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IV
Social Trends, Household Behavior, and Social-Sector Policies



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Transforming Post-Communist Political Economies IV Social Trends, Household Behavior, and Social-Sector Policies

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Transforming Post-Communist Political Economies This page in the original is blank.

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Transforming Post-Communist Political Economies IV Social Costs, Social-Sector Reforms, and Politics in Post-Communist Transformations Joan M. Nelson INTRODUCTION The social costs of attempting to transform command into market economies have been very high—far higher than almost anyone anticipated at the beginning of the post-communist transitions. The impact on people of dismantling old economic institutions and rules of the game and beginning to build new ones has been compounded in many countries by the effects of the dissolution of the Soviet empire and the disruption or collapse of governmental capabilities. At the same time that the scope of social costs has become clearer, the challenges of restructuring social programs in a manner consistent with the needs and constraints of mainly market economies have begun to emerge. A triple shift in social-sector concerns is under way: A shift in the definition of the key problems from an almost exclusive focus on the immediate impact of transformation policies on welfare to a much broader array of long-term structural concerns. A corresponding shift in policies from an initial emphasis on limiting or buffering the social costs of transformation to addressing the challenges of restructuring social security, health, and education systems to be compatible with and sustainable within mainly market economies. At the same time, I would like to thank Harley Balzer, Nick Barr, Valerie Bunce, Carol Graham, Janos Kornai, Vladimir Mikhalov, Branko Milanovic, Dena Ringold, and Irena Topinska, as well as my colleagues on the Task Force on Transition Economies, for valuable comments and data.

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Transforming Post-Communist Political Economies social-sector reforms have moved from the margins to the center of the transformation agenda, especially in those countries hat have addressed fairly successfully the initial challenges of macroeconomic stabilization and liberalization. A shift in concerns regarding the political implications of social costs. Initial concerns focused on the possibility of a backlash against poverty, unemployment, and social stress that might jeopardize or reverse market reforms, democratic consolidation, or both. Fear of reversal persists in much of the former Soviet Union, but has ebbed in most of Eastern Europe; attention is shifting to the ways in which changes in social structure and social policies may shape the long-term character and quality of post-communist political systems. These shifts introduce far more complex and controversial challenges—for data collection, analysis, policy formulation, and policy implementation—than the already formidable challenges of initial safety net concerns. The next section of this essay briefly sketches the changing nature of and forces driving the social-sector agenda. The following section examines major political and institutional obstacles to social-sector reforms. The final section turns to the implications of social trends and policies for still-evolving post-communist political systems. First, however, a caveat is necessary. The post-communist world—Eastern Europe and the former Soviet Union—includes a tremendously varied array of states. Several of the chapters in this and earlier parts of this volume explore contrasts among countries or regions. This essay, however, glosses over important differences among countries with respect to pre-communist and communist histories, the nature and sharpness of the break from communism, socioeconomic structure, and a great deal more. Its goal is not to describe or analyze in detail, but to provide an overview and perspective on major trends in social costs, social-sector policies, and their political implications in the course of transformation. THE EVOLVING SOCIAL-SECTOR AGENDA Initial Policies: Selective Gradualism and Safety Nets When most of Eastern Europe and much of the former Soviet Union began to transform their economic systems from command to mainly market models after 1989, few anticipated the scope and depth of economic disruption and social costs that would result. Despite widespread disillusionment with communism's economic performance, ordinary people had no grasp of the depth and pervasiveness of its distortions and inefficiencies, and therefore no premonitions of the extent and speed of collapse once key controls had been

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Transforming Post-Communist Political Economies lifted.1 Paradoxically, some ardent market reformers (domestic and foreign) seem to have underestimated transformation costs for the opposite reason: they were so thoroughly convinced of the massive inefficiencies of the old systems that they hoped changes in key incentives would trigger rapid improvement after only brief disruption. The repercussions from the collapse of the Council for Mutual Economic Assistance (CMEA), the disintegration of the Soviet Union, and (more briefly) the Middle East War were also unexpected. Although the extent of social costs was a surprise, both the public and reformist officials certainly did expect costs; many were deeply concerned. Broadly, policy responses took two main forms: (1) ''selective gradualism," or measures to delay (and therefore, it was hoped, soften) those reforms that would most directly harm large numbers of ordinary people, and (2) compensatory programs, mainly through direct cash transfers. Selective gradualism with respect to consumer price decontrol and state enterprise reforms was designed to prevent or delay social costs from occurring. Many countries retained full or partial price controls for medicines, rents, utilities, and sometimes selected food staples for months or years after most other price controls and consumer subsidies had been removed. Most governments also moved quite slowly on privatizing or otherwise reforming large state economic enterprises, in part for technical reasons, but also because of concern about the social costs and political risks of rapidly rising unemployment. For instance, in the Czech Republic, despite far-reaching and determined market-oriented reforms in general, bankruptcy legislation that would have forced action on inefficient state enterprises was thrice delayed; when it was finally passed, its implementation was again postponed. In contrast to selective gradualism, compensatory programs were designed to mitigate the impact of costs after they occurred. Concern focused mainly on the unemployed and the elderly, but also on families with young children. Between 1987-1988 and 1993-1994, most post-communist countries increased cash social transfers, usually by 2 to 4 percentage points of gross domestic product (GDP). Hungary and especially Poland did much more; by 19931994 both were spending almost a fifth of GDP on these programs. The Czech Republic, Moldova, Romania, and Russia maintained but did not increase cash transfers as a share of GDP.2 However, even in those countries that substantially increased money transfers and partly indexed some benefits, inflation eroded their real value. In countries where increases were smaller, the real value of social transfers shrank to a fraction of earlier levels. More- l   In some Eastern European countries, there may also have been widespread expectations of generous Western aid, comparable to the Marshall Plan in Western Europe after World War II (personal communication from Valerie Bunce). 2   See Milanovic (1997:40, Table 4). Data are not given for the Central Asian countries.

