Transition to Market
Chapter

Chapter 8 Russian Federation: Economic Reform and Policy Options for Social Protection

Editor(s):
Vito Tanzi
Published Date:
June 1993
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Author(s)
Ehtisham Ahmad and Ke-young Chu 

This paper analyzes the implications of the present and possible future reform policies for vulnerable groups in the Russian Federation and the role of a social safety net in protecting them during the transition to a market-oriented economy. In view of the rapidity of the changes in economic conditions, policy measures, and institutions, our aim is to sketch broadly the effects of Russia’s reform policies on vulnerable groups and to discuss economic aspects of potential social safety net options in protecting these groups. The economic aspects include the implications of the various options for the budget. In discussing the economic situation and institutional arrangements, our starting point in general is December 1991–just before a major increase in prices. We also discuss the developments during the first half of 1992.

Russia is a middle-income country with a large population and a vast territory. It is in the throes of a market-oriented economic reform. While the living standards for a large number of people are deteriorating rapidly, Russia, on average, is relatively better off than many of the other states of the former U.S.S.R. It is nevertheless important to note that, given large pre-reform distortions, major changes in relative prices will have a differential effect on various income groups. Without an effective safety net, the social effects of the reform would be immense, with a potentially severe negative impact on the political viability of the reform process.

The paper is organized as follows. The effects of economic reform measures on vulnerable groups are first discussed, and then the existing social protection measures, their potential role as social safety nets, and their budgetary implications are described. The discussion of the budgetary implications is based on very rough simulations. Next, possible options for reforming the existing social protection measures are assessed, and finally a summary and conclusions are provided.

Economic Reform and Vulnerable Groups

Living Standards and Vulnerable Groups

A Study of the Soviet Economy, published in 1991,1 estimated Russia’s per capita income in 1989 at 10 percent higher than the average—estimated at US$1,800—for the former U.S.S.R. While this level was lower than per capita incomes in the Baltic states, it was above the per capita incomes in most states of the former U.S.S.R., in particular, those in Central Asia. Russia has a large population—150 billion people.

The recent decline in Russia’s production suggests that per capita income in Russia, as in the other states of the former U.S.S.R., has declined substantially since 1989. Nevertheless, the common practice of expressing Russian incomes in U.S. dollar terms on the basis of the commercial rate may be misleading. For example, in December 1991, the monthly salary of a typical professional in Moscow was perhaps some rub 1,000, which at the then commercial exchange rate of rub 100 per U.S. dollar was equivalent to about US$10. However, a monthly income of rub 1,000 in Moscow, in spite of the limited use of rubles resulting from great shortages of goods and services, commanded a substantially larger basket of essential goods than US$10 would, for example, in Washington, D.C.

A child dependency ratio2 of 43 percent and an old-age dependency ratio of 32 percent imply a young-age population of 37 million, an old-age population of 27 million, and a working age population (including the unemployed, college-age students, and housewives) of 75 million. The child dependency ratio in Russia is substantially lower than those in the Central Asian states of the former U.S.S.R., China, and India, but higher than that in the United States; the high old-age dependency ratio reflects both the relatively long life expectancy and the retirement system that allows workers to retire relatively early (Table 1).3

Table 1.Russia: Basic Indicators Compared with Selected Countries, 1989-901
Infant
PerMortalityLifeDependency
Capita CDPRateExpectancyRatio
Population(In U.S.dollars)(Per 1.000)at BirthChildOld age
Russia1501,98018704332
Other states of
former U.S.S.R.
Belarus101,82012724435
Kazakhstan171,67026696120
Kyrgyzstan41,30032697820
Tajikistan597043699516
Ukraine521,73013714138
Baltic states
Estonia22,40015714236
Latvia32,20011704037
Other countries
China1,1143503070409
India8333409559637
Turkey551,3706166577
United States24920,91010763318
Sources: International Monetary Fund, World Bank, Organization for Economic Cooperation and Development and European Bank for Reconstruction and Development (1991), Vol. I, p. 230;World Bank (1991), Table 26.

The dependency ratios for the states of the former U.S.S.R. and other countries are for rough comparisons. For the ratios for the former U.S.S.R. states, a child is defined to be age 16 or younger and the elderly to be older than 55 for women and 60 for men. For the ratios for other countries, a child is defined to be age 14 or younger and the elderly to be older than age 64.

Sources: International Monetary Fund, World Bank, Organization for Economic Cooperation and Development and European Bank for Reconstruction and Development (1991), Vol. I, p. 230;World Bank (1991), Table 26.

The dependency ratios for the states of the former U.S.S.R. and other countries are for rough comparisons. For the ratios for the former U.S.S.R. states, a child is defined to be age 16 or younger and the elderly to be older than 55 for women and 60 for men. For the ratios for other countries, a child is defined to be age 14 or younger and the elderly to be older than age 64.

In December 1991, the number of employees in the state sector (including state farms) was estimated at 65 million and pensioners at 38 million. The difference between the working-age population of 75 million and the number of employees of 65 million in the state sector is accounted for largely by college students, nonworking housewives, and the unemployed. The number of pensioners of 38 million, together with the old-age population of 27 million, implies that 11 million pensioners receive disability and survivors' benefits.

