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p. 9 of 15 BACK | NEXT Executive Summary I. An Analytical Framework II. Regional Experiences A. Africa B. Asia and Pacific C. Central and Eastern Europe, the Baltic States, and the CIS D. Latin America and the Caribbean E. Regional Summary III. Policy Actions to Help Poor People Gain from Globalized Markets

Global Poverty Reduction 2001 : II. Regional Experiences

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C. Central and Eastern Europe, the Baltic States, and the CIS

34. In no region has the liberalization of trade and the integration into global markets over the past decade been more radical and far-reaching than in the transition economies of eastern Europe and the former Soviet Union. In 1989, only around 40 percent of total foreign trade in eastern Europe and 10 percent of trade in the former Soviet Union was conducted with market economies outside the Soviet block. By the end of the 1990s, these shares had increased to 75 percent in eastern Europe and to around half of the total in the former Soviet Union (EBRD, 1999).

35. These changes have gone hand in hand with comprehensive domestic price liberalization, privatization and far-reaching institutional reforms, making it analytically difficult to separate out the effects of trade liberalization on people’s welfare in the region. Nonetheless, at a conceptual level, the transition can be represented as a process of adjustment following a large relative price shock, similar to the effects of trade liberalization, but on a much larger scale. As a result of this price shift, heavy industry has given way to the expansion of the services sector. The result has been a dramatic downsizing of the labor force employed in manufacturing. At the same time, state-owned enterprises were forced to contract by the reduction in state subsidies and the rise of competition, particularly from imports.

36. The most apparent immediate effect of the transition was a large decline in aggregate output, as a result of adjustment costs associated with sunk capital, imperfect labor markets and disorganization effects. Thus, although welfare should have improved with the availability of a wider range and of goods and services of better quality, the social costs of early transition were large. As outlined in the GPR 2000, the number of poor people has greatly increased across the region and, while aggregate incomes have fallen, their distribution has also become more unequal. At the same time, it is worth pointing out that many people have gained from new opportunities in the private sector and the chance to make better use of their skills and talents (World Bank, 2000b).

37. A major way in which the shock of market liberalization (including trade liberalization) has been transmitted to the population has been the adjustment in the labor market. Here, significant differences have emerged across the region. In the more advanced countries of eastern Europe, employment initially fell rapidly, but has recently picked up again as a result of growing private sector activity. Real wages have been hit far less than aggregate output and while the dispersion of earnings has increased, it has been contained at a level similar to that of western Europe.

38. By contrast in the Commonwealth of Independent States (CIS), employment has declined more gradually and the brunt of adjustment was initially borne by measured real wage declines. This has led to a dramatic fall in earnings among those still employed in the old sector and has given rise to the problem of the working poor. For example in Ukraine, by 1997 80 percent of all workers were earning a wage below the subsistence level. At the same time, far fewer private sector jobs have been created in the CIS, leaving many workers stuck in dead-end employment. Wage dispersion has grown dramatically, while aggregate labor productivity has failed to recover. Many have been pushed into multiple job holdings and work in the informal sector with little security. By the late 1990s, for instance, around one fourth to one third of workers in CIS countries reported being engaged in informal subsistence work, against only 4 percent in Poland (EBRD, 2000).

39. Trade liberalization negatively affected government revenues in most transition countries, as it led to the dismantling of the system of implicit trade taxes (and price distortions) that characterized trade under the Council for Mutual Economic Assistance before. Governments have tended not to replace it with explicit trade taxes, as tariffs have generally been relatively low (although export taxes have been used in several CIS countries), while indirect taxes on household consumption and income have only gradually replaced the old corporate sales tax. The ability of governments to provide social safety nets has therefore been severely limited, particularly in the less advanced transition economies. Moreover, the evidence suggests that existing benefits and transfer systems are often highly inefficient, as a result of universal entitlements, privileges to special groups, and administrative inefficiencies. The result has been that only in the most advanced transition economies have social safety nets provided a cushion against the shock of transition and contained the associated rise in inequality and poverty.⁴

40. The experience of the first decade of transition points to the following conclusions. First, the negative effects of restructuring on people’s livelihoods cannot be adequately addressed by keeping inefficient companies alive; rather policies that promote entry of the new private sector seem to be the key to a socially and economically sustainable transition. Note that the reduction in the tax burden that entry-friendly policies might entail need not lead to lower revenues overall, if private companies can be encouraged to operate in the official economy.

41. Second, the absence of social safety nets may have been one of the factors delaying enterprise restructuring in the CIS, as workers had few alternatives to remaining in old state sector jobs. Even with limited government budgets, it should be a priority for governments and international finance institutions to consider ways of providing temporary support for those made redundant through restructuring. The support for small and medium-sized enterprises, the financing of severance packages, and investments in re-training should all be part of such policy measures.

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