j443 THE WORLD BANK ECONOMIC REVIEW, VOL. 5, NO. 2: 187-205 ~44Y pq5 Poverty in Eastern Europe in the Years of Crisis, 1978 to 1987: Poland, Hungary, and Yugoslavia Public Disclosure Authorized - 6 " torii ) X Branko Milanovic Eastern Europe experienced an economic crisis between 1978 and 1987. Declining income led to substantial increases in poverty rates in Poland and Yugoslavia, while poverty in Hungary remained at about the same level as before the crisis. In all three countries urban poverty increased, as the economic condition of state sector workers deteriorated to a much greater extent than that of agricultural and mixed households. The increased poverty was entirely explained by declining income, because the overall income distribution did not change or in some cases improved. Public Disclosure Authorized In the past decade countries in Eastern Europe have experienced declining growth rates, debt problems, worsening economic efficiency,and a widening technologicalgap comparedwith the West. These aspects of the economiccrisis in Eastern Europe have been studied recently by, among others, Gomulka (1988), Gomulka and Rostowski (1988), Winiecki (1986), Zloch (1987), and Knirsch (1984). However, little is known about how the crisis has affectedthe standard of livingand its impact on poverty. Most studies on these topics have been anecdotal or are concerned with income distribution rather than poverty (Flakierski 1986, Morrisson 1984, Okrasa 1988, and Bergson 1984). This article charts the evolution of. poverty in Poland, Hungary, and Yugoslavia during the 1980s. A headcount index of poverty is used to look at poverty rates by country, for various social groups, and in rural and urban areas. Public Disclosure Authorized The slowdown of growth and the reversal in the resource transfer in the three East European countries were so great that they were reflected at the level of households in an almost uniform decline in real income and increase in poverty. Section I looks at the effects of recession on poverty in socialist countries and how they differ from those in capitalist countries. Section II presents macro- Branko Milanovic is in the Country Economics Department of the World Bank. The discussionin this artide is based in part on background papers prepared for the World Development Report 1990 by Milanovic (1989), Posarac (1989), and Szalai (1989) on Poland, Yugoslavia,and Hungary, respectively. The author thanks Bela Balassa, Aleksandra Posarac, Tine Stanovnik, Irena Topinska, and the anony- mous refereesfor their comments. © 1991 The International Bank for Reconstructionand Development/THEWORLD BANK. Public Disclosure Authorized 187 188 THE WORLD BANK ECONOMIC REVIEW, VOL. 5, NO. 2 ' o nAhic indicators of the crisis in Poland, Hungary, and Yugoslavia and looks at the impact of the crisis on per capita income. Poverty lines, poverty rates, and income distribution in the three countries are discussed in Section III. Section IV analyzes the determinants of the poverty rate, and the change in the poverty rate is decomposed into the income, distribution, and demographic effects. Conclu- sions are presented in Section V. I. THE EFFECTS OF RECESSION ON POVERTY IN SOCIALIST COUNTRIES There are two primary ways in which the effects of recession on poverty may differ between socialist and capitalist countries. First, in capitalist economies the total income of those with a relatively high share of capital income decreases faster than does the income of other groups. In socialist economies the share of capital income in total household income is much less. Profits are originally not received by individuals, but are retained by enterprises or transferred to the state. Therefore a recession may not change the functional income distribution at the household level very much. Second, the recession in the socialist economies during the 1980s was not accompanied by increased unemployment. In Poland and Hungary unemploy- ment was virtually nonexistent, and in Yugoslavia unemployment as a percent- age of the labor force remained unchanged. The wage bill was reduced through uniform cuts in all wages. This probably resulted in part from the strong role of workers' councils and trade unions at the enterprise level and in part from government policies designed to prevent increases in unemployment (including the subsidization of loss makers). Uniform wage cuts probably resulted in less severe effects on poverty than would have been the case if the same reduction in the wage bill had been achieved through layoffs (Nolan 1988-89; Buse 1982; Sawhill 1985, p. 1092). In capitalist economies unemployment benefits may sustain some of the unem- ployed above the poverty line. However, the low share of capital income and the absence of increased unemployment suggest that the increase in poverty