Labor markets, Inequality and Income Distribution in Transition

I. Labor Markets 1. The Labor in the Command Era characteristics

– major element was education, the transition started with major stock of human capital

– full employment-underemployment in a setting where the dismissal of workers, whether productive or not was generally difficult

– wage differentials were used to reward differential inputs and to motivate effort, but even so the outcome was generally egalitarian, compared with market economies

2. The labor in transition– conflict between labor market adjustment and command economy "job right

constraint" (full employment) – distribution of income changed sharply – Movement of labor from state sector to private sector; considerable

unemployment created.– Reasons for increase in unemployment rate in transition

• decreased state employment (closure of state enterprises)• decreased private employment (closure of private enterprises)• job quitters’ entry into unemployment• the imposition of hard budget

– problem of financing unemployment benefits

• Aghion-Blanchard model“On the Speed of Transition” Aghion P. & O. Blanchard, NBER Paper

1994; Model analyzes the movement of labor from the former state sector to the private sector; the levels of unemployment and change in wages. It includes:

a) The speed with which production and hence inputs will be transferred from the state to the emerging private sector.

b) The nature of the mechanisms involved-changes in wage level in the declining state sector and in the emerging private sector, and the level of unemployment.

• Model:– Relative cost and demand changes with hardening the budget constraint have

forced firms to substantially reduce employment.– The same relative cost and demand changes have led to a rapid initial increase

in private employment (small scale trade and services) but further growth of private sector is constrained by lack of expertise and external finance.

– The net effect of these changes has been an increase in unemployment that affects the speed of restructuring and rate of private sector growth.

E+N+U=1 labor forceE-state sector employment; N- private sector employment; U-unemployment

Before transition E=1 and N=U=0During transition:• State sector-restructuring, decrease in employment• New private sector-increase in employment

– Job creation– Private wages depend on labor mkt conditions– Higher unemployment→ lower wages→ faster private job creation– Higher unemployment→ unemployment benefits→ higher taxes per

worker→ c.p. decrease in private job creation.

• Unemployment and speed of restructuring– The flow into unemployment s(1-λ) depends on the speed of restructuring and

the proportion of workers loosing their jobs in the process– The flow out of unemployment is equal to the private job creation, H– As unemployment increases, the effect that dominates initially is the direct

effect on wages, so that private job creation increases; as unemployment gets sufficiently large, the effect on taxes dominates, and private job creation declines.

• Equilibrium rate of unemployment and speed of restructuring—the flow into employment from restructuring is just absorbed by the rate of private job creation. – The initial adjustment→ initial unemployment rate that exceeds the

equilibrium rate. Restructuring does not take place until job creation has reduced unemployment to low levels.

• Policy implication—the initial phase of adjustment, priority should be given to private job creation. Trying to increase the speed of restructuring may not be feasible (opposition of workers in state firms).

• Poland

3. Empirical Evidence:“Value of human capital in transition to market: Evidence from

Slovenia,” P. Orazem and M. Vodopivec, European Econ Review 41.

Goal: How transition has altered returns to human capital? It focuses on changes of labor mobility and wage structure.

• Human Capital and Labor Market Transitions• Changes in patterns of mobility--identifying the determinants of exit from both

unemployment and employment (multinomial logit and hazard models)• Education—more educated, more likely to find a job; the share of university

graduates among unemployed declined• Experience—the least experienced group faced significantly higher probability of

job loss• Human Capital and Transition Wages

• Dramatic changes in the structure of earnings– Returns to education—average returns to years of education rose relative to earnings of

the least educated group– Returns to experience—returns to the most experienced rise relative to those with the

least experience, for men and women.• Conclusions

– Transition dramatically increased the wage and employment premium attached to skilled labor. More educated workers have not only experienced an increase in relative wages, but they have experienced greater relative success in switching jobs, lower probability of layoff, and better chance of finding a job if unemployed.

– The increase in the premium to job experience is much less pronounced than for education, but still shows up in higher probability of exit from unemployment to job and in lower probability of exit from employment to unemployment.

– Relative wages have grown dramatically for the most educated.

“Winners and Losers in Russia’s Economic Transition,” E. Brainerd, American econ Review 88(1998): 10-94-1116

Goal—to answer the questions: “Have Russian workers benefited from the changes?, “Who are the winners and losers of the transition?, “Is increased inequality in Russia real?

