Rationales for Wage Controls in Transition Economies

Two types of arguments for wage controls in transition economies have been made. Besides the argument that is familiar from disinflation strategies in other countries—wage controls can be an important tool in a heterodox stabilization program—there are the arguments that are specific to transition economies—wage controls can address the “corporate governance problem” and can encourage labor shedding in a bloated state sector.

Experience with wage controls in other countries has produced a general view that wage controls can play an important temporary role in a strong disinflation program but tend to lose their effectiveness rapidly.¹ Inflation stabilizations in Latin America and Israel suggest that wage controls can help break the inertia of inflation. Although fiscal correction is a sine qua non for low inflation, a disinflation strategy that focuses exclusively on the adjustment of aggregate demand may not be sufficient to bring down inflation quickly, because inflation is strongly affected by expectations and institutions. As long as wage setters are uncertain about the behavior of wages in other parts of the economy, they may hesitate to take the lead in halting wage increases in their sector. Thus, along with resolute fiscal consolidation and a firm primary nominal anchor—on money or the exchange rate—wage controls can help coordinate the adjustment of inflationary expectations.

The severity of the disruptions facing the Central European countries reinforced this argument for using wage controls. First, there were immense obstacles to stabilization: large monetary overhangs in Bulgaria and Romania, high inflation in Poland and Yugoslavia, and the threat of wage-price spirals as prices were liberalized in each of the countries. Second, there were enormous real shocks—the collapse of regional trade, sharp deteriorations in the terms of trade, and the need for strong investment to effect restructuring—all of which necessitated sizable reductions in real wages. Two other influences were also expected to reduce measured—though not actual—real wages: the shift from resource allocation through queuing and black markets to price mechanisms, and the potentially large improvement in the quality of the consumption basket as markets were opened to foreign goods.² On all these scores, the IMF had seldom if ever been involved in situations of such profound macroeconomic adjustments.

The task of addressing these problems was made all the more difficult because programs had to be formulated in conditions of institutional chaos. Particularly in Bulgaria, Czechoslovakia, Poland, and Romania, there was a real question whether existing and emerging institutions could exert the needed restraint on demand, prices, and wages. This suggested the need to secure several holds on the economy-through the conventional channels of credit and fiscal policy, but also the exchange rate (where possible), interest rates, and wages. In addition, discussions about wage controls between the government, labor unions, and employers could provide a forum for forging a social consensus on required adjustments.

While these problems argued for the use of wage controls in the initial stabilization phase, when macroeconomic conditions become more stable the justification for wage controls must rest on other considerations. Previous experience indicates that wage controls tend to be undermined over time by problems with enforcement, particularly increasing exemptions and noncompliance by would-be free riders. Also, real wage reductions achieved through wage controls are often reversed by a spurt in wages following the lifting of the controls (Flanagan (1992)). Therefore, the question for the medium term is whether the distinctive conditions of transition economies—specifically the dominance of the state sector in employment and production—justify wage controls on an ongoing basis.

It has been argued that transition economies require wage controls in order to address the “corporate governance problem” and to encourage labor shedding in the state sector.³ The corporate governance problem has two dimensions. First, given that budget constraints were “soft” under central planning—that is, credit policy was subjugated to the fulfillment of material targets—firms in transition economies do not face the same kind of budget constraints as firms in market economies. If the attempts to impose hard budget constraints are not credible, wages may escalate, since firms expect to be bailed out if they experience financial difficulties. Second, even if budget constraints are hard, poorly defined property rights mean that the objective functions of firms may differ from those of firms in market economies. With the collapse of communism, the control mechanisms of central planning no longer exist, but market institutions have not yet developed fully (“neither plan nor market”). In the absence of clearly defined property rights, the prospect of privatization may cause workers and managers to try to appropriate the firm’s assets—for example, by forgoing maintenance and replacement investment. With no advocate for capital, the combination of worker influence on management decisions and the anticipation of ownership transformation may lead firms to overpay labor.

The second distinctive rationale for wage controls in transition economies is that, by taxing the marginal labor input, they can provide an incentive to shed labor. Reducing employment in the state sector was a specific program objective in Poland in 1990 and in Bulgaria in 1991 and 1992. The idea is that labor shedding in the state sector promotes economic restructuring. These considerations conditioned the incorporation of wage controls in the initial programs, except in Yugoslavia, where they were meant to play a more conventional nominal anchor role (see Box 5-1).⁴ Yugoslavia will, therefore, not be included in the remainder of this review.

The case against wage controls is that they distort the structure of wages and inculcate wage indexation. In transition economies, the distortive effects are particularly important because the wage structure was highly distorted to begin with. Wage distortions result in a misallocation of resources that causes existing labor to be used inefficiently, though the static welfare costs due to these distortions are probably not large, as the analysis of deadweight losses indicates. Of greater concern is the effect of wage distortions on the accumulation of human capital and therefore on economic growth. Even a small effect on the growth rate can have a large impact on welfare over time.

Box 5-1.

Yugoslavia

Wage controls were a key feature of the 1990 stand-by arrangement with Yugoslavia. Although Yugoslavia had previously been a centrally planned economy, important aspects of the economy had been liberalized from the 1960s on. For example, by 1990 most prices were freely determined. Thus, the 1990 program did not mark an important break with the past or the beginning of a transition to a market economy.

Wage controls took the form of an intervention law that froze wages in the entire socialized sector for six months. In principle, this provided a second nominal anchor in addition to the exchange rate. By preventing any adjustment of relative wages, the wage freeze would have ossified the wage structure.

In practice, the nominal wage freeze was not implemented, because the federal government was unable to prevent republican and provincial authorities from granting exceptions to the freeze. Lax fiscal and monetary policies led to nominal wage growth substantially in excess of its target. Thus, notwithstanding the dampening effect of the fixed exchange rate on inflation expectations, the performance criterion on the average wage was breached at the first test date (end-March), and wages were never brought back on track (Table 5-1).

Table 5-1.

Yugoslavia: Performance Criterion on Wages¹

Source: IMF staff estimates.

¹ Average monthly net personal income per worker in the socialized sector (new dinars per month).

² Since wages were frozen for six months (only), neither performance criteria nor indicative ceilings beyond June were specified initially.

Table 5-1.

Yugoslavia: Performance Criterion on Wages¹

	19902
	January-March	April-June
Maximum limit	2,602	2,602
Outcome	3,344	4,003

Source: IMF staff estimates.

¹ Average monthly net personal income per worker in the socialized sector (new dinars per month).

² Since wages were frozen for six months (only), neither performance criteria nor indicative ceilings beyond June were specified initially.

View Table

Table 5-1.

