Working-Age Population

From LFS. Defined as 15 years old and above. However, some countries did not adopt this widely accepted definition when they began conducting LFS, making the time series inconsistent over the period (refer to the footnotes under each table for details).

Employment

From LFS. For the period prior to the beginning of LFS, data from the IMF’s World Economic Outlook are used.

Unemployment

From LFS. For the period prior to the beginning of LFS, data from the IMF’s World Economic Outlook are used. The series labeled “Registered” come from each authority’s labor office.

Youth Employment/Unemployment

From LFS. Defined as 15–24 years old. The series labeled “Registered” come from each authority’s labor office.

Long-Term Unemployment

From LFS. “Long-term” is defined as 12—13 months and over. The definition slightly differs depending on the country (refer to the footnotes under each table).

Unemployment by Education Attainment

From LFS. The classification of education levels are based on each authority’s definition, and these definitions may not be completely comparable across countries.

Unemployment Rates (including youth and long-term-both LFS and registered)

All are calculated using the working-age population presented in the country-by-country tables and the LFS tables as the denominator, and they may not be exactly the same as the “official” rates that may be found in each country’s official sources.

Private Sector Employment

Although LFS data are used whenever possible, almost half of what is presented in the summary tables is taken from other sources, including Statistical Appendixes of IMF Country Reports, and authority’s employment registration (refer to the footnote under each table).

Employment by Industry

LFS data (taken from ILO’s database, Laborsta) are used whenever available, and they are spliced with the data from the World Bank’s World Development Indicators.

Regional Employment/Unemployment

Provided by national authorities or taken from the EU’s New Cronos database.

Economy-Wide Monthly Wages

From the ILO Laborsta database. Original data in local currency units have been adjusted as necessary for cross-country comparison.

Private and Public Sector Monthly Wages

Provided by national authorities or taken from national statistical yearbooks or from national authorities’ websites whenever available. Thus, the data may not be completely consistent with economy-wide wages that come from the ILO database, Laborsta.

Minimum Wage

Taken from various sources including: authorities- statistical yearbook, statistical offices’ websites, ILO, and IMF staff estimates.

Duration of Unemployment Benefits; Family Benefits; Early Retirement Age

Constructed based on the information provided on Social Security Worldwide website and in Social Security throughout the World by the U.S. Social Security Administration. Because the social security information is not published every year, we assumed the policy of the previous year was carried on for the years for which we did not have information, and this assumption may not always be correct for those countries that have gone through rapid change in transition. In addition, such information is descriptive with a wide range of variation in detail across countries, and although we tried to construct the time series in as consistent a manner as possible using the same definition- they may not always be consistent for cross country comparison.

Tax Rates

Estimated by using average marginal income tax rate and payroll tax rate listed in Price water house – Coopers, Individual Taxes in each year of the sample period.

Unemployment Benefits

Based on the information listed in Social Security throughout the World, the data taken from the Vienna Institute for International Economic Studies database, and data provided by the authorities. The replacement ratio is the ratio of stipulated unemployment benefits to previous earnings during the first six months of the unemployment period. Duration is the one applied to a worker with 20 years of social security contributions.

Government Spending on Social Security and Welfare

From IMF, Government Finance Statistics

Employment Protection Legislation (EPL) Index

From OECD, Employment Outlook 1999; and World Bank estimates (2002).

Labor Market Performance

The end of central planning resulted in the collapse of participation and employment and in a sharp increase in the unemployment rate and its persistence. Economic restructuring and privatization significantly increased redundancy, leading many workers to retire from active participation. The latter declined significantly, mostly among older, less educated, females, and workers in remote regions. During 1993–98, an estimated 40 percent of the unemployed withdrew from the labor force citing “discouragement” from low job prospects, feeding the decline in participation rates. After the initial drop (a third by 1993), employment continued to decline well into the early 2000s, while unemployment went the opposite way, peaking at 22 percent in 2001 after a slight decline prior to the 1995/96 banking crisis, despite continued declines in participation. The acceleration of structural reforms—including enterprise restructuring and privatization—beginning in 1997 brought a new round of labor shedding. As entire industries became obsolete, regions that relied often on one or a few large enterprises registered higher unemployment rates. In contrast, the capital city area was able to soften the impact because it was more diversified and benefited first from the switch toward services. The period since 1989 has also seen a significant emigration, totaling around 9 percent of the 1989 population. Most migrants were aged between 30 and 40, with a secondary education level.