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Transforming Post-Communist Political Economies over, most transfers (with the exception of the new unemployment compensation programs) were targeted to categorical groups (the elderly, or families with children), but not to the poor within those groups. As market reforms increased inequality, the lack of targeting to the poor made transfers still less effective in reducing poverty.3 At best, selective gradualism and compensatory programs could only partially mitigate the costs of the initial period of adjustment. Social costs varied tremendously across countries (as well as within countries, with major cities generally faring far better than rural areas and smaller towns). Costs were determined largely by initial conditions, including the scope and depth of poverty in absolute terms, and by the character of macroeconomic reforms, which ranged from consistent and determined to vacillating, partial, and chaotic. In Hungary before 1989, only about 1 percent of the population was poor (measured by an absolute, cross-national standard of $120 a month at 1990 international prices); in 1993 that figure was 2 percent. In Poland, poverty increased from 6 to 12 percent during the same period (using the same yardstick); in Bulgaria it increased from 2 to a startling 33 percent. In Russia as well, poverty swelled dramatically to more than a third of the population by 1993 (World Bank, 1996a:69, Table 1). In the absence of at least partly effective stabilization and liberalization, compensatory programs are a bucket brigade confronting a forest fire. Once major macroeconomic reforms are in place, such programs can become more effective (Åslund, 1997). Will Resumed Growth Solve Social-Sector Problems? Analysis and debate regarding the actual social costs of the initial post-communist periods will undoubtedly continue for a long time, given the knotty problems of appropriate concepts, standards of comparison (across time periods and among countries), quality of data, and interpretation.4 It has long been recognized that much production and income go unrecorded in official data. Estimates of the importance of the informal economy grow steadily; however, middle- and upper-income households may well benefit more than poorer ones from informal opportunities. Household survey data for several countries indicate that a great many households increased their holdings of consumer durables and/or their savings even in the early years of the transformation. Rather than suggesting increased incomes, however, 3   I am indebted to Nick Barr for the observation that categorical transfers were reasonably well targeted for comparatively flat income distributions under communism, but became poorly targeted once incomes became more unequal. 4   For concise summaries of some of the conceptual and data difficulties, see World Bank (1996a:67, Box 4.1) and van de Walle (1996:5-6).

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Transforming Post-Communist Political Economies that fact may reflect liberalized exchange rates and dramatically appreciated currencies.5 Direct data and indirect clues on the subjective impacts of transformation are also emerging. For many, especially older, less educated, and rural people, the tremendous changes have imposed overwhelming psychological costs in terms of insecurity and uncertainty, the devaluing of lifetime contributions to now-crumbled systems, and (for Russians) the collapse of national prestige along with empire. These impacts may be indirectly but dramatically signaled by the accelerated increase in mortality rates among adult men, particularly in Russia, in the early 1990s.6 For others, particularly the younger and better educated, the transformation is quite literally liberating, with respect to both economic opportunities and political freedom.7 From a policy perspective, however, the key questions do not hinge on understanding of the recent past, but on prospects for the near-term future. In particular, in those post-communist countries that have turned the corner, will price stability and economic growth erase the social costs of the initial shocks? By 1994, most of Eastern Europe had stopped its economic slide. Polish GDP increased steadily from 1992. Most Eastern European countries had brought inflation to or below 30 percent by 1995; six of ten grew 5 percent or more in that year (World Bank, 1996a:173, Table A.2). Growth remains fragile in some Eastern European and several Soviet successor states, and a few, including Bulgaria, Belarus, Serbia, and Bosnia, show little progress. Unemployment has responded fairly rapidly to improved economic conditions: in most Eastern European countries, unemployment peaked in 1993 or 1994 and has since declined.8 Measured poverty levels have been slower to respond. In Poland, with the longest record of growth, different measures of 5   I am indebted to Branko Milanovic for this point. He offers the following example. In 1989, a Polish worker's average monthly wage in zlotys could be converted at the parallel exchange rate for roughly $20. (The official exchange rate was available only to state companies.) A simple imported VCR would cost the equivalent of 10 months' salary. In 1995, that worker's real zloty salary was about the same, but could be converted at the liberalized legal foreign exchange rate for $200; a VCR could be purchased with 1 month's salary. Currency appreciation was particularly dramatic in Russia. 6   However, mortality rates among men had been increasing in the Soviet Union from the late 1970s. See National Research Council (1997). 7   For survey data regarding attitudes toward transformation, see the reports based on successive rounds of the New Democracies Barometer, available through the Centre for the Study of Public Policy, University of Strathclyde, Glasgow. 8   See Allison and Ringold (1996:23). Irena Topinska of the University of Warsaw notes that legislation concerning unemployment, taking effect in January 1995, may have affected the actual unemployment rate in Poland, but she confirms that unemployment has been decreasing somewhat (personal communication).

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Transforming Post-Communist Political Economies poverty tell varied stories; while poverty seems to have stopped increasing, 1995 data show no clear downturn.9 One major factor limiting the effects of growth in cutting poverty and other social costs is the dramatic increase in inequality in all post-communist countries, coupled with dwindling state redistributive capabilities. In most countries, growing inequalities in income and wealth are coupled with failure to rationalize the tax system and collect taxes effectively, and thus to direct some of the winners' gains from growth into programs targeted to reducing poverty. More specifically, the transformation process has created large pools of poverty that will not shrink automatically as economies strengthen. Two problems in particular stand out: (1) the large number of acutely depressed regions and cities that depended on industries that are now dying, and (2) the growing pool of long-term unemployed. As noted earlier, in most of Eastern Europe, unemployment has declined since 1993 or 1994. However, workers who have been unemployed for more than a year comprise a growing proportion of the still-substantial totals. By 1995, long-term unemployed were more than 40 percent of total unemployed in all Eastern European countries except the Czech Republic, and exceeded 60 percent in Bulgaria and 87 percent in Macedonia (Allison and Ringold, 1996:27-28). In most of the Eastern European countries for which data are available, roughly a fifth of the long-term unemployed are under 25 years of age, while two-thirds to three-quarters are between 25 and 60; substantial portions are unskilled or have comparatively limited education (supplementary tables provided by Dena Ringold). Experience in Western Europe and elsewhere indicates that it is particularly difficult for the long-term unemployed to find and keep new jobs (see, for example, Boeri and Scarpetta, 1994). Other longer-term problems are probably emerging in some of the poorest countries. For instance, in Albania, it is likely that child labor has increased, and school attendance (particularly by girls) has dropped (personal communication from Katherine Verdery). If brisk and sustained growth can be achieved, many of the households near the center of the income distribution that were pushed into hardship in the early 1990s will rise once again above the poverty line. But some of the costs of the initial transformation—sharply increased inequality, dying industries, and the long-term unemployed—pose problems for social policy that will not yield to growth alone. The Need for Systemic Reforms in Social Sectors In addition to the enduring problems created by the initial stages of transformation, post-communist countries face an array of social-sector challenges that have quite different causes. Even more than the problems generated by 9   Personal communication from Irena Topinska, University of Warsaw, and Branko Milanovic, The World Bank. Data for 1996, still being analyzed, may indicate a slight decline in poverty.

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Transforming Post-Communist Political Economies the transition process, these additional problems require not simply safety nets or add-ons to existing social-sector programs, but far-reaching reforms in the entire systems of social transfers and services. One of communism's undeniable and proudest achievements was the expansion of access to education and health services for entire populations. However, as Schieber and Klugman (in this volume) detail with respect to health, major inefficiencies were built into the design of these services, including excessive emphasis on hospital care and low priority for public health measures addressing some of the most important causes of poor health and mortality, such as personal behavior (alcohol, smoking, diet), environment, and safety. Moreover, as broader economic difficulties and budget pressures developed in many communist nations from the 1970s on, problems deepened in the health and education systems. The quality of services deteriorated, while queuing, reliance on personal connections, and corruption (including widespread use of under-the-table fees) increased. So, too, did informal and illegal privatization. For example, it became common for doctors to offer fee-for-service treatment after normal hours, using public facilities and equipment. Despite these shortcomings, old social-sector institutions might have continued to function semi-adequately in the absence of the larger transformation. But as command economy arrangements are dismantled or crumble and formal and informal market arrangements emerge, social-sector programs and policies need fundamental redesign to operate in the new context and to address new as well as old needs. For example, under state socialism, a wide array of health, education, housing, and other services and benefits were channeled largely through state industries and farms. As these are dismantled, privatized, and/or streamlined, they are shedding their social functions. Moreover, more mobile labor forces and the growing importance of small firms necessitate entirely different arrangements for delivering social services and benefits. Financing also needs to be rethought. For instance, in many post-communist countries, pension and health systems are funded largely through payroll taxes (see Fox, in this volume). These taxes swell the wage bill by as much as half, discouraging new investment in general and labor-intensive investment in particular. Both market economies and more democratic political systems demand changes in content, as well as finance and delivery systems, especially in education. Beyond the obvious requirements for new or revised curricula (for instance, in business management, economics, and social sciences more generally), basic teaching approaches and techniques must give more emphasis to initiative, flexibility, and problem solving (for a comprehensive overview, see Heyneman, 1996). More broadly, as Kornai discusses (in this volume), post-communist nations need social service and benefit systems that provide more choice and place more emphasis on individual responsibility. Such changes will demand

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Transforming Post-Communist Political Economies revised assumptions about entitlements and social contracts between state and citizens-assumptions discussed in more detail later. Shifts toward choice and individual responsibility will also require much more sophisticated publics, with a better grasp of the implications of alternative options for themselves and others (including the next generations). Altered perspectives and increased sophistication are difficult challenges in established market democracies; they may prove still more wrenching in Eastern Europe and especially in the Soviet successor states. Changes in the division of responsibilities and financing between national and subnational governments do not necessarily accompany market-oriented reforms. But in the half-dozen years since the collapse of communist monopolies on power, many post-communist countries have decentralized major responsibilities for public services and facilities from national to provincial and local governments. The trend has often been driven by financial pressures and general administrative overload on central governments, as well as by reactions against communism's strong central controls and a desire to spread both power and participation. Devolution is particularly marked in the education and health sectors. Whatever the motives, the effects thus far have often been tremendous confusion regarding who is responsible for what, and mismatches among responsibilities, finances, and technical and administrative capacities. In some post-communist countries, aging populations add pension reform to the formidable agenda of social-sector issues (see Fox, in this volume). In 1990, between 10 and 13.5 percent of the population of most Eastern European countries, and Russia and the Ukraine as well, was over 65 years of age. (In Albania and the Central Asian republics, the elderly are a far smaller proportion of the population.) Long-established patterns of early retirement and generous disability, a surge in retirements at the outset of the transition, and the rapid growth of the informal sector and tax evasion intensify the effects of age structure on pension systems. In 1993, 1.9 workers in Russia and Poland were contributing to the pension system for every retiree drawing on it; the ratio in Hungary was 1.5:1 and in Bulgaria only 1.2:1. Pensions consumed 10.4 percent of GDP in Hungary in 1992 and more than 15 percent of Poland's GDP in 1994 (see Svejnar, 1996:Tables 1, 4, 5). There is almost universal agreement among specialists that the commitments embedded in existing systems are unsustainable. Moreover, in some countries, including Hungary and Poland, pensions' large and growing share of government expenditures may well be squeezing other social-sector expenditures, including education and health for children (see also Ferge, in this volume).10 10   The inadvertent intergenerational clash between growing outlays on pensions and health care for the elderly and dwindling programs for children is also an emerging theme in debates over social security reforms in the United States and some other industrial democracies.

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Transforming Post-Communist Political Economies As social-sector reforms move to the center of the policy arena, a still larger issue may loom in the Central European countries with very high total levels of social expenditures: a clash between social spending and the levels of saving and investment needed to spur rapid growth. If the Czech Republic, Hungary, and Poland wish to catch up with Western European income levels within one or two generations, the argument runs, they must reduce current very high levels of social expenditures relative to gross national product (GNP)—levels that perpetuate high taxation and inhibit public and private investment (Sachs and Warner, 1996). The same point can be made regarding Slovenia and Slovakia. The argument moves beyond the earlier emphasis on the need to reduce public spending to contain inflation and highlights a long-term clash between particularly high levels of social expenditures and rapid growth. That clash is further sharpened by the fact that some key social-sector reforms, including certain pension measures, can be extremely costly in the short or medium run. In other parts of the post-communist world, social spending claims a much more modest share of GNP. Moreover, national and local public revenues have virtually collapsed in Russia and some other countries. Not only has the real value of pensions and other social assistance shrunk in Russia, but payments are often delayed for months. For many of those still in the labor force, delays in wages spell poverty; miners, teachers, and others have periodically struck in protest (see McAuley, in this volume). In contrast to Central Europe, in Russia the need is not for cuts in mandated or actual social spending, but for restoration of state capacity to collect taxes and administer public programs, including social services and transfers. Indeed, restoring and reorienting state capabilities is crucially important, above all in Russia, but depends on decisions and actions that go far beyond the social sectors themselves. In sum, the social-sector agenda has evolved with almost bewildering speed in the past half-dozen years. From the understandable initial preoccupation with minimizing and buffering the social costs of transformation, the agenda must now address the persistent transformation legacies of deeply depressed regions and long-term unemployed, the inefficiencies and distortions inherited from the communist era, the demands of emerging market economies, the opportunities and problems of rapid decentralization, and (in some cases) the threat of fairly imminent pension crises. In some countries, the overall balance between social spending and the requirements of rapid growth poses a still larger issue. These formidable challenges cannot be met by modest improvements in existing systems. They demand systemic reforms—far-reaching changes in organization, financing, administration, and incentives. In parts of the post-communist world, they also require a still broader revitalization of basic state capacities.

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Transforming Post-Communist Political Economies and is willing to run the political risks. More often, politicians make difficult decisions only when they are convinced that the risks of action are less than those of failing to act. In the context of post-communist transformation, certain sets of reforms are obviously urgent: inaction courts disaster. Examples include measures to cope with rapidly accelerating inflation and/or low and dwindling foreign exchange reserves, and aspects of financial-sector reform. Systemic social-sector reforms, however, seldom have this urgent edge. At the beginning of the transformation, social safety net provisions—especially with respect to unemployment compensation and pensions—were indeed viewed as urgent and were rapidly enacted, but they did not entail basic changes in existing systems. In those countries with large and rapidly increasing elderly populations, the costs of failure to adjust existing pension systems can be fairly precisely predicted and timed, but in most cases, massive shortfalls remain some distance in the future. The costs of delay in reforming education and health delivery arrangements, including financing, are much more difficult to gauge precisely. In these circumstances, politicians' incentives will favor delay. The costs and risks of action are likely to be seen as clearly outweighing the costs of inaction. Hesitation is reinforced by the facts reviewed above: the absence of a consensus template and disagreements among technical specialists regarding the design of reforms; the predictable opposition from citizens who believe reforms threaten their entitlements; and the formidable complexity, long timetables, and delayed benefits of major social service reforms. The pattern in many post-communist countries is likely to be similar to that in many industrialized democracies and some Latin American countries: growing recognition of the need for reform, but slow, partial, and inconsistent action. Overcoming Obstacles to Social-Sector Reforms In the mid-1990s, a number of countries have moved ahead with significant social-sector reforms despite the above gloomy prognosis. Social security reforms are well under way in Argentina, Bolivia, Peru, Uruguay, and (more tentatively) Mexico; Argentina is also undertaking major reforms in the health sector. In Eastern Europe, Latvia has adopted far-reaching pension reforms, as Fox discusses (in this volume). Hungary and Poland are likely to take major actions in 1997. Paradoxically, the crisis atmosphere generated by macroeconomic pressures and stabilization policies may itself foster reforms in social (as well as other) sectors. In Chile in the 1980s and in Argentina, Bolivia, and Peru in the early 1990s, social service reforms were part of much broader reform agendas undertaken by political elites convinced that their nations faced

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Transforming Post-Communist Political Economies fundamental economic and political risks. A sense of crisis and far-reaching economic and societal change broader than the social sectors themselves can help overcome the obstacles discussed above through several channels. First, protracted crises tend to weaken vested interests and lower aspirations. Labor unions in much of Latin America are much weaker in the mid-1990s than they were a decade or more earlier; structural economic changes have also undermined union power in much of Eastern Europe. Moreover, benefits from old arrangements may become so severely eroded that the commitment of vested interests to the status quo dwindles. For example, where pensions have become almost derisory, as in Russia, existing arrangements have few supporters. Weakened unions and eroded benefits are not inherently desirable. But such factors may indeed facilitate reforms that would have been impossible earlier. Second, crises and major political and economic changes involve new stakeholders in specific issues. New stakeholders in turn make possible new coalitions and altered relationships. Most obviously, ministers of finance and economy have become much more attentive to social-sector issues. As more open economies expose local industries to international competition, progressive businessmen may become more concerned about the quality and content of secondary and technical education; this trend is already evident in some Latin American countries. In many countries, nongovernmental organizations are also taking a rapidly increasing role in direct provision of certain social services and in pressing for better governmental programs. Third, both ongoing pressures and structural changes stretch receptivity to new ideas. In Latin America, many stakeholders viewed the fiscal pressures that became acute in the early 1980s as temporary; their first instinct was to wait until things "returned to normal." Only after roughly a decade during which it became increasingly clear that the "golden age" would not return has a serious search for alternative solutions begun. In Eastern Europe, despite recognition (and, for many, strong desire) that the reforms of the early 1990s would bring fundamental changes, many expected only temporary economic hardships, and very few anticipated major changes in the social sectors more specifically. It has taken several years to begin to recognize important longer-run resource constraints and trade-offs among resource uses, and to perceive the implications of changing economic structure for the design and delivery of social services. In short, changed circumstances can improve the prospects for social-sector reforms, despite the obstacles catalogued earlier. As Graham emphasizes (in this volume), reformers' tactics also matter. I argue elsewhere that sustainable institutional reforms demand different political tactics than do

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Transforming Post-Communist Political Economies macroeconomic stabilization and liberalization, and that reforms undertaken in later stages of the adjustment process inherently have different political dynamics than do the initial measures (see Nelson, 1994:13-20). More specifically, precisely because of the political difficulties and vulnerabilities of social-sector reforms, the process through which policies are formulated is crucial to their success. In Pinochet's Chile, radical reforms in education, health, and social security could be designed by technical specialists and mandated by the executive (though even in this setting, considerable education and persuasion accompanied the launching of the measures). In more open political systems, it is obviously far more difficult to push through measures that command little support. If such measures are adopted, perhaps in the context of financial crisis, they are vulnerable to reversal. For example, New Zealand adopted radical hospital privatization and other health care measures in the early 1990s as part of a broader program of market-oriented reforms responding to severe and long-standing economic troubles. The health measures were bitterly controversial. After the elections of October 1996, they were abandoned (while spending on health and education was increased) as part of the bargaining to create a new governing coalition. In contrast, monetary policy was merely eased, without moving sharply away from the design or intent of earlier reforms. In short, sustainable social-sector reforms almost surely require much more investment in public education and broadened support than do reforms in many other sectors. That process can be immensely frustrating (as the United States discovered a few years ago with respect to health-care delivery reforms). Yet shortcuts may well leave measures vulnerable to early reversal or erosion, thereby lengthening the route to sustainable reform. This point bears on the roles international agencies and advisors should and should not play in promoting social-sector reforms in the post-communist world (and elsewhere). These agencies can make extremely important contributions to the internal debates now beginning in Eastern Europe. They have a wealth of information and experience from many countries, which can critically to inform debate in sectors that have tended to be somewhat parochial. They are also well qualified to point out the implications of sectoral policies for broader economic stability and growth. However, they may well be tempted to go beyond advisory and educational roles, pressing and perhaps even insisting on rapid action. Similar pressure in other fields, such as macroeconomic management or financial-sector restructuring, has often proved a useful catalyst for sustainable reforms. The argument here is that the intrinsic features of social-sector reforms, including the fairly wide array of feasible designs, simultaneously reduces the justification for external pressure and heightens the risk that measures adopted under pressure will not be politically sustainable.

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Transforming Post-Communist Political Economies THE POLITICAL IMPLICATIONS OF TRANSFORMATION COSTS Initial Political Concerns: The Threat of Backlash As Eastern Europe and (somewhat later) the successor states of the former Soviet Union began to adopt market-oriented reforms, concerns about high social costs focused both on welfare (as already discussed) and on possible political implications. Reformers and their foreign supporters worried that the dislocations and sacrifices of economic transformation would fuel a backlash against market-oriented reforms, democratic governments, or both. That backlash could take a variety of forms: direct support for the return to power of communist politicians and parties; scapegoating and extreme ethnic or nationalist appeals (possibly leading to violent clashes within or between countries); widespread protest and instability; or spreading disillusion and alienation, indirectly opening the way for extremist groups or the military to seek the violent overthrow of governments and the reversal of economic reforms. Seven years later, it is striking how few instances there have been of these scenarios. Politics has been fragmented, quarrelsome, and indecisive in many countries and polarized and stalemated in some. In several countries, very little economic reform and/or political opening has occurred. But neither democratic politics nor market-oriented economic reforms have been reversed once clearly started. Nationalist and extremist ethnic politicians have appeared, but generally have not drawn enough support to dominate politics, nor is there any consistent pattern linking support for such groups to the severity of social costs. Ethnic conflict has indeed broken out in a number of ethnically heterogeneous countries (Tajikistan, Moldova, Georgia, the Russian Federation, and of course former Yugoslavia), but has not emerged in other states with diverse populations. Bunce (1996) argues that such conflict has been largely unconnected with overall economic performance, and is much better explained by whether leaders and citizens tend to define the political community in ethnic rather than residential terms and by specific actions of political leaders toward ethnic minorities (Bunce, 1996).12 Starting with the parliamentary elections in Lithuania in November 1992, formerly communist politicians and parties that were fairly clearly descended 12   In contrast, Woodward (1995) argues that stabilization and liberalization efforts guided by the International Monetary Fund were a major factor in the complex causes of Yugoslavia's disintegration after 1990. Economic hardship heightened ethnic tensions, the need to strengthen central government authority over macroeconomic policies triggered resistance in regional governments, and media and politicians exploited increased political openness to press divisive claims. The analysis may well hold for Yugoslavia; however, in much of the rest of the post- communist world, one or more of the preconditions or concomitants of the Yugoslav dynamics would appear to be absent.

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Transforming Post-Communist Political Economies from the old communist parties won pluralities in half a dozen parliamentary elections: Poland (September 1993), Russia (December 1993), Hungary (May 1994), Bulgaria (December 1994), and Estonia (March 1995). Many observers expected market-oriented reforms to be rolled back, or at least to slow abruptly. Yet despite their desire to ease the social costs of reform, the new social-democratic coalitions did not reverse the broad thrust of economic or political reforms. Indeed, in Poland, Hungary, and Lithuania, post-communist social-democratic parties clearly moved toward the center of the political spectrum. Initial fears of backlash turned out to be off target because they were based on far too simple a model. (Such expectations have proved similarly unreliable in Latin America and elsewhere.) The model posits a direct and strong causal relationship running from social costs to widespread political protest and/or the emergence of powerful antidemocratic and antimarket movements. Without attempting a detailed discussion, we can briefly review a few of the flaws in that model. Worsened living conditions do not automatically generate political protest, even in permissive political settings. People's reactions to rising prices, falling real incomes, and deteriorating services are shaped by their assessments of the causes of these trends and the prospects for improvement. Many in Eastern Europe and some in the former Soviet Union hold communism and its legacies responsible for much hardship. Moreover, if today's hardships are believed to be the price of reasonably likely improvements tomorrow—or next year—patience is rational. These beliefs are widespread in Central Europe, but weaken farther east. Within individual countries, age and education quite rationally influence whether one focuses on the costs or opportunities of transformation. For instance, Eastern European opinion surveys indicate that younger people in particular prefer unaffordable to unavailable goods.13 Even if hardships are attributed to the current government and the future looks bleak, political protest is only one of a wide array of possible responses—and by no means the most probable. Indeed, in the post-communist world (as in much of Latin America and Africa during hard times in the 1980s), most people cope primarily by using individual initiative and household, kinship, neighborhood, and community networks. Many households gain from inter-household transfers; other survey evidence documents the varied forms and sizable quantitative importance of informal earnings. Less constructive individual responses range from excessive drinking or beating one's spouse to seeking solace in religion. While blind anger can prompt riots, sustained collective political action depends on participants' perceptions that that course is worth the costs and 13   Richard Rose, drawing data from the fourth round of the New Democracies Barometer survey in Eastern Europe, reported in World Bank (1996b).

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Transforming Post-Communist Political Economies risks—and is likely to be more effective than alternative uses of time and energy. Many of those hardest hit by the transformation—older, less educated, and often rural people—are likely to view protests and demonstrations as risky and ineffective. Solidaristic groups such as miners may well resort to protest to exert pressure for specific claims such as payment of back wages, but are not likely to extend their demands to broader goals. Moreover, not many leaders or groups are eager to provoke antisystem efforts. In most of Eastern Europe and increasingly in Russia, elections are now viewed as the sole legitimate route to power. More specifically, communist parties or their reoriented successors seek to establish their credentials as players in the system rather than challengers outside of it. Therefore, they will appeal for electoral support by criticizing the social costs of transformation, but have not been quick to try to organize disorderly protests. In short, the links between social hardship and political protest are mediated by a large number of subjective interpretations and expectations, by institutional and organizational contexts, and by explicit or (more often) implicit rational assessments of the benefits and costs of alternative courses of action. In the post-communist world as in much of the noncommunist world, severe economic hardships have prompted a great deal of complaint and considerable protest, but only rarely a sustained backlash strong enough to derail economic reforms or political openings already under way. Longer-Run Impacts: What Kinds of Societies and Polities Are Emerging? A focus on the risks of reversal is a very narrow lens through which to examine the political implications of the costs of transformation. While they probably will not provoke reversal, social costs (and benefits) already incurred or still unfolding will profoundly shape the character and quality of rapidly evolving and still fluid political systems. Preoccupation with reversal may lead to neglect of other, less dramatic yet ultimately crucial impacts. A glance at current trends in much of Latin America suggests some of the issues at stake. Bolivia, Mexico, and several other countries adopted stabilization programs and market-oriented reforms in the mid-1980s, several years before the beginning of the transformation in Eastern Europe; Argentina and Peru launched particularly draconian reforms at roughly the same time as Central Europe. Since Latin American economies were largely market economies, despite extensive government intervention, structural adjustment has been far less profoundly disruptive there than in the post-communist world. Where initial measures contained hyperinflation (Bolivia, Argentina, Peru), they brought early popular support. In Argentina and Peru, they also generated striking macroeconomic success, including initially rapid growth and sharply expanded exports. But many of the benefits of new growth have been

