Report No. 28233-POL Poland Growth, Employment and Living Standards in Pre-Accession Poland March 22, 2004 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank CURRENCYAND EQUIVALENTUNITS `_ (Exchange Rate Effective March 19,2004) Currency Unit =Zloty (PLN) US$l.OO=3.859 PLN ACRONYMS AND ABBREVIATIONS ALMPs Active Labor Market Policies BAEL Labor Force Survey (BadanieAhnos'ci Ekonomicznej Ludnos'ci) BGD Household Budgets Survey (Badanie Budzetow Gospodarstw Domowych) CAL Local ActivitiesCenter (CentraAktywnoSciLokalnej) CASE Centerfor Social and Economic Research (CentrumAnuliz Spoleczno- Ekonomicznych) CEEC Central and Eastern European Countries CIT CorporateIncome Tax COICOP Classificationof Individual Consumptionby Purpose (KlasyJikacja Spozycia Indywidualnego WedlugCelu) COP Central Industrial Area (Centralny OkrggPrzemyslowy) CPI Consumer Price Index cso Civil SocietyOrganization ECA Europe and Central Asia EPL Employment ProtectionLegislation EU EuropeanUnion FDI ForeignDirect Investment FDPA Fundation for the Delopment of Polish Agriculture (Fundacja na Rzecz Rozwoju Polskiego Rolnictwu) FTE Full Time Employment Contract GDP Gross Domestic Product GUS Central StatisticalOffice (Gldwny UrzqdStatystyczny) HBS Household Budget Survey HDI Human Development Index IALS InternationalAdult Literacy Survey IMF InternationalMonetary Fund IPISS Institute of Labor and Social Studies (InstytutPracy i Spraw Socjalnych) ISP Institute of Public Affairs (Instytut Spraw Publicznych) mus Old Age and Disability Pensions System for Farmers (Kasa Rolniczego Ubezpieczenia Spolecznego) LFS Labor Force Survey LS Living Standard LSA Living StandardAssessment 11 MARD Ministry of Agriculture andRuralDevelopment (~inisterstwo Rolnictwa i Rozwoju Wsg MGPIPS MinistryofEconomy, Labor andSocial Policy (~inisterstw~ Gospodarki, Pracy i Polityki Spotecznej) MONAR Center for Drug Addicts' Therapy (Centrum Terapii ~ a r k o ~ a n ~ w ) MPC Monetary Policy Council (RadaPolityki Pienieznej) NAS National Account Statistics NBP National Bank o fPoland (T\iarodowyBank Polskg NGO Non-governmental Organization OECD Organization orEconomic Cooperation andDevelopment OLS Ordinary Least Square OMC Open Methodof Coordination OPS Social Aid Centers (OSrodki Pomocy Spotecznej) PCK PolishRedCross (Polski CzenvonyKrzy.2) PCPR Poviat Center for Family Assistance (Powiatowy OSrodekPomocy Rodzinie) PD Poverty Deficit PGR State Farm (Palistwowe GospodarstwoRolne) PI Price Index PIS Social Intervention Threshold (Prbg Intenvencji Spolecznej) PISA Program for International StudentAssessment PIT Personal Income Tax PLFS PolishLabor Force Survey PPP Purchasing Power Parity REER RealEffectiveExchange Rate SAPARD Special Accession Programme for Agriculture andRural Development SGH MainTrade School (Szkola GtdwnaHandlowa) SME Small andMediumEnterprises UNDP UnitedNations Development Program VAT Value Added Tax zus WB World Bank Social Security Office (Zaklad UbezpieczeliSpoiecznyc~) Fiscal Year January 1to December 31 Vice President: Shigeo Katsu Country Director: Roger Grawe Sector Director: Cheryl Gray Sector Leader: AsadAlam TeamLeader: PierellaPaci iii CONTENTS EXECUTIVESUMMARY ......................................................................................................... x 1 INTRODUCTION . 1 A The Objectives andScopeof the Rep0rt . ................................................................................................................. ....................................................................... 1 I3 The Structure ofthe Rep0rt . ........................................................................................... 3 2 THE ECONOMICBACKGROUND . 4 A . .................................................................................. The "Big Bang" ............................................................................................................... 4 B The HighGrowthYears 5 C The Economic Slowdown .. ................................................................................................. 5 D EUAccession andthe Challenge for theFuture . ............................................................................................... .......................................................... 6 3.THE GROWTH-POVERTYLINK 8 A A StatisticalArtifact? ..................................................................................................... .................................................................................... 8 B ButIncreasedInequality isAlso A Factor 9 C What is Behind the Increase inInequality ... .................................................................... ................................................................. 11 4.THEPROFILEOFPOVERTYOVERTHE LASTDECADE ..................................... 