I Overview

Philippe Egoume Bossogo, Jerald Schiff, Miho Ihara, Tetsuya Konuki, and Kornelia Krajnyak
Published Date:
July 2006
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More than a decade after the start of transition, the unemployment rate remains in double digits in a number of Central and Eastern European (CEE) countries. After a period of gradual decline, unemployment has actually increased recently in several transition economies. In addition, in a number of these countries, long-term unemployment rates are high, and regional variations in unemployment large.

The failure of unemployment rates to decline significantly in many countries—including some with good growth performance—is something of a puzzle. At the outset of the transition there were expectations that quick, market-driven reallocation of resources would lead to a rapid decline in unemployment after an initial surge. However, this did not happen, even though labor market institutions in these countries are considered generally flexible and minimum wage and unemployment insurance levels modest. Understanding better this phenomenon may have consequences beyond the transition context, since many countries undergoing market-oriented reforms may need to struggle with initial increases in unemployment.

This Occasional Paper seeks to explain the persistence of high unemployment in transition economies. We focus, in particular, on three interrelated issues:

  • How has the process of transition from largely centrally planned to market economies affected labor market performance?

  • What part do labor market institutions and policies play in explaining developments over time and across countries? A large literature for industrial countries establishes that rigid labor market institutions correlate positively with unemployment. This paper seeks to fill a gap in the literature by analyzing the impact of institutions on unemployment in CEE countries.

  • Why have regional unemployment differences persisted? The paper presents a framework for understanding why regional differences in unemployment have remained, limiting also aggregate declines in unemployment. This requires an understanding of the factors limiting both the movement of labor from high unemployment regions and the movement of capital and jobs to those regions.

Given the complexity of the issues involved and the severe data limitations, the paper takes an eclectic methodological approach to these issues. First, a new database has been compiled from a number of national and international sources on labor market developments and policies. This allows us both to track labor market developments across a number of transition countries and to compare labor market policies in a more systematic way than has to our knowledge been done before. Second, the database is utilized for an econometric analysis focusing on the impact of transition and labor market policies on unemployment and employment. Most econometric studies for transition countries have relied on a snapshot comparison of institutions and labor market performance at a point in time. By using panel data for 11 countries over 10 years, this study seeks to explain the labor market dynamics during transition as well as differences among countries. However, given the limitations of this database (Appendix I), our analysis is supplemented by several case studies of countries with good and poor labor market outcomes. Finally, to look at the issue of labor and capital mobility within countries—for which data are particularly limited—we examine the implications of simple analytical models.

Results suggest that both the transition process and labor market institutions and policies have affected unemployment. Among our key findings are the following:

  • Faster-reforming countries have had better unemployment records, not with standing initial job losses. Those countries that have been able to move most quickly to an advanced stage of transition have generally proved best placed to experience job-creating growth.1 This points to the need to complete the structural reform process and remove the remaining bottlenecks that have hindered faster reallocation of resources and decline in unemployment.

  • Labor market policies have some, but not a dominant, influence over labor market outcomes. It appears that those countries with more flexible policies are better able to take advantage of positive macroeconomic shocks with higher employment and lower unemployment rates. It is plausible, moreover, that data problems have obscured stronger links between labor policies and outcomes.

  • Policies not typically viewed as labor market policies can nevertheless have a major impact on labor market outcomes. For example, difficult business climates in some countries appear to have limited the ability for small and medium-sized enterprises to play their role as a key employment generator.

  • Market processes cannot be relied on to eliminate regional differences in unemployment. In fact, agglomeration effects may reinforce initial differences in labor market performance. In addition, there are important constraints both on labor mobility to low-unemployment regions and on the movement of jobs to less prosperous areas. For example, housing policies can play a key role in limiting workers’ mobility, while the failure to provide decent transportation infrastructure may limit the ability of high-unemployment regions to attract capital.

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