229, 243-44; to depcndent Gomulka, Stanislaw, 89, 91, 147 wives, 244; duration of, 244; impact Gordon, Margaret, 209, 224 on labor productivity of, 246-47; Govcrnmcnt: distrust of, 59, 85, 97, impact on wvo men of, 227-28, 240; 328; international comparisons of inccntive effects of, 232, 246-47; social spending by, 15-17; role of, 5- incomc smoothing and rcdistributivc 6, 13-15, 19, 25-26, 29, 49, 58-60, functions of, 201; income test for, 323; top-down approach to, 94, 106, 256, 257; incomplete coverage of, 326, 335; types of intervention by, 15, 230-31; need to reduce historical 34-35. S &e als Administration; levels of, 226; and negative income Decentralization; Democracr Elec- tax, 240; povertv relief and, 201, 240, toral systems 247-49; in prcreform Ccntral and Govcrnment failure, 45-47 Easteri, Europe, 71, 227-32; rationale for, 239-40; reform of, 238; relation to Harc, Paul, 54, 62, 149 family size of, 249; targeting of, °28, Have], Viclav, 97 230-31, 247; taxation of, 248-49, Health care: access to, 117, 289, 303; 257; types of, 227 administrativc and political issues in, Feachcm, Richard G. A-, 288, 292-94 316-17, 319; ambulatory versus hos- Fimancial markets. See Capital markcts pital, 310; budget caps for, 318, 319; Financing: of activc labor market poli- collapsc of centrally planned system cies, 175-76; of education, 264, 268, of, 300, 318; consumer choice and 1380] INDEX Health care fconmdnaue 274, 278, 281, 286 n3, 287 nl2; fam- information about, 299-300. 308-09; ily bencfits in, 228, 231, 259 n9; costs of, 299, 305-06, 312, 314, 318, health care in, 289. 294, 297, 299, 320 n5; dangers of too-rapid liberaliza- 305, 308-10, 312-13,316,317; job tion of, 26, 299; decentralization of, creation in, 184; "market socialism" 300; education for providers of, 319; in, 54, 75 n3; maternity bencfits in, efficicney and incentives in, 43-44, 229; output declinc in, 10, 90; poverty 290, 297, 312-13, 319; impact of rates in, 235; privatc employmcnt scr- other reforms on, 298; long-term resi- vices in, 179; trade with Western dential, 310: maintaining qualitv of, countrics by, 55; unemplovment 290, 296-97, 304-05, 314; market among women in, 80; wagc dispcrsion failure in, 313; nongovernmental in, 128 organizations and, 310; ownership and Idcologv, communist, 56-63 fintancing of, 297, 306-12, 314-15, Immunization 304, 318 320 n3; in prcreform Central and East- Incentives and incentive effects: of active em Europe, 68, 70, 72, 288-97; pre- labor market policies, 179-81; of cash ventive, 304, 319; reform of, 301-02; benefits. 152, 161; in education, 128- 317-20; regulation of, 299, 313, 316; 29, 267. 277-78; facing administra- specialization in, 296; saffing prob- tors, 46-47; facing enterprises, 143, lems in, 300; spcnding during transi- 158; in familv benefits, 2.32, 246-47; tion on, 317; subsidies for, 314,319, in health care, 297, 312-13; improve- 320; for women and children, 304, ment in earlv reforms in, 24; of mini- 318. Salsonoamzsoftowuries mum nnge, 152; of poverty relief, Health insurance: market failure in, 44- 153. 197, 237, 245-46; role in 45; necd for propcr regulation of, 27, improving efficiencv of. 30; role in 44; poor capacity to mobilize resources ovcrall rcform strategv of, 115-16; of during transition of, 306-07, 318; pri- social insurance. 