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Transforming Post-Communist Political Economies channeled to the top. While the proportion of poor has dropped somewhat since 1990, the absolute numbers have grown (fed by rapid population growth, a problem not shared by most post-communist countries). Moreover, growth has not generated many formal-sector jobs. In Argentina, despite several years of rapid growth in the early 1990s, roughly one in six workers remains unemployed. Violence of all sorts, from crime to guerrilla insurrection, has increased sharply. Social services in most countries continue to deteriorate (see Schrieberg, 1997; for more careful empirical evidence, see Londoñio and Székely, 1997). Similar but more intense trends are all too obvious in Eastern Europe and the former Soviet Union. As more post-communist states succeed in stabilizing their economies and introducing basic elements of market systems, concern grows about what kinds of societies are being created by the new institutions. Surveys indicate that many people value new political, religious, and personal liberties and prefer the wider array of consumer goods, even with high price tags, to the scarcity economy. But unemployment remains very high even in those countries that have begun to grow. Concerns about the pathologies of half-installed market mechanisms are widespread. Most citizens are frightened and cynical regarding organized crime unchecked by ineffective or corrupt police and courts, sometimes linked to high officials. Many are also deeply worried by the decline—in some countries, the virtual disintegration—of social services and transfers that used to provide considerable security and opportunity. Already high and rapidly increasing inequality may be generating particularly undesirable effects, especially in societies that until recently had comparatively narrow spreads in income, opportunity, and security. Low-end poverty—the possible emergence of a pool of long-term unemployed, the plight of many elderly living alone, the hardships faced by many large families—is clearly a humanitarian or welfare challenge. It is less clear to what extent and in what ways poverty also threatens to erode system legitimacy or distort representativeness. The hard fact is that in most societies with more or less open political systems, the very poor play little role in politics. That fact is not desirable, but if post-communist systems replicate the pattern, they will not be very different from most other open or semi-open political systems. However, the fact of considerable poverty may be an insidious solvent of social solidarity and national self-respect among citizens in general. This may be particularly true in countries that did not have (or denied that they had) extensive poverty before the transformation. The impoverishment of large segments of the old middle strata of society may have more powerful effects on evolving political systems than the emergence (or growth) of severe poverty in post-communist societies. Civil servants, teachers and professors, medical and scientific workers, and other professionals in public service have been hard hit by falling revenues and budget

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Transforming Post-Communist Political Economies cuts. Many of the most articulate and active proponents of democratic values have been drawn from these groups in the past. Much the same can be said of some of the greatly weakened trade unions. Disillusionment and alienation in both groups weakens democratic prospects. In some post-communist countries, the declining state-dependent middle class may be counterbalanced by a rapidly growing class of small- and medium-scale entrepreneurs. It remains to be seen whether the new middle classes will believe that their best prospects are linked to liberal and democratic as well as stable governments. At the top end of the socioeconomic scale, the fact that some people have grown extremely rich in the course of the transformation carries clear-cut risks for stable societies and open political systems. In most post-communist countries, the manner in which the very rich have acquired their wealth (as well as the fact that many among the wealthy were also well placed under communism) erodes confidence in the rule of law and the fundamental fairness and transparency of new political and economic arrangements. Still more important, in some cases (perhaps most clearly Russia), the growing links between economic wealth and political influence corrode the integrity of democratic processes. In an ironic echo of Marx, government is indeed increasingly the instrument of the rich. Institutional arrangements—such as laws governing the financing of parties and political campaigns or the concentration of the media—can help limit the political influence of wealth. Thus far, however, there are few such laws and even less enforcement. Opportunistic networks, relationships, and norms of behavior that emerged in the chaos of initial transformation may well jell. Democratic politics need transparency and credibility as much as markets. The political implications of highly concentrated wealth threaten both. Regional inequalities, too, can distort and fragment national unity and political systems. Sometimes regional inequalities combine dangerously with ethnic or religious cleavages, as in Serbia, Slovakia, and perhaps Latvia and Estonia. Like increased vertical inequality, geographic or horizontal inequality is bound to increase with the introduction of mainly market systems. But the collapse of central taxing authority in some of the post-communist countries—again, most obviously Russia—removes the main means of mitigating regional inequality and its political consequences. Sharp inequalities not only pose direct political risks, but also may slow economic growth. A growing (though not yet conclusive) body of cross-national evidence suggests that over time, more equal access to education and to credit is associated with more rapid economic progress, while markedly unequal income distributions are associated with slower growth, perhaps in part because they generate populist policies and/or political unrest.14 More- 14   For an excellent review of theories and empirical research, see Benabou (1996).

