VI Reform of the Wage System and Labor Market Policy

János Somogyi, and Anthony Boote
Published Date:
March 1991
  • ShareShare
Show Summary Details

The wage structure under the system of classical central planning reflected the importance of providing educational and health care services free, housing and communal services at a nominal cost, and other basic consumer goods at heavily subsidized prices. The wage structure was deliberately biased in favor of blue collar workers. The structure of basic wages was laid out in separate matrices of pay scales for blue collar and white collar employees and managerial personnel. Labor income from the socialized sector was subject to no income tax other than a moderate pension contribution by employees. This wage system created a sizable gap between the component of remuneration that represented labor costs for enterprises and the effective disposable income of households; the latter included consumer price subsidies and social benefits in money and kind, financed mainly by heavy taxes on enterprises.

After the 1968 economic reform, wage policy norms were intended to control purchasing power but also to stimulate a more efficient use of labor in an environment of greater enterprise independence. The authorities used various mechanisms to achieve these ends, including heavy taxation of wage increases above a certain level; these taxes were based alternatively on the enterprise wage bill or average wage (providing an allowance for falling employment), with a minimum tax-free wage increase applicable to all enterprises, and performance indicators linking the permissible wage increase to gross value added or profitability. Differential schemes also existed, for periods, for wage increases for enterprises subject to competitive pricing rules, and for agriculture, with wage premia from after-tax profits alternately included and excluded from wage regulation. With the introduction of the personal income tax in 1988, gross wages were increased by an average of 16 percent to compensate for the incidence of the new tax. Wage regulation was intensified to forestall the risk of wage overruns. Penalties on management premia were increased where overruns on the centrally established limits were accommodated, while a more flexible scheme was introduced for certain enterprises (members of a so-called wage club).

A new round of wage reform was introduced at the beginning of 1989. A key innovation was that wages in the competitive sector began to be determined through collective bargaining carried out at the national and enterprise levels. At the central level, the negotiations took place within a new National Interest Coordination Council, composed of representatives of the Government, the Chamber of Commerce and associations of cooperatives, and the national trade union organization. In addition, all wage increases were subject to the 50 percent corporate profit tax, with a tax rebate granted to enterprises whose wage increases were below a certain proportion of the rate of increase of their value added, determined by the National Interest Coordination Council. At the same time, the Government agreed to abstain from any further interference with the freedom of enterprises in the competitive sector to determine individual earnings.

For 1989, the Council approved for wage negotiations at the enterprise level a value of 0.5 for the maximum ratio of the increase of wages to that of value added for an enterprise to qualify for the above tax rebate. In addition, representatives of the employers and of the trade union organization also agreed to recommend in the Council’s name a minimum of 3 percent and an upper limit of 10 percent for the increases in the wage bill to be negotiated in individual enterprises. For 1990, increases in the enterprise wage bill that exceeded the increase in value added of the firm were not treated as costs and could not be deducted from the base of the company profit tax. Firms with revenues of less than Ft 20 million were not subject to the regulation, nor were joint ventures with foreign corporations.

The authorities recognized the key importance of wage liberalization in enhancing economic efficiency. They adopted a plethora of wage schemes since 1968, and wage reform became a permanent concern of the economic administration. Although wage regulation schemes largely prevented sizable wage overruns associated with loose financial discipline, they did not help widen the narrow wage dispersion nor correct the distortions in the wage structure. This reflected competing and inconsistent objectives of successive wage reforms, influenced by sociopolitical constraints on the scope of acceptable income differentiation. Unlike the reform of prices, the authorities undertook no systematic realignment of wages aimed at reversing the low labor costs of enterprises coupled with the high taxes on profits to finance consumer price subsidies; neither did they seek to correct the wage and salary bias in favor of blue collar workers introduced earlier. The Government reduced retail price subsidies on several occasions but simultaneously granted partial income compensation, which tended to reinforce the egalitarian structure of wages and salaries. Enterprises were also reluctant to exhaust even the limited scope for differentiation of wages and salaries that would have been allowed by existing wage regulations.