204-05; under social- vate, 313, 315, 317, third-parvpay- ism, 94-95; of taxation, 13, 30, 34, ment problem in, 312; versus diret 114; of unemploymcnt benefits, 153 charges for health care, 312, 315 Income distribution: as force driving Health maintenance organizations, 321 change, 70-21, 78; impact on cash n7 benefits system of widening, 200: role Health staus: declining during transition, of price and wage liberalization in wid- 81; impact of environment and wvork- ening, 8041; under socialism, 60, ing conditions on, 303-04,314; 73-74; during transition, 219, 234 impact of life-stvies on, 303, 319; Income smoothing, 30, 118, 201, 208, impact on labor productivity and eco- 239-40. 244 nomic growth of, 4, 30 1-02; and labor Incomes policies: allocativC and distribu- mobilicy, 301; measures to improve, Eional cffects of. 143, 145-46; for con- 302-05; in prereform Central and uol of inflation, 135, 142-43, 157; in Eastern Europe, 290-95 earlv transition, 26, 142, 144; through Higher education, 261, 263, 265, 271- excess wage tax, 144; cxeniptions 72, 274-76, 278, 280-81, 284-85 from, 145; in prereform Ccntral and Horizontal cfficiency, 114, 194, 234 Eastern Europe, 122, 133, 135; and Horizontal cquity, 31 privatization, 146; tendencv to Housing, 43, 61, 79, 94, 155 improve competitiveness and maintain Hughes, Gordon, 62, 149, 250 emplovment of, 143 Hungary: activc labor markct policies in, Incomc tax, negative, 237, 240, 242, 165, 176; Catching up with European 257, 259 n7 Higher Education Fund in, 272; child Income resting, 194, 221, 252, 256, 257 care benefits in, 231; Close the Gap Income transfers. S& Cash benefits Program in, 302; education and train- Indicators of poverty, 117, 194, 206, ing in, 182, 264, 266, 268, 271-72, 221,256,257 [3811 INDEX Individual Retirement Accounts, 224 Invisibic hand thcorem, 41-42 n13 Industrial adjustmcnt policics, 182-83 Jackman, Richlard, 147, 152, 156, 158, Industrial countries: active labor market 198, 224 ng policy in, 148, 179-83, 186-87; dem- Japan, 28 n3, 175, 1iS ocratic practices and institutions in, Jarvis, Sarah J., 228, 248 326,331-32, 339.340,342; educa- Job brokering, 163 tion in, 49, 273, 280; family and Job counseling and asscssment, 182 maternal benefits in, 226, 229-30, Job crcation, 163, 175, 183-85. St also 239, 249, 259 n2; government and Employment services; names of social spending in, 15-20; health care cwumnies delivcry and financing in, 44,49, 288, Job mobility. &Se Labor mobility 290, 308, 311-12, 315-16, 321 n7; Job safcty, 96, 109 n7, 304, 3134 314, hcalth status in. 294; pensions in, 319 210-1 1; political communication in, Job security. 57, 70, 81, 123, 164 101, 333; private employment agen- Judicial svstem, 104, 343 cies in, 178-79; regulation in, 95; role of governmcnt in, 29, 153; social Kopits. George, 20, 195, 215. 224 n8 insurance in, 198, 205: trade with. 55, Kornai, Jinos, 53, 54, 63, 91, 126 90; wage and emplovment policy in, 147, 152-53, 156. 162, 329. Sees Labor, dignity of, 329 names ofcounrie; Western Europe Labor, forced, 122 Infant mortality, 81, 293, 320 n2 Labor hoarding, 65, 126, 140 Inflation: expectations about, 144; mac- Labor market policies. &e Active labor roeconomic and redistributive effccts market policies of, 10; pensions and, 217, 22. 224 Labor markers: building institutions for, nI1; as uninsurable risk, 40, 45, 209; 150, 158, 175; competition in, 151; use of incomes policies to control, democratization and, 137; impact of 135, 142-43, 157 liberalization on, 139-41; incentives Information: about cducational choices, in, 152, 179; increasing choice in, 276-77; in labor markets, 177, 182; 151-52; in prereform Ccntral and regulation needed in cases of impcr- Eastern Europe, 121-36; purpose of, fect, 36, 49; role in market efficiency 4, 14; rceform of, 137, 150; rcgulation of, 35 of, 155, 157. Seeako Activc labor mar- Information ystfrms. ket policies &e Computerization Labor mobilitv: health and, 301; impact Infrastrucure, physical, 106, 330 of active labor market policies on, 161, In-kind bencfits. 