14 A The MethodologyUsed . ................................................................................................. MovingCloser to the Concept o f ConsumptionFlow ............................................. 14 14 15 Usinga "Poor PriceIndex" ...................................................................................... UsingRegionalPrices.............................................................................................. 16 B The Extent ofPovertyinPolandandits Trends Over Time 16 C Who are the Poor inPre-Accession Poland? .. Poverty Lines and Poverty Indicators ...................................................................... 16 .............................................................. .................................... 18 D HastheProfile ofPoverty Changed Over the Decade? 22 E .. Multi-dimensional Differences inEducationalAttainments................................................................... Aspects o f Poverty ........................................................................ ............................................. 22 The Ethnic Dimension.............................................................................................. 23 The Gender Dimension............................................................................................ 23 23 24 F POVERTY,VULNERABILITYAND SOCIAL EXCLUSION . The Growing Threat o f Alcoholism......................................................................... Informal Networks and Social Exclusion................................................................. .............................. 24 24 Civil Society Organization as InformalSafety Nets ................................................ 25 5.SKILLS. EMPLOYMENTAND SOCIAL INCLUSION: AN EVERSTRONGER LINK ..................................................................................................................................... A What isBehind the IncreaseinInequality inHouseholdLabor Income? . Wage Inequality has not Increased Substantially Over Time .................................. ...............26 26 26 26 B WhatisBehindPolishRecentJobless Growth . ButEmploymenthas DeclinedConsiderably .......................................................... 28 C The Roleof RegionalVariations andImbalances inthe Supply andDemand . .......................................................... 29 D The GrowthofLongTerm UnemploymentMay also be the Answer . for Skills ........................................................................................................................ ...................... IncreasingLabor Demand May not be Enough........................................................ 31 32 Mobility.................................................................................................................... Wage Expectations. Social Transfers. Unemployment Duration and Labor 33 iv 6. A TWO-EDGED SWORD: THE ROLE OF SOCIALTRANSFERSIN MAINTAININGSOCIAL INCLUSION .......................................................................... 35 A An EffectiveButInefficientand Costly SystemofTransfers 36 B 37 C Butthe ``Poverty Trap" is Likelyto be Small ... ................................... SomeWorkersMay Facea Substantial"UnemploymentTrap" ............................................................ ............................. 38 7. MOVINGCLOSER TO THE LISBONTARGETS ........................................................ 39 A Growthis Centralfor PovertyReduction . .................................................................. 39 B GoingBeyondEconomicGrowth . ............................................................................................. ................................................................................ 40 C PolicyRecommendations . Interventions on the SupplyofLabor....................................................................... IncreasingLabor Demand........................................................................................ 41 40 42 ReducingMismatch ................................................................................................. 43 EncourageEntrepreneurship.................................................................................... 44 .. Howto The Scope for Active Labor Market Policies........................................................... 44 D Supportingthe LivingStandardsoftheMostVulnerable ....................................................................... ........................................ 45 E MonitorFurtherDevelopment 45 Annex Matrix of ConclusionsandPolicyRecommendations ........................................................................................................................... .................................. 