Tuesday, October 13, 2009

Markets can be expensive

In Central Eastern Europe and the Former Soviet Union the transition to an open market economy was accompanied by the rise and persistence of unemployment, the rise of inequality and of poverty. These phenomena were particularly serious because they meant a drastic reversal of earlier conditions of full employment, greater equality and low poverty incidence. Moreover higher inequality could not be justified as the reward for efficiency, as in normal market economies, but – particularly in Russia – was mostly the result of unrestrained pillage by privileged operators.

Before the Fall

The traditional, pre-Transition, Soviet-type system was characterized by full employment of labour, indeed by over-full employment: excess demand for labour at the prevailing wage rate. While full employment was obviously desirable, it was not the result of a specific policy but the by-product of persistent repressed inflation, i.e. excess demand for commodities at artificially low prices below equilibrium, which translated into excess demand for labour. Of course there was nothing positive about over-full employment, which was only a cause of high labour turnover and inflationary wage drift, which in turn contributed to the perpetuation of a state of excess demand for goods.

Wealth was almost entirely in public hands (in Albania even private ownership of cars was forbidden); the little that remained private was a source of direct satisfaction rather than income. By itself, this made distribution of income among the population more equal than in a market economy where income is derived also from private wealth (which is always more unequally distributed than labour incomes). There were also factors making for greater equality across Soviet republics and countries within the bloc: the emphasis on industrial development in every country, regardless of efficiency considerations; the socialization of enterprise profits and their re-distribution via the state budget; large scale subsidies via the All-Union Soviet budget, and via the under-pricing of raw materials and oil within the USSR and Comecon.

By World Bank standards of poverty – equivalent to $2.15 per head per day at 1996 Purchasing Power – in the socialist countries of Europe and Central Asia in 1988 on average fewer than 4% of the population lived in such absolute poverty.[1]


The initial prolonged recession of the early 1990s was naturally accompanied by shrinking employment and the rapid emergence of labour unemployment, converging to similar average values and dispersion typical of European Union countries. The many queues for goods typical of the old, typical shortage economy were replaced by a single but much longer queue for jobs. In the CIS, however, there were lower rates of job loss and limited job creation, leading to an increase in under-employment and reductions in real wages.[2]

Table 1 provides data for unemployment rates and employment ratios for 1998–2006. While unemployment remained high in Central and Eastern Europe, it tended to decrease in the rest of the area. Employment ratios did not have a clear trend, with several countries remaining under 60% and only a few being close to the Lisbon target of 70% for the EU member states. Employment rates tended to be higher in the CIS countries than in CEE countries, but this partly reflect higher under-employment and lower unemployment benefits.
The global economic crisis of 2008–2009 has already raised unemployment and reduced demand for migrant labour.

Table 1. Unemployment rates and employment ratios in CEE/CIS

Source: UNICEF (2006), TransMONEE data bank, updated 2009, Florence.
Note: Results from national Labour Force Surveys, except for Albania, Belarus, Armenia, Azerbaijan, Kazakhstan (2004 and 2005), Kyrgyzstan, Tajikistan and Uzbekistan, which are official data. The different sources may use different criteria, for example for registering unemployment, working activities in the informal sectors, temporary jobs.


Egalitarian ideals associated with socialist ideology should not be exaggerated. First, there was significant residual real inequality due not so much to monetary income differentials but to privileged access to goods for the Party nomenklatura: this was no small matter, as it affected access to housing, motorcars, holiday facilities, health and education, foreign travel, imported and luxury goods as well as simple items of daily consumption which were in scarce supply for the ordinary citizen. Second, in 1931 Josef Stalin in person had condemned the “leftist leveling of wages” (uravnilovka), and urged the introduction of sharp wages differentials between skilled and unskilled and between difficult and easy jobs. And there were prizes for managers for plan-fulfilment and over-fulfilment, discretionary prizes for workers, money to be made by mediators (tolkach) in the informal semi-legal exchange of materials among enterprises, in the black and grey markets among consumers, the reliance on "pull" (blat’) through "acquaintances" (znakomstvo) to obtain scarce goods and services; a few legal markets, such as kolkhozian food markets and flea markets (barakholki). Bribes and large gifts (prinoshenie) were also common. All these factors distorted the significance of the degree of inequality as measured through official monetary incomes.