161, 237, 250, 258 163, 179; impact of dcecntralization Inman, Robert P., 45, 47 163, inact ousintralizarion Insurancc: cefficicncy of markets in, 36, on, 167, inadequate housing as barier 39-4t 95; impossibility of providing to, 155; in pr-refofn Central and anti-inflation, 45, 95. pensions as, Eastern Europe, 123, 154-55; role of 200; providing an enabling environ- education in preparing individuals for, ment for, 118, 208. See ako Hcalth 268 insurance; Invaliditv pensions; Social Labor mobilization campaigns, 122-Z3 insurance; Unemployment bencfits Labor productivity: active labor marker Interest groups, 46, 331 policies and, 181-82; human Intemational Labour Organisation, 14, rsources dcvelopment and, 4; impact 28 nZ, 155, 157. 178, 179 of family benefits on, 246-47; impact Intervention, govemment, types of, 15, of health on, 301-02; policies to 34-35 improve, 116, 154-55; in prereform Invaliditv pensions. 196. 203, 221 Central and Eastern Europe, 65, 126- Investment, bias in socialist economies 27, 133; training and, 181-82; wages toward, 64, 70, 73 and, 128-Z9 [ 382 l INDEX Laporte, Bruno, 275 Nationalism, 266, 325 Latin America, 17, 211-14, 39 Nongovernmental organizations: role in Latvia, 224 health care of, 310; role in social assis- Layard, Richard, 147, 152, 156, 158, tance of, 234, Z43, 256-58; role in 198, 224 n8 unemploymcnt scrvices of, 184, 186 Lcgislation: consumer protcction, 34, Nuti, Domenico M., 91, 141 49; essential design elemcnts of, 341- Occupational mobility. See Labor 42: to establish rights of workers and mobility property owfners, 37, 49, 116, 151, Occupational safety. SeJob safety 157; lack of capacity to implement, Ofcr, C., 53, 66, 68, 75 103-04; lack of market-supporting, Okun, Arthur, 41, 42 21-22, 37, 95; monitoring outcomes "Oldthink:" 23, 107 of, 347-49; need to involve persons On-thejob training, 184. 261 with implementation skills in drafting, Opinion polls, 338 119, 218, 220; primary versus second- Opportunity cost, 32, 62, 107 ary, 34243 Organization for Economic Cooperation Legislative overload, 22, 86, 100 and Development. See Industrial Leipziger, Danny M., 4, 239 countrics Life expectancy, 290-92, 293, 294 Output decline: causes of, 66, 89-91; Lithuania, 1, 10, 259 n7 effccts of, 5-6, 79-81,.92-93; cxtent of, 10, 66-67. See also nats of cownnes McAuley, Alastsir, 74.80 Overstaffing by enterprises, 65, 126 Macroeconomic stabilization, 10-12, 23, 90, 113-14 "Paradox of inEenE" 64 Managed competition, 308 P"ay-s-ou-go insurance schemes, 208- Mandates, electoral, 102, 331, 340-41 10, 22a, 224 nl1% Marker failurc, 43-45, 95 Pensionable 2gc, 17. 196, 203, 22 Marx, Karl, 56 Pensions: administrative issues regard- Matching grants. 246 ing, 214, 21t7; alternative models of, Materni, v be. cfits, 2-2, 230 &ro ^ .222-23; consumer information and Maternity benefits, 222 230. eechoice in, 209; cst containment for, namer of rozontriss 202; defined benefit and defined con- Maternity leave, 71, 72, 154, 227 tribUEio n types of, 209, 212Z; effects of Measism-LagoCaImcome 21.e12s 29-1 reform of, 210, 213-15; eligibility of Mc2a3 cr clo, e I ontinuing workers for, 196, 203, 221; funded versus pay-as-you-go schemcs Micklewrighr. John, 73, 80, 82, 133, for, 208-9, 210. 