Data-cross-section household surveys conducted before and after the transition

Findings:a) Overall wage inequality nearly doubled 1991-1994 and reached a level higher than that in the USb) Returns to both measured skills (education, occupation) and unmeasured skills within groups have increased.c) Relative wages for older workers have declinedd) Wages of women relative to men have declinede) The winners-young well-educated men; the losers-older workers (men) and women

II. Human capital-demographic characteristics1. Health and education conditions are generally still favorable

compared with other countries at similar levels of income2. Demographic patterns -life-expectancy in transition countries

decreased dramatically and recovered modestly.• increase in death rates and decrease in birth rates• these patterns have been much more severe in CIS than CEE

III. Social problems

1. Increased poverty – Definition-it is necessary to establish a poverty line in terms of appropriate

variable, such as income, health conditions– Measurement-means determining what portion of the population is in poverty

and thus fall falls below the established minimum– Incidence of poverty is significant in CIS & less significant in CEE

2. Problem of maintaining adequate spending on health, education and pensions

3. Income inequality increased during early years of transition

“Impacts of Economic Reform in Poland; Incidence and Welfare Changes within a Consistent Framework,” Huffman S.& S. Johnson, The Review of Economics and Statistics, Vol. 86, 2, May, 2004

• Goal—how do households adjust their behavior when the opportunity sets of consumption goods change? How do consumption patterns change in response to increased variety of goods? Are the households better off or worse off under the new system? – This study focuses on the consequences of removing rationing for demands of

goods and for the household consumption patterns generally and then on welfare.

– Welfare implications of the transition are derived from a model of household consumption that explicitly reflects the effects of rationing.

– In answering the question of how consumption patterns change we have to consider the following:

• Increased availability of consumption goods: quantity & variety.• What did household's "resources buy" before and after the reforms (change in the

household’s budget constraint)

• Consumer patterns during the transition in Poland– Decrease expenditure share on food, clothing and footwear– Increase expenditure share on fuel, electricity, transport, communication and

other goods– Growing demand for housing and durables

• Empirical specification– The final specification of the equations for estimating of the AIDS with virtual

prices is

where i = 1, ..., n goods, and t = 1, ..., T observations.

– The standard demand system is

• Calculation of virtual prices– Definition-the price at which the consumer voluntarily chooses the rationed level– external prices- from Germany– Hausman method for calculating virtual prices.

• Data– Polish Household Budget Survey 1987 – 1992– Variables-the budgeted shares for six expenditure groups

• food • alcohol and tobacco • clothing and footwear • housing • fuel, electricity, communication, and transportation• other

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– The results show that over 1987 to 1992 the CLI, ignoring the rationing effects, is biased upward from 1.53 to 3.71 percentage points per year.

– Compared to the estimates of welfare loss that neglect the rationing effects during the prereform period, the estimated welfare losses that reflect the rationing are reduced by 50 percent using Hausman’s virtual prices and by 75 percent using external proxy virtual prices.

– The Incidence of Impacts of Transition for Selected Household Groups

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“Returns to skills and the speed of reforms: evidence from Central and Eastern Europe, China and Russia,” Fleisher B, K. Sabirianova and X. Wang. Journal of Comparative Economics 2005, 33.

I. Introduction.• Econ reforms—enterprises operate under fewer constraints. Therefore,

returns to schooling should have increased.• The time path of returns to schooling has not been uniform.

– Studies of CEE and Russia (CEER) indicate a trend for returns to schooling to rise almost immediately after reform, but at different speeds.

– Studies of China in the period covering approximately the first 15 years of its econ transition report low rates of return to schooling.

• Post-reform time paths of major economic variables were also quite different

– In China, a relatively small proportion of workers experienced declining real incomes in the early transition whereas, in CEER, the opposite was true.

– The role of econ reforms, the speed of relaxation of the old planning constraints, and the new forms of ownership in promoting changes in relative wages.

• The path of returns to schooling in transition economies has evolved in two phases

– The early phase (initial, disequilibrium phase of econ transition)--the period in which the transition economies moved from wage setting toward a phase in which wages reflect the relative marginal products of workers.

– In the latter phase, the relative wages are expected to match more closely the relative marginal products of skilled and unskilled, or highly educated and less educated, workers.

• Hypothesis

– Speed of the reforms —the higher the speed of reforms, the faster should returns to schooling be adjusted to market rates. To explain wage adjustments during the first phase-- the speed of relative wage adjustment to the ratio of marginal products reflects the speed of the relaxation of legal, regulatory, and institutional constraints on wage-setting behavior.