Recent survey data indicate that in the second quarter 1991, between 80 percent and 90 percent of families received a per capita monthly income of rub 360 (about twice the minimum wage) or less. Pensioners were in a particularly difficult position because the increase in the minimum pension had been less than the price rise in 1991. In December 1991, the minimum pension and the minimum wage were both rub 180 a month. By comparison, the average pension was rub 160.4 With the adjustment of the minimum pension to rub 342 on January 1, 1992, about 95 percent of pensioners received the minimum pension.

Survey data also indicate that, on average, Russia’s consumption of bread, meat products, and milk was not substantially below that of upper middle-income countries. The per capita annual consumption of bread, meat products, and milk in Russia during 1991 was 140 kilograms, 72 kilograms, and 390 liters, respectively. By comparison, the per capita consumption of meat products and milk of low-income groups (lowest 20-30 percent income groups) was 38 kilograms and 300 liters, respectively. A comparable figure for bread is unavailable, but, on the basis of the bread consumption levels of various income groups in other countries, it would not be unreasonable to estimate it at 120 kilograms. These levels undoubtedly have been reduced in recent months. While the average consumption of essential foodstuffs is not low in comparison with other middle-income countries, the consumption of low-income groups is considerably lower than the average for some commodities (for example, meat products and milk). In particular, the consumption of meat, even for the poorest groups, is high by international standards (the poorest group in Russia in 1990 consumed as much meat per capita as the richest 20 percent of the population in a middle-income country–Jordan–in 1989). Considering the apparent further decline in their consumption in recent months, some groups (for example, children, nursing mothers, and elderly) are particularly vulnerable to a further large decline in consumption, particularly of milk and milk products.

Economic Reform and Vulnerable Groups

The large pre-reform price distortions imply that any economic reform effort should aim, among other things, at improving both the structure of relative prices and the functioning of the price system. The extent of distorted domestic prices at the end of 1991 can be illustrated by using the example of bread prices and exchange rates. At the end of 1991, the official price of a loaf of bread was rub 0.48, the basic official rate was rub 1.8 per U.S. dollar, and the commercial exchange rate was about rub 100 per U.S. dollar. These implied that the price of a loaf of bread was less than half a U.S. cent at the commercial rate, and, even at the grossly overvalued basic official exchange rate, was as low as 28 U.S. cents. By comparison, the comparable price in Washington, D.C. was between 80 U.S. cents and $1.

In the Government's discussion of price reform, a major issue has been whether the liberalization of prices should precede, or be preceded by, creating conditions for competition, the latter including measures to establish private ownership of properties, including land, to privatize stateowned enterprises, and to break up monopolies. The Government apparently decided, first, to increase prices, perhaps to reduce a large monetary overhang, and, at the same time, to correct, at least to a certain extent, the grossly distorted relative prices.

The Government liberalized and raised a large number of prices. For example, in January 1992, the Government increased essential food prices by a factor of between 3 and 5. Consumer prices subsequently increased further, resulting in a 250 percent increase in the consumer price index (CPI) during the first quarter of 1992. The Government also raised the minimum wage and minimum pensions. The minimum wage was raised from rub 180 a month to rub 342 a month in January 1992, and again to rub 900 with effect from May 1, 1992. The minimum pension was adjusted from rub 180 a month to rub 342 a month in January 1992, but only to rub 800 a month in May 1992, thus effectively breaking the link with the minimum wage.

Although it is unclear to what extent the present relative prices reflect market conditions, the price increases imply substantial reductions in the real minimum wage and pension. It is evident that real living standards have fallen, particularly for groups, such as pensioners, dependent on state transfers. For instance, between December 1991 and March 1992, pensions have increased about two times, compared with a price increase of approximately six times.5 And income distribution data for early January 1992 suggest that the concentration of per capita incomes around the minimum wage has increased relative to the mid-1991 bunching of incomes. 6 Under these circumstances, a lowering of the benefit below the current minimum wage may not be socially acceptable, although there may be some scope for using a lower subsistence minimum in the determination of localized social assistance programs. A substantially higher level of benefits than at present would, however, entail serious budgetary consequences.

The labor market situation is shrouded by great uncertainties. The tight budgetary situation calls for a sharp reduction in enterprise subsidies and transfers; this, in turn, implies the possibility of an increase in unemployment. Moreover, it is likely that a large number of defense enterprises will be restructured, adding to the increase in unemployment. Moreover, defense conversion will have further social implications because of the extensive reliance of some large towns on one or two enterprises for providing social services, such as health and education.

In March 1992, slightly more than 100,000 workers were officially registered as unemployed; on August 1, 1992, that figure was reported to have increased to about 250,000. While low, it represents a substantial increase since the beginning of the year. As there have been no bankruptcies so far, the trend is deceptive, and it is difficult to predict the future course of unemployment. Moreover, there are reports that many workers are not being paid, and are effectively unemployed, although they have not been laid off. Others who have been laid off have not been registered as unemployed. Thus, the true extent of unemployment is probably considerably higher than reported. The above figure represents a small proportion of the labor force. As is seen in other transition economies, an unemployment rate of 5-10 percent is not uncommon, and in Russia, an unemployment rate of 5 percent would imply some 3-4 million unemployed workers and 10 percent would imply some 6-7 million unemployed workers.