216; impact of infla- 198,228,234,.238,248 tion on, 217, 222, 224 nl t; insurance Migration, 123, 136 function of, 200-01; invalidity, 196, Milanovic Brralnko, 228, 235 203, 221; in prereformn Central and Minimum wage: and arguments for Eastern Europe. 71; private, 27, 84, retaining, 159 n5; and gro'vth in over- 208-18,221-22; reform of, 217; rela- all wages, 145; inccntive effccts of, tionship between contributions and 152; need to reduce or abolish, 153; benefits of, 204; role in social inegra- rclation of cash benefit levels to, 197, tion and income smoothing of, 201. 205; relation to poverty line of, 153- alsao names of countis 54, 249. See a/so names of coiaers Pharrnaceuticais, 299, 314 "Missine ecanomic concepts, 62-63, Poland: active labor market policies in, 107 174, 177, 191 nl; administrative pay Monetary overhang, 90 increases in. 95; education in, 264-65, Moral hazard, 41, 44-45, 218 268, 272-73, 277, 281, 286 nn5-6, Mortality rates, 291, 294 287 n 14. 287 n16; enterprise profits [383 1 INDE'X Poland (contdiupa) bcnefits of, 258; cost containment in, in, 109 n5; cxcess wage tax in, 145; 243-44, 257; cffccts on cconomic external debt of, 68; family allowances growth of, 4; efficiency of, 194; in, 229; hcalth carc in, 299, 300, 304- emphasis in carly transition on, 26, 05, 307-10, 316, 317; incomes policy 192, 201, 206,220, 226; family benc- in, 145; inflation in, 259 n4; job crc- fits and, 201, 240, 247-49; financing ation in, 184; pensions in, 196, 224; of, 258; gaps in coverage of, 196-97; poverty rates in, 80, 2:35; privatization incentive effectN of, 153, 197, 237; in, 151; proportional representation in, negative incoine tax and, 237; non- 99; reform within socialist system in, governmental organizations and, 243; 54; training programs in, 165, 179, objectives of, 30-31; in prereforrn 181, 191 n3; unemployment and Central and Eastern Europe, 228; benefits in, 1, 80, 135, 162, 174, 196, reform of, 238-42; relation to mini- 206; unions in, 135; wage dispersion mumrwage of, 197; targeting of, 117, in, 128 194-95; types of, 194, 227, 237, 256 Policy advisers, role of, 340 Poverty trap, 245 Policy strategy, overall design of pro- Preker, Alexander S., 288 posed, 23-24 Preschool cducation, 261, 281, 283, 285 Political and administrative cycles. 336- Preventive health carc, 304, 319 37.349-50 Price liberalization, 24, 80, 91, 139-40 Political conimunication, 27, 101-02, Primary education. See Basic education 219, 326, 333-34, 33739, 350 Private pensions. See Pcnsions, private Political issucs: in active labor market Privatization, 49, 146, 151, 190. St also policy, 187; as constraint on reforms, Capital narkets; Chile; Competition; 98-102, 326-34; as force driving Economic restructuring, Legislation change, 2 1, 8487; in education, 263, Productivity, labor. See Labor 282-83; as intcgral part of reforms, 7; productivity in labor market reforms, 137; in over- Pro-natalist policies, 231, 232, 240 all reform strategv, 119; priorities and Proportional representation, 84, 331, sequencing of, 349-51; in social assis- 351 n5 tance, 25455; in unemnployment Psacharopolous, George, 239, 289 Political parties, 84. 97, 326, 331.334, Public goods: theory of, 36, 37; in hcalth 340-41 care, 309, 310 Politcal stability, as prerequisite. for Public health services, 289, 296, 310, Pn brarcfrmsse 7for425 314,315,319 reforms, 7. 324 25 Public labor cxchanges, 163, 177, 178 Poverty: attitudes tow ard, 233; defining, Public relations. See Political communica- mcasuring, and monitoring, 82, 193- 96, 256-57; incidence of, 234-35; Pior indicators of, 117, 194, 206, 221, Pubicworks employmcnt. &eJob 256, 257; output decline as cause of creation increasing, 81; in prereform Central Quality. See Standards and Eastern Europe. 73-74, 80; women and children in, 81, 236. Set "Ratcher principle," 59 also names of ountries Ravallion, Marrin, 118. 228, 251 Poverty gap, 235 Redistribution: inflation and, 10; famrily Povertv line: definition of, 193-94, 252; benefits as means of, 20; income historical levels of, 232; relationship of transfers and, 14; intcrrcgional, 98; as cash benefits to, 205-07. 221; rela- objectiVC of reform, 31; regulation of, tionship of minimum rage to, 153-54, 23-24; social insurance as means of, 249 207; through pensions, 215, 223 Poverty relief: cash versus in-kind, 237, Reform: expectations for, 27, 87, 119, 250; coordination with other cash 259 n3, 328, 338, 351 n3; monitoring 1384 INDEX Reform (eondned) Sipos, Sdndor, 228, 231, 234, 236, 240 outcomes of, 347-49; strategy for Sick pay, 71, 197, 202. 206 overall, 113-20; Slowdown in growth. Ste Output decline Regulation: absence during transition of Small businesses, 183 adequate, 95; capturc by interest Smith, Adam, 33 groups of. 46; in cases of imperfect Social assistance: administrative issues information, 36, 49; of consumer regarding, 234, 245, 251-53, 256-58; goods production, 42; of financial mar- coordination of withdrawal of subsidies kets, 209; of health carc, 299, 313, with, 242, 232; cost of, 243-44, 257; 316; of health insurance, 27, 44; of dangers of inadequate, 250, 254; housing, 43; of labor markCts and decentralization of, 243; definition of, institutions, 155, 157; in ovcrall 193; financing of, 245-46, 256; in prc- reform strategy, 1 16-18; of private rcform Ccntral and Eastcrn Europe, employmcnt scrvices, 178; of private 232-34; incentive effects of, 245-46; pensions, 27, 208, 217, 222; purposes incomc testing for. 252; nongovern- of, 23, 34; of social insurance, 205-08 mental organizations in, 234, 243, Rcplaccmcnt rates. 197-98, 204-05 256-58; other social policies and, 207, Restructuring, cconomic, 9, 13-20. 87, 241, 245, 252, 253; rationale for, 93-95. 115-16 241-42; reform of, 252-53, 255-58; Retircmcnt pensions. See Pcnsions setting lcvcls of, 249; targting of, Rctraining See adult cducation; Training 243, 256, 257 Revenga, Ana, 145 Social insurancc: administrative issues Romania: active labor market policies in, regarding, 218-19, 221; building mar- 165, 191 n2; distrust of governmcnt kets in, 204-05; contributions regimc in, 328; cducation in, 264, 266, 268, for, 198, 204-05, 207-08, 218-19, 271, 272, 287 nlZ; extcrnal debt of, 222, 224 n9; cost continment in, 68; health care in, Z97; maternitv 195-96, 202 221; coverage of, 207; benefits in, 229; output decline in, 90; definition of, 192; incentive cffccts of, poverty rare in, 236; training in, 181 204-05; linkages betwvcn social assis- Rosa, Jcan-Jacques, 210 rance and, 207, 241, 245; need to sep- Rule of law, 59, 98-99 aratc other cash benefits from, 200, Russia: constitutional conflicrs in, 99; 256; objectives of, 30; in prereform death rates in. 1; distrust of govem- Ccntral and Eastern Europe, 195; pri- ment in, 328; exccss vage tax in, 145; orities and scquencing of reform of, health carc in, 294,301, 308,310, 220-23; rediscrbucve