47 References 60 Tables Table 2.1 MainMacroeconomicIndicators ......................................................................... 6 Table 3.1: InternationalComparisonsof Consumption-BasedandIncome-Based Measuresof Inequality for Accession Countries............................................... Table 3.2: Income Inequality and Decompositionby IncomeSources, 1994-2002...........10 12 Table 3.3 Inter-Group Inequality as Percentof Total Inequality, 1994-2001.................... 13 Table 4.1: Poverty in 1994-2001: An Overview ............................................................. 17 Table 4.2: Absolute Poverty Ratesof SelectedAccessionCountries, SelectedYears, 1995-99.............................................................................................................. 17 Table 4.3 : Poverty inRural and Urban Areas..................................................................... 20 Table 4.4: Poverty by Employment Categories .................................................................. 21 Table 5.1: InternationalComparisonsofLabor Market Indicators..................................... 28 Table 5.2: by Levelof CompletedEducation, 1992-2002.................................................. Changes inthe Distributions of Employment, Population and Unemployment Table 5.3a: LongTerm Unemploymentby CompletedEducationLevel, Spring 2002.......30 31 Table 5.3b: Average UncompletedUnemploymentDuration by Educational Attainment, 1998 and2002 ................................................................................................... 31 Table 5.4: The ChangingProfile ofPolishLong-termUnemployment, 1992-2002.......................................................................................................... 33 Table 6.1: ReplacementRatios inandout of Work by Family Type andPotential Wage.................................................................................................................. 37 Figures Figure 1: Decomposition of Changes inPoverty. 1994-2002.......................................... xii Figure3.1: Trends inGrowth andPoverty ............................................................................. 8 Figure 3.2: 9 Growth Incidence Curves.................................................................................. Inequality, 1994-2001.......................................................................................... Private ConsumptionGrowth, inNAS & HBS, 1995-2001................................ Figure3.3: 9 Figure3.4: 10 V Figure 3.5: Decomposition of Changes inPoverty. 1994-2001........................................... 11 Figure 3.6: ModeratePoverty by Placeof Residence, Poland2001.................................... Trends inEmployment andPoverty.................................................................. 13 Figure4.1: 20 Figure 4.2: Poverty andUnemployment, Poland 1994-2001............................................ Figure 5.1: Trends inPrivate andPublic Employmentover the Last Decade(,000s) .........22 27 Figure 5.2: The Evolutionof PolishUnemploymentSincethe Inception ofTransition, 1990-2002.......................................................................................................... 32 Figure 6.1: 36 Targeting of SocialTransfers(Excluding OldAge Pensions)........................... Poverty and Social Transfers, 1994-2002.......................................................... Figure 6.2: 36 Boxes Box 1: Main Policy Recommendations........................................................................ xvi Box 1.1: 2 15 FindingsofExistingLiterature.......................................................................... The Polish HouseholdBudgetSurvey............................................................... The LisbonStrategy............................................................................................. Box4.1: Box 4.2: 18 Box 4.3: MainPoverty Diagnostics.................................................................................. 18 Box 5.1: 34 The Structure ofthe SocialTransfer System..................................................... Information on Wage Expectations................................................................... Box 6.1: 35 Box 7.1: MainPolicy Recommendations......................................................................... 41 Maps Map 4.1: MediumPoverty 2001 (WBO) .......................................................................... 