V. Labor Markets

James Roaf, Ruben Atoyan, Bikas Joshi, and Krzysztof Krogulski
Published Date:
October 2014
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Starting from a common base of full but unproductive employment under communism, reform of labor market policies and institutions has varied widely across countries. While labor market outcomes also depend on factors well beyond the labor market itself, these policy differences are associated with very different results in terms of employment and unemployment. Institutional reforms to improve the working of the labor market, while protecting vulnerable groups, thus remain a key priority for many countries of the region.

The transition from central planning to market-based economies was initially accompanied by severe effects on output and employment. At the beginning, unemployment was low (outside the Western Balkans), but the headline numbers masked unproductive employment in inefficient state-owned enterprises and the public sector. Inevitably, the early reforms of deregulation and privatization—along with the collapse of trade and supply links—resulted in large job shedding from the restructuring of enterprises, which outweighed new job creation. Job shedding, however, was important for transition. By forcing the acquisition of new skills by workers, it facilitated job matching in the context of the radical enterprise restructuring and the emergence of the private sector, particularly in countries where appropriate labor market institutions were quickly established. It also helped establish a balance between the bargaining powers of workers and managers, putting a check on real wages dynamics.

Deep recessions with weak systems of support led to long-term unemployment and politically irrevocable commitments to support affected individuals. Throughout the region, workers laid off from declining industries had difficulty finding jobs in new industries due to skill mismatches, and many ended up locked in informal employment.1 Thus, labor market institutions had to be established to manage labor relations and mediate job shedding. Countries had to decide on proper levels of unemployment benefits and severance protection; approaches to trade union representation and collective bargaining; active labor market programs for the unemployed (for example public employment services, training schemes, and employment subsidies), and how these programs could be financed in the face of severe fiscal constraints. Many countries have struggled in the face of these challenges.

The pace of labor market reforms differed across countries. Central European countries were fairly aggressive in upfront deregulation and large-scale enterprise restructuring. This led to large job losses, but by the late 1990s these reforms started to pay off as unemployment declined and employment rates started to recover. Similar trends were witnessed in the Baltics, which saw large cyclical swings between employment and unemployment through the transition, and SEE EU countries. In contrast, postponing layoffs in CIS countries may have helped to reduce labor market congestion, but at a cost of less job creation in the higher productivity private sector. As a result, employment creation was modest and employment rates continued to fall. In the Western Balkans, high rates of unemployment and low rates of employment persisted throughout the transition, pointing to deep structural factors.

Labor market trends


Source: WEO, World Bank, IMF staff calculations.

In transforming labor market institutions, the region has moved a long way towards Western European norms. Nevertheless, there are significant differences across countries in cost rigidities, unemployment benefit systems, collective bargaining, and active labor market policies. Equally important are differences in labor taxation and the design of social protection programs, as these are likely to have a significant bearing on incentives to formal work and may discourage employment among low-wage earners. Other barriers, some outside the labor market—lack of child and elderly care options, limited flexible work arrangements, imperfect access to information, or adverse social norms—can effectively exclude some groups from labor markets, especially women, youths, older workers, and ethnic minorities. These factors are important for understanding the significant variations in labor market indicators. Indeed, activity rates vary drastically across the region, from about 70 percent in the Baltics and the Czech Republic to around 40 percent in the Western Balkan countries. The latter also report the highest youth and long-term unemployment rates in Europe.

Youth and long-term unemployment


Sources: Country authorities; OECD; Haver; Eurostat; CEA: and IMF staff calculations.

1/ 2012

2/ Balkan average used for long-term unemployment rate. due to missing data.

Cross-country differences in labor market institutions

Labor market institutions

Source: European Commission; Kovtun and others (2014); IMF staff calculations.

Note: Data as of 2009-12, depending on availability; data for trade union as of 2004. Data are not available for CIS countries for all presented categories.

The legacy of centrally planned economies and their self-management system of enterprises—leading to “over-protecting the insiders”—is still weighing on labor market outcomes in a number of countries in the region. In the course of the transition, different political balances were drawn between the protection of jobs (with generous severance payments making dismissals very costly) and the protection of transition (by strengthening unemployment benefit systems and active labor market policies):

  • Cost rigidities appear to be high in SEE non-EU countries, likely contributing to the overall labor market rigidity. Similarly, minimum wages are high relative to the average wages in most of these countries, further aggravating unemployment problems (Hamermesh, 2014).

  • Relatively generous social assistance programs could have also contributed to the rigidity of labor markets in many countries in the region. Notable exceptions are the Central European and Baltic countries (CEB, grouped together reflecting generally fairly similar labor market characteristics), where lower social assistance spending coincides with more generous unemployment benefit programs. In contrast, a fairly low level of unemployment benefits in SEE non-EU countries coincides with higher severance benefits, likely reflecting the public choice of placing the burden of income support of the unemployed on employers.

  • While trade union membership has dropped throughout the region, SEE countries—especially non-EU members—are also those where trade unions played a stronger role. Powerful unions in an environment of overly rigid employment protection legislation often contributed to labor market duality, a division into “insiders” (with higher incomes, job security, and prospects for upward mobility) and “outsiders” (with lower incomes and security, and little training).

  • Dramatic emigration and diminishing of human capital due to the “brain drain” played a role in all transition countries. But high rates of emigration from the Balkans, which increased dramatically during the devastating conflicts of 1990s, were critical in shaping labor markets and institutions of this region. High emigration rates also resulted in the high level of remittances inflows—averaging over 8 percent of GDP annually—which provided a steady stream of nonwork-related income and probably therefore significantly relaxed budget constraints and affected labor-leisure decisions of households. Internal migration of better skilled labor from rural to urban areas likely also fueled structural unemployment in a number of countries (Ebeke and Everaert, 2014).

Role of the (un-)finished transition

Business environment indicators

Source: World Bank; World Economic Forum; IMF staff calculations.

FDI and labor productivity

Source: WEO; Haver; IMF IIP Database; IMF staff calculations.

Differences in labor market outcomes reflect factors broader than the labor market itself. In CEB countries (and to a lesser extent SEE EU countries) that advanced transition quickly, comprehensive structural reforms helped to develop a vibrant private sector. The reforms are also reflected in a strong link between better standings in international competitiveness and business indicators, and greater responsiveness of labor markets to economic cycles. In these countries, a large number of younger and smaller firms fueled much of the job creation during the pre-crisis boom years. Furthermore, the earlier push for reforms also helped lower investors’ risk perceptions and strengthen the overall competiveness of the economy. Foreign capital—especially greenfield foreign direct investment (FDI)—played a key role in developing new sectors that could reabsorb the dismissed employees from the declining sectors. By facilitating transfers of technology, managerial skills, and international marketing networks, deepening pools of FDI appeared to have opened a self-enforcing cycle of fast productivity convergence and job creation.

Challenges going forward

Completing successful transition in the labor market is far from simple. Policy priorities vary according to individual country circumstances, with the Balkan countries having the most pressing and far-reaching needs, reflecting weaker labor market institutions and the legacy of worker-managed firms in the former Yugoslavia. However, there are also common themes. First, there is a need to address remaining structural impediments to growth. Maintaining macro-financial and political stability is a key pre-condition, but robust economic growth will ultimately hinge on cultivating more competitive product and factor markets and deeper trade integration, both within the region and more globally. Improving the business and investment climate will stimulate entrepreneurship, improve productivity, and create more and—importantly—better jobs, including for younger workers and women.

Second, strong labor market institutions are key to generating productive employment. But these institutions are equally important for providing support to those for whom labor market reforms may result in a reduction in benefits, and addressing duality between “insiders” and “outsiders” in the labor market. This balance is difficult to achieve, but there are roles to be played by active labor market policies, as well as appropriate levels of employment protection and unemployment benefits (along the lines of the “flexicurity” model of the Nordic countries), coupled with revamped collective bargaining institutions. Welfare reforms aimed at better targeting of social assistance and incentivizing labor market participation for all groups are needed, as is boosting skills and adaptability of workers through improved training and education.

Third, sustained employment growth requires improving cost competitiveness. The mix between improving competitiveness through greater exchange rate flexibility and reductions in business and labor costs will vary across countries. In many cases, legislation governing minimum wages and redundancy costs would need to be revisited. Broadening the tax base by addressing tax evasion is also needed to create fiscal space to lower the tax burden on labor and reduce the shadow economy.

Finally, completing the labor market transition in an environment of slow post-crisis recovery will inevitably have wide-ranging social consequences. Social cohesion should be achieved through extensive consultation between all social parties. The adjustment must be seen as fair, and as involving labor not just in the production sector, but also in the services and financial sectors. It is also important to have a well-targeted social safety net in place to protect the most vulnerable and make fiscal space for critical social and infrastructure spending.

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