result- ing from recession would, in a typical socialist economy and all other things being equal, be less than in a capitalist economy. II. ECONOMIC CRISIS IN POLAND, HUNGARY, AND YUGOSLAVIA The late 1970s marked the onset of economic crisis in Poland, Hungary, and Yugoslavia. During the 1970s a substantial inflow of foreign capital had masked the effects of weakening economic performances. But the period of relatively easy and cheap borrowing drew to a close, and the 1979 oil shock and increased real interest rates in the early 1980s were final blows for East European econ- omies. By 1981 Poland, Hungary, and Yugoslavia were in deep crisis. In Hungary and Yugoslavia the 1980s was a period of stagnation and crisis. In Poland two subperiods can be distinguished. From 1978 to 1982 real gross Milanovic 189 domestic product (GDP) contracted by one-fifth, while from 1982 to 1987, GDP grew at an average annual rate of 5 percent. However, the current account deficit decreased from almost 6 percent of GDP during 1979 to 1982 to only 1.6 percent of GDP during 1982 to 1987. The impact of recovery on domestic demand and personal income was therefore less than the relatively high GDP growth rate alone would suggest. Macroeconomic Indicators of the Crisis Selected macroeconomic indicators of the crisis are given in table 1. Output per capita, which in the three countries grew at an average annual rate of between 5 and 7 percent during the 1970s, decreased in Poland and increased by less than 2 percent annually in Hungary and Yugoslavia during the 1980s. The substantial current account deficits that the countries were able to run in the previous decade were no longer feasible during the 1980s, when voluntary lending dried up. The squeeze on domestic demand originated from two direc- tions: real output practically ceased to grow and resource transfers from abroad either decreased or became negative. All three countries attempt'ed to protect personal consumption by making severe cuts in fixed investment. The decline in current consumption was arrested at some indeterminate cost in future output and consumption. The lower level of investment probably helped to widen the technological gap between these countries and the West (Brada 1989). In Poland the crisis began in 1978, when the economy started on a fast downward plunge. GDP decreased by 20 percent during the next four years, thus recording the sharpest decline in postwar Europe. The level of GDP attained in 1978 was not regained until 10 years later. Per capita consumption was prac- tically stagnant throughout the 1980s. After an almost 6 percent average annual growth in the 1970s, during the 1980s real wages declined by 3.7 percent a year. In 1987 real wages were thus 30 percent below the 1978 level. The share of gross fixed investment in GDP decreased by 8 percentage points. Table 1. Selected Macroeconomic Indicators of the Crisis (percent) Poland Hungary Yugoslavia Indicator 1970-78 1979-87 1970-78 1979-87 1970-79 1980-87 Per capita growth ratea GDP +7.1 -0.6 +5.9 +1.9 +5.1 +0.9 Consumption +6.5 -0.2 +3.7 +2.6 +4.5 +0.8 Real wagesb +5.6 -3.7 +2.9 +0.1 +2.1 -2.2 Share of GDPc Current account -5.0 -3.5 -4.8 -2.5 -1.7 +0.2 Gross fixed investment 33.6 25.3 31.6 25.6 32.1 24.1 a. Averageannual growth rate. b. Real wagesin the socialized sector of the economy. c. Averageannual value. Source: Statistical Yearbooks of the three countries, except for current account, from IMF Interna- tional FinancialStatistics (various years), Bilten Narodne Banke Jugoslavije (various years), and IMF (1987). 190 THE WORLD BANK ECONOMIC REVIEW, VOL.5, NO. 2 During the 1980s Poland was compelled to reduce its current account deficit as a percentage of GDP to about half of its previous amount. Moreover, the current account deficit measured as a percentage of GDP was underestimated in the 1970s. This was due to an overvalued exchange rate of the zloty, which made the dollar GDP appear higher than it was in reality. Reduction in the external inflow of resources in the 1980s was thus greater than suggested by the data in table 1. In Hungary the first full crisis year was 1979. Since then the rate of growth has failed to recover to the levels it routinely reached during the 1970s. Per capita consumption grew by an average annual rate of 2.6 percent during the 1980s, which compared with 3.7 percent during the 1970s. Hungary alone of the three counties succeeded in maintaining a constant real wage level. It re- duced its current account deficit as a percentage of GDP to about half of its previous amount. The share of gross fixed investment in GDP decreased by 6 points. In Yugoslavia the crisis began in 1980. It had been postponed by a surge in short-term borrowing in 1979, which allowed the country to finance a current account deficit equal to 6 percent of GDP.