– Economic disequilibria —structural transformations, disruptions, and economic disequilibria are important factors so that the rapid increase in returns to schooling during the first phase reflects the ability of highly-educated individuals to respond to changing opportunities in a disequilibrium.

• Goal of the paper —to compare the relative importance of speed of the reforms and economic disequilibria with metadata from 39 studies of 11 transition economies, linking these data to a set of measures on reform progress and macroeconomic volatility.

Table 2 • Reports average returns to schooling, 11 countries, 1975-2002. • The overall trend of returns to schooling is positive, and highly

significant with a noticeable increase in the mean and variance of the returns to schooling over time.

Table 3• The time path of returns to schooling has not been uniform across

countries or steady within countries over time• Pre-reform periods, schooling rates ranged from a low of 1.5 percent

in China to a high of 6.3 percent in Hungary,• Early reform period, schooling returns increased in China, but from an

extremely low level to one that remained far below those in other transition economies. These returns rose much more in percentage points in the other countries.

• Some variation is noticeable in the time paths of rates of return among the CEER countries, particularly between low-return countries, e.g., Romania and Ukraine, and other CEER countries.

• The biggest gap in the first phase is between the CEER countries on the one hand and China on the other.

II. Returns to schooling and the speed of reforms and macroeconomic disequilibrium

1. How cross-country variation in the growth of returns to schooling in transition economies can be explained by the speed of market reforms, initial conditions, and degree of macroeconomic volatility during the early reform period.

2. Reform progress is defined in terms of liberalization of prices and wages, private ownership, enterprise reforms, and the openness of the economy; used quantitative measures such as the proportion of GDP produced in the private sector and the share of foreign direct investment (FDI) in GDP as well as qualitative indices developed by the EBRD, such as the degree of price, wage and trade liberalization, large-scale privatization, and enterprise restructuring.

3. An overall measure of the speed of reforms, which is a composite of all seven reform indices and variables.

4. Transition approach • The big bang reform (CEER) vs growing out of the plan approach (China,

where the Chinese Communist Party has retained political power throughout the econ transition).

5. In contrast to its relatively slow movement toward free markets, China experienced the most rapid economic growth among these transition economies.

Table 5– China experienced the largest real GDP growth and real wage growth during

the first five transition years, while real wages declined in all CEER countries except Hungary.

– The effects of a loss of macroecon control defined as the fraction of total output produced under the Plan felt much more sharply in CEER than in China. In China, where the early transition was more gradual, inflation was lower than in any CEER.

– GDP growth and real wage growth, and inflation over the early reform period, indicate less volatility in China than in the CEER, the only exception being the standard deviation of real wage growth Hungary.

– This variation in the volatility of economic development across countries and between CEER & China may explain cross-country differences in returns to schooling in the early reform period.

– A rapid increase in returns to schooling may reflect the ability of highly-educated individuals to exploit opportunities that emerge in periods of disequilibrium.

– Hence, both disequilibrium and the speed of adjustment should determine the payoff to schooling during the transition process.

III. Empirical estimation and results• An empirical framework for explaining the cross-country and over-

time variation in returns to schooling based on differences in the speed of reforms and the volatility of economic change.

• On average, rates of return increase by 0.2 of a percentage point per year during the respective countries’ planning periods. Rates of return increase by 0.5 of a percentage point per year during early reform, by 0.3 of a percentage point during the late reform.

• Returns to schooling are estimated to have the highest rate of growth during the early period of the transition to a market

• All the coefficients on the speed of reform and macroeconomic volatility variables are statistically significant. Both reform speed and volatility are positively associated with an increase in the rate of return, but reform speed has a larger quantitative impact.

• Initial conditions have a substantial effect on the estimated returns to schooling—the higher is the level of liberalization at the start of reforms, the higher are the initial returns. Countries with less administrative regulations on wages and prices during the planning period are estimated to have higher schooling returns.

IV. Conclusions• The speed of economic transformation and the degree of economic

disequilibrium measured by macroeconomic volatility explain differences in the increase in the rates of return to schooling over time and across countries.

• The speed of reforms and volatility are positively associated with returns to schooling, ceteris paribus, and the quantitative impact of speed of reforms is perhaps twice as large as that of volatility.

• China is an outlier in that its rapid economic growth is associated with returns to schooling that remain below world average for comparable countries.