Subject to these qualifications, pre-transition measures of inequality, such as the Gini coefficient (=0 for absolute equality; 1 for absolute inequality, a situation in which one subject takes all) were impressively low in the Soviet Union and Central Eastern Europe, about 0.25-0.30. From 1989 to 2004 Gini coefficients increased significantly nearly everywhere in the transition, to around 0.35-0.40. Indeed, in many countries especially in the CIS they soon surpassed the degree of income inequality normally found in western market economies. The exceptions are the Czech Republic, where the Gini coefficient was and still is lower, though rising from 0.198 to 0.235; Belarus, with a similar trend; and Slovenia where it fell slightly from 0.265 to 0.243 between 1991 and 2004 (see UNICEF 2006).

“In recent years inequality has either increased at a much slower rate, or – in some cases – even declined. For example, in those CIS countries, where levels shot up in the mid-to-late 1990s, there have been signs of reductions; while in the Central European countries, where levels increased less dramatically in the 1990s, rates of increase have continued to be slow but steady. However, in most of the region, levels of inequality have remained high in the period of economic recovery, suggesting that growth has not always been inclusive in nature” (UNICEF, 2009).

An apparently similar degree of income inequality – Russia in 2007 had a Gini coefficient of 42%, i.e. a more equal income distribution than China’s 47% – can conceal a profound diversity. In China, and in “normal” capitalism, income inequality depends mostly on entrepreneurial success and is the price to be paid for efficiency; in Russia it depends primarily on the pillage of national resources during the transition and therefore it is a form of inefficient inequality.

Table 2. Trends in disposable income inequality, selected countries, 1989-2006

Figure 1. Gini coefficient of income distribution in China and Russia, 1978-2006[3]
Source: Popov (2009).


Post-socialist transition, by itself and together with the associated deep and protracted recession, brought about a drastic increase in poverty. By 1998 it was estimated that, in the transition countries of Europe and Central Asia, one out of every five people survived on less than $2.15 per day (at 1996 Purchasing Power), whereas a decade earlier “fewer than one out of twenty-five lived in such absolute poverty” (World Bank, 2000). “There is little doubt that poverty has increased dramatically in the region. Moreover, the increase in poverty is much larger and more persistent than many would have expected at the start of the process.” By 1998 the people living in poverty had reached 20%. Poverty began to fall after 1998, with the generalized resumption of economic growth; by 2003 the poor represented only 12% of the population.[4]

With respect to the predicament of the poor in developing countries, the material hardship associated with poverty in the transition was made much worse by the drop from earlier achieved levels and expectations, and the loss of security. Sudden large scale unemployment, prolonged nonpayment of salaries, unpaid or decimated pensions, hyperinflation and loss of savings, the loss of free or subsidized social services “made people feel unusually vulnerable, powerless, and unable to plan for the future.” For most of the new poor, transition brought “the destruction of "normal" life and accustomed social patterns.”[5]

“The highest levels of absolute poverty are in poor countries of Central Asia”: Tajikistan (70 percent), and the South Caucasus (with Georgia with a poverty rate of 50 percent in 2003). “Yet most of the poor and vulnerable in the transition countries of the Region are in large middle-income countries such as Kazakhstan, Poland, Russia, and Ukraine.” Those most at risk are “the young, residents in rural areas and in secondary cities. The unemployed, people with little education, and those belonging to underprivileged minorities, such as the Roma are also at great risk. Most of the poor are working poor”.[6]