Children in low-income families are particularly vulnerable. (Further, younger families with children tend to have lower per capita incomes.) Assuming that about one fifth of the 38 million children are infants (two years or younger), some 8 million children, together with their nursing mothers, especially those in low-income families, would be affected by an increase in the price of food. If nursing mothers and pregnant women leave paid employment in the absence of adequate provisions for maternity care, a considerable reduction in household living standards would result.

Existing Social Protection Measures and Implications

Russia has inherited a set of social protection measures from the former U.S.S.R., and shares many of its features with other states of the former U.S.S.R. After liberalizing many prices and discarding the longestablished system of fixed consumer prices, the Government delegated the authority to set the prices of a number of essential commodities (such as bread, sugar, energy products, and transportation) to local governments. Some (such as Moscow) have chosen not to retain explicit subsidies; others still retain them. Note that implicit subsidies would still obtain, depending the extent of input subsidies. It is also possible to view the difference between domestic and world prices as an implicit subsidy, as argued above.

In addition to subsidies, the Government maintains a guaranteed minimum wage for those who work, and a set of cash transfers (pensions, family allowances, and unemployment benefits) for those who do not. In principle, the minimum wage sets the floor for wages of unskilled workers, but it is also used as a reference for cash transfers. The pension scheme is a social insurance arrangement for old-age, disability, and the loss of breadwinner. The Pension Fund was established in 1991 to introduce social insurance; however, along with pensions some family allowances were also to be paid from the Pension Fund (see Ahmad (1992)).

The social security system, however, has been changing rapidly. The Government has abandoned the policy of guaranteed employment for all, but introduced the Employment Fund to finance unemployment compensation and retraining programs. Both the Pension Fund and the Employment Fund are financed through payroll taxes. Budgetary transfers are also involved, particularly for some family allowances, and may well have to be incurred also for increased unemployment.

Existing Measures

Generalized Consumer Subsidies

In December 1991, the system of administered prices still existed. The Government controlled both producer and consumer prices. For foodstuffs, the Government compensated for low producer prices through the subsidized provision of inputs, credits, or cash subsidies. Although there had been efforts to reduce cash subsidies, producer prices were set on the basis of the administratively determined consumer prices, with certain allowed margins for the state-owned enterprises engaged in processing and distributing the good, rather than on the basis of the levels that would provide the farmers with adequate incentives. The administratively determined consumer prices did not reflect the scarcity of the goods and were thus much lower than the prices that prevailed at the few free markets allowed to operate in large cities.

This system benefited those consumers who had access to the goods at the administered prices by keeping prices low, but created severe shortages of subsidized goods and imposed a financial burden on the Government for the budgetary subsidies (to compensate for the losses of state enterprises engaged in processing and distributing the goods) together with implicit taxes on the farmers who received unremunerative prices.

The extent of the benefits may be indicated by comparing the official consumer prices of a set of illustrative foodstuffs with those prevailing at Moscow free markets. For example, in December 1991, the official price of milk was rub 0.43 a liter, whereas the free market price was about rub 15 a liter; similarly, the official price of beef was rub 7 a kilogram, whereas the free market price was between rub 80 and rub 100 a kilogram.

A general subsidy for a commodity tends to provide greater benefits to the better-off groups, who consume more of the subsidized commodity than do the poor. In Russia, while the smaller benefits received by the poor from subsidies accounted for a large share of their household expenditure, the system had degenerated in that the well connected continued to have special access to goods, whereas others had to queue for the severely limited supplies at official prices, or buy in open markets at considerably higher prices.

Although consumer price controls have been lifted by and large, the Government still is unable to eliminate subsidies to agricultural producers on the grounds that consumer prices for staples would have to rise. Thus, despite the ostensible removal of subsidies and price controls, an effective generalized subsidy still remains, and its effects are as opaque as the situation in 1989.

Cash Transfers Based on Social Security

Minimum Wage. The minimum wage was set at rub 900 a month in May 1992, compared with rub 342 at the beginning of 1992 and rub 180 at the end of 1991.7 The Government once contemplated a system of wage indexation to increase the minimum wage fully to compensate for the increase in the cost of living, while increasing the average wage at a lower rate. Because of the linkage of the minimum wage, pensions, family allowances, and unemployment compensation, the increase in the minimum wage has important implications for overall cash benefits and the financial viability of the Pension Fund and the Employment Fund. It remains unclear, however, how nominal wages and social security benefits will be adjusted for inflation.

Pensions and Allowances. To establish a best-practice market-based system, a new pension law was prepared and legislated in 1991, with help from international agencies such as the International Labor Organization.

At present there is a total payroll tax of 37 percent for pensions and allowances and 1 percent for unemployment insurance. Eighty-five percent of the overall payroll tax (or 31.6 percent of the payroll) is allocated to the Pension Fund to finance old-age, disability, and survivors’ pensions and to finance a part of family allowances (for infants); the balance (or 5.4 percent of the payroll) accrues to the Social Insurance Fund to finance the social programs, including family allowances for older children, sick leave, maternity leave, and use of sanatoriums; these programs are administered by trade unions.