The new Government seeks to make wage growth more responsive to labor market conditions and financial pressures on enterprises, thereby reducing the importance of tax-based incomes policies and central wage agreements. It believes that market-determined wages will promote structural change and efficient resource use. Nevertheless, pending the full imposition of market discipline on state enterprises, for these enterprises the Government has continued to use tax-based wage regulations to reinforce the impact of fiscal and monetary policy restraint on curbing wage growth. For 1991, the Government decided that:

  • if the enterprise wage bill does not rise by more than 18 percent, no tax applies;

  • if the enterprise wage bill increases by between 18 percent and 28 percent, the increase exceeding 18 percent is subject to the profit tax; and

  • if the wage bill rises by more than 28 percent, the entire increase is subject to the profit tax.

In addition, the savings arising from reduced employment may be used tax-free for salary increases up to 5 percent.

Labor Market Policy

Management prerogatives concerning dismissal were limited by a narrow interpretation of the concept of full employment and job security. Whereas enterprises were legally allowed to lay off employees, management had to consult with trade union representatives and give advance notice to the competent local authorities. As managers sought to avoid conflict with the trade union and local authorities, dismissals were rare. The relatively high labor turnover thus resulted from mobility decisions of employees. As a result, the labor market was characterized by underemployment combined with labor shortages in many enterprises.

In 1983, the authorities relaxed the requirement for managers to secure new jobs for employees prior to dismissal, created a legal framework for temporary financial support for and retraining of dismissed persons, and began to set up a network of labor exchanges. A new scheme to assist dismissed workers, introduced in 1986, specified a minimum three months’ notice during which the labor exchange was obliged to find the dismissed worker a new job. If the exchange could not provide new employment requiring the same training and no more than one hour’s commuting time and paying no less than 90 percent of the initial salary, the dismissed person qualified for a transfer payment ranging from full compensation to 60 percent of his initial salary on a declining scale over a nine-month period. In 1987, an Employment Policy Fund was instituted to finance the above relocation transfers, job retraining, and new job-creation facilities.

In 1988, the Government extended nationwide a scheme of interest-free credits—which had been applied in 1988 in selected regions—to stimulate the creation of independent enterprises by qualified persons laid off during restructurings. Furthermore, the authorities upgraded job retraining facilities and took steps to establish unemployment benefits for those who qualified; the eligibility criteria were strict and included collaboration with the labor exchanges in search of new employment. A Professional Training Fund was also established in 1989 to promote the employment of newly qualified graduates. To finance these schemes, budget appropriations for the Employment Policy Fund were doubled to Ft 2.4 billion in 1989 and to Ft 5.5 billion in 1990. Not all of the new schemes were successful: the program granting interest-free credits for self employment was widely abused and was terminated in 1990. A major constraint on labor mobility was the difficulty of transfers in light of the highly segmented housing market.

The new Government’s approach, as noted above, is to rely on a market-based wage determination, while assisting the unemployed. The Government has taken several measures to improve the operation of the labor market and to enhance the skills of the work force. A National Training Council was established in early 1991 to improve regional adult training programs. The Government plans to establish regional labor centers and labor exchanges and to improve vocational training. It also intends to enhance labor mobility by tackling rigidities in the provision of housing. Recent measures to overhaul the subsidization of private and public housing, and the restructuring of the construction sector, represent initial steps toward a more efficient use of housing resources (see Section VIII). To satisfy better the growing need for unemployment compensation, the authorities established in 1991 an unemployment insurance scheme (Solidarity Fund), partly financed by employer and employee contributions. Measures to promote small- and medium-sized enterprises are also expected to reduce unemployment. The Government is developing a social assistance program to improve the targeting of social assistance benefits and establish a cost-sharing arrangement between the State and local governments. It is determined to provide a social safety net for the poor, the elderly, children, and the disabled.

    Other Resources Citing This Publication