Yugoslavia: Performance Criterion on Wages¹

	19902
	January-March	April-June
Maximum limit	2,602	2,602
Outcome	3,344	4,003

Source: IMF staff estimates.

¹ Average monthly net personal income per worker in the socialized sector (new dinars per month).

² Since wages were frozen for six months (only), neither performance criteria nor indicative ceilings beyond June were specified initially.

The constrained geographical mobility of labor in transition economies may amplify the costs of wage distortions. The unreformed housing markets, with largely state-owned apartments, subsidized rents, and allocation other than by price, make it difficult for workers to move and discourage housing investment. Since labor mobility is limited, it is even more important to allow relative wages to change to reflect the scarcity of labor in different parts of the country. If relative wages are not allowed to change, say, because of an implicit indexation rule, then there will be less of an incentive to invest in labor-abundant parts of the country (where investment is most needed) and more of an incentive to invest in labor-scarce parts of the country. To the extent that the short-run elasticity of investment with respect to the real wage is low, the short-run costs of wage controls are low, but medium-term effects are likely to be larger.

Design of Wage Controls

Wage controls during the arrangements were similar to those that had been in effect in the more reform-oriented centrally planned economies, namely, Poland and Hungary before 1990. Prior to the transition, wages had been either completely centrally determined or regulated by an excess wage tax. In Bulgaria, Czechoslovakia, and Romania, base wages were set according to predetermined schedules. Wage dispersion was minimal, returns to skills were low, and wages were biased toward manual workers (see Adam (1980)). In Hungary and Poland, with the relaxation of vertical controls and the increase in enterprise autonomy, wages were set by enterprises but were subject to a tax on payments in excess of a centrally determined norm. Although the wage norms were often related to enterprise productivity or profitability, the absence of market prices made these indicators difficult to measure. The experience with the excess wage tax was disappointing, because the tax was not applied consistently to all enterprises and the rules for setting the wage norm effectively amounted to the full indexation of wages to prices.

How Were the Costs of Wage Controls Minimized?

The central challenge in designing wage controls was to maximize their effectiveness while minimizing their costs. Transition economies addressed this trade-off by exempting the private sector to the degree possible, setting wage ceilings on firm-level variables, enforcing them with tax penalties, and limiting the coverage to easily observable types of compensation.

Because private firms were not expected to suffer from soft budget constraints or undue sensitivity to labor interests, each country exempted the private sector from wage controls in some way (Table 5-2).⁵ Thus, as the private sector expanded, the role of wage controls would diminish automatically. In Bulgaria, the wage controls applied only to the socialized sector. In Czechoslovakia and Hungary, small firms—the vast majority of private firms—were exempt. Although the private sector was covered in Poland in 1990, once inflation slowed markedly in 1991 wage controls applied only to the socialized sector. In Romania, majority private- or foreign-owned firms were not subject to controls. Exempting of the private sector reduced overall wage restraint but allowed expanding private firms to pay the wages needed to attract the right mix of workers.

Table 5-2.

Design of Wage Controls, 1990–92

Source: IMF staff reports

¹ In budgetary institutions, ceilings applied to average monthly wages.

² In 1992, Hungary had a conditional excess wage tax (EWT): if the average wage in the economy increased by more than 23 percent (which did not occur), the EWT was applied to those firms whose wage bill increased by more than 28 percent.

³ If employment rose by more than 5 percent, firms were allowed to increase their wage norms proportionately.

⁴ In the first half of 1990, the lowest marginal rate was 200 percent.

Table 5-2.

Design of Wage Controls, 1990–92

	Change in Wage Norm	Control Variable	Penalty Tax Rates	Exemptions	Compensation Coverage
Bulgaria	Ceilings based on projected inflation, with compensation if forecast error exceeded 10 percent	Wage bill adjusted for productivity1	1991: 100–800 percent 1992: 50–400 percent	Private sector	Wages and bonuses
Czechoslovakia	1991 Q1: Ceilings based on projected inflation 1991 Q2–4: Full indexation 1992: Ceilings based on projected inflation, later adjusted	Average wage, adjusted for profitability in 1992	200–750 percent	1991: Fewer than 25 employees 1992: Fewer than 150 employees or more than 30 percent foreign ownership	Wages. Bonuses covered in 1991, but exempt in 1992
Hungary2	In 1990, ceilings allowed to increase in line with value added. In 1991, ceilings raised by 18 percent over the year, No automatic ex post indexation	1990: Wage bill adjusted for value added 1991: Wage bill3	Corporate tax rate (40 percent)	Less than 20 million forint wage costs or more than 20 percent foreign ownership	Wages
Poland	Formal ex post partial indexation. Frequent and widespread exceptions result in de facto full indexation as of 1991	1990: Wage bill As of 1991: Average wage adjusted for profitability	100–500 percent4	1990: None 1991: Private sector, i.e., more than 50 percent private ownership	Wages. Bonuses covered separately as of 1991
Romania	Implicit backward-looking partial indexation	Average wage and individual wages	Average wage: 500 percent Individual wages: 40–80 percent	Less than 50 percent private or foreign ownership	Wages and bonuses

Source: IMF staff reports

¹ In budgetary institutions, ceilings applied to average monthly wages.

² In 1992, Hungary had a conditional excess wage tax (EWT): if the average wage in the economy increased by more than 23 percent (which did not occur), the EWT was applied to those firms whose wage bill increased by more than 28 percent.

³ If employment rose by more than 5 percent, firms were allowed to increase their wage norms proportionately.

⁴ In the first half of 1990, the lowest marginal rate was 200 percent.

View Table

Table 5-2.

Design of Wage Controls, 1990–92

	Change in Wage Norm	Control Variable	Penalty Tax Rates	Exemptions	Compensation Coverage
Bulgaria	Ceilings based on projected inflation, with compensation if forecast error exceeded 10 percent	Wage bill adjusted for productivity1	1991: 100–800 percent 1992: 50–400 percent	Private sector	Wages and bonuses
Czechoslovakia	1991 Q1: Ceilings based on projected inflation 1991 Q2–4: Full indexation 1992: Ceilings based on projected inflation, later adjusted	Average wage, adjusted for profitability in 1992	200–750 percent	1991: Fewer than 25 employees 1992: Fewer than 150 employees or more than 30 percent foreign ownership	Wages. Bonuses covered in 1991, but exempt in 1992
Hungary2	In 1990, ceilings allowed to increase in line with value added. In 1991, ceilings raised by 18 percent over the year, No automatic ex post indexation	1990: Wage bill adjusted for value added 1991: Wage bill3	Corporate tax rate (40 percent)	Less than 20 million forint wage costs or more than 20 percent foreign ownership	Wages
Poland	Formal ex post partial indexation. Frequent and widespread exceptions result in de facto full indexation as of 1991	1990: Wage bill As of 1991: Average wage adjusted for profitability	100–500 percent4	1990: None 1991: Private sector, i.e., more than 50 percent private ownership	Wages. Bonuses covered separately as of 1991
Romania	Implicit backward-looking partial indexation	Average wage and individual wages	Average wage: 500 percent Individual wages: 40–80 percent	Less than 50 percent private or foreign ownership	Wages and bonuses

Source: IMF staff reports

¹ In budgetary institutions, ceilings applied to average monthly wages.

