Transfers and the transition from socialism : key tradeoffs

The old days in the now transition societies were characterized by stagnant incomes, rationed goods, and few civil liberties, but a high degree of income security. The early days of reform have brought crashing incomes, more goods, civil liberties, and rising insecurity. Most countries are set on a course toward some form of capitalism, which by definition means greater risk-taking, less security, and almost certainly greater inequality in income distribution. Should transfers be used to compensate for increasing insecurity and poverty? The short-run drop in incomes, the heritage of cradle-to-grave state protection, and the Western European vision of the welfare state provide compelling motivation for using transfers. But, argue the authors, there are significant tradeoffs between moving to a welfare state and shifting to dynamic, growing economies. The transition economies do not have the real levels of productivity or the tax bases needed to sustain the kind of tax effort a large-scale system of transfers would require. Short-run gains in security could in the long run mean insufficient private and public capital accumulation and lack of competitiveness. The result could be financial collapse (as witnessed in Ukraine) or an extreme form of Eurosclerosis (a possibility for Hungary or Poland). Under either scenario, those whom the transfers are supposed to protect - the old, the poor, the disabled, and the unemployed - are most likely to suffer disproportionately over the medium to long term, and probably even in the short term. In any viable scenario, transfers are likely to be important for both welfare and political reasons. Some options for providing transfers are more likely to be consistent with macroeconomic imperatives and to have relatively low adverse-incentive effects - for example, flat-rate (or flatter) pensions at quite low replacement rates, and local rather than general (income-tested) social assistance. The authors recommend using intrisically temporary measures - such as temporary employment schemes - in the transition. This avoids a permanent transfer burden while recognizing the severity of the interim transition period. In sum, the alternative of less reliance on comprehensive transfers puts more pressure on private coping mechanisms and will, in the short run, increase risk. But it may be the price of a viable transition to the growth that is essential to success.