Explaining the Increase in Inequality During the Transition

Abstract

Since the beginning of transition to market economy, inequality has increased in all transition countries. The factors driving inequality up: increasing wage inequality (as workers move from a relatively egalitarian state sector to a less equal private sector), and the rising share of income from self-employment and property (both very unequally distributed). Social transfers have failed to dampen the increase in inequality because they have remained, as under socialism, unfocused.

The transition from planned to market economy has witnessed one of the biggest and fastest increases in inequality ever recorded. On average, inequality in Eastern Europe and the former Soviet Union increased from a Gini coefficient of 25?28 (below the OECD average) to 35?38 (above OECD average) in less than 10 years. In some countries, such as Bulgaria, Russia, and Ukraine, the increase in inequality has been even more dramatic, outpacing the yearly speed of Gini increase in the United Kingdom and the United States in the 1980s by three to four times.

What are the factors pushing inequality up? Milanovic constructs a simple model of transition defined as the removal of restriction on private sector development. As the private sector becomes free, it attracts workers who leave the shrinking state sector. Wage inequality in the private sector is greater than in the old, relatively egalitarian state sector. This is one of the forces pushing inequality up. The second is the growth of income from self-employment and property, both of which are fairly unequal sources of income both before the transition and now. In addition, some of the released state sector workers remain unemployed. Their incomes decline. Increased inequality is thus accompanied by the hollowing out of the middle class (where the middle class is defined as the former state sector workers). One part of state sector workers moves to higher incomes as workers in the private sector or entrepreneurs; another remains jobless.

The model is contrasted with the actual developments in six transition economies: Bulgaria (over 1989-95), Hungary (1987-93), Latvia (1989-96), Poland (1987-95), Russia (1989-94), and Slovenia (1987-95). In all countries, wage inequality has increased (in some, like Russia, dramatically); income from self-employment has remained as unequal as before but its share in total income has risen, and the importance of social transfers in total income has increased, but its focus on the poor has not improved.

This paper - a product of the Development Economics Research Group - is part of a larger effort in the group to study social issues in transition economies. The author may be contacted at [e-mail].

JEL Classification: D31, P2