Explaining the increase in - siteresources.worldbank.org.pdf

Economics of Transition Volume 7 (2) 1999, 299–341 Explaining the increase in inequality during transition1 Branko Milanovic Policy Research Department, The World Bank, 1818 H Street NW, Washington D.C., 20433 USA, E-mail: bmilanovic@worldbank.org Abstract This paper attempts to explain the increase in inequality that has been observed in all transition economies by constructing a simple model of change in composition of employment during the transition. The change consists of the ‘hollowing-out’ of the state-sector middle class as it moves into either the ‘rich’ private sector or the ‘poor’ unemployed sector. The predictions of the model are contrasted with the empirical evidence from annual household income surveys from six transition economies (Bulgaria, Hungary, Latvia, Poland, Russia and Slovenia) over the period 1987–95. We find that the most important factor driving overall inequality upwards was increased inequality of wage distribution. The non-wage private sector contributed strongly to inequality only in Latvia and Russia. Pensions, paradoxically, also pushed inequality up in Central Europe, while non-pension social transfers were too small everywhere and too poorly focussed to make much difference. JEL classification: D31, D63, H42, P21. Keywords: transition, inequality, wage distribution. 1 The findings, interpretations, and conclusions expressed in this paper are entirely those of the author. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. I am grateful to Jan Rutkowski, Simon Commander, Ehtisham Ahmad and participants at the IMF Conference ‘A Decade of Transition: Achievements and Challenges’ held in Washington D.C., Febru