function of, 312, 316; infant mortalitv in, 81; loss 207; regulation of, 205-S08; reiation of of empire by, 326; political parties in, povcrty linc to, 207, 221. S.ralo 334; povertv in, 236; privatiaidon in, namnsofcountnis 151; unemploymenc among women in, Social integration, role of social policy in, 80; workcr participation in managc- 31,200-01,260 ment in, 137; workfare and employ- Social securitv. Se Cash benefits ment subsidies in, 329. Steak. Soviec Social workcrs, 234, 238, 253 Union, former Soft budget constraints, 13, 54 Rutkowski, Michal, 135, 139 Soviet Union, former: alcoholism in, 68; auarkic policies of, 54-56; bias Sachs, Jeffrey, 91, 144, 155, 259 n4 toward producer goods in, 64; death Secondarv education, 261, 279, 275, rates in, 72; decentralization in, 167; 284 erosion of rule of law in, 98; hcalth Self-employmcnt, 183. 245 carc in, 300, 309. 316; incidence of Self-intercst, economic function of, 60, povcrtv in, 74; income distribution in, 83-84 73-74. 1 28; inexperience with democ- Self-targting of benefits, 118 racv and unemplovment in, 22, 96, Sickness funds, 306 329; labor rnobility in, I 2Z; life expec- 1385 1 INDEX Soviet Union, former (continued) Think tanks, 340 tancy in, 72; output decline in, 66-67, Third-party payment problem, 41, 44, 90; pensions in, 254; poverty and 198, 205,312,314,315 inequality in, 80, 235; reforms of cen- Top-down approach to government, 94, tral planning system in, 54; support for 106, 326, 335 loss-making enterpriscs in, 174. See Trade unions. See Unions also names of republics Training; in activc labor markct policy, Stabilization, macroeconomic, 10-12, 190; to address sectoral imbalances, 23, 90, 113-14 163; of administrators, 280, 346-47; Staffing issucs, 300, 346-47 adult cducation and, 270-71; costs Standards: in education, 26, 269-70, and benefits of, 182; cfficiency of mar- 273, 279, 283-85; in health care, 290, kcts in, 45; importance for economic 296-97, 304-05, 314; for private growth of, 5; on-the-job, 61, 184, 261; employment services, 178 in prereform Central and Eastern State. role of. Se aGoveinmen, role of Europe, 71, 165, 166; provision by Static efficiency, 33 enterprises of, 267, 275; relationship Stiglitz, Joseph E., 49 ni, 50 n3, 224 to labor productivity of, 181-82; role nIO of private providers in, 84. 179, 185- Student-teacher ratios, 272, 286 nIO 86; of social assistance workers, 254; Student loans, 37. 244, 280. 275, 285 in socialist economics, 61; maxtion to Subsidies: for basic commodities, 13, 34, mobilize resources for, 165, 275, 286 61. 70, 81; coordination with social nl3 assistance of withdrawal of. 242, 252; Training boards, 271 in education, 275, 277; cmploymcnt, Transitional private cmployment., 184 150, 184, 20Z, 330; for health care, Tullock, Gordon, 46 314, 319, 320; for housing, 61; as a pcrcentage of oDP, 224 n4; purpose of, Ukraine: constitutional conflict in, 109 34; in situation of increasing returns to n9; family bcnefits in, 232; fiscal crisis scalc, 39 in, 92; minimum wage in, 153; social insurance contributions in, 198; uncm- Targeting: of activc labor market poli- ployrrient benefits in, 197 cies, 162, 176-77; of cash benefits, Unemploymenc assessment and coun- 201; of family benefits, 228, 231, 247; selingfor, 178; attitudes toward, 22, horizontal vcrsus vertical efficiency in, 96, 165, 328-29; community co- 114; of poverty relief, 1 17, 194-95; nomic development and, 185; hidden, self-, 118; of social assistance, 243, 134-35; impact on wage levels of, 256,257 147; increase during transition in, 79; Taxation: absence of clear concept of, inevitability in markct economy of, 107; excess wage, 133, 142, 144-45; 147; long-tcrm, 147, 158, 169; rnon- of family benefits, 248-49, 257; fiscal itoring of, 174-75, 18243, 189; non- crisis and, 21, 92-93; impact of infla- govemmcntal organizations and, 184, don on revenues from, 10; incentivc 186; outflow rates from, 169; output effects of. 13, 30. 