² In 1992, Hungary had a conditional excess wage tax (EWT): if the average wage in the economy increased by more than 23 percent (which did not occur), the EWT was applied to those firms whose wage bill increased by more than 28 percent.

³ If employment rose by more than 5 percent, firms were allowed to increase their wage norms proportionately.

⁴ In the first half of 1990, the lowest marginal rate was 200 percent.

Ceilings were put on either firms’ wage bills (Bulgaria, Hungary, Poland in 1990) or firms’ average wages (Czechoslovakia, Poland after 1990, Romania). Although some of the flavor of rules that governed the wage ceilings is provided in Table 5-2, the rules were complicated, and it is impossible to infer what they meant for the wage ceiling of the “typical” firm. This situation contrasts with an economy-wide norm on wage increases (for example, a wage freeze), common in heterodox stabilization programs in which the nominal anchor role is dominant. Firm-level ceilings introduced some flexibility into wage setting by allowing the wages of individual workers within a firm to be adjusted without penalty. However, they did entail distortions at the level of the firm by interfering with firms’ employment decisions. The wage-bill ceiling gave firms the incentive to shed labor and to subcontract work, enabling them to increase the average wage, but constrained their exploitation of new, profitable opportunities. (In an attempt to compensate for this effect, wage ceilings in Bulgaria could be adjusted to take into account new lines of production.) Poland switched to ceilings on average wages in 1991 in order to remove this disincentive.

Ceilings on the average wage provided an incentive to hire low-paid workers or fire high-paid workers, and discouraged the payment of higher wages for greater effort or the acquisition of skills. Tax penalties allowed some flexibility in interfirm relative wages or wage bills, in that firms could break the wage-setting rule as long as they were willing to pay the penalties. Bulgaria. Czechoslovakia. Poland, and Romania adopted “prohibitive” penalty tax rates, while Hungary taxed excess wage increases at the corporate tax rate. Tax rates of several hundred percent provided a strong incentive for wage restraint (although after mid-1990 many firms in Poland were willing either to pay the excess wage tax or to accumulate large tax arrears), but severely limited the scope for firms to expand or to reward skills or effort. Of course, to the extent that firms were willing to pay wages that exceeded the wage ceilings, this flexibility came at the price of less wage restraint.

The trade-off between wage restraint and administrative cost was reflected in the fact that not all types of compensation were covered. While bonuses were covered in every country except Hungary, nonpecu-niary compensation—an important part of compensation but notoriously difficult to measure—was not covered anywhere.⁶ The experience in Hungary illustrates how compensation that was covered—wages—grew much more slowly than compensation that was not—assimilated incomes, which consisted of payments-in-kind (for example, vacations and use of automobiles) and untaxed side payments (for example, meals and clothing). Assimilated incomes, which constituted 12 percent of the total in 1990 and 17 percent in 1991, grew by 65 percent and 76 percent in those years, versus 19 percent and 22 percent for wages. Comprehensive coverage of compensation would have removed the incentive for such substitution but would have involved far greater administrative cost.

Role of Wage Controls in Restraining Nominal Wage Growth

Even though the price increases following price liberalization were generally larger than expected, nominal wage growth in Central Europe did not explode, and wage-price spirals did not develop. In fact, nominal wage increases lagged price inflation in every country, even when inflation significantly overshot initial forecasts. Although real wage declines were warranted in each of the countries, this is not a picture suggestive of wage-driven inflation. What roles did wage controls play in these outcomes?⁸

The best technique for isolating the independent effect of wage controls on nominal wage growth is to control for all the other factors that affect wage growth. In practice, given just a few years of data for each country and several explanatory variables, there are not enough degrees of freedom for such an investigation. Thus, the role of wage controls must be considered with second-best techniques—examining actual wage behavior relative to projections and comparing wage behavior when controls were in place to that when controls were not in place. Data on projected and actual nominal wage growth are available for nine program years. There are even fewer experiences where wage controls were not in place—Hungary (from the beginning of 1992), the Slovak Republic (1993), and the Czech Republic (first half of 1993).⁹ The effect of wage controls on nominal wage growth may be assessed by analyzing three distinct time frames: the period of price liberalization, the period after price liberalization, and the period after the removal of wage controls.

First, the available evidence suggests that wage controls on average were not binding during the initial price liberalization. In Czechoslovakia (first quarter of 1991) and Poland (first quarter of 1990), despite price jumps that were larger than programmed, wages rose less than programmed.¹⁰ This is not to say that wage controls did not play any role during this very uncertain period, but rather that it is difficult to attribute a major role, particularly in the aggregate, to them.

Second, during the period when wage controls were in effect, the behavior of wages relative to projections suggests (i) that wage controls alone were insufficient to restrain wages and (ii) that there is a close association between meeting credit targets and meeting wage projections. Wage controls were in effect in all nine program years for which data are available, but wage projections were exceeded by large amounts in two (Poland (1990) and Romania (1991)) and by smaller margins in four (Bulgaria (1992), Czechoslovakia (1992), Hungary (1990), and Poland (1991)) (Table 5-4). In these nine program years, there is close to a one-to-one association between the adherence to programmed credit restraint and the adherence to initial wage projections (Table 5-5). (The extension of credit to nonfinancial enterprises was compared with the program projection in order to control for, among other things, periods of high expected inflation.)

Box 5-2.

Wage Bill Versus Average Wage as a Nominal Anchor

Even though the choice between the average wage and the wage bill for the control variable was driven by the different incentives for labor shedding, it is interesting to consider whether they were equally effective as a nominal anchor. The price that wage controls aim to stabilize is unit labor costs (ULC), which can be expressed either as the ratio of the average wage (AW) to productivity (P), or as the ratio of the wage bill (WB) to output (Y):

$ULC=\frac{AW}{P}=\frac{WB/L}{Y/L}=\frac{WB}{Y},$

where L is employment. If the forecast for output is more certain than the forecast for productivity, then unit labor costs will be more certain if the wage bill is controlled. However, if the forecast for productivity is more certain than the forecast for output, then unit labor costs will be more certain if the average wage is controlled.