Productivity gains, skill mismatch, and a shallow housing market are leading causes of long-term unemployment and regional disparities in unemployment. Economic restructuring and the privatization of public enterprises have led not only to higher unemployment, but also to significant gains in productivity—which shot up by 19 percent during 1998–2000. The associated labor supply shock has not yet been fully met by demand, leading to long-term unemployment. In addition, because of the shift away from heavy industries to lighter manufacturing and services, a significant skill mismatch affecting a large segment of the active labor force has developed. The World Bank found that some jobs go unfilled because of the lack of adequately skilled job seekers, while at the same time there are not enough low-skilled jobs created at the prevailing minimum wage to absorb the available low-skilled individuals among the unemployed. This phenomenon seems more pronounced in Bulgaria than in other CEE countries. A disproportionately high number of blue collars workers in regions compared with the capital city area have contributed to persistent large regional disparities in unemployment, since the unemployed find it unappealing to move to a different region where their skills are not in demand. In addition, the high rate of house ownership and the associated shallow housing market may have contributed to the disparities, because individuals are reluctant to migrate, thereby trading a significant part of their net worth for an uncertain future.

Small and medium-sized enterprises have failed to create as many jobs in Bulgaria as in other transition economies, pointing to potential institutional problems. The shift of activity from heavy industry to light manufacturing and services has meant more small and medium-sized enterprises. But, contrary to a number of other transition economies (for example, Hungary), small and medium-sized enterprises in Bulgaria create far fewer jobs and employ a lower proportion of total workers (only 41 percent). More generally, jobs created in small enterprises (most of which are new) continue to fall short of jobs eliminated in large enterprises. Legal barriers to firm entry do not seem to be the main problem, since Bulgaria does not compare poorly with other CEE countries according to the “Doing business indicators” compiled by the World Bank and based on relevant regulations. However, there is some evidence that implementation of regulations may be a problem. For example, the time required to enforce a contract is high in Bulgaria among CEE countries (see Table 3.3). Business surveys also indicate that Bulgaria scores poorly in administrative burdens for business startups.

The informal sector is believed to employ many registered unemployed, and recent government measures may have flushed out some of these jobs. The unusually large number of discouraged job seekers suggests that workers take jobs in the informal sector while still receiving social benefits. New regulations introduced in 2003 cut social benefits for those recipients who are not willing to take low-paid jobs offered under government programs. The authorities reckoned that this measure, combined with the newly introduced minimum insurable income, has flushed into the formal sector as many as about 300,000 jobs, contributing to the rapid decline in the unemployment rate.

Labor Costs

After declining during the better part of the 1990s, real wages have been increasing moderately, but more slowly than productivity. Real wages dropped at the start of the transition and remained depressed for many years subsequently. Despite some recovery owing to the strong economic growth since 2000, they are still trailing the level in 1989. Productivity, on the other hand, has been recovering faster, contributing to the competitiveness of the economy. Estimating the equilibrium dollar wage (as a function of productivity indicators) in Bulgaria and comparing it with the actual dollar wage, Krajnyák and Zettelmeyer (1998) found that the former was well above the latter, suggesting that the Bulgarian economy remained competitive. The minimum wage was raised steadily to recoup the real erosion that took place over the years. It now represents 38 percent of the average wage, a level that is not terribly high (in France the level is 50 percent) but may limit job opportunities for the less skilled and experienced workers, notably in the country’s depressed regions.

Other labor costs remain relatively high, in part because of widespread tax evasion. Garibaldi, Dimitrov, and Stoyanova (2000) report a 1996 study that found that a large number of employers and workers evaded payment of social security contributions. To avoid an erosion of collected revenue, the authorities steadily raised contribution rates, possibly leading to a further rise in the informal sector. At up to 50 percent of gross labor income, labor taxes are much higher than in many Western European countries and represent a serious hiring deterrent. The high dependency ratio (ratio of pensioners to contributors, which reached 80 percent in 1998) is a reflection of the large evasion. The new minimum insurable income thresholds were also designed to boost collection of social security contributions by increasing the base (that is, registered work contracts), and while there was some success in the first half of 2003, it is still too early to assess the full impact of this measure.

Wage Setting Process

Collective bargaining, although mostly centralized, has not led to high wage pressures. Industrial relations in Bulgaria are based on the tripartite system of negotiation involving the government, labor unions, and employers’ representatives. This system is rooted in the country’s constitution. Negotiations take place at four levels (national, branch, regional, and enterprise) depending on the encompassing nature of the issue. The national minimum wage and wage setting mechanisms, for instance, would be decided at the national level, whereas branches can decide to set their own minimum wage higher than the national level. While wages in the central government are completely centralized, decentralized collective bargaining is more prevalent in the nonbudget state-owned entities and in the private sector. But compared with other countries, centralized collective bargaining is more resorted to and less confrontational in Bulgaria. The ILO in 1998 found that only 70 percent of surveyed units had collective agreements at the local level compared with all units in other CEE countries in the survey, and a higher proportion of labor unionists found the atmosphere of the negotiations “good” compared with their counterparts in other countries. This relative collegiality, coupled with the high level of unemployment, has led to lower union pressure to award high wage increases.

