EUROPE AND CENTRAL ASIA STUDIES Public Disclosure Authorized TOWARD A NEW SOCIAL CONTRACT Taking On Distributional Tensions in Europe and Central Asia Public Disclosure Authorized Public Disclosure Authorized Maurizio Bussolo Public Disclosure Authorized María E. Dávalos Vito Peragine Ramya Sundaram Toward a New Social Contract Toward a New Social Contract Taking On Distributional Tensions in Europe and Central Asia Maurizio Bussolo, María E. Dávalos, Vito Peragine, and Ramya Sundaram © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 21 20 19 18 This work is a product of the staff of The World Bank with external contributions. The findings, interpreta- tions, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Contents Foreword ..................................................... xiii About the Authors and Contributors ................................. xv Acknowledgments .............................................. xvii Abbreviations ................................................. xix Regional Classifications Used in This Report ......................... xxi Overview .......................................... 1 Distributional Tensions and the Need to Rethink the Social Contract ...... 2 Equity: A Key Aspiration in the Region .............................. 3 Balancing Markets, Policies, and Preferences ......................... 3 The Market-Generated Distribution of Incomes ....................... 5 Public Policy Responses ........................................ 10 Preferences for Equity .......................................... 12 Fissures in the Social Contract ................................... 14 Looking Ahead: Public Policies for a Stable Social Contract ............ 15 Conclusion .................................................. 18 Notes ...................................................... 18 References .................................................. 19 1 Introduction .............................................. 21 Emerging Distributional Tensions in Europe and Central Asia ........... 21 The Potential Implications for the Social Contract .................... 22 Is a Rethinking of the Social Contract in the Region Warranted? ......... 24 Notes ...................................................... 26 References .................................................. 26 2 Are Distributional Tensions Brewing in Europe and Central Asia? ............................................. 29 Inequality Across Individuals in Europe and Central Asia ............... 30 Labor Market Polarization and the Shifting Demand for Skills ........... 38 An Increasing Generational Divide, and the Young Are Losing Ground ... 50 Persistent Spatial Disparities across the Region ...................... 65 Rising Inequality of Opportunity, Particularly in the East ............... 77 Distributional Tensions and the Path to a Middle-Class Society .......... 87 Annex 2A. Statistics Tables ..................................... 100 Notes ..................................................... 101 v References ................................................. 105 vi ● Toward a New Social Contract 3 Are Public Policies Equipped to Respond to Distributional Tensions? ................................. 113 Labor Markets Are Changing, and Policy Is Not Ensuring Equal Protection ........................................... 114 The Impact of Tax and Transfer Systems on Income Redistribution ...... 128 Limited Labor Mobility Affects the Opportunities in High-Productivity Areas .................................................... 148 Annex 3A. Decomposition Analysis: Drivers of Change in Redistribution ... 152 Annex 3B. Policy Changes that Have Contributed to Redistribution ..... 157 Annex 3C. The Impact of Taxes and Transfers on Redistribution ........ 158 Notes ..................................................... 169 References ................................................. 171 4 The Social Contract: Do Distributional Tensions Matter?. 175 Introduction ................................................ 175 The Third Component of the Social Contract: The Preference for Equity ... 177 There Are Fissures in the Social Contract in the Region ............... 189 Notes ..................................................... 196 References ................................................. 198 5 How Can the Stability of the Social Contract Be Restored? ............................................ 201 Introduction ................................................ 201 Promoting Growth and Protecting People ......................... 202 Extending Social Protection to Everyone .......................... 205 More Progressive Taxation ..................................... 217 Reducing Inequality of Opportunity through Improved Services ........ 220 Conclusion ................................................. 221 Notes ..................................................... 222 References ................................................. 223 Boxes 2.1 Horizontal Inequality .................................... 37 2.2 Construction of Occupational Categories .................... 40 2.3 Decomposing the Change in Wages: The Role of Occupational Change ................................. 45 2.4 Teachers and Drivers: Low Wages in High-Skill Occupations in the former Soviet Union Economies ...................... 48 2.5 The Changing Education and Task Profile of Nonstandard Employment .......................................... 53 2.6 A Closer Look at Spatial Disparities in the Russian Federation .... 75 2.7 Calculating Measures of Intergenerational Mobility ............ 85 2.8 Defining the Middle Class ................................ 88 2.9 Defining the Absolute Middle-Class Threshold, a Vulnerability Approach .................................. 96 Contents ● vii 3.1 Labor Market Institutions Pick the Winners, France vs. the United States ........................................ 122 3.2 Italy: Toward One Type of Employment Contract ............. 123 3.3 Housing and Labor Mobility Constraints in Kazakhstan ......... 150 4.1 Preferences for Equity and Demand for Redistribution, a Brief Digression ..................................... 178 5.1 The Perils of Excessive Employment Protection .............. 203 5.2 Helping Displaced Workers through Active Labor Market Programs .....................................