In Central Europe at the outset of the programs, there was a great deal of uncertainty about the future course of all economic variables. In Bulgaria, productivity was viewed as more uncertain than output, since productivity depended on difficult-to-predict decisions about whether to hoard or to shed labor with zero marginal productivity in the hugely overstaffed state sector. Controls on wage bills, therefore, provided a better nominal anchor. In the other countries, there was little to suggest whether output or productivity was more uncertain. Consequently, there was no reason to prefer either the average wage or the wage bill as the better supplementary nominal anchor.

With the benefit of hindsight, the relative accuracy of the IMF staff’s output and productivity forecasts can be compared. Given that forecast and actual data on output and productivity in the state sector are not available, forecast and actual data for real GDP and overall productivity—the latter inferred from the output and unemployment forecasts, assuming a constant labor force—are used.¹ Comparable data on both the forecast and the outcome are available for nine program years (Table 5-3). The forecast errors are sometimes large, but on only one occasion was the error larger than 15 percentage points (in Romania in 1992). On the basis of these nine program years, the root mean squared error (RMSE) of the output and productivity forecasts is similar. Ex post it therefore appears that the average wage and the wage bill were equally desirable as a nominal anchor.

Table 5-3.

Forecast Accuracy in Central Europe

(Percentage change)

Source: IMF staff estimates.

Table 5-3.

Forecast Accuracy in Central Europe

(Percentage change)

		Real GDP		Productivity
		Projection	Actual	Projection	Actual
Bulgaria	1991	–11.0	-11.7	-6.3	6.4
	1992	-4.0	-5.4	11.6	14.0
Czechoslovakia	1991	-5.0	-15.9	-1.0	-10.7
	1992	-5.0	-5.9	-2.0	-7.3
Hungary	1991	-3.0	-11.9	-1.5	-6.2
	1992	1.9	-4.4	5.4	0.8
Poland	1990	-5.0	-11.6	-2.6	-5.6
	1991	3.0	-7.6	7.6	-1.7
Romania	1992	5.0	-13.6	7.3	-8.8
Root mean squared error of forecast			7.2		8.7
Root mean squared error of forecast excluding Romania			7.0		7.3

Source: IMF staff estimates.

View Table

Table 5-3.

Forecast Accuracy in Central Europe

(Percentage change)

		Real GDP		Productivity
		Projection	Actual	Projection	Actual
Bulgaria	1991	–11.0	-11.7	-6.3	6.4
	1992	-4.0	-5.4	11.6	14.0
Czechoslovakia	1991	-5.0	-15.9	-1.0	-10.7
	1992	-5.0	-5.9	-2.0	-7.3
Hungary	1991	-3.0	-11.9	-1.5	-6.2
	1992	1.9	-4.4	5.4	0.8
Poland	1990	-5.0	-11.6	-2.6	-5.6
	1991	3.0	-7.6	7.6	-1.7
Romania	1992	5.0	-13.6	7.3	-8.8
Root mean squared error of forecast			7.2		8.7
Root mean squared error of forecast excluding Romania			7.0		7.3

Source: IMF staff estimates.

1Forecasts for labor force participation are unavailable. In Bulgaria, state sector employment was forecast.

Table 5-4.

Comparison of Projected and Actual Nominal Wages¹

(Period average; percentage change)

Source: IMF staff estimates.

¹ See Appendix 5-2 for full definitions. The projection is taken from the initial program document.

² End-1992 over end-1991.

³ Data on wage bills are unavailable.

⁴ No projection made.

⁵ In 1990, the control variable was the wage bill, but no annual projection for this variable was made.

Table 5-4.

Comparison of Projected and Actual Nominal Wages¹

(Period average; percentage change)

		1989	1990	1991	1992
Bulgaria (wage bill)	Projection	…	…	139	64
	Actual	6	23	121	65
Czechoslovakia (average wage)	Projection	…	…	28	122
	Actual	2	4	16	18
Hungary (average wage)3	Projection	…	20	30	—4
	Actual	20	28	31	28
Poland (average wage)5	Projection	…	240	68	—4
	Actual	276	377	79	39
Romania (average wage)	Projection	…	…	60	—4
	Actual	4	10	122	169

Source: IMF staff estimates.

¹ See Appendix 5-2 for full definitions. The projection is taken from the initial program document.

² End-1992 over end-1991.

³ Data on wage bills are unavailable.

⁴ No projection made.

⁵ In 1990, the control variable was the wage bill, but no annual projection for this variable was made.

View Table

Table 5-4.

Comparison of Projected and Actual Nominal Wages¹

(Period average; percentage change)

		1989	1990	1991	1992
Bulgaria (wage bill)	Projection	…	…	139	64
	Actual	6	23	121	65
Czechoslovakia (average wage)	Projection	…	…	28	122
	Actual	2	4	16	18
Hungary (average wage)3	Projection	…	20	30	—4
	Actual	20	28	31	28
Poland (average wage)5	Projection	…	240	68	—4
	Actual	276	377	79	39
Romania (average wage)	Projection	…	…	60	—4
	Actual	4	10	122	169

Source: IMF staff estimates.

¹ See Appendix 5-2 for full definitions. The projection is taken from the initial program document.

² End-1992 over end-1991.

³ Data on wage bills are unavailable.

⁴ No projection made.

⁵ In 1990, the control variable was the wage bill, but no annual projection for this variable was made.

The direction of causality between credit and wages is somewhat ambiguous. That is, did meeting credit targets restrain wages, or did well-enforced wage controls reduce the pressure on the monetary authorities to relax credit policy so as to limit the adverse effects on output and employment? The conventional view that credit is more under the control of the government than are wages (that is, credit is “more” exogenous) is not necessarily accurate in Central Europe, because of the history of credit policy being subjugated to enterprises’ credit needs. The possibility that wage controls may have helped to restrain wages and credit underscores the importance of setting wage norms on the basis of projected inflation. The degree to which wage controls were set exogenously varied across countries, and even within countries over time, but the strongest examples are Bulgaria (1991 and 1992), Czechoslovakia (1991), and Hungary (1991). However, even in these countries, the catch-up provisions in case of projection errors meant that wage norms were not completely exogenous.

Table 5-5.

Adherence to Wage and Credit Projections

Source: IMF staff estimates.

¹ Projected credit to enterprises (or nongovernment) (see Charts 5-1 to 5-7) from initial program document, except for first year of transition, when the midyear projection was used (because of the effect of unexpectedly high inflation on nominal credit targets).

² Nominal wage projection from initial program document (see Table 5-4).

³ Actual minus projection was less than or equal to 1 percent.

⁴ Actual minus projection was between 1 and 15 percent.