Labor unions in Bulgaria appear relatively strong, but not confrontational. The two main labor unions in Bulgaria are the Confederation of Independent Trade Unions (KNSB) and the Confederation of Labor (“Podkrepa”), both founded at the start of the transition and with total membership in excess of 1.5 million workers. Through numerous branches they cover virtually all the economic sectors. In a 1998 survey, the ILO found that the percentage of union members in 60 percent of the units surveyed was between 70 and 100 percent, compared with only 20 percent in Hungary and 5 percent in Poland. They found relations between labor unions and employers’ organizations to be characterized by “cooperation and partnership” as opposed to “partnership and opposition” in other countries (as reported in Garibaldi, Dimitrov, and Stoyanova, 1998).

Labor Market Institutions and Policies

A succession of amendments have modernized the Labor Code (initially promulgated in 1986) and increased labor market flexibility, but restrictions remain that may constrain employment performance. Employment protection legislation in particular may be a deterrent to job creation. For instance, separations are often referred to courts, where the burden of proof for a range of causes for dismissal (for example, inadequate skills, poor performance, and violation of discipline) falls squarely on the employer. Dismissal related to technological advances or reorganization is prohibited, which may discourage firing during a downturn and hiring during an upturn. The use of overtime work is strictly limited to 150 hours a year (the limit is twice as large as that in Hungary) and must be paid with a premium of at least 50 percent of the base wage. Fixed-term employment contracts are allowed only for work that is temporary or seasonal in nature and can be renewed only once. Also, wage adjustments are restricted: employers must pay 100 percent of wages during work stoppage regardless of whether the stoppage is due to low demand.

Passive labor market policies compare well with other countries and do not appear high enough to deter job search. To be eligible for unemployment benefits in Bulgaria, one has to be registered in a labor office, have a minimum employment spell of 9 months during the past 15 months, and be willing to accept a job or training if offered. Recipients are paid 60 percent of their last gross salary, capped at 140 percent of the minimum wage, and the entitlement period varies between 4 and 12 months. Because of the growth of long-term unemployment, unemployment benefits have fallen over the past decade. Social assistance, on the other hand, is available to all families on the basis of aggregate family income and the number of children in the household, thus providing a safety net to the unemployed whose eligibility for unemployment benefits has lapsed. Both the replacement rate and the coverage rate in Bulgaria are lower than in many other CEE countries.

To reduce unemployment the Bulgarian authorities are focusing on active labor market policies (ALMPs). These include temporary employment programs-training with nonguaranteed jobs, training with guaranteed jobs, subsidized employment, employment associations, and self-employment support programs. Although the government continues to spend more on passive labor market policies to support the unemployed, the share of ALMPs in total labor market policy expenditure of the government has increased steadily since 1996, with a significant jump in 2003. During that year, the government set up a program of 100,000 public, low-killed jobs in municipalities for long-term unemployed, who were given the alternative choice to forgo this opportunity and lose social assistance. Although some training goes along with these jobs, the government envisaged to renew them in 2004 and subsequent years, which could create another large public program. Indeed, ALMPs are no panacea and sometime provide only temporary and limited relief to the unemployed. In addition, ALMPs can generate deadweight losses and substitution effects, which negate the policies’ intended goals. Consequently, these policies should be part of a package of labor policies including measures to further increase labor market flexibility, notably the firms’ ability to determine the size of their labor force and wages. But, the government prefers to let social partners negotiate among themselves further measures to increase labor market flexibility instead of imposing them.

Labor Market Performance

The labor market in Croatia has not performed well. In the early 1990s, economic restructuring and privatization significantly increased redundancies. The war during 1991–95 worsened the situation. While labor shedding by many firms led to improved productivity, it also contributed to massive inflows to unemployment. Although economic growth has remained brisk since the mid–1990s, outflows from unemployment, including outflows to jobs, have not accelerated, and fell short of inflows until 2000. The LFS-based unemployment rate has been hovering around 15 percent for the past five years. A majority of the unemployed (55 percent) are jobless for over one year.³ The labor force participation rate has remained about 50 percent. In particular, unemployment is high, and participation low-among youth. The overall low participation may reflect poor availability of job opportunities and skill mismatch problems.

Firm-level data reveal that the job reallocation in Croatia is sluggish. Croatian firms yearly close about 5 percent of all jobs, compared with a job destruction rate of 10–11 percent in other CEE countries.⁴ At the same time, the job creation rate in Croatia is only 3.5 percent, compared with 7–11 percent in other CEE countries. These figures point to the stagnant nature of the Croatian labor market and indicate that, unlike some leading reformers in CEE countries, the Croatian economy has not undergone an intensive enterprise restructuring. In addition, regional analysis has proved that the job creation and destruction rates are modest at most across Croatia, although the unemployment rate varies significantly among regions.⁵ Regional differences in the unemployment rate are more likely to be of a historic nature rather than the result of recent developments in enterprise restructuring.

start-ups of small and medium-sized businesses have not created as many jobs in Croatia as in other CEE countries. As in many other CEE countries, small private firms have played a role as an engine of job creation in Croatia. The share of employment by the old sector, consisting of large state-owned enterprises, in total employment has been declining while the share of employment by the new sector, consisting of small private firms, has been expanding. However, these changes have been modest compared with other leading reformers such as the Czech Republic and Hungary-since the rate of new business start-ups has been insufficient to offset the employment reductions by existing firms.⁶ Between 1997 and 2002, the total number of small and medium-sized enterprises, a proxy for the new sector, has declined by about 20 percent, while their employment has remained stagnant. The share of employment by small and medium-sized enterprises is 46 percent. This lags behind main CEE countries, where the share of employment by small and medium-sized enterprises is well over 50 percent.

Strict employment protection, which is discussed below, is likely to have discouraged entry or expansion of new businesses in Croatia. According to the World Economic Forum’s “Quality of the National Business Environment,” which ranks almost 100 countries mostly on the basis of survey scores of various factors that affect the business environment, Croatia ranks significantly behind main CEE countries such as the Czech Republic, Hungary, and Poland. Among various factors, Croatia ranks worst in “cooperation in labor employer relations,” which could be explained by the strict employment protection.

Labor Costs

Labor costs could partly explain stagnant job creation in Croatia. Gross wage comparison in manufacturing sector among CEE countries by the World Bank (2003) shows that gross wages in Croatia are higher than those in most of other CEE countries. It also indicates that relatively high wages in Croatia could not be justified by proportionately higher labor productivity. Economy-wide gross wage comparisons also support the findings of the World Bank. However, economy-wide unit labor cost dynamics for the past five years indicate that Croatia has contained the labor cost increases more successfully compared with other CEE countries, partly reflecting the government’s efforts to restrain public sector wage level in recent years. The tax wedge on labor income slightly exceeds 50 percent. Although it is higher than most of the EU–15 and non-EU OECD countries, it is moderate among CEE countries (see Figure 2.10). Labor income tax and social security contributions do not seem to have had unfavorable effects on the country’s competitiveness among CEE countries.

Wage Setting Process

The wage determination process is centralized in Croatia. About 40 percent of the private sector employees are union members, while most of the public sector workers are union members. Trade unions in the private sector play a dominant role in wage setting because the industry-level bargaining prevails, especially in large firms. Public sector workers’ unions also negotiate collective agreements with the government. Although there is no statutory minimum wage in Croatia, the minimum base for social security contribution- which at present accounts for about 35 percent of the average gross wage, plays the role of the wage floor. This notional minimum wage is as a rule used in collective agreements as the floor for the wage structure, although in some industries, where trade unions’ bargaining position is stronger, this floor is set at a somewhat higher level. Although unions in Croatia generally favor cooperation over confrontation and conflict, they occasionally resort to strikes to force employers or the government to give in. Wage pressure exerted by unions apparently led to some excessive increases in labor costs in Croatia in earlier stage of transition.

Labor Market Institutions and Policies

The unemployment benefit system in Croatia is not particularly generous. The unemployment benefit in Croatia is a flat rate benefit in practice, since the fixed maximum amount of the benefit is only about one fourth of the average wage. Relatively few unemployed receive the unemployment benefit. The duration of the unemployment benefit payment is capped at 312 days, which is not out of line with other CEE countries. The benefit coverage rate has been below 20 percent since the mid–1990s, reflecting two factors: (i) the unemployment rate is highest among new entrants to the labor market, who do not qualify for the unemployment benefit; and (ii) a large proportion of unemployed are long-term unemployed who are no longer eligible for the benefit. All these characteristics—low replacement rate, moderate duration of the benefit payment, and limited coverage—indicate that labor supply disincentives related to the unemployment benefit system are likely to be modest in Croatia. In particular, low benefit coverage means that labor supply disincentives are not significant because few people are affected by them.

However, employment protection in Croatia is among the strictest in CEE countries. According to the estimated value of the EPL (employment protection legislation index), employment protection in Croatia is stricter than that in most of the EU–15 and other CEE countries (see Table 2.12).⁷ Until the amended labor law took effect in January 2004, individual dismissals were costly because of the long advanced notice period and high severance pay. Collective dismissals were even more difficult, mostly because of the overly inclusive definition of collective redundancy. Although fixed-term employment is a way of circumventing high costs of terminating regular employment contracts, the labor law until recently restricted its use by requiring that fixed-term contracts be signed only on exceptional basis. World Bank (2003) concludes that stringent employment protection has contributed to the stagnant labor market performance in Croatia, such as low job creation and hiring, long duration of unemployment spells, and the concentration of unemployment among disadvantaged worker groups. It also points out that the country’s strict employment protection also provides an incentive for firms to move to or remain in the informal sector in order to lower labor costs.⁸

With a view to making the labor market more flexible, the labor law was amended in July 2003. The amended labor law, which fully entered into effect at the beginning of 2004, has lowered Croatia’s EPL index by 23 percent. The main changes include: (i) relaxing restrictions on the use of fixed-term contracts; (ii) easing the preconditions for valid dismissals; (iii) shortening the advanced notice period from six to three months; (iv) reducing the amount of severance pay from half to one-third of the monthly pay; and (v) relaxing the definition of mass layoffs.

The chronic unemployment problem prompted the government to initiate a number of active labor market measures in early 2002, including self-employment promotion, subsidies and loans to small and medium-sized enterprises, and public works.⁹ Some of the measures are focused on promoting hiring of young and highly educated people by subsidizing at least 60 percent of their gross wages for the first year. Also, an employer of workers with university education receives a one-off subsidy of €1,000 if the employment extends beyond one year and becomes permanent. Although it is too early to evaluate the effects of these active labor market measures, local economists cast some doubts whether they are well targeted (Institute of Economics, 2002). In particular, young people coming out of universities tended to manage to find jobs before the introduction of the new measures. Consequently, they can have only a minor impact on boosting employment.

Labor Market Performance

Strong economic activity in recent years has contributed to low and declining unemployment, which reached its lowest level, 5.5 percent, in December 2003. The decline in unemployment has been generally accompanied by rising economy-wide employment, and, although quite low, rising participation rates. However, the labor market has been characterized by important weaknesses.

• The participation rate is the lowest in the EU-15 area. This reflects a number of factors. First, weaknesses in labor demand, particularly for low–paid jobs. Second, although the transfer system is not generous with respect to benefit levels, it is generous in its coverage. For more than 25 percent of the working-age population (15 to 64 years), transfers (social or labor market related) are the main source of registered income. Total social security outlays paid by the government are higher than in other CEE countries, reflecting these high take-up rates. Third, for older age groups, the low participation rate reflects the combination of a low statutory retirement age—the statutory retirement age has been steadily increased and is now at 62 for men and 59 for women, which is low relative to other OECD countries—and sizable early retirement schemes. Fourth, the take-up of disability benefits in Hungary is very large in international comparison (about 9 percent of the 20–64 age group are on disability benefit).¹¹

• Regional inequalities are high. Low-employment areas register more than half the employment rates of high-employment areas (Table A2.1). This is partly due to the regional variations in the purchasing power of benefits. While benefit levels are low on average (see discussion below), their purchasing power varies widely across regions: the costs of living are much lower in the less-developed northern and eastern parts of the country than in the prosperous central and western regions. This, in particular, reduces incentives to move from the poorer regions to those where job search has more chances of success.

Table A2.1.

Regional Inequalities in Hungary-2003:Q3

(In percent)

¹Population aged 15–74.

Table A2.1.

Regional Inequalities in Hungary-2003:Q3

(In percent)

Regions	Participation Rate1	Unemployment Rate
Central Hungary	57.8	4.1
Northern Hungary	58.4	4.7
Northern Great Plain	58.2	4.4
Southern Great Plain	51.9	7.9
Central Transdanubia	50.0	9.4
Western Transdanubia	49.7	6.2
Southern Transdanubia	50.4	6.3
Country total	54.1	5.7

¹Population aged 15–74.

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Table A2.1.

Regional Inequalities in Hungary-2003:Q3

(In percent)

Regions	Participation Rate1	Unemployment Rate
Central Hungary	57.8	4.1
Northern Hungary	58.4	4.7
Northern Great Plain	58.2	4.4
Southern Great Plain	51.9	7.9
Central Transdanubia	50.0	9.4
Western Transdanubia	49.7	6.2
Southern Transdanubia	50.4	6.3
Country total	54.1	5.7

¹Population aged 15–74.

At times, foreign-owned firms have had a significant role in the creation of new jobs. According to Kaminski and Riboud (2000), foreign-owned firms were responsible for the creation of 75 percent of all new jobs during 1992–97 in Hungary. At that time, new entry by foreign companies helped to absorb workers from public enterprises, and foreign companies helped to contain unemployment in the relatively early stage of transition.

Labor Costs

Wages have increased rapidly since 2000, reflecting large increases in minimum wages, strong aggregate demand, possible lagged inflation expectations, and demonstration effects from increases in public sector pay. Most public sector employees received a 50 percent increase in wages in the fall of 2002. Together with increases in the minimum wage of over 90 percent during 2001–02, these increases spilled over into the private sector. This contributed to private sector wage inflation significantly above productivity (Figure A2.1), and a surge in real wages on an economy-wide basis by some 14 percent in 2002 and 10 percent in 2003 (Figure A2.2).

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Productivity, Wages, and Unit Labor Costs in the Private Sector

(Annualized quarter-on-quarter growth rates, in percent)

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Also significant has been the increase in the number of workers subject to a minimum wage. Until 2000, the minimum wage had been decreasing in real terms and so had its incidence. The hikes in statutory minimum wages reversed this trend. While about 7 percent of business employment was on the minimum wage in 2000, this share had risen to 18 percent in 2002, with a similar proportion earning wages no more than 10 percent above the minimum statutory level. The direct increase in labor costs from the minimum wage hike hit small domestically owned firms particularly hard because these employ the large majority of low-paid workers.

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Real Wages

(Year-on-year growth, in percent)

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Empirical evidence on the effect of the minimum wage increases on labor demand and supply is scarce. Kertesi and Köllő (2003) estimate wage elasticity of demand for various categories of labor and find that unskilled workers have the highest elasticity, in the 1 to 1½ range. Applying this to data on the wage distribution suggests that the demand for unskilled labor might have declined by some 6 percent as a result of the increase in minimum wages. The impact is likely to be quite uneven across industries, and probably higher in the textile industry, assembly line productions, and low-paid services activities such as tourism. Also, obtaining a clear picture of the impact of the minimum wage is not without difficulties: some analysts argue that the minimum wage increases may have prompted some employers (particularly small and medium-sized enterprises) to under report hours worked or to shift jobs to the gray economy, thus distorting estimates of that impact on the formal economy.

Despite a decrease in social security contribution rates since the early years of transition, total taxes and contributions on labor remain among the highest in the OECD, and particularly high given the level of economic development. While this does not necessarily discourage labor demand per se, the difficulty in controlling the informal economy and preventing tax evasion results in excess burden on those who do not evade. In turn, this contributes to weaker official labor demand and supply, providing a strong incentive not to declare employment both to the tax authorities and in surveys recording labor market activity.

A key element of the tax wedge, weakening incentives to employ low-skilled and part-time workers, is the employers’ lump-sum contribution to health care funds. In 2003, this fixed contribution represented 7 percent of the employer’s contribution at the average wage but 17 percent at the minimum wage. This not only makes for relatively high nonwage costs on low-paid workers but also dissuades the development of part-time employment. Part-time work is indeed very little developed in Hungary, representing slightly less than 7 percent of total registered employment in 2003, against 15 percent in the OECD. The government had plans for a gradual phasing out of the fixed health contribution by 2006, partly in order to harmonize with EU rules on part-time work but also reflecting concerns about its impact on the labor market. However, after a reduction by almost 25 percent in 2003, the phase-out was to be slowed down in 2004 for fiscal reasons, and the 2004 act on taxation abolishes the contribution only for part-time workers on parental leave and for long-term unemployed over 50 coming back to work. Under the agreement reached in October 2003 in the National Reconciliation Council, the fixed health contribution was to be reduced across the board to HUF 2,250 in 2005 and to be eliminated completely in 2006.

Wage Setting Process

Hungary has a national collective bargaining system whereby, each year, discussions aimed at agreement on wage guidelines are held by the Interest Reconciliation Council (IRC). The IRC includes representatives of trade unions, employers, and the government. Agreement is not binding, but it is viewed as the floor for sectoral or firm-level negotiations. Although the IRC agreement is generally applied in the public sector, actual wage increases in the private sector have generally exceeded IRC recommendations. The recommendations have usually been made in terms of nominal gross wage increases. For 2003, the recommendation was couched in terms of a real net increase. This weakened the transparency of the recommendation, and the IRC switched back to making the recommendation in gross nominal terms in 2004.

In practice, wage formation has tended to reflect an increasing decentralization of the wage bargaining system. The number of national branch agreements affecting the private sector declined rapidly in the 1990s, and, in many branches, wages are now decided directly at the firm level. Also, some rapidly expanding sectors of the economy (the financial sector, some sectors where multinational corporations are dominant) are not represented in the IRC. Moreover, unionization is only around 20 percent. While scarce, there is some evidence that wage negotiations in the private sector indeed take place now mainly at the enterprise or individual level: wage differences across companies tend to reflect productivity, location, size, and ownership, and to highlight the dominance of company-level bargaining (Köllő, 2002b).

Labor Market Institutions and Policies

A number of changes have been made to the unemployment insurance scheme in recent years, which makes it much less accessible and generous than in the past. The conditions for eligibility have been tightened, and the maximum duration of benefit has been reduced from 12 to 9 months. In addition, the replacement rate has been significantly reduced. The statutory replacement rate is 65 percent, but with a ceiling of HUF 39,240 per month (2003 figures) or 180 percent of the minimum old-age pension, which is equivalent to three, quarters of the minimum wage and about 30 percent of the average wage.

Unemployment assistance is available for those who are not eligible for unemployment insurance (or who have reached the end of unemployment insurance benefits). The assistance benefits have been significantly altered in recent years. An “unemployment assistance” benefit for long-term unemployed has been gradually eliminated and replaced by an access to regular social assistance, conditional on acceptance of public sector work when offered. A new assistance benefit was introduced in July 2003: the “job-search allowance.” For eligibility, individuals must have been on unemployment insurance benefits for at least 180 days and must be willing to engage in intensive cooperation with labor centers. The allowance is 85 percent of the minimum old-age pension in 2003, a sum of HUF 18,530. The maximum duration is six months (nine months for those aged over 45). A key goal of the scheme is to encourage individuals to take up work: if the recipient is employed, even in a part-time job, before the exhaustion of the disbursement period, half of the remaining subsidy to the end of the disbursement period can be paid in a lump sum on request.

ALMPs (active labor market policies) now absorb around 60 percent of the Labor Market Fund, which finances passive and active labor market policies. Several years ago, reforms to ALMPs raised spending on such measures considerably and devolved more responsibility to local governments. These policies consisted mainly of public works, training, and wage subsidies. Public works allowed long-term unemployed to break their unemployment period and provided localities with community services that they would not have afforded otherwise. In principle, since public work schemes also make it difficult to continue informal work while on unemployment benefits, they encourage people to take official market jobs that offer better wages and working conditions.

However, impact studies of ALMPs seem to indicate little positive effect from such programs in terms of success in rehabilitating the long-term unemployed into regular private sector jobs. For instance, Fazekas (2004) concludes that in the majority of cases, public works have proved unable to transfer unemployed persons into formal market jobs. Wage subsidies—provided generally for one year to employers (mostly small and medium-sized enterprises) who hire the long-term unemployed with the obligation to employ them for another year after the supported period—seem to have been more successful because employment has been continued beyond the period when employers have signed up to employ them in 70-90 percent of the cases. Köllő(2002b) provides an overall assessment of recent reforms to passive and active labor market policies in recent years, and concludes that, while the reforms have reduced the number of benefit claimants significantly, they have not increased private sector employment and the labor force.¹²

In recognition of the influence of transfers on labor market participation, eligibility criteria for state financed early retirement schemes have been significantly tightened since the second half of the 1990s. Currently, only older workers with long contribution histories are allowed to benefit from early retirement, and less than 170,000 people—or 2.6 percent of the working-age population—are now receiving these benefits, compared with more than 500,000 in 1999. To promote labor force participation among people on old-age pensions, the government has fully excluded old-age pensions from the taxable income. Previously a pension formed part of the tax base if the person was getting additional revenues through work. Because a number of retirees seem to be already working in the informal sector to supplement their revenues, this should provide an incentive for them to switch to the formal economy.

Labor Market Performance

Poland has had one of the worst labor market performances among new EU member states. Having declined from 14 percent in the early 1990s to almost 10 percent in early 1998, the unemployment rate rose rapidly, exceeding 20 percent in 2002, as employment and labor force participation rates fell to 51 and 64 percent, respectively. Some improvement in the labor market took place during 2003–04, largely because of higher economic growth, which helped reduce unemployment to under 19 percent and raise employment to 52 percent in 2004. The labor force participation rate remained at around 64 percent.¹⁴

These negative trends are a legacy of economic transition and restructuring. Initially, restructuring and closing down old industries led to massive job destruction during 1990–93 and resulted in double-digit unemployment rates. While there was simultaneous private sector job creation, skill mismatches occurred that, along with a sharp productivity increase in the mid 1990s, help explain the lack of aggregate net employment growth. Job losses recurred in large numbers in the second wave of restructuring after the Russia crisis, which seems to have mostly affected exporters and heavy industries. Privatization also led to job shedding, as did the slowdown that gripped the country in 2001–02. Therefore, by 2004, redundancy or closing down of businesses explained nearly half of unemployment among previously employed persons.

The uneven impact of these factors across the country has led to regional labor market disparities. The process of industrial destruction at the onset of the transition has led to regional disparities in labor market performance. Mobility seems partly hampered by housing market problems, including little availability of rental units associated with rent controls and overly protective tenant rights. Also, the uniform application of benefits and minimum wages across regions has tended to raise workers’ effective reservation wage in poorer regions, discouraging labor supply. Lack of labor cost differentiation to reflect differences in average labor productivity across regions—with the uniform minimum wage also contributing to the lack of such differentiation—is suspected to be another factor that impeded growth of labor demand.

A number of policy and institutional problems likely contributed to persistently high unemployment since the late 1990s. The factors that seem to have particularly exacerbated the impact of transition, restructuring, and cyclical shocks include, in no particular order and certainly not exclusively, the following: (i) regional and skills mismatches resulting from shortcomings in infrastructure, in incentives for labor mobility, and in the education and training systems; (ii) easy access to benefits; (iii) high labor costs; and (iv) an insufficient degree of flexibility in regular employment contracts.

Labor Costs

Despite some pick-up in early 2004, real wage growth remains contained. Real wages had grown strongly in the late 1990s, exceeding productivity growth, which contributed to a decline in competitiveness. The second wave of restructuring in the late 1990s, however, resulted in accelerated productivity growth; at the same time, real wage growth slowed, which restored part of the lost competitiveness. Recently, real wage growth has remained moderate overall, and smaller than productivity growth.

