Colloquium 1995 Panel II : Living Standards and Social Welfare

Living Standards and Social Welfare in Central and Eastern Europe Domenico Mario Nuti Official statistics don't tell the whole truth about improvements in the quality of life in Central and Eastern Europe, says Professor Domenico Mario Nuti. They record the fact that the queues have vanished, and that the shops always have well-stocked shelves. But even so, the truth must be faced. Unemployment is high and set to remain high, and an increasing number of people are falling below the poverty line. In the short term, active labour market policies will help even out the benefits of the reform policies. But the only viable long term solution, he says, is a massive boost in economic growth. Dr. Nuti is Professor at the University of Rome "La Sapienza" and visiting Professor at the London Business School.

Between 1990 and 1995 the systemic transformation of Central and East European economies has been accompanied initially by a drastic and sustained fall in real income and living standards and the rapid rise of mass unemployment. These trends are now being reversed in the Visegrad countries, which undertook an earlier significant and accelerated growth of real income. Other Central and East European countries have only just began to recover, while former Soviet republics, which started later and less decisively, are experiencing further output decline; unemployment has been delayed but is poised to grow rapidly once capacity restructuring is undertaken. The rapid decline of investment which accompanied the recession allowed a smaller decline of living standards (except for housing), and an earlier recovery with respect to real income. At the same time, investment levels must be substantially raised for economic growth to be sustainable. To some extent the picture offered by official statistics is distorted. Some of the output reported as lost may have existed only on paper, or have been accumulated as unsaleable inventories, or have been subtracting rather than adding value at international prices. Output and employment in the private sector, now legalised and rapidly expanding, are likely to have been under-declared or otherwise under-recorded; thus some of the unemployed may be engaged in productive activities. Tangible improvements in living standards, - created by the ready availability of a greater range of consumption goods instead of old style endemic shortages and queues - by their nature are not included in national income statistics. At the same time, much non-economic output has continued while the decline has also affected unprofitable activities which still produced some value added. Private sector growth is bound to have been over-estimated, as already existing activities are now surfacing into the legal economy. Some of the unemployed may not register as they lose their entitlement to benefits and are discouraged from seeking a job. An unrecorded decrease in welfare now comes from the misery of the unemployed, the job insecurity of the employed, and generalised exposure to higher criminality and risk of disease. By and large, the distortion of official statistics cannot be deemed to reverse or even alter dramatically the assessment of economic performance during the transformation. An enquiry into the causes of this disappointing performance would raise controversial issues and is outside the scope of this paper. Within five years from the start of transition, registered unemployment had leapt from zero - indeed from the labour shortages typical of the old system - to almost 10 million in mid-1994, of which 7.5 million were in Central and Eastern Europe, 1.9 million in the CIS and 160,000 in the Baltic states. Unemployment rapidly converged to the European average of 12 percent, replicating a simular range and dispersion. Unemployment rates in the former Soviet Union and the Czech Republic appear to be an exception but they are currently underestimated, about to rise, and conceal underlying results from a combination of slow labour shedding and an even slower process of unemployment absorption, leading to a large, growing and - above all - stagnant pool of unemployed. Current prospects foresee continued and sustained high unemployment rates.

In general, unemployment benefits have been set at relatively generous levels for a limited period. A wide range of social services which typically were provided by state enterprises - such as housing, education, health, holidays, recreation - were curtailed, transferred to local authorities or left to the private sector on a market-driven basis. Food subsidies (which used to be of the order of 5 percent of GDP) have been cut sharply. Many of the social costs have fallen more heavily on women, given their higher proportion among the unemployed and the sharp fall in child care provision. Health trends vary, with infant mortality rising in the former Soviet Union and Bulgaria and falling decisively everywhere else; the death rate rising spectacularly in Russia, Ukraine and Belarus, and falling in Poland and the Czech Republic. The fast, variable and unanticipated rates of inflation obviously had adverse effects on income distribution, as naturally the weaker groups lost out with respect to those able to assert their relative strength. Everywhere an increasing proportion of the population has fallen below the poverty line - no matter how this is defined. Using a single absolute poverty line of $120 monthly per capita income, a World Bank study indicates an increase in the number of poor from 1989 to 1994, from eight million (3 percent of total population) to 58 million (18 percent of total population), i.e. 50 million new poor in a population of 320 million. Various groups have suffered to a different extent in different countries. For instance, while everywhere pensioners lost out in absolute terms, in some countries they have been able to maintain their relative position (e.g. Slovakia, Hungary) or even improve it substantially (Poland - contrary to appearances). In all countries, children have been the heaviest losers in the transformation, with significant increases in the percentage of children under 16 living in households under the poverty line (according to UNICEF data for 1989-92). It is well understood that the ageing of the European population in the next few decades will place a heavy burden on national economies. This is particularly the case for some Central and East European economies, especially Poland. In the short run, transformation can be made more equitable by standard instruments of economic policy used to contain unemployment - such as employment subsidies, other instruments of active labour policies, and public works. These are precisely the progressive policies that even, indeed most of all, Vaclav Klaus - for all his Thatcherite rhetoric - has shrewdly implemented to contain unemployment in the Czech Republic. Looking further ahead, the best way to make post-communist transformation more equitable is through the resumption and acceleration of economic growth. For the West, these trends imply: a large-scale need for external assistance (though not through support for the unemployed, as was initially suggested, due to their chronic nature); the great importance of improving trade access - still greatly restricted in spite of Association Agreements and other agreements with the European Union - and raising direct foreign investment (still very small relative to both needs and to developing countries); and for members of the European Union, the high cost of accession for potential Central and Eastern European members if these were entitled to the same kind of income support (through structural funds and other sources within the European policy of pursuing "Cohesion") enjoyed today by the weaker European regions.