⁵ Actual minus projection was greater than 50 percent.

Table 5-5.

Adherence to Wage and Credit Projections

	Wage Projection2
Credit Projection1	Met3	Almost met4	Largely exceeded5
Met3	Bulgaria, 1991, 1992 Czechoslovakia, 1991 Hungary, 1991	Poland, 1991	None
Almost met4	None	Czechoslovakia, 1992 Hungary, 1990	None
Largely exceeded5	None	None	Poland, 1990 Romania, 1991

Source: IMF staff estimates.

¹ Projected credit to enterprises (or nongovernment) (see Charts 5-1 to 5-7) from initial program document, except for first year of transition, when the midyear projection was used (because of the effect of unexpectedly high inflation on nominal credit targets).

² Nominal wage projection from initial program document (see Table 5-4).

³ Actual minus projection was less than or equal to 1 percent.

⁴ Actual minus projection was between 1 and 15 percent.

⁵ Actual minus projection was greater than 50 percent.

View Table

Table 5-5.

Adherence to Wage and Credit Projections

	Wage Projection2
Credit Projection1	Met3	Almost met4	Largely exceeded5
Met3	Bulgaria, 1991, 1992 Czechoslovakia, 1991 Hungary, 1991	Poland, 1991	None
Almost met4	None	Czechoslovakia, 1992 Hungary, 1990	None
Largely exceeded5	None	None	Poland, 1990 Romania, 1991

Source: IMF staff estimates.

¹ Projected credit to enterprises (or nongovernment) (see Charts 5-1 to 5-7) from initial program document, except for first year of transition, when the midyear projection was used (because of the effect of unexpectedly high inflation on nominal credit targets).

² Nominal wage projection from initial program document (see Table 5-4).

³ Actual minus projection was less than or equal to 1 percent.

⁴ Actual minus projection was between 1 and 15 percent.

⁵ Actual minus projection was greater than 50 percent.

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Bulgaria: Inflation, Wages, and Credit

Sources: IMF staff estimates, and International Financial Statistics, various issues; and national authorities.¹Credit to nonfinancial public enterprises.

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The leads and lags in credit growth and wage growth provide some indication of changes in credit preceding changes in wages. (Given the range of factors that affect wage growth, including expectations about wage policy and inflation, and labor market conditions, the fact that there is any appearance of credit leading wages is remarkable.) In Bulgaria in 1991 and 1992, there is no distinct pattern in the relationship between changes in wage growth and in credit growth, but in the first half of 1993 both growth rates increased at the same time (Chart 5-1). In Czechoslovakia, credit and wages appear to move mostly together, but in early 1991 and late 1992 accelerations in credit seem to have led accelerations in wages (Chart 5-2); the subsequent acceleration of wages in the Czech Republic (in the second quarter of 1993) might also have reflected expectations that wage controls would be reintroduced. In Hungary, there seems to have been a rather regular one or two quarter lag in the response of wage growth to credit growth (Chart 5-3). In Poland in 1990, a distinct shift towards more expansionary financial policies preceded an acceleration in wages: the credit projection was exceeded as of the second quarter, while the performance criterion on wages was breached from the third quarter onward (Chart 5-4 and Table 5-6). In 1991 and 1992, a deceleration of credit growth appears to have led the deceleration of wages. In Romania, there also appears to be a one or two quarter lag in the effect of credit on wages (Chart 5-5).

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Czechoslovakia: Inflation, Wages, and Credit

Sources: IMF, staff estimates, and International Financial Statistics, various issues; and national authorities.1Beginning in 1993, credit to Arms and households.

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Third, the behavior of wages following the (sometimes temporary) removal of wage controls in the Czech Republic, Hungary, and the Slovak Republic provides mixed evidence about the restraining effect of wage controls. In Hungary, wage controls were removed permanently at the beginning of 1992. While the spurt in wage growth in the first quarter of 1992 may point to wage controls having had a restraining effect, the acceleration was short-lived, and wage growth declined for the year as a whole. The fact that the labor share rose sharply in 1991, when wage controls were in effect, and leveled off in 1992, after wage controls were removed, does not provide prima facie evidence of wage controls having had a critical restraining effect (Table 5-7). In the former Czechoslovakia, after wage controls were formally eliminated at the beginning of 1993, wage growth rose in the Czech Republic but fell in the Slovak Republic. In the second half of 1993, wage growth slowed in the Czech Republic following the reimposition of wage controls at midyear, but wage growth slowed in the Slovak Republic also, where wage controls were not reimposed. In other words, the with-and-without comparison of wage growth is consistent with wage controls having a restraining effect in the Czech Republic, but not in the Slovak Republic.

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Hungary: Inflation, Wages, and Credit

Sources: IMF, staff estimates, and International Financial Statistics, various issues: and national authorities.

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Poland: Inflation, Wages, and Credit

Sources: IMF, staff estimates, and International Financial Statistics, various issues; and national authorities.¹Credit to nonfinancial public enterprises.²Including capitalization of interest due but not paid.

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Evidence on the Distinctive Rationales for Wage Controls

Thus far, the discussion has focused on the role of wage controls as a nominal anchor—a role familiar from stabilization efforts in some market economies. Beyond this role, however, there were three rationales for wage controls distinctive to transition economies: that wage controls would help constrain the excesses of firms with soft budget constraints; that wage controls would prevent labor from exerting undue influence in wage setting; and that limits on wage bills would promote needed reductions in state sector employment.

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Romania: Inflation, Wages, and Credit

Sources: IMF. staff estimates, and nternational Financial Statistics, various issues; and national authorities.

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Did wage controls help to mitigate the effects of soft budget constraints? The preceding discussion about the relative endogeneity of wages and credit points to a possible role for wage controls in helping to strengthen the authorities’ hand in enforcing hard budget constraints. However, the fact that changes in financial policies, and the extension of credit in particular, appear frequently to have preceded changes in wages raises questions about the importance of this role.

This section addresses the other two distinctive rationales for wage controls. To determine the effectiveness of wage controls in preventing excessive labor influence in wage setting, the behavior of real wages and microeconomic evidence are reviewed. Next, to investigate the role of controls on the wage bill in reducing state sector employment, data on the latter are compared across countries.

Table 5-6.

Poland: Performance Criterion on Wages

(Percentage change)

Source: IMF staff estimates.

¹ Performance criterion on the wage bill.

² Three-month change.

³ Six-month change.

⁴ Performance criterion on the average wage.

⁵ No projection made.

⁶ Initial projection of January–June average compared with December 1990.

⁷ Initial projection of January–September average compared with December 1990.

Table 5-6.