34, 114; negatiive decline as cause of, 79-80; policies to income, 237, 240, 242, Z57, 259 n7; address, 117, 133-35, 158, 174-81, to pay for worker retraining, 165, 275, 188-91; political issues relating to, 286 n13; of pension contributions, 166-67; sectoral and geographical dif- 211 fercnces in, 167; social and political Tax credits, 248 aspects of. 165-67, 330; of unskilled Taylorism, 61, 123, 159 n2 and skilled workers, 167; among Teachers, 273, 278, 28345 women and vouth, 801 81, 167-69. Temporanrjob creation, 184-85 'Zee aL mnams ofcountries Textbooks, 267, 273-74, 276-77, 283, Unemployment benefis absence in pre- 284 reform Central and Eastem Europe of, 1 386 1 IN D EX Unemploymcnt bcncfits (cotinned) institutions and legal framework for, 70, 122, 135, 166; capitalization of, 143; palliativc mcasurcs for, 157; pri- 184, 191 n7; conditions on reccipt of, orities and seqluencing of reform of, 171; covcragc of, 207; duration of, 157; strategy for, 142-44. SWan/o 171; eligibility for social assistance Active labor market policies; Incomes and, 207; flat-rate, 195, 206; incentive policics; Unemployment benefits effects of, 153; information scrvices in Wages: impact of uncmployment bene- administration of, 218; linkages of fits on, 141; incrcasing dispcrsion of, active labor market policies to, 189; 78-79; labor productivity and, 128- moral hazard in, 44-45; need to sim- £9; role of market in setting, 14; in plify administration of, 218, Z21; rela- socialist economics, 60-61, 94; ten- tion of povcrty linc and minimum dcncy to cxceed marginal product of, wagc to, 205, 207, 221; replacemcnt 152 rate for, 197, 198; time limits on, 206, Wage setting: by enterpriscs, 135; in pre- Z41; urgent need to strcngthen, 220 reform Central and Eastern Europe, Unemployment trap, 245 60, 122, 128, 133; in relation to indi- Unions: and active labor market policy, vidual performance, 78. 128; role of 167, 189; and cnterprisc managcment, unions in, 135, 155 137; in prereform Central and Eastern Wagc taxes, excess, 133, 142, 144-45 Europc, 62, 123, 165; unemploymcnt Weitzman, Marin, 67 in countrics with strong, 156; and Western Europe: active labor market pol- wage setting, 135, 155; weakness of, icies in, 180; differences in incomes 139, 14 and living standards vith, 74, 199; Union of Sovict Socialist Republics. Se: family benefits in, 226, 229, 23 1; pov- Soviet Union erty relief in, 238; privatc pensions in, United Kingdom: family benefits in, 240; 211; shared values of, 6; social soli- poll tax in, 348; private pensions in, darity in, 19, 31; social spending in, 224 n13, 225 n17; reduced role of 17-19; spcnding on education in, 17 state in, 19; private training scrvices Wilcs, Peter, 53, 56, 60, 62, 63, 73, 133 in, 179; social assistance in, 238; Wilkinson, R. G., 291 social spending in, 17; wage dispcrsion Women: advantages of fimily benefits in, 133 for, 227-28, 240; education for, 72, United States: activc labor market poli- 263; entreprcncvrship among, 183- cies of, 180; health care in, 5, 70; pen- 84; health