A major difficulty has been the high contribution rate, of about 37 percent of the payroll, for pensions and family allowances, in addition to 1 percent for unemployment insurance. Given substantial and growing inter-enterprise arrears, enterprises defer payments, and there are considerable lags in collection. Also, the contribution rate paid by those in the agro-prom complex is considerably lower than elsewhere (20.6 percent, compared with 31.6 percent). This differentiation leads to considerable distortions, as enterprises seek to be reclassified as part of agro-prom.

The system of family allowances is extremely cumbersome, with 18 different types of overlapping allowances, and lacks a clear rationale. Moreover, legally many of the allowances are set as multiples of the minimum wage–for example, the lump-sum birth grant is set at three times the minimum wage. In practice, the minimum wage used for the calculation has remained at the 1990 level of rub 70 a month, and a lump-sum compensation for price changes has been made. For the birth grant, this compensation has been rub 140, making for a total grant of rub 350 (compared with the minimum wage of rub 900 in mid-1992).

Unemployment Benefits. An earnings-related unemployment benefit system is in operation for those who have lost their employment. After a three-month period of severance pay financed by the enterprise,8 unemployment benefits are 75 percent of the average wage during the most recent pre-unemployment 12 months for the first 3 months following the loss of a job, then 60 percent and 45 percent, respectively, for the subsequent two quarters. The benefit is to be no lower than the minimum wage. For those without a work history, the minimum benefit is equivalent to the minimum wage. Under the present circumstances, the administration of the system is complicated by the calculation of the earnings-related benefit. The authorities believe that the task would become overwhelming if there is an increase in the numbers becoming unemployed.

Budgetary Implications and Trade-Offs

The budgetary implications of the social protection system have several dimensions. The cost of consumer subsidies depends on a number of factors: the producer price, the consumer price, and the quantity of subsidized consumption. There are many trade-offs. Other factors remaining constant, an increase in the producer price would improve production incentives but would increase the budgetary cost of subsidies. An increase in the consumer price would reduce the budgetary cost, but would raise the cost of living for all, including the poor. These dilemmas underscore the importance of reducing the quantity of subsidized consumption to a bare minimum and, if possible, by targeting, for example, on a geographical or categorical basis.

Subsidies are extremely costly. For example, on the assumption that Russia's domestic producer prices were equalized with world market prices, the financial cost of allowing the entire population access to minimum subsidized consumption of bread, milk, and meat products at half the world prices would cost US$7.6 billion annually (Table 2). At a hypothetical exchange rate of rub 100 per U.S. dollar, this amounts to rub 760 billion.

Table 2.Russia: Illustrative Calculations of General Food Subsidies–Bread, Milk, and Meat
Quantity and Price
Assumptions
Annual
subsidized
consumptionProducerNumber ofAmount of
per capita 1prices2beneficiaries3Subsidies4
(In kilograms(In U.S. dollar(Million(In billions of(In billions
Commoditiesor liters)per unit)persons)U.S. dollars)of rubles)
Bread1000.131500.990
Milk3000.1 41503.1310
Meat242.001503.6360
Total7.6760
Source: Authors' calculations. See also Table 4 for altenative calculations that provide a safety net at lower costs.

Authors' assumptions based on the household income and expenditure survey. The unit is kilograms for bread and meat; liters for milk.

World market prices in early 1992.

Entire population.

The cost of subsidies at official retail price equal to half the levels equivalent to the world market prices. The ruble amount is based on a hypothetical exchange rate of rub 100 per U.S. dollar.

Source: Authors' calculations. See also Table 4 for altenative calculations that provide a safety net at lower costs.

Authors' assumptions based on the household income and expenditure survey. The unit is kilograms for bread and meat; liters for milk.

World market prices in early 1992.

Entire population.

The cost of subsidies at official retail price equal to half the levels equivalent to the world market prices. The ruble amount is based on a hypothetical exchange rate of rub 100 per U.S. dollar.

The budgetary cost of cash benefits depends on the deficits of the Pension Fund and the Employment Fund. These deficits, in turn, depend on their revenues and expenditures. Because the revenues derive from the payroll taxes, the total wage bill and the tax rates are two major determinants. An increase in the wage bill or the tax rates would raise revenues, but the former itself–to the extent that wages of government employees are raised–implies an increase in budgetary expenditure, while the latter would have a negative impact on the financial position of enterprises, unless the enterprise can shift the tax. The shift would result in either an increase in prices, lower wages, lower production or employment, or a combination of these. The fundamental dilemma for the Pension Fund and the Employment Fund in Russia is that the wage restraint, which is inevitable and necessary, will limit the growth of revenues of these funds, but the benefits for a large number of vulnerable groups–particularly minimum social benefits–need to be raised in line with increases in prices. This will aggravate the financial imbalances of these two funds. Thus, the full indexation of benefits with respect to price changes during the transition would be infeasible. However, this will endanger the living standards of the vulnerable. At best, benefits could be adjusted from time to time with respect to the growth in contributions, although formal indexation with respect to wages should be avoided.