19 vi c CONTRIBUTORS TitoBoeri Professor o fEconomics, Bocconi University, Milan, Italy, and Director, field o f Labor Market and Social Policy Reforms, Fondazione Rodolfo Debenedetti, Milan, Italy. BoguslawaBudrowska ResearchUniton Women and Family o fthe Institute o f Philosophy and Sociology o f Polish Academy o f Sciences, Warsaw, Poland. Agnieszku ChLon-Dominczak Director o fthe Department for Economic Analyses and Forecasting at the Ministryo f Economy, Labor and Social Policy, Warsaw, Poland. Edwurda Dabrowska Heado fthe Unito f Social Protection, Department for Economic Analyses and Forecasting, MinistryofEconomy, Labor and SocialPolicy, Warsaw, Poland. Pietro Garibaldi Associate Professor of Economics, Bocconi University, Milan, Italy, and Head o f Labor Studies for the Fondazione Debenedetti, Milan, Italy. Piotr Gliiiski Professor o f Sociology, Heado f Civil Society Unit, Institute of Philosophy and Sociology, Polish Academy o f Sciences, Warsaw; Head of Social Structure Unit, University o f Bialystok, Poland, Katarzyna G h i u k Assistant Lecturer, Institute o f Social Sciences andAdministration, Warsaw Universityo f Technology, Warsaw, Poland; Member (professional bodies), Polish Sociological Association. GrzegorzGorzelak Professor of Economics and Director of the Centre for European Regional and Local Studies (EUROREG), Warsaw University, Poland. Stanislawa Golinowska Professor inEconomics and lecturer, Jagiellonian University, Poland. Jolanta Grotowska-Leder Associate Professor, Departmento f Sociology, University o f Lodz, Poland. Alexandre Kolev Economist, Poverty Reductionand Economic Management Sector, Europe and Central Asia Region, The World Bank, Washington, D.C., United States. Karol Kuhl Teaching Assistant (Mathematical Statistics and Econometrics); and PhD student, Department o f Economics, Warsaw University, Poland. vii Ewa Lisowska Associate Professor, Women's Entrepreneurship, Warsaw School o f Economics, Warsaw, Poland. Mark Lundell LeadAgricultural Economist, Environmentally & Socially Sustainable Development Sector Unit, Europe and Central Asia Region, The World Bank, Washington, D.C., United States, Mauro Maggioni Junior Researcher, Fondazione Rodolfo Debenedetti, Milan, Italy. EugeniaMandal Associate Professor, Instituteo f Psychology, University inKatowice, Poland. Andrew Newell Professor, University o f Sussex, Brighton, U.K.and ResearchFellowat IZA (Institute for the StudyofLabor), Bonn, Germany. Hanna Palska Associate Professor, Civil SocietyUnit, Institute of Philosophy and Sociology, Polish Academy o f Sciences, Warsaw, Poland. Marcin Sasin Economist, PolandCountry Office, Europe and Central Asia Region, The World Bank Office in Warsaw, Poland. Janina Sawicku Professor, Agricultural Economics and Agrarian Policy, Warsaw Agricultural University, Warsaw, Poland. MieczysawW. Socha Professor, Department of Economics, Warsaw University, Poland. Piotr Stronkowski Headof Labor Market Analyses Section, Department for Economic Analyses and Forecasting, MinistryofEconomy, Labor andSocialPolicy, Warsaw, Poland. Irena Topihska Associate Professor, Department o f Economics, Warsaw University, Poland, Katarzyna Tyman-Koc Economic Advisor to the Plenipotentiaryfor Equal Status o f Women, Government o f Poland, Jos Verbeek LeadEconomist, Poverty Reduction & Economic Management 1, Africa Technical Family, The World Bank, Washington, D.C., United States. Wielislawu~a~zywoda-Kruszy~ska Professor, Department o f Sociology, University o f Lodz, Poland. ... V l l l Acknowledgments This participatory report is the result of a team effort involving staff of the Polish government, main Polish think-tanks, Polish and international experts; and a multi-disciplinary World Bank team. The Bank team is grateful to all government and non-government officials who cooperate with the work of the team, The Polish experts include Agnieszka Chlon-Dominczak, Edwarda DabrowskaandPiotr Stronkowski (Departmentfor EconomicAnalyses and Forecasting,Ministry of Economy, Labor and Social Policy, Government of Poland), Katarzyna Tyman-Koc (Plenipotentiary for Equal Status of Women, Governmentof Poland), Grzegorz Gorzelak, Karol Kuhl, Maciej Smqtkowski, Mieczyslaw W. Socha and Irena Topinska, (Warsaw University, Poland), Jolanta Grotowska-Leder and Wielisiawa Warzywoda-Kruszynska(University of Lodz, Poland), Stanislawa Golinowska (Jagiellonian University, Poland ), Piotr Glinski (Polish Academy of Sciences, and University of Bialystok, Poland), Katarzyna Gbrniak (Warsaw University of Technology, Poland) and Hanna Palska. Three Polish think-tanks were directly involved with the preparationof the report: IPISS (Institute o f Labor and Social Studies), CASE (Center for Social and Economic Research) and ISP (Institute of Public Affairs). The international consultants involved were Tito Boeri, Pietro Garibaldi and Mauro Maggioni (Bocconi University and FondazioneRodolfo Debenedetti, Italy) and Andrew Newel1(University of Sussex, U.K). The World Bank team was composed of Pierella Paci (Task Team Leader and author of Volume I), Verbeek, Mark Lundell, Jan Pakulski, Jacez Wojciechowicz, MarcinJ. Jos Sasin, MarