Journal Issue

Transition in Eastern Europe—The Social Dimension

International Monetary Fund. External Relations Dept.
Published Date:
January 1990
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New governments struggle to maintain and improve vital social services as countries undergo wrenching transitions

For Eastern European countries, the move away from centrally planned economies to market-oriented ones involves three central social policy challenges:

• How, without intolerable hardship, can people be encouraged to move from low-paid, unproductive jobs offering little other than lifetime security of employment, to productive—and potentially, better-paying but less secure—jobs in a market economy?

• How should the most vulnerable groups (pensioners, single-parent families, the unemployed, children, etc.) be protected from the social costs of adjustment? and

• How can the needs for greatly improved health and education be satisfied at a time when budgetary deficits and inflation threaten the already meager resources devoted to the social sectors?

These challenges are turning out to be complex and difficult to solve. It has sometimes been argued that the countries of Eastern Europe, despite low productivity and obsolete technologies, at least enjoyed highly skilled, healthy, well-educated populations. In truth, however, this is not the case, and many painful, slow adjustments lie ahead, not just in terms of the institutions that must deliver these services, but in attitudes as well. Indeed, underlying all of these challenges is the need to adapt administrative and managerial mentalities to operate in a decentralized, market-oriented environment.

Faced with these formidable and unprecedented problems, the new governments in Eastern Europe are turning to the World Bank, the IMF, the European Community, and other multilateral and bilateral agencies for urgent technical advice and financial assistance. Ambitious programs are already underway, and in the next few years, large-scale assistance—both financial and technical—will be needed to encourage reallocation of labor and occupational mobility, reform the way in which social services are provided, improve the health of the population, and train managers, businessmen, and technicians to run a market economy.

Reforming labor markets

Among the most difficult of the many problems facing Eastern European administrations is the need to reform drastically the way labor markets operate, especially in light of a new phenomenon: emerging unemployment. But why is this so critical, since even Poland, perhaps furthest along with an economic reform program, has only a 7 percent unemployment rate—still quite modest compared with levels seen in the West during the 1980s (e.g., 19 percent in Spain in 1988)?

The reason is that under the former communist regimes, with unemployment deemed a “social” crime, the policies and institutions required to encourage reallocation of labor and occupational mobility existed only in rudimentary form. Poland is a case in point. In January 1990, at the start of the stabilization program, the country’s employment offices were low in number and seriously understaffed, with virtually no capacity to pay benefits to the unemployed (rapidly approaching one million), monitor the local employment situation, and provide critical counseling and aptitude testing. Moreover, the country lacked a legal framework to even administer such benefits. Since then, the Polish authorities (as well those in Hungary and Yugoslavia), assisted by the Bank and other donors, have made great efforts to create a modern employment service. But the fear of large-scale structural unemployment resulting from adjustment efforts may hamper the speedy implementation of economic reforms.

Emerging unemployment, however, is just one facet of the urgent need to reform labor markets. Centrally determined systems of wage determination—which favored heavy over light industry and blue collar over white collar workers—have resulted in narrow wage differentials and inefficient uses of labor. Moreover, innovation, productivity, and scarce skills have rarely been rewarded. In Hungary, cases were reported where skilled workers earned more than highly skilled engineers, and semi-skilled workers earned more than skilled workers. But dismantling these wage systems poses a dilemma: too rapid decentralization risks wage inflation, since many firms still enjoy monopoly positions, while moving too slowly risks discouraging the efficient use of labor. Various “intermediate” approaches are thus being tried, including punitive taxes on large wage increases in Poland and Hungary, and national tripartite agreements in Hungary.

Tackling poverty

As with unemployment, an ideological reluctance to acknowledge the existence of poverty has resulted in weak institutions and policies to address the issue. These must be rapidly developed as new strains are placed on the capacity of social welfare systems to provide a safety net for the most vulnerable groups. Reforms are needed in both the financing and delivery of social welfare to ensure equitable provision and stable funding. The pension problem is particularly acute because of the widespread practice of retirement on full pension, as early as 55 years of age, coupled with demographic trends that point to increasing proportions of elderly people. Bulgaria, for example, spends about 11 percent of GDP on civilian pensions alone—roughly 20 percent above the average for the Organization for Economic Cooperation and Development (OECD) countries—yet most of the beneficiaries receive pensions below the minimum wage and half of all beneficiaries receive only the minimum benefit.

The absence of much reliable data on poverty makes it difficult to target benefits on specific needy groups, a critical issue as subsidies on a range of commodities are removed. However, despite the poor data, there is no doubt that widespread poverty—in no way limited to certain vulnerable groups—has not only existed but increased in recent years (see Chart 1). Moreover, during the early stages of the switch to market-oriented economies, the incidence of poverty may rise further. For example, incomes fell by as much as 40 percent in Poland during the first six months of the 1990 stabilization program, and although this must be seen in the light of unsustainable increases in incomes over the previous two years, there is little doubt that certain groups—pensioners, single-income families, and the sick—have been adversely affected. As a result, countries such as Poland, Hungary, and Bulgaria are moving to reform the administration and financing of benefits, improve targeting of social assistance, and reorganize pension systems.

Chart 1.Rising poverty1 in Poland, 1978-87

Source: “Poverty in Poland, Hungary, and Yugoslavia in the Years of Crisis: 1976.87.” Branko Milanovic, PRE Working Paper No. 507, World Bank. 1990.

1Poverty is defined here in terms of incomes below the “social minimum” defined by the Institute of Labor and Social Affairs in Poland. The bars represent the percentage of each group below this poverty line. Although the social minimum is higher than some definitions based on a minimal calorie intake, it allows for only a very minimal satisfaction of human needs. Since it is constant in real terms. It is a useful indicator of how the extent and composition of poverty have changed during the 1980s.

Improving health

Another worrying trend since 1970 has been the declining state of health of the populations of Eastern European countries. As of 1989, all the standard health indicators were well below OECD averages. (Despite methodological difficulties and significant differences in per capita GDP levels, such a comparison is important, as these countries compare themselves with Western Europe, which provides the natural markets in which Eastern Europe—drawing on its human resources—must compete.) The infant mortality rate, at 18 per 1,000, was twice the OECD average, and life expectancy, particularly for adult males, was two to three years lower in 1985 than the average of 73.9 years for Europe as a whole. Further, some key health indicators have deteriorated. For example, male standardized (i.e., from all causes and for all ages) mortality rates began rising in the mid-1960s in Hungary, Czechoslovakia, and Poland—contrasting sharply with falls in many Western European countries (see Chart 2). Although Hungary did show a slight improvement after 1985, the most recent evidence shows male mortality rates for those aged 20-55 on the rise once again.

Chart 2.Eastern Europe: Male mortality began rising in the 1960s while it fell in Western Europe

Source: “Health in Eastern Europe,” by D. Foster and P. Jorza, The Lancet, February 24, 1990.

1Per one hundred thousand.

Although the populations’ demographic profile and unhealthy lifestyles (heavy smoking and drinking, and poor nutrition, including a heavy diet of unsaturated fats) contributed to these trends, an additional factor, as highlighted by recent World Bank reports, has been inadequate management and financing of health care services. Health spending is no more than 5 percent of GDP, compared with a median OECD level of over 8 percent. In Poland, the 1990 health budget has not adequately kept up with inflation, resulting in severe shortages of drugs, equipment, and high-volume disposable articles, such as syringes and needles.

Further, environmental pollution in Eastern Europe has generally been higher than in OECD countries, and exceptionally bad in areas such as Bohemia in Czechoslovakia and Silesia in Poland. In Katowice, Poland, for example, high blood lead levels among children have resulted in a very high incidence of anemia, digestive tract problems, mental disturbances, and other symptoms of lead poisoning.

Public dissatisfaction with the quality of health care is now widespread. Although patients are guaranteed universal access to free and comprehensive services, in practice, under-the-counter payments are routine in order to supplement the very low official pay of doctors and other health care workers, and for many patients, illness now poses a considerable financial burden. The impact of the adjustment process (unemployment, short-term declines in real wages, worker dislocations, etc.) will place further strains on the health sector. Clearly, restructuring of the health care system is becoming a high priority, and securing more adequate health revenues is a preoccupation in the region. Among the options being discussed are: financial incentives to improve resource utilization, improving the budgetary system to encourage more equitable resource allocation and efficiency, and diversifying the sources of financing through social and private insurance. The absence of a well-developed private insurance industry makes the latter option problematic in the short term.

Upgrading education and training

There is also much talk of improving education and training to respond to the needs of a market economy. At first glance, the system may appear sound (a sufficient number of schools, a well-developed system of vocational and technical education, etc.), giving rise to the belief that, at the very least, residents are relatively well-educated and thus well-placed to attract inward investment that could take advantage of skilled work forces with low labor costs. But upon closer scrutiny, it becomes clear that the focus and structure leave much to be desired, particularly in comparison with OECD countries.

Enrollments in secondary, and in particular, tertiary, education remain significantly lower than OECD averages (e.g., tertiary enrollments in Hungary are only 50 percent of the OECD average). Then, too, there is a dearth of broad-based multidisciplinary programs in secondary and higher education. In Hungary, for example, 50 percent of the 14-year-olds enter apprentice training, which often provides narrow occupational training in obsolete skills and only a thin veneer of further education in the core skills (mathematics, science, communications, etc.). This contrasts sharply with practices in countries such as the Federal Republic of Germany, Switzerland, and Austria, where apprentice training commences at a later age and increasingly emphasizes broad skills training and academic education. Further, the education and training systems generally lack the capacity to provide the new skills needed in the emerging market economies. Management, commerce, and “high tech” industrial skills are all in short supply. Equally critical is the need to retrain the large numbers of workers who will lose their jobs as industry and agriculture restructure.

How donors can help

Many bilateral donors and multilateral agencies have begun providing essential technical and financial assistance. An early focus has been on training for the new management and business skills (in banking, finance, accountancy, law, small business development, etc.), most of which have to be developed almost from scratch. Attention is also being given to the skills needed to run local governments, stemming from the decentralization of administration in countries such as Poland and Hungary, and the new technical skills required to modernize industry and agriculture.

The Bank is cooperating closely with other agencies to provide the extensive assistance needed to modernize education, science, health, social welfare, and technology. In Hungary, an ambitious project is being prepared to develop employment services, reform and upgrade youth and adult training, and assist an initial restructuring of higher education and scientific research. Projects in Poland will assist employment services, small business development, improvements to the health system, and upgrading technical education. In Romania, a project will help improve family planning and maternal and child health, as well as health sector management and finance.

Adjustment loans to Poland, Hungary, and Yugoslavia have significant components to alleviate the social costs of adjustment. For example, the loan to Poland will help the Government develop a social safety net, focusing on unemployment benefits, training, small business development, minimum social assistance, and health policy reform. An improved survey of living standards is also being introduced to enhance the measurement of poverty and the targeting of social benefits.

New from the International Monetary Fund


Edited by Vito Tanzi

Based on papers presented at the 44th Congress of the International Institute of Public Finance, this book deals with public finance and macroeconomic policy in open, developing economies, with case studies of Chile, Mexico, Turkey, Korea, and the Arab oil-exporting countries.

Available in English. ISBN 1-55775-118-8. viii + 229 pp. 1990, US$15.00

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