It is widely believed that high payroll taxes have tended to discourage employment in Poland. OECD estimates for 2004 indicate that the tax wedge in Poland, at about 42 percent, is between 10 and 15 percentage points above the OECD average. Social security contributions are an important component of that tax wedge. They are relatively high, at about 45 percent of gross wages, and their burden is shared almost equally between employers and employees.

Wage Setting Process

Wage negotiations are largely decentralized in Poland. A tripartite commission, representing the government, the private sector, and trade unions, sets the wage for the public sector—for employees in both the administration and public enterprises—on the basis of a bargaining process. The role of private sector representatives is restricted to giving an opinion on how much public sector wages should increase without active participation in the negotiations. In the past, the bargaining process often failed, and the government had to decide on public wage increases by decree. Private sector wages are negotiated at the firm level and bear no formal relationship to increases decided for the public sector. Labor unions are generally weak and unable to exert pressure during wage negotiations.

Minimum wages are also set by the tripartite commission in case of agreement. The minimum wage was around 42 percent of the national average wage in the early to mid–1990s, but this share has declined since and reached 36 percent in 2004. The uniformity of the minimum wage across regions is suspected to be an obstacle to job creation: the minimum wage is likely to be more binding in poorer regions because of the large economic differences they exhibit vis-à-vis richer ones (Estevão, 2003; Selassie, 2001).

Labor Market Institutions and Policies

The Polish labor code dates from 1974 but has been amended to adapt to Poland’s post-transition status. The first reform of the labor code took place in 1996 and usefully clarified many employment rules, although it did not seem to remove rigidities from the system overall. This reform was relatively favorable to employees in several respects—such as the prohibition of firing employees in case of mergers; the shortening of the weekly working time; and the increase in the length of the annual leave entitlement for some employees. Another labor code reform followed in 2002 that helped improve labor market flexibility, particularly in favor of small businesses. For example, a new type of contract was introduced to ease the hiring of temporary workers replacing employees on extended leave; the amount of additional remuneration for overtime work was reduced; the minimum number of employees for which a code for work had to be written was raised to 20 employees; and most employee entitlements became a function of the duration of employment with the current employer, rather than total lifetime employment.

Additional amendments to the labor code in 2003, largely needed for compliance with EU regulations, represented some backtracking from the 2002 reforms. These amendments, effective from 2004, introduced daily and weekly statutory rests and limits on overtime work, limiting the flexibility of work arrangements. Leave arrangements were changed to the workers’ advantage. Also, mass layoff procedures were lengthened, and entitlements for severance payments were extended in cases of employment restructuring.

The government has taken steps to address Poland’s labor market problems. To improve youth employment, a law was passed in October 2002 setting the minimum wage for new entrants at 80 percent (90 percent) of the nationwide minimum wage in the first (second) year of work (so-called “first job” program). A reform to the disability system effective in 1998 tightened eligibility requirements and introduced frequent reviews of disability certificates and measures to prevent work accidents. The retirement age became compulsory with the 1999 pension reform for persons who were integrated in the new pension system, although it remained at 65 for men and 60 for women. Some forms of preretirement allowances¹⁵ were eliminated (albeit with grandfathering) from January 2002. A law on Employment Promotion and Labor Market Institutions, passed by parliament in April 2004, tightened eligibility for registering as unemployed and receiving social benefits, and reduced the length of access to unemployment benefits in some regions.

The government also uses active labor market programs to promote employment. Spending on these programs rose to about 1.3 billion zlotys (under 0.2 percent of GDP) annually during 2003–04, more than double the level in the previous two years. The activation of new graduates (in the context of the “first job” program) captured more than one-third of that amount; about a fifth of it was spent on public works programs; and about 16 percent of the total spending went to subsidized employment programs.

Poland’s social security and social assistance systems include a range of benefits. Employees and the self-employed have access to old-age insurance; disability, sickness, and maternity insurance; and to work injury and occupational disease insurance. Farmers have access to a separate social security system that includes similar benefits. Unemployment benefits are granted for a period of 6,12, or 18 months, depending on the region where the unemployed person is registered. In addition, based on the revenue situation of the family, benefits can be provided that include family benefits, nursing benefits, child-care benefits, and alimony benefits. The minimum revenue criterion for access to family and alimony benefits was lowered in 2003, and other criteria for eligibility for family and nursing benefits were also tightened, resulting in fewer beneficiaries. Low-income households can also be entitled to housing benefits paid by local authorities outside the social assistance system.

Poland’s benefit replacement rates tend to increase once individuals are no longer eligible for unemployment insurance but are eligible for social assistance. This holds for most individuals but not for single persons without dependents. Nevertheless, compared with other Visegrad countries, benefit replacement rates do not seem to be excessive in Poland. OECD estimates for 2002 indicate that long-term net replacement rates for a number of family types in Poland were below counterpart rates for the Slovak Republic and were broadly similar to rates in the Czech Republic, although they exceeded relatively significantly replacement rates calculated for Hungary.