Labor markets in the transition economies: an overview.

• Author: Bah, El-hadj
• Position: P. 3-26 - Report

1. Introduction

   One of the more controversial aspects of the process of transition from central planning to a market economy in Eastern Europe and the former Soviet Union has been the performance of the labor market. High levels of unemployment at the outset of the transition were variously seen as having the potential to derail or delay meaningful reforms, as evidence that pursuing so-called "big bang" transition strategies were misguided, and as a demonstration that the transition was a complex process, one that brought both the fruits of capitalism as well as its problems, not the least of which were unemployment and income inequality. (3)

   While the subsequent recovery of output in these economies in the late 1990s was taken as evidence of progress with transition, the persistently high levels of unemployment gave rise to the notion of a "jobless recovery" where output rose without a concomitant increase in employment, leading to greater income inequality and to labor market pathologies such as high levels of youth unemployment and rising long-term unemployment. From 2000 to 2008, the transition economies experienced something of a boom, fueled in part by the global bubble economy that increased inflows of FDI, thereby increasing both the rate of capital formation and the growth of TFP through technology spillovers (Brada and Slaveski, 2012). Financial capital inflows increased as well, stimulating domestic demand and, at times, setting off housing and asset bubbles. The expansion of the global economy also increased the prices of fuels and minerals exported by some transition economies as well as the demand for steel, automobiles, etc., which were important in the export mix of other transition economies. On the eve of the crisis, unemployment rates had fallen significantly, suggesting that the effects of whatever labor market distortions, such as labor hoarding, soft budget constraints for employers and restrictive labor regulations, that had existed earlier in the transition period had ceased to be barriers to effective labor market functioning, and, although the crisis led to sharp increases in unemployment, the effect appears to have been short lived.

   This paper highlights the main issues surrounding the performance of transition economy labor markets, reviews these within the framework of a consistent set of macroeconomic data, identifies areas of agreement and those where further research is needed, and draws policy conclusions where possible. We begin by examining the macroeconomic trends evident during the transition, discuss some of the issues pertaining to the data on unemployment, and examine the literature on the functioning of the labor market from a macroeconomic standpoint. In the second half of this paper we examine microeconomic and structural factors that shape employment and labor market performance.

2. Macroeconomic Trends and Their Effect on Labor Markets

   2.1 Reforms and Growth

   The period since 1989 has seen major changes in output and employment in the countries of Eastern Europe and the former Soviet Union (FSU). Initially, all these countries saw a large decline in GDP (Table 1). The true extent of the decline in economic activity may have been less than official statistics suggest, and the true magnitude of the decline is the subject of considerable controversy (Campos and Coricelli, 2002), due to possible errors in the measurement of output (Johnson et al., 1997); to problems in the proper measurement of prices in a period of high inflation, large relative price and quality changes, and changes in the structure of economic activity (Filer and Hanousek, 2000); and to the emergence of a large, partly private, shadow economy of unregistered producers and under-reported output (Dobozi and Pohl, 1995). Nevertheless, for the purposes of this paper, we assume that the large inter-country differences in performance, as well as of the general path of output and inflation, can be viewed as reasonable approximations of events in the transition economies.

   Figure 1, which reports the real per capita GDP of most of the countries in the region, provides a clear view of aggregate output's path through the "transition recession followed by recovery" that characterized virtually all countries in the region. In the countries that joined the EU in 2004, called the Central European group in this paper, per capita GDP has exceeded 1989 levels since the mid-1990s. It is important to bear in mind that, leaving distributional issues aside, this performance implies a significant improvement in consumption because the share of government and domestically-financed investment in GDP declined relative to the Communist period. In the Balkan countries, with the exception of Croatia, GDP growth was less robust. Here too, however, most countries have attained 1989 per" capita levels of GDP, even if they have not exceeded them by the margin seen in the Central European countries. The countries of the former Soviet Union, excluding the Baltic States, the CIS countries in this study, only reached the 1989 level of GDP in the mid-2000s. This is true even of CIS countries exhibiting robust growth from the late 1990s onward. More troubling is that there is a group of low-income CIS countries that have experienced serious declines in per capita GDP for a sustained period of time. Such performance, however it translates into labor market performance, is a sign of a serious decline in welfare. Indeed, for all of the countries under consideration, taking the entire trajectory of the transition experience into account suggests that no country's population has been spared some economic hardship as a result of the transition. Implementing successful measures to improve employment opportunities and to provide for a better functioning of the labor market should have been and should continue to be an important policy concern in all transition economies.

   There is considerable controversy about the causes of the decline in output at the onset of transition. Some blamed a reduction in aggregate demand due to a sharp decline in central government spending on investment and defense, the collapse of CMEA trade and falling real incomes and wealth as the result of inflation brought about by price liberalization. (4) Others blamed supply-side dislocations, such as disruptions of production brought about by the end of central planning (Blanchard, 1997; Blanchard and Kremer, 1997), large relative price changes, and the absence of institutions needed to make markets function effectively (Murrell and Wang, 1993).

   Some countries sought to shelter firms and workers from the effects of large demand shocks and the need to undertake rapid restructuring and privatization by providing government subsidies and other supports to firms. In the long run, these economies found themselves in a low-growth, high-unemployment equilibrium in which neither the emergence of markets and market-supporting institutions nor effective response by firms to changes in relative prices were much in evidence. Nevertheless, it is also true that the countries with robust recoveries were characterized by strong growth of consumer and investment outlays, as well as by robust export growth. This suggests that a demand stimulus was a necessary but not sufficient condition for the resumption of economic growth. The fact that the faster-growing countries were also characterized by better-functioning markets, higher levels of private ownership of businesses, and the development of market-supporting institutions suggests that addressing supply-side factors through economic reform was also necessary for robust economic growth.

   A number of studies (e.g., Aslund et al. 1996, deMelo and Gelb, 1996, 1997 and Fischer et al., 1996) concluded that more reform led to higher GDP growth. Other research suggested that differences in the economic performance of the transition countries could be explained by variables other than the intensity of reforms such as location or starting conditions (Krueger and Ciolko, 1998; Stuart and Panayotopoulos, 1999). A meta-analysis of these and similar studies by Babecky and Campos (2011) concluded that the short-term effects of reform tend to be negative, but the long-term effects are positive for economic growth.

   One problem in drawing policy conclusions for the labor market from these results is that the findings described above apply to the early transition period. Polanec (2004) found that the manner and extent to which transition countries implemented...