These dilemmas underscore the importance of designing the level and structure of the benefits carefully to provide adequate benefits to vulnerable groups and to limit the budgetary cost. Provision of social benefits in excess of minimum levels may not be feasible.9

The earnings-related benefits structure, differentiating pensions or unemployment compensation in accordance with past earnings of the beneficiaries, may not be feasible on financial or administrative grounds. The benefits should be structured so as not to produce negative incentives to work.

Table 3 illustrates calculations of the cost of providing children, pensioners, and the unemployed with minimal cash benefits: a family allowance equivalent, as of July 1992, to half the minimum wage for each child and a pension or unemployment compensation equivalent to rub 800 a month to each pensioner or unemployed worker. The cost of such provision, without including the benefits being provided through the Social Insurance Fund, amounts to about rub 600 billion. Assuming that the average monthly wage in Russia is rub 4,000, this amount is equivalent to some 20 percent of the wage bill. Assuming that wages are partly indexed (with a coefficient of 0.7) on prices and that the cash benefits are fully indexed on prices, a 50 percent rate of inflation would raise the ratio between cash benefits and the wage bill by more than 2 percentage points. This would worsen the financial balance of the Pension Fund and the Unemployment Fund.

Table 3.Russia: Simulated Social Protection Costs in Mid-1992
Unemployment Assumptions
Two MillionFive Million
PersonsPersons
Base50 percentBase50 percent
lineinflationlineinflation
Number of persons
Employed 163636060
Not employed
Children37373737
Pensioners38383838
Unemployed22255
Average amount (in rubles a month)
Wages34,0005,4004,0005,400
Cash benefits
Allowances4450675450675
Pensions8001,2008001,200
Unemployment compensation8001,2008001,200
Total amount (in billions of rubles)
Wages3,0244,0822,8803,888
Cash benefits 5584877613920
(In percent of wage bill)19.321.521.323.7
Allowances200300200300
Pensions365548365548
Unemployment compensation19294872
Sources: Government announcements and the authors' assumptions.

Total number of state sector employees minus the number of unemployed.

Hypothetical numbers.

Hypothetical number based on authors' observations. It is extremely difficult to obtain precise wage data.

Assumed to be half of the minimum wage.

Sum of allowances, pensions, and unemployment compensation, excluding the benefits financed through the Social Insurance Fund.

Sources: Government announcements and the authors' assumptions.

Total number of state sector employees minus the number of unemployed.

Hypothetical numbers.

Hypothetical number based on authors' observations. It is extremely difficult to obtain precise wage data.

Assumed to be half of the minimum wage.

Sum of allowances, pensions, and unemployment compensation, excluding the benefits financed through the Social Insurance Fund.

There is a need for a system of social protection that cushions the vulnerable from the effects of major changes in the prices of essential goods. This would reduce the need for adjustments in benefit levels to the full extent of the price change which would have to be met from the payroll contributions and the pension funds. As argued in Ahmad and Schneider (1992), a limited quantity-based system of food stamps (or the cash equivalent) could be viewed as a basic benefit in kind, which would avoid the need for indexation of cash benefits. It is to be emphasized that such a system is mainly relevant for a period of transition with major relative price changes–not as a permanent instrument of social protection.

Social Safety Net Reform Options and Implications

In the Russian context, the transition to a market economy imposes a set of constraints relating, in particular, to the administrative feasibility of several of the measures that might be advocated for a market-based economy. In addition, the reliance of a large section of the population on transfers underlines the need to ensure adequacy of the benefits provided during a period of rapid change. At the same time, the overall costs of the system and the need for fiscal restraint during the transition make it imperative to evaluate the budgetary consequences of various alternatives.

Russia’s special conditions need to be taken into account. For example, the severe budgetary constraint and a large population of old people do not allow for generous social benefits. The large population of old people and a vast territory pose special difficulties in designing the administrative arrangements for the delivery of social benefits.

Subsidy Reform Options

We will focus our discussion on consumer subsidies for foodstuffs (such as wheat or bread, milk, and meat products), although the analysis could be extended to other subsidized goods or services. Russia’s recent introduction of a more liberalized system of market prices is a move in the right direction. The faster Russia moves to a fully functioning system of market pricing, the faster will be the improvement in resource allocation. However, the market-oriented pricing system cannot operate satisfactorily without a liberal external trading regime. Especially with a large number of monopolistic enterprises, allocative efficiency requires vigorous external competition. The domestic price of a tradable good (for example, wheat) should be determined at a level comparable with its world mark price at an exchange rate appropriate to ensure a sustainable external payments position. A higher price would imply a protected, inefficient domestic wheat sector and excessive use of domestic resources for the production of wheat; a lower price would imply insufficient production incentives.

The first step in reforming subsidies should be to liberalize producer prices. In the Russian context, this would imply a substantial increase in producer prices. Given the present system of subsidies, which provide unrestricted access by all to the subsidized goods, an increase in key agricultural producer prices to their world market levels would imply (1) an increase in budgetary subsidies (if consumer prices are to be kept low) or (2) an increase in consumer prices (if budgetary subsidies are to be constrained). The first option would add pressure on the fiscal deficit; the second option would add to the cost of living for the poor, implying the need to raise cash benefits. A third option would be to liberalize both producer and consumer prices (for example, for bread), but keep consumer subsidies at a limited level–for example, only for well-specified groups, such as urban residents (or low-income urban residents), who will tend to suffer from a deterioration in the terms of trade for urban area, relative to rural areas, during economic reform. Subsidies to children and nursing mothers can be targeted through the provision of milk. This option can be less costly and more equitable than a system of generalized subsidies. However, the administrative requirements may be demanding. It would be important to assess the existing administrative arrangements for the possibility of simplifying and adapting them as social protection instruments.10

Reforming subsidies along these lines would reduce the budgetary burden substantially. For example, on the assumption that bread and meat subsidies are targeted to urban residents and milk subsidies to children, these subsidies could be reduced from rub 760 billion to rub 300 billion (Table 4).

Table 4.Russia: Simulated Social Protection Costs—Illustrative Calculations of Food Subsidies
Quantity and Price
Assumptions
Annual
subsidized
consumptionProducerNumber ofAmount ot
per capita 1prices 2beneficiaries 3Subsidies 4
(In kilograms(InU.S.dollar(Million(In billions of(In billions
Commoditiesor liters)per unit)persons)USdollars)of rubles)
Untargeted 5
Bread1000.131500.990
Milk3000.141503.1310
Meat242.001503.6360
Total7.6760
Targeted 6
Bread1000.137S0.550
Milk3000.14170.770
Meat242.00751.8180
Total3.0300
Source: Authors' calculations

Authors' assumptions based on the recent household income and expenditure survey. The unit is kilograms for bread and meat; liters for milk.

World market prices in early 1992.

Entire population.

The cost of subsidies at official retail price equal to half the levels equivalent to the world market prices. The ruble amount is based on a hypothetical exchange rate of rub 100 per U.S. dollar.

The same as in Table 2.

Bread and meat subsidies area assumed to be targeted to urban residents; milk subsidies to children.

Source: Authors' calculations

Authors' assumptions based on the recent household income and expenditure survey. The unit is kilograms for bread and meat; liters for milk.

World market prices in early 1992.

Entire population.

The cost of subsidies at official retail price equal to half the levels equivalent to the world market prices. The ruble amount is based on a hypothetical exchange rate of rub 100 per U.S. dollar.

The same as in Table 2.

Bread and meat subsidies area assumed to be targeted to urban residents; milk subsidies to children.

In Russia, the Government appears to have chosen to eliminate budgetary subsidies as quickly as possible. If the elimination of budgetary subsidies is accompanied by a vigorous policy to liberalize both producer and consumer prices, the outcome would be very desirable. If the elimination of budgetary subsidies were achieved simply by eliminating the negative margins between consumer and producer prices, with one or both prices still controlled, the result would not be satisfactory. In any case, a general increase in consumer prices would raise the cost of living for the poor, and the cash benefits would have to be adjusted, keeping in view other protective measures that might also be instituted.

Social Security Benefits

Russia has an extensive system of benefits for major life-cycle contingencies–old age, disability, unemployment, and so on. Many of the measures have been introduced recently, and there are serious difficulties concerning the administrative and financial viability of some of the funds that have been established.

Pensions and Allowances

The recent reduction in the real pension benefits have tended to reduce pension outlays relative to the contribution base, leading to a substantial buildup of reserves of the Pension Fund. This buildup of reserves, however, may be temporary, and pension benefits should be determined on the basis of longer-term financial considerations, as well as social protection objectives. There may be some scope for the reduction in the portion of the fund allocated for the old-age, disability, and survivors’ pensions, although care should be taken to evaluate (1) the aging of the Russian population, and (2) possible re-evaluation of benefit levels, both of which would lead to increased outlays. The savings could be used to finance family allowances, or greater unemployment benefits, thus reducing budgetary transfers.

An amendment was introduced in the Pension Law in April 1992, revaluing the pensions of people who had retired prior to recent increases in nominal wages. This amendment came into effect in June 1992. The revaluation is based on a one-time recalculation of the pension base, as a function of the average wage in the year of retirement relative to the average wage in 1991. People who retired in 1971 or earlier would have their base salary increased by a factor of 11.2. This factor decreases by 0.3 for each year–to 5.5 for 1990 and 2.9 for 1991.

The revalued pension is expected to be indexed to prices in the future, but pension benefits are now restricted to being less than twice the minimum wage,11 compared with three times the maximum currently in force. It also appears that the calculation of the pension base is being changed to include the greater of the two last years before retirement, or any five-year period of activity. The revaluation, indexation, and change in the calculation of the base are all likely to add considerably to the cost of pensions. The revaluation of existing pensions, while desirable from an equity perspective, might pose problems, particularly if indexation proposals were implemented.

The administrative requirements of the Pension Fund appear to be more structural and institutional. For example, pension administration would benefit from the introduction of individual social security numbers, computerization, and improved administrative, monitoring, and reporting capabilities.

The system of allowances seems to face more challenging tasks. The Government’s proposed streamlining of the system of allowances and the introduction of a simplified system is a move in the right direction. The main benefit is to be the child benefit, payable from birth to age 16 or 18 (if the child continues to study). This could be a flat-rate benefit, although supplements would be possible for single parents and abandoned children. The basic child benefit should also replace the benefit paid to children below the age of 18 months using the resources of the Pension Fund. In addition, there would be four other benefits, including pregnancy and maternity benefits, birth grants, and child care and invalidity allowances.