services for, 304,318; inci- sionable age in, 17; private pensions dencc of povercy among, 81, 236; in, 224 n 13; reduced role of staec in, labor force participation races of, 72, 19: social assistance in, 227, 232, 80, 125-6, 227-28, 247, 281; unem- 238-39; spending on education in, 17 ployment among, 80, 81, 167-69 Universal benefits, 193, 245 Work, attitudes towvard, 122 Universities. See Higher education Worker participation in enterprise man- Uprating of benefits, 204 agement, 123, 137, 139 Van de Walle, Dominique, 228 'Workers councis, 123, 125, 137. 144 Vertical efficiency, 114, 117, 194, 234 Workfre, 329-30 Vocational education, 73, 129, 261, 264, Yeltsin, Boris, 224 n7 270, 272, 276, 284 Yugoslavia, former, 15, 54.68 Wage bargaining, 135, 155, 158 Wage controls. Se Incomes policies Wage differentials, 78, 122. 128, 129, 136, 141 Wage and employment policy: adminis- trative issues in, 155-56; building 1387] The complete backlist of publications from the World Bank is shown in the annual Index of Publicatons, which contains an alphabetical tide list and indexes of subjects, authors. and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. Z0433, or from Publications, The World Bank, 66, avenue d'lena, 75116 Paris, France. The' World Bank THE PEOPLE OF-CENTRAL AND EASTERN EUROPiE need no reminder that the early', stage of reform is uncertain and painful.. Their. new economic --and politicatl i systems are giving them more individual freedom.' 'But for most of them, living- standards are falling-poften sharply-as poverty, unemployment, and death,races ;.':-are.rising. Thisbook presenrcspolicies for labor markets and social needs-in this.' time of hopes, transformation, andtears.. The'book--whichis, about the-Eu'ropean'irepublics, of the former U.S.S.R.'as well as the'other Central and Eastern European countries-makes. three: main -argurnents.:-!First, it is crucial th ththese countries' human resources be developed -. thraugh more effective labor marke improved education, reduced poverty and, - better health care. Secund, the statestill'has a major role.? Third, reform will'fail' unless. p-lincal and .administradve, ,realitie ae cnsidered when policis' are designed and implemente. ', ' , . . - V-icla& Havel says in his for word: . . . . .. ::-.-The rue-'aim of'ch refors' is'to empowr individual citizens. The mtfk: -way:to do so is to.givetem. owledge,and the 'reedom to use 1 ,.! Empowerment. also has a. more- technical dimension It comes very directly from betr heth comsfrm sferbljob sisad well-functioning labour' markets ,which-;.allow, people, some power over * the&. worl .at cois' fm'ameasure, o -.income-ecun.. Though. .-nsome isecunty is 'inescapable in a rnarket- conomny,'exeme. poverty and -. insecuy sap a peon's ide ity 'and c 'ry hisor her freedomi These d'; topics re the subjectof this boo Theylare .important oih:material aspects of the' refoirins.. More -important, they'. are. cn 'd .citizens of,ou r 'eformng counties;-genuire- tfreedom 'd-isome ontrolnt over., eir own lives. - , - '; NICHOLAS: BARR, is-sn economist at the Lod'on -School. 'o Economics ,and Political Science He ;was a; conulta to 'te- Human- ReourcsOperans Division of the Wod Bank's Central:and'Souther-.Europe Deparmenti from 1990 to 1992.-: 9 780195 209983 ; . . * - ;v , -; . . . - A . -, , . rd, , e , . ,*5 _ *;X. ;: :O d University Prs ISBN 0 -19- 520998- 2 ' - Coer ' dXakrsbyStxdio Cn4J - ; - . - - . . - t'. * : ' '' f- - -' :-t ~~~~~~~~~~~~-: . --- W ;;, ' , -5