Poland: Performance Criterion on Wages

(Percentage change)

		Program	Actual
19901
	March2	31	18
	June3	44	36
	September2	14	26
	December3	30	62
19914
	March5	…	…
	June6	12–13	6
	September7	12–13	11

Source: IMF staff estimates.

¹ Performance criterion on the wage bill.

² Three-month change.

³ Six-month change.

⁴ Performance criterion on the average wage.

⁵ No projection made.

⁶ Initial projection of January–June average compared with December 1990.

⁷ Initial projection of January–September average compared with December 1990.

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Table 5-6.

Poland: Performance Criterion on Wages

(Percentage change)

		Program	Actual
19901
	March2	31	18
	June3	44	36
	September2	14	26
	December3	30	62
19914
	March5	…	…
	June6	12–13	6
	September7	12–13	11

Source: IMF staff estimates.

¹ Performance criterion on the wage bill.

² Three-month change.

³ Six-month change.

⁴ Performance criterion on the average wage.

⁵ No projection made.

⁶ Initial projection of January–June average compared with December 1990.

⁷ Initial projection of January–September average compared with December 1990.

Role of Wage Controls in the Decline in Real Wages

In each of the transition economies, wage ceilings were set exclusively on nominal wages; appropriately, in light of the scope for destabilization, real wages were never formally targeted. Nevertheless, either explicitly or implicitly there was an “objective” for real wages, which in each country, except Hungary, amounted to a large drop in the level. What considerations entered into the formulation of these objectives? There was invariably a high degree of uncertainty about the level of the equilibrium real wage. The deterioration in the terms of trade, the collapse of traditional markets, the large change in the composition of the consumption basket as imports were liberalized (which rendered base measures of consumption wages irrelevant), and changes in labor productivity all pointed to the need for a substantial decline in the real wage, but the precise amount was unknown. A consideration raised in Czechoslovakia was how the real wage would affect the speed of enterprise restructuring. An intermediate balance was sought between a low real wage, which would tend to slow down the demise of old enterprises but promote investment in new industries, and a high real wage, which would tend to produce the reverse.

Table 5-7.

Hungary: Comparison of Projected and Actual Nominal Wages

(Period average; percentage change unless otherwise noted)

Source: IMF staff estimates.

Table 5-7.

Hungary: Comparison of Projected and Actual Nominal Wages

(Period average; percentage change unless otherwise noted)

		1989	1990	1991	1992
Projections (state sector)
	Average wage	…	20	30	—1
	Wage bill	…	16	23	—1
	Employment	…	–3	–5	—1
Outcomes
	Average monthly earnings in industry	18	21	30	26
	Gross labor income per employee	20	28	31	28
	Share of labor income in GDP (percent)	46	47	52	52

Source: IMF staff estimates.

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Table 5-7.

Hungary: Comparison of Projected and Actual Nominal Wages

(Period average; percentage change unless otherwise noted)

		1989	1990	1991	1992
Projections (state sector)
	Average wage	…	20	30	—1
	Wage bill	…	16	23	—1
	Employment	…	–3	–5	—1
Outcomes
	Average monthly earnings in industry	18	21	30	26
	Gross labor income per employee	20	28	31	28
	Share of labor income in GDP (percent)	46	47	52	52

Source: IMF staff estimates.

In all countries under review, regardless of whether nominal wage projections were met, measured real consumption wages declined. Surprisingly, given the great uncertainty under which real wage targets were formulated, the cumulative changes in the first two years of the program were largely in line with program projections (Table 5-8). The sizes of the declines were not related to whether the nominal wage projections were met.

Of course, judging whether the adjustment in the real wage was sufficient is difficult in light of the structural transformations in these countries. The level of U.S. dollar wages, which is an imperfect indicator, suggests that by 1992 wages were reasonably competitive in each of the countries from an international standpoint (Table 5-9).¹¹ In dollar terms, wages in Central Europe were approximately a tenth the level in OECD countries, and about half of the level in a group of middle-income countries in Latin America. Wages in Central Europe were higher than in Africa or most of Asia, but labor productivity was higher as well. Abstracting from differences in labor force participation rates and unemployment rates, a broad measure of labor productivity is GNP per capita. Therefore, a rough measure of “unit labor costs” is the ratio of wages to GNP per capita. By this measure, Central Europe was far more competitive than Africa and Latin America, comparable to the OECD, but a little less competitive than the Asian newly industrializing economies (Hong Kong. Korea, and Singapore). While these comparisons do not necessarily imply that real wages are at their equilibrium levels, they do provide some reassurance that wages are reasonably competitive by international standards.

Table 5-8.

Comparison of Projected and Actual Real Wages¹

(Period overage; percentage change)

Source: IMF staff estimates.

¹ For full definitions, see Appendix 5-2. The real wage is defined as the nominal wage divided by the consumer price index.

² No projection made.

Table 5-8.

Comparison of Projected and Actual Real Wages¹

(Period overage; percentage change)

		1989	1990	1991	1992
Bulgaria	Projection	…	…	–35	16
	Actual	2	–2	–39	9
Czechoslovakia	Projection	…	…	–9	0
	Actual	1	–6	–27	7
Hungary	Projection	…	–3	–5	—2
	Actual	2	–1	–3	4
Poland	Projection	…	–31	4	—2
	Actual	12	–27	0	–3
Romania	Projection	…	…	–28	—2
	Actual	…	6	–15	–13

Source: IMF staff estimates.

¹ For full definitions, see Appendix 5-2. The real wage is defined as the nominal wage divided by the consumer price index.

² No projection made.

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Table 5-8.

Comparison of Projected and Actual Real Wages¹

(Period overage; percentage change)

		1989	1990	1991	1992
Bulgaria	Projection	…	…	–35	16
	Actual	2	–2	–39	9
Czechoslovakia	Projection	…	…	–9	0
	Actual	1	–6	–27	7
Hungary	Projection	…	–3	–5	—2
	Actual	2	–1	–3	4
Poland	Projection	…	–31	4	—2
	Actual	12	–27	0	–3
Romania	Projection	…	…	–28	—2
	Actual	…	6	–15	–13

Source: IMF staff estimates.

¹ For full definitions, see Appendix 5-2. The real wage is defined as the nominal wage divided by the consumer price index.

² No projection made.

Table 5-9.

Central European Wages in U.S. Dollar Terms

Source: IMF staff estimates.

¹ For Central Europe, IMF staff estimates (see Appendix 5-2). For the rest of the world, wages in nonagricultural activities, which is the broadest coverage available, for the latest available year from the ILO Yearbook of Statistics 1992. Average exchange rates from International Financial Statistics. The group means are unweighted.

² World Bank Atlas 1994.

³ Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan, Netherlands, New Zealand, Portugal, Spain, Switzerland, Turkey, United Kingdom, and United States.

⁴ Burundi, Egypt, The Gambia, Ghana, Kenya, Malawi, Sierra Leone, and Zimbabwe.

⁵ Brazil, Costa Rica, Chile, Paraguay, Peru, and Venezuela.

⁶ China, Jordan, the Philippines, Sri Lanka, and Thailand.

⁷ Hong Kong, Korea, and Singapore.

Table 5-9.

Central European Wages in U.S. Dollar Terms

		Average Monthly Earnings, 1992 (US$)1	GNP per Capita, 1992 (US$)2	Wage/Output per Capita (index: OECD = 100)
Central Europe		186	1,932	101
	Bulgaria	179	1,330	138
	Czechoslovakia	168	2,270	76
	Hungary	286	3,010	98
	Poland	214	1,960	113
	Romania	83	1,090	78
Memorandum items:
OECD3		1,848	19,465	100
Africa4		130	370	358
Latin America5		376	2,115	211
Asia, excluding NIEs6		120	930	129
Asian NIEs7		857	12,640	86

Source: IMF staff estimates.

¹ For Central Europe, IMF staff estimates (see Appendix 5-2). For the rest of the world, wages in nonagricultural activities, which is the broadest coverage available, for the latest available year from the ILO Yearbook of Statistics 1992. Average exchange rates from International Financial Statistics. The group means are unweighted.

² World Bank Atlas 1994.

³ Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan, Netherlands, New Zealand, Portugal, Spain, Switzerland, Turkey, United Kingdom, and United States.

⁴ Burundi, Egypt, The Gambia, Ghana, Kenya, Malawi, Sierra Leone, and Zimbabwe.

⁵ Brazil, Costa Rica, Chile, Paraguay, Peru, and Venezuela.

⁶ China, Jordan, the Philippines, Sri Lanka, and Thailand.

⁷ Hong Kong, Korea, and Singapore.

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Table 5-9.

Central European Wages in U.S. Dollar Terms

		Average Monthly Earnings, 1992 (US$)1	GNP per Capita, 1992 (US$)2	Wage/Output per Capita (index: OECD = 100)
Central Europe		186	1,932	101
	Bulgaria	179	1,330	138
	Czechoslovakia	168	2,270	76
	Hungary	286	3,010	98
	Poland	214	1,960	113
	Romania	83	1,090	78
Memorandum items:
OECD3		1,848	19,465	100
Africa4		130	370	358
Latin America5		376	2,115	211
Asia, excluding NIEs6		120	930	129
Asian NIEs7		857	12,640	86

Source: IMF staff estimates.

¹ For Central Europe, IMF staff estimates (see Appendix 5-2). For the rest of the world, wages in nonagricultural activities, which is the broadest coverage available, for the latest available year from the ILO Yearbook of Statistics 1992. Average exchange rates from International Financial Statistics. The group means are unweighted.

² World Bank Atlas 1994.

³ Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan, Netherlands, New Zealand, Portugal, Spain, Switzerland, Turkey, United Kingdom, and United States.

⁴ Burundi, Egypt, The Gambia, Ghana, Kenya, Malawi, Sierra Leone, and Zimbabwe.

⁵ Brazil, Costa Rica, Chile, Paraguay, Peru, and Venezuela.

⁶ China, Jordan, the Philippines, Sri Lanka, and Thailand.

⁷ Hong Kong, Korea, and Singapore.

Microeconomic Evidence on Wage Setting

The only systematic firm-level study of enterprise behavior in Central Europe is a World Bank survey of 75 state-owned enterprises in Poland (Pinto, Belka, and Krajewski (1993)). The overrepresentation of labor in the objective function of the firm would seem to be especially a problem in Poland, where managers serve at the pleasure of workers’ councils: state firms are “self-governing” under the direction of a workers’ council that hires and fires managers, determines managers’ compensation, and clears all important strategic and even operating decisions. The study found that wage setting in Poland was similar to bargaining outcomes commonly seen in market economies, which suggests that inadequate investment was not due to excessive payments to labor. Wages were not set to exhaust the surplus, but to share the surplus between labor and capital. Profitable firms paid the highest wages and hence the highest excess wage taxes, but also invested the most and were therefore the least decapitalized. By contrast, decapitalization was pronounced in loss-making firms, which also paid lower wages. This evidence suggests that decapitalization was more of an adjustment phenomenon than a deliberate attempt to squander state assets.¹²

Table 5-10.

State Sector Employment¹

(Percentage change)

Source: IMF staff estimates.

¹ Data for Hungary and Poland are not available.

² Employment in nonbudgetary institutions, given by employment in the material sphere minus private employment in the material sphere (period average).

³ Employment in the state, communal, and cooperative sectors (end of period).

⁴ Employment in the state and cooperative sector (end of period).

Table 5-10.

State Sector Employment¹

(Percentage change)

	1990	1991	1992
Bulgaria2	–7.6	–18.8	–19.8
Czechoslovakia3	–6.1	–20.5	–10.7
Romania4	–4.4	–27.2	–13.7

Source: IMF staff estimates.

¹ Data for Hungary and Poland are not available.

² Employment in nonbudgetary institutions, given by employment in the material sphere minus private employment in the material sphere (period average).

³ Employment in the state, communal, and cooperative sectors (end of period).

⁴ Employment in the state and cooperative sector (end of period).

View Table

Table 5-10.

State Sector Employment¹

(Percentage change)

	1990	1991	1992
Bulgaria2	–7.6	–18.8	–19.8
Czechoslovakia3	–6.1	–20.5	–10.7
Romania4	–4.4	–27.2	–13.7

Source: IMF staff estimates.

¹ Data for Hungary and Poland are not available.

² Employment in nonbudgetary institutions, given by employment in the material sphere minus private employment in the material sphere (period average).

³ Employment in the state, communal, and cooperative sectors (end of period).

⁴ Employment in the state and cooperative sector (end of period).

Magnitude of the Costs of Wage Controls

Empirical evidence does not yet exist to evaluate meaningfully either the degree to which wage controls have impeded the needed shift toward a more differentiated wage structure or the effect of wage distortions on economic growth. The sketchy data available suggest that there has been at best a small increase in differentiation.¹³ In Bulgaria, the variation of wages across industrial branches has increased, but there has been little movement in the occupational wage structure. In Czechoslovakia, interindustry wage dispersion has risen and survey data point to a small increase in the return to education, but enterprise-level data indicate no increase in wage dispersion across firms. In Hungary, the variation of wages across industrial subsectors has increased, but the relative wages of professional workers have changed only a little. In Poland, the coefficient of variation of wage increases across sectors remains small. In Romania, the structure of wage differentials is broadly unchanged, and average wages across enterprises in the same sector of the economy can vary by as much as 250 percent, without any apparent economic justification.