Centralized benefits should be uniform throughout the country, although local authorities would have the power to supplement some of the benefits out of their own resources to suit local conditions. The latter appears to be a continuation of current practices (for instance, in Moscow, some of the benefits are augmented through an additional sales tax on tobacco).

The Government’s stated objective to tailor benefits to available resources is encouraging. Taking as an indicative guide the 5.4 percent contribution for allowances, now channeled through the trade union-administered Social Insurance Fund, it would appear that the level of the basic child benefit could not exceed half the current minimum wage without major calls on the budget or a substantial increase in the payroll tax. Neither of the above outcomes is desirable and, in addition, a high level of child benefit (for example, at the minimum wage, as proposed) would generate work disincentives. It would be preferable to limit the basic child benefit to a flat rate no greater than half the minimum wage and to provide social assistance supplements in deserving cases.

The system of adjustment of benefits has major implications for the balances of the social security funds. Indexation to prices, when contributions are linked to the growth of the wage bill which is declining in real terms, will quickly lead to deficits.

At present, most family allowances, as well as holidays and other benefits, are provided by the Social Insurance Fund managed by trade unions, financed by the 5.4 percent payroll tax. These resources should be reallocated through the budget to provide for the new system of allowances. Some of the services that are provided by trade unions may continue, but should be financed by the voluntary contributions of members and should no longer form part of the social security system. To guarantee the payment of the allowances and also to impose discipline on the overall level of expenditure on allowances, the 5.4 percent payroll contribution should continue to be earmarked in the medium term to protect the levels of benefits. In the longer term, allowances should be paid directly from the budget without earmarking, the levels thus being determined jointly with the other expenditure decisions of the Government.

Employment Fund and Other Labor Market Intervention

An alternative to the earnings-related system is a two-tier system for providing unemployment benefits.12 This would simplify the calculation of benefits. For budgetary and incentive reasons, it would be important to reduce the period during which it would be paid. Thus, persons losing their jobs could be paid a flat-rate benefit of 125 percent of the minimum wage for a period of 6 months. There could be a second, lower-tier benefit of 75 percent of the minimum wage payable for 12 months to those without a recent work history. After the 12-month period, there could be other assistance, such as aid to dependents, rent payments, and in-kind benefits. It is important that Russia maintain the basic unemployment support for the transition period, since the simplification of administrative procedures and speedy payments of benefits will be crucial to the overall acceptability of Russia’s economic reform program, and would also be less costly than the current legislation.

In the longer term, to generate equity, it may be advisable to revert to an earnings-related system. This issue will become politically important as the variance in earnings levels increases. Further, to improve work incentives and contain overall costs, for the longer-term unemployed, or for fresh entrants to the work force, it would be desirable to require the recipients to retrain or participate in public works.

Arrangements for public works are already under way, with the preparation of documents and the training of personnel. This measure is expected to be particularly useful in defense-oriented “closed towns.” The expenditures on public works should be supported in part through the resources of the local communities that benefit directly, topped-up by allocations from the Employment Fund.

Preparations for retraining programs are also in place. Many of the workers of the former defense-based industries are highly skilled, and it is believed that some retraining would make them highly productive members of a market economy. While considerable emphasis is being placed on the retraining aspects of the employment services, the official priorities are clearly to first provide support to those being laid off.

The costs of stipends for retraining purposes, or wages for the participants in public works, could be charged to the unemployment contribution receipts. However, overhead costs of the Employment Services, including staff salaries and building and equipment costs, are likely to be incurred, increasing the expenditures of the Employment Fund above the revenues based on the 1 percent payroll contribution. These expenditures could be met, in part, through external assistance (for example, for automation of the services), but would also require budgetary support. The capital outlays, such as building and equipment costs, should be included in the capital expenditure budget.

Although under present conditions it may be politically difficult to increase the 1 percent payroll tax, or even introduce an individual contribution at this stage, there may be a possibility of increasing the contribution rate allocated to the Employment Fund if there is a more than corresponding decrease in the payroll contribution for other purposes.

During the last quarter of 1991 and the first quarter of 1992, the expenditures of the Employment Services had been a relatively small share of the receipts. Reserves had been invested with a commercial bank—at a substantial rate of return (a 40 percent rate of return is not unlikely) in nominal terms; however, the current level of reserves could be exhausted in a matter of a few months with a higher level of unemployment than at present.

Social Assistance

It will take time to develop criteria and administrative mechanisms for means testing, and such assistance will eventually only be feasible at the local level. It is here that the work on subsistence minimum baskets (which will vary by region) could be of some use. Despite local administration and financing, many of the eligibility and financing criteria should be centrally coordinated, and this would require considerable further work, with the participation in survey work by institutions such as the World Bank.

The use of means testing poses difficulties. The verification of household or per capita income levels and assets is an essential ingredient of a means test–the wage level of an individual member of a household is an important, but by no means sufficient, element in a proper means test. While the identification of wages received by an individual or from a single enterprise is possible, the verification of the total income of the household is quite another matter. It is important not to overburden the stretched administrative resources during the transition period–as seen in the case of provision of unemployment insurance.

Despite the difficulties that are associated with setting up means-tested mechanisms, it is possible to use categorical targeting as a method of providing social assistance. For instance, age, family composition, employment status, and residential location could be some of the criteria for such targeting. Public works participation, at, say, the lower tier of unemployment benefit, could be thought of as an assistance mechanism. The low wage, together with the works test, combine to target the assistance through self-selection to those who really need help.

Concluding Remarks

The issue of appropriate social safety nets and protecting vulnerable groups during the transition from an administered to a market economy is of crucial importance in providing an underpinning of reforms. It is also important to be aware of the budgetary consequences of alternatives. Moreover, policy measures taken with respect to subsidy reduction and price reform will have important implications for the living standards of various groups. This will affect the subsequent need to adjust the “permanent” social security instruments–pensions, allowances, unemployment benefits–and to provide for those who might fall below an acceptable minimum standard.

In designing social safety nets for the transition, in many respects, Russia faces difficulties similar to those in other reforming countries. The budgetary constraint is a problem common to the group of reforming countries with or without the socialist legacy. Russia has inherited a set of social programs and institutional arrangements many other reforming countries outside the former socialist world do not necessarily have. These programs and institutions can provide a basis on which Russia can design a reformed social protection system, but they may also be an obstacle to instituting such a system. In particular, scaling down the inefficient, but extensive social benefits–such as guaranteed employment, generous family allowances, and various employment-related benefits–before the fruits of a market-oriented economic system materialize can meet considerable opposition from present beneficiaries.

Russia’s demographic profile is more like those of the Baltic states than the Central Asian states of the former U.S.S.R. While both old-age pensions and family allowances are costly in Russia, family allowances (for children) are relatively less costly in Russia (and the Baltic states) than in some Central Asian states of the former U.S.S.R. (Ahmad (1992)). Russia has a vast territory and a large population. A highly centrally administered, nationally uniform social benefit system would be more difficult to establish in Russia than in some other states of the former Soviet Union, with a smaller population and territory. In Russia, local governments will have to play an important role.

The ability to adjust benefits for the “permanent” social security instruments is constrained by the overall level of the payroll tax, and even maintaining the current level is likely to lead to labor-market disincentives as well as evasion. It is thus important to rationalize benefits and procedures for adjustment. A combination of policy instruments will be needed to provide for social protection of the vulnerable in a costeffective manner.

References

    AhmadEhtisham“Poverty Demographic Characteristics and Public Policy in CIS Countries” paper presented at the forty-eighth Congress of the International Institute of Public Finance Seoul Korea1992.

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    AhmadEhtishamSchneiderJean-Luc“Alternative Social Security Systems in CIS Countries” paper presented at Conference on Fifty Years After the Beveridge Report York United Kingdom1992.

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    ChuKe-young and RobertHolzmann“Public Expenditure: Policy Aspects” in Fiscal Policies in Economies in Transitioned. by VitoTanzi (Washington: International Monetary Fund1992.

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    International Monetary Fund World BankOrganization for Economic Cooperation and Development and European Bank for Reconstruction and Development A Study of the Soviet EconomyVols. I II and III (Washington: International Monetary Fund1991.

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    World BankWorld Development Report1991 (New York: Oxford University Press1991).

Ehtisham Ahmad is Deputy Division Chief and Ke-young Chu is Division Chief of the Expenditure Policy Division of the Fiscal Affairs Department. The authors are grateful to colleagues in European II Department for helpful comments.
1International Monetary Fund and others (1991).
2This is denned as the ratio between the number of children under age 16 and the number of persons of working age. The old-age dependency ratio is defined as the ratio between the number of the elderly (men over age 60 and women over age 55) and the number of persons of working age. The definition of these ratios for other countries is slightly different (see Table 1).
3See Chu and Holzmann (1992), Kopits (1992), Ahmad (1992), and International Monetary Fund and others (1991) for a further discussion of the living standards and the demographic profiles of the former U.S.S.R. and its states, compared with other countries.
4This figure includes social pensions, which were half of the minimum pension.
5Based on the urban CPI.
6See Ahmad (1992).
7Given the increasing extent of inter-enterprise arrears and a cash shortage, it appears that the minimum wage adjustment was not fully implemented in May as originally envisaged.
8In mid-1992, the number of unemployed receiving severance pay was substantial (more than 600,000). They are not included in official unemployment statistics until the cessation of the three-month period of severance pay.
9Minimum levels of social benefits should be determined to ensure the minimum consumption of basic necessities. See the next section for a related discussion of a subsistence minimum.
10Delegating the authority to set prices to local governments, however, will increase geographical inequities, depending on the financial situations of local governments and will also intensify price distortions across regions. The problem may reappear as an increased need for transfers to local authorities.
11Exceptionally, if the person has worked more than 45 years and receives the maximum pension he would be entitled to an additional rub 342–above twice the minimum wage.
12Apparently the Government is considering this option, along with another proposal to relate unemployment benefits to a matrix of earnings and length of service. This would approximate an earnings-related system and would be less cumbersome to administer but more complex than the two-tiered system

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