Russian $-Billionaires

Conversely, in the early 2000s Russia saw a spectacular increase in the number of dollar billionaires. In the Soviet era there might have been, at most, a dozen dollar-millionaires in the shadow economy. In 1995 there were no billionaires in Russia. In 2007, according to Forbes, Russia had 53 dollar-billionaires, in third place after the US (415) and Germany (55), but in second place in terms of their wealth, which in Russia totaled $282 billion ($37 billion more than Germany’s billionaires). In 2008 the number of billionaires in Russia increased to 86, with a total wealth of over $500 billion, corresponding to one third of a year’s GDP. Russia’s “primitive accumulation” took the form of privileged access to natural resources at prices lower than in the world market, to subsidized credit and to privatized assets also on privileged terms.

Trends in the current recession

In a recession such as that of 2008-2009 it is plausible to conjecture that initially inequality falls – because the rich lose proportionally more than those who have less to lose – and poverty rises because the poor cannot afford to lose what they have (viceversa in a boom). This is probably what has been happening in transition economies, though it is too early to tell. If the crisis lasts, losses among the poor – primarily through unemployment – become more substantial, and inequality as well as poverty may increase.

Lack of markets can be expensive. But so can the operation of markets. Is this an integral part of the human condition?

[1] World Bank (2000), Making Transition Work for Everyone: Poverty and Inequality in Europe and Central Asia, Washington D.C.
[2] UNICEF (2009), Innocenti Social Monitor 2009, Florence.
[3] Popov Vladimir (2009), “The long road to normalcy: where Russia now stands”, Conference Paper, UNU-WIDER, Helsinki, 18-19 September 2009.
[4] Alam Asad, Mamta Murthi, Ruslan Yemtsov, Edmundo Murrugarra, Nora Dudwick, Ellen Hamilton, and Erwin Tiongson (2005), Growth, poverty and inequality – Eastern Europe and the FSU, World Bank, Washington.
[5] World Bank 2000.
[6] Alam et al., 2005.


Wojtek said...

In many transition countries, including the former Soviet Union, privatisation of state assets took the form of mass privatisation, through the distribution of near-free vouchers exchangeable for shares or for physical assets. Surely that was an important move towards greater equality?

D. Mario Nuti said...

Mass privatization was a large scale experiment in institutional engineering in the transition, without any historical precedent. It was implemented in all transition economies except Hungary.

The idea was to give away state assets in order to 1) establish a private sector quickly; 2) prevent a transition reversal by giving the population something to lose in that case; 3) get around the lack of financial means in the hands of the population, that had seen its liquid assets pulverized by high inflation in the early days of stabilization; 4) avoid the problems of evaluation of assets to be privatized; 5) last but not least, as you suggest, implement an egalitarian solution. Never mind the obvious drawbacks: loss of revenue for the government budget, fragmentation of shareholders and thus ineffective corporate governance, no injection of management, of investment or technology.

Practice was very different from intentions. Poland took over seven years to implement this allegedly fast process, due to squabbles over details and government involvement in the choice of investment funds. Equality went by the board immediately if privatization vouchers were transferable, or after their conversion into shares if the vouchers were not transferable: ownership concentrated fast, especially in the hands of managers who succeeded in cornering large stakes on the cheap. In Poland at the end of 2008 the total assets corresponding to the entire mass privatization scheme were worth less than 1% (sic!) of the Polish stock exchange capitalization. In Belarus there was a voucher overhang, i.e. paper not covered by privatization assets just as domestic currency was not covered by goods in the old days. Methods other than mass privatization were highly skewed in the resulting distribution of wealth. Mass privatization, like other aspects of the transition, probably contributed to both the initial recession and the subsequent recovery, but did not do much for equality in the transition.

Alberto Chilosi said...

"With respect to the predicament of the poor in developing countries,
the material hardship associated with poverty in the transition was
made much worse by the drop from earlier achieved levels and
expectations, and the loss of security"

But probably they had also more household goods accumulated in the past and possibly more relatives and acquaintances to whom to turn for help than where poverty is more widespread.