sEIU:U*I:E±U/E_ REG I ONA L AND SECT UR AL ST U DIES Income, Inequality, Public Disclosure Authorized and Poverty during the Transition from Planned to Market Economy Public Disclosure Authorized (71911 Feb. 19q8 RuR5ia'sGDP during \>,~~tetransition USGDP,duin;g v Public Disclosure Authorized thd. reatDepressin \ BRANKOMILANOVIC Public Disclosure Authorized Income, Inequality, and Poverty during the Transition from Planned to Market Economy WORLDBANK REGIONALAND SECTORALSTUDIES Income, Inequality, and Poverty during the Transition from Planned to I Market Economy BRANKOMILANOVIC The World Bank Washington, D.C. © 1998 The International Bank for Reconstruction andDevelopment/TheWorldBank 1818HStreet,N.W.,Washington,D.C.20433 All rights reserved Manufactured in the United States ofAmerica First printing February 1998 The World Bank Regional and Sectoral Studies series provides an outlet for work that is relatively focused in its subject matter or geographic coverage and that contributes to the intellectual foundations of development operations and policy formulation. 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Branko Milanovic is principal economist in the World Bank's Development Research Group. Cover design by Sam Ferro and Sherry Holmber,. The graphic shows that the decline in Russia's gross domestic product (GDP) during the transition (1987 to 1995) was even greater than that of the United States during the Great Depres- sion (1927 to 1935). U.S. GDP in 1927 and Russia's GDP in 1987 = 100. Photograph: church in Tula, Russia, by Jan Pakulski. Library of Congress Cataloging-in-Publication Data Milanovic, Branko. 1957- Income, inequality, and poverty during the transition from planned to market economy / Branko Milanovic. p. cm. - (World Bank regional and sectoral studies) Includes bibliographical references. ISBN 0-8213-3994-X 1. Income distribution-Europe, Eastern. 2. Income distribution- Former Soviet republics. 3. Poverty-Europe, Eastern. 4. Poverty- Former Soviet republics. 5. Europe, Eastern-Economic conditions-1989- 6. Former Soviet republics-Economic conditions. I. Title. II. Series. HC244.Z91547 1997 339.2'0947-dc2l 96-32776 CIP Contents Preface xi 1. The Tectonic Changes 1 Political Developments: The New States 1 Social Costs 6 2. The Way It Was 12 Income Composition and Inequality 12 Ideological Underpinnings 19 3. Income 23 The Post-Communist Great Depression 23 The Effect on Population Incomes: How Level and Composition of Income Changed 30 4. Inequality 40 Income Inequality 40 Distribution of Income Sources: Wages, Social Transfers and Private Sector Income 47 Disparity among Social Groups 54 5. Poverty 60 What Happens to Poverty When Income Goes Down? 60 By How Much Has Poverty Increased? 64 How Much Is Needed to Cover the Poverty Deficit? 76 How to Explain Increases in Poverty? 85 Who Are the Poor? 92 The Incidence of Cash Social Transfers 108 v vi Contents 6. Selected Issues in Social Policy 115 Should OECD-Like SocialAssistance Be Introduced in Transition Economies? 115 Transfer Payments to Different Groups of Recipients 120 Guaranteed Minimum Income and the Supply of Labor 122 Informal Sector and Pension Reform 126 7. A Look Ahead 132 Appendices 1. Description ot the Surveys Used and Data Problems 135 The Surveys Used 135 What Biases Are Inherent in the Data? 146 How Biases Affect Comparability between Pre-transition and Transition Years 152 2. Decile Shares of Total Income 156 3. Change in the Poverty Deficit Due to a Uniform Slide in Income 163 4. The Original Income Distribution Statistics 164 5. Poverty Headcount Calculations Based on the Original Income Distribution Statistics Given in Appendix 4 183 6. Distribution of International Funds Based on Minimization of Deprivation Function 192 7. Sources for Table 1.2 193 Country Data Sheets 195 Russia 196 Ukraine 202 Poland 208 Latvia 214 References 221 Indices 233 Contents vii Tables 1.1. Countries at War or under Economic Blockade, 1991-96 4 1.2. Speed of Reforms in Selected Countries, 1992-96 8 2.1. State Employmentas a Proportionof the LaborForce, 1988 12 2.2. Composition of Income in Socialist Economies, 1988-89 13 2.3. Composition of Gross Income in Socialist, Market, and Developing Countries, 1980s 14 2.4. Family Allowance for Two Children as Percentage of Average Earnings, 1988 21 3.1. GDP Growth Rates in Eastern Europe and the Former Soviet Union, 1987-96 25 3.2. Russia's Output Decline after the Dissolution of the Czarist Empire and after the Dissolution of the U.S.S.R. 27 3.3. Ratio between Expenditures and Income Reported in Household Budget Surveys 33 3.4. Change in Real per Capita GDP and Real per Capita Population Income between 1988 and 1993 34 3.5. Population Income by Sources in 1987-88 and 1993-94 36 4.1. Changes in Inequality during the Transition 41 4.2. Decomposition of the Change in the Gini Coefficient between Pre-transition and 1993-96 48 4.3. Change in Real and Relative per Capita Income of Worker, Farmer, and Pensioner Households 57 5.1. Estimated Poverty Headcount and Poverty Deficit in 1987-88 and 1993-95 Using HBS Income 68 5.2. Estimated Poverty Headcount and Poverty Deficit in 1993-95 Using a Higher (Macro) Income instead of HBS Income 75 5.3. Estimated Poverty Headcount and Poverty Deficit in 1993-95 Using HBS Expenditures 77 5.4. Explaining Increase in Poverty Headcount between 1987-88 and 1993-94 90 5.5. Relative Poverty Rates for Different Types of Unemployed Households 95 5.6. Concentration Coefficients of Family Benefits before the Transition (1988-89) and in 1993-95 109 5.7. Concentration Coefficients of Unemployment Benefits and Social Assistance, 1993-95 110 5.8. Concentration Coefficients of Non-pension Cash Social Transfersbefore the Transition(1988-89) and in 1993-95 112 viii Contents 5.9. Percentage of Social Assistance, Unemployment Benefits, and Non-pension Cash Social Transfers Received by the Bottom Quintile Of Population 113 6.1. The Composition of the Poor, 1993-95 117 6.2. Relationship between Poverty Lines and Wages, 1992-94 125 Figures 1.1. Number of Independent States in Europe, 1860-1995 2 1.2. A Map of Europe and Central Asia 10 2.1. Distribution of Social Cash Transfers by Income Decile 17 2.2. Concentration Curve for Pensions in Hungary, Czechoslovakia, and the Russian Republic, 1988-89 18 3.1. Distribution of Countries' Growth Rates in Eastern Europe, 1987-96 24 3.2. Distribution of Countries' Growth Rates in the Former I Soviet Union, 1987-96 24 3.3. Real GDP in Poland and Russia (1987-95); and the United States, and Germany (1927-35) 26 3.4. Real Wages in Poland and Russia (1987-96); and in the United States, the United Kingdom, and Germany (1927-36) 29 3.5. Unemployment Rates in Hungary, Poland, and Russia (1987-95);and in the United States, the United Kingdom, and Germany (1927-35) 30 3.6. Real per Capita GDP and Real per Capita Population Income in 1993-95 35 4.1. Dispersal of Gini Coefficients in Transition Economies 42 4.2. Changes in Quintile Shares in Hungary, Slovakia, and Slovenia between 1987-88 and 1993-94:Little Change 43 4.3. Changes in Quintile Shares in Belarus, the Czech Republic, Latvia, Poland, and Romania between 1987-88 and 1993-94: Moderate Regressive Transfers 43 4.4. Changes in Quintile Shares in Bulgaria, Estonia, Lithuania, Moldova, Russia, and Ukraine between 1987-88 and 1993-94: Large Regressive Transfers 44 4.5. Relationship between Type of Adjustment and Increase in Gini Coefficient 46 4.6. Composition of Disposable Income in Bulgaria, 1987-95 50 4.7. Concentration Coefficients of Wages, Cash Social Transfers, and Non-wage Private Sector Income in Bulgaria, 1989-95 50 Contents ix 4.8. Composition of Disposable Income in Poland, 1987-95 51 4.9. Concentration Coefficients of Wages, Cash Social Transfers, and Non-wage Private Sector Income in Poland, 1987-95 51 4.10. Composition of Disposable Income in Slovenia, 1987-95 52 4.11. Concentration Coefficients of Wages, Cash Social Transfers, and Non-wage Private Sector Income in Slovenia, 1987-95 52 4.12. Composition of Disposable Income in Hungary, 1987-93 53 4.13. Concentration Coefficients of Wages, Cash Social Transfers, and Non-wage Private Sector Income in Hungary, 1987-93 53 4.14. Composition of Disposable Income in Russia, 1989-94 55 4.15. Concentration Coefficients of Wages, Cash Social Transfers, and Non-wage Private Sector Income in Russia, 1989-94 55 4.16. Composition of Disposable Income in Latvia, 1989-96 56 4.17. Concentration Coefficients of Wages, Cash Social Transfers, and Non-wage Private Sector Income in Latvia, 1989-96 56 5.1. Income Density Function and the Poverty Line 63 5.2. Average Monthly per Capita $PPP Incomes, 1993-95 70 5.3. Income Distributions in Moldova and Slovakia, 1992 72 5.4. Estimated Number of Poor before the Transition and in 1993-95 76 5.5.