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Transforming Post-Communist Political Economies over, higher inequality in one period reduces the effects of growth in reducing poverty in later periods; at the same rate of growth, poverty will fall more rapidly in societies with less unequal distributions of income and wealth (Ravallion and Chen, 1996:24-27). Containing the explosive growth of inequality and mitigating its social and political effects will require a wide range of instruments and strategies. As already noted, restructuring taxes (including revised relations between national and subnational units) and building capacity to collect them is one crucial approach. In some countries, continued direct or indirect subsidies and controls have created opportunities for immense profits for the few (see Åslund, in this volume); dismantling these vestiges of old systems is a key step in capping the growth of inequality. Appropriate regulations to encourage and protect lively media competition and to limit the influence of wealth on elections are also vital. On any list of strategies for containing and mitigating inequality, revitalized and reoriented social services and transfers must have a major place. They are among the most direct and visible approaches for increasing security against the risks and costs of ill health, disability, and old age, and for opening opportunities and improving life prospects through education. Moreover, in much of the world, but particularly in the post-communist countries, ensuring reasonably high-quality social services is viewed as a prime responsibility of a legitimate state—whether that responsibility is discharged directly through public programs or through combinations of public and private provision and finance. Under state socialism, universal entitlement to state-provided services was viewed as a major force for equity and social cohesion. Proposals for reforms to address new and old needs within resource constraints—for example, proposals for targeting to replace universal entitlements—are not simply pragmatic solutions to technical problems. Such proposals spotlight competing interpretations of equity, social justice, and community cohesion. As social-sector reforms move higher on the reform agenda, their design will be powerfully shaped by financial considerations and by some of the specific needs generated by the broader shift to market economies (such as the need to find alternatives for the functions previously served by state economic enterprises). Those are indeed vital considerations. But they must not exclude attention to other goals—in particular, the need to counterbalance emerging severe inequalities in security and opportunity and to encourage social cohesion. This essay argued earlier that social service reforms are burdened by special political obstacles. Therefore, politically sustainable reforms probably require more consultation, persuasion, and negotiation than do many other sectoral reforms. The goal of consolidating democratic institutions provides a further reason for focusing on the process of designing social-sector reforms, as well as on the designs themselves. Because social-sector institutions are so

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Transforming Post-Communist Political Economies central to the security and opportunity of most of the population, the way reforms are determined will be regarded as an important test of democratic institutions. A process that takes time to disseminate information, permit debate, consult stakeholders, and perhaps experiment with pilot efforts is more likely to build confidence in democracy than is a process controlled more fully by technocratic and financial perspectives—even though the latter approach is likely to produce more rapid and coherent action. The very fact of growing concern about the character of emerging post-communist societies, together with the embryonic but growing realization that considerable redesign of social services is unavoidable, may create a climate for a broad public debate, rather than one dominated mainly by vested interests. In short, both the process of social-sector reforms and their specific design can make major contributions to shaping livable societies and legitimate political systems—or can fall short of that potential. REFERENCES Allison, C., and D. Ringold 1996 Labor Market Transition in Central and Eastern Europe, 1989-1995. World Bank Technical Papers No. 352, Social Challenges of Transition Series, Washington, DC. Åslund, A. 1997 Social problems and policy in post-communist Russia. In The Social Safety Net in Post-Communist Europe, E. Kapstein and M. Mandelbaum, eds. New York: Council on Foreign Relations. Benabou, R. 1996 Inequality and Growth. Working Paper No. 5658 (Revised June). National Bureau of Economic Research, Inc., Cambridge, MA. Boeri, T., and S. Scarpetta 1994 Dealing with a Stagnant Pool: Policies Coping with Long-Term Unemployment in Central and Eastern Europe. Paris: Organization for Economic Cooperation and Development. Bunce, V. 1996 It's the Economy, Stupid . . . Or Is It? Unpublished paper presented at the Workshop on Economic Transformation: Inequality and Social Sector Reform, National Research Council, September, 1996, Washington, DC. Department of Political Science, Cornell University. Heyneman, S.P. 1996 Education and Economic Transformation. Unpublished paper presented at the Workshop on Economic Transformation: Inequality and Social Sector Reform, National Research Council, September, 1996, Washington, DC. World Bank. Londoiio, J.L., and M. Székely 1997 Distributional Surprises After a Decade of Reforms: Latin America in the Nineties. Unpublished paper, Inter-American Development Bank, Office of the Chief Economist, March , Washington, DC. Milanovic, B. 1997 Income, Inequality, and Poverty During the Transition. The World Bank, Washington, DC. Forthcoming.

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Transforming Post-Communist Political Economies National Research Council 1997 Premature Death in the New Independent States, J.L. Bobadilla, C. Costello, and F. Mitchell, eds. Committee on Population, National Research Council. Washington, DC: National Academy Press. Nelson, J.M. 1994 How market reforms and democratic consolidation affect each other. In Intricate Links: Democratization and Market Reforms in Latin America and Eastern Europe, J.M. Nelson et al. New Brunswick, NJ: Transaction Publishers for the Overseas Development Council. Ravallion, M., and S. Chen 1996 What Can New Survey Data Tell Us About Recent Changes in Living Standards in Developing and Transitional Economies? World Bank, Working Paper No. 1, Research Project on Social and Environmental Consequences of Growth-Oriented Policies, Policy Research Department, April, Washington, DC. Sachs, J.D., and A.M. Warner 1996 Achieving Rapid Growth in the Transition Economies of Central Europe. Development Discussion Paper No. 544, Harvard Institute for International Development, July, Cambridge, MA. Schrieberg, D. 1997 Dateline Latin America: The growing fury. Foreign Policy 106(Spring): 161-175. Svejnar, J. 1996 Pensions in the Former Soviet Bloc: Problems and Solutions. Unpublished paper prepared for the Conference on Global Pension Crisis, Council on Foreign Relations, November 15-16, New York. J. Svejnar, University of Michigan Business School, Ann Arbor, MI. van de Walle, D. 1996 Common pitfalls in measuring welfare during transition. Transition 7(7-8):5-6. Woodward, S. 1995 Balkan Tragedy. Washington, DC: Brookings Institution. World Bank 1996a From Plan to Market: World Development Report 1996. Washington, DC: World Bank. 1996b Transition. Washington, DC: World Bank, May-June.