IMF Conditionality on and Monitoring of Wage Controls

IMF conditionality on and monitoring of wage controls varied considerably across countries. The arrangements with Poland and Yugoslavia included quarterly ceilings on wages as performance criteria; the implementation of wage controls was a prior action in the arrangements with Bulgaria and Romania; in Czechoslovakia, wage controls were mentioned specifically as being subject to review only in 1991; and no conditionality was attached to wage controls in Hungary.

In Poland, the performance criterion was a wage ceiling, the level of which in any quarter was determined by backward-looking partial indexation. The system of wage controls in Poland created a distinction between a firm’s wage norm and actual wages paid by the firm: the wage norm was determined by the government, but wages themselves were set by enterprises. The performance criterion applied to actual wages, rather than the wage norms. Performance criteria are not always set only on items that are directly controlled by the government, and it is certainly true that the government’s general policy stance would be reflected in the growth of the nominal wage. However, especially because deviations from the wage norms were explicitly allowed in the excess wage tax system, it might have been preferable to set the performance criterion on the wage norm and its enforcement through the application of tax penalties, and to set indicative targets for the growth of the actual wage. In fact, the 1993 stand-by arrangement with Poland included a benchmark rather than a performance criterion on average monthly wages.

In the 1990 stand-by arrangement with Poland, the performance criterion on wages was observed in March and June, but was breached in September. Subsequently, the arrangement remained off-track and expired in March 1991 with no further purchases made. The 1991 extended arrangement went off-track immediately, although wage growth was below the projected performance criteria through September 1991.

In Yugoslavia the performance criterion on wages was also a ceiling on actual wages in the socialized sector. However, in Yugoslavia wage controls took the form of a law that froze wages in the entire socialized sector for six months. Under these circumstances, actual wages should have been under the direct control of the government. The 1990 stand-by arrangement went off-track immediately, partly because the performance criterion on wages was breached.

In the other four countries, the monitoring of wage policy differed. In each country except Hungary, there was extensive discussion of wages in IMF staff reports. Often, however, the complexity of the wage controls and the weak data base made it difficult to portray these developments precisely. In most of the countries, wage policy was explicitly subject to review: even when there was not an explicit review clause, however, staff reports usually reviewed wage policies comprehensively.

Conclusion

In the initial IMF-supported programs in Central Europe in 1990–91, the exceptional challenges of stabilization and transition, the unusually large shocks, and the high degree of uncertainty about the capacity of existing and emerging institutions to prevent wage-price spirals argued for using wage controls despite the rigidities they imposed. Wage controls were potentially an important tool in the stabilization of prices and in addressing the distinctive problems of state enterprises during the transition.

The wage controls, which were tax-based, were restricted to the state sector, and had firm-level ceilings on the average wage or the wage bill, were designed to limit their distortive effects and permit needed flexibility in wage-setting behavior. With respect to the nominal anchor role of wage controls, the greater the degree to which wage norms were set exogenously with adjustments only in extreme circumstances, the more likely was wage and credit restraint. When wage restraint occupies a particularly important role in the stabilization process (as in Poland and Yugoslavia), there is a case to put a performance criterion on wage policy. However, reflecting the principle of putting performance criteria on instruments and not objectives, if deviations from wage norms are explicitly permitted under the wage policy, then it might be preferable to put the performance criterion on the wage norm, and to set indicative targets for the growth of actual wages.

In practice, the extent of wage restraint across countries and across time was remarkable. While the short time that has elapsed since transition began in Central Europe does not permit a rigorous testing of the role of wage controls in this restraint, a review of the experience gives rise to three main observations. First, the available evidence indicates that wage ceilings were not binding during the initial period when most prices were liberalized. Second, the patterns of credit and wage growth tend to suggest that more often than not the stance of financial policies, and the extension of credit in particular, led wage increases. Had wage developments led increases in credit, this would have tended to confirm the presumption that wage controls substantially influenced credit growth. Third, following the removal or temporary suspension of wage controls in a few countries, wages typically failed to spurt upward. All this is not to say that wage controls had no restraining effect—particularly through their role in helping to focus wage settlements and to reduce inflationary expectations—or that they conferred no benefits. Rather, the evidence in the countries under review points to the limits of these benefits.

While there is no doubt that the state sectors in transition economies faced and continue to face distinctive problems—including soft budget constraints, an exceptionally weak relationship between ownership and management, and bloated employment—the degree to which wage controls could and did address these problems is less clear. In any economy, the ultimate strength of the budget constraints facing firms is a function of policy choices made by the fiscal and monetary authorities. To the extent that the fiscal and monetary authorities do not enforce hard budget constraints (and enterprises have easy access to credit), the penalty of an excess wage tax is softened. Did wage controls help enterprise managers to resist pressures for increases in the labor share? The fact that real wages declined in every country regardless of the degree of nominal wage restraint, and that wages in U.S. dollar terms in 1992 appeared to be quite competitive by international standards, point to moderate labor influence in these economies. Consistent with this macroeconomic evidence are the survey data from Poland, which suggest that wage-setting behavior may not be as dissimilar as often thought from that in market economies. Altogether, while experiences may differ from country to country, in general the record does not provide strong evidence that wage controls made a significant contribution to either improving corporate governance or encouraging labor shedding in the state sector.

While wage controls can help to secure macroeconomic stabilization, they impede the structural adjustment of the economy by perpetuating wage distortions and wage indexation. An insufficiently differentiated wage structure not only causes the misallocation of existing resources, but also distorts the incentives that guide physical and human capital investment. Any movement toward de facto wage indexation makes subsequent attempts to reduce inflation or adjust real wages more difficult. However, like the benefits of wage controls, the costs of wage controls are difficult to measure, and may become important only over time. Data on the structure of wages are weak, and in the short time since reform started it is not clear how much progress in improving the wage structure could have been made.

These considerations suggest that it should not be taken for granted that wage controls in transition economies play a role in restraining nominal wage growth and addressing corporate governance problems, particularly after the initial stabilization phase of adjustment. While tripartite consultations on wages may be desirable, they do not necessarily require the vehicle of wage controls. Even when there is a strong conviction that wage controls are needed, they should not be viewed as anything more than a small part of much broader efforts to control inflation and improve corporate governance. Against these possible benefits are the well-known distortionary effects of wage controls, which have militated against their prolonged use in other countries. Thus, in deciding whether to maintain wage controls after the initial stabilization, it is important to weigh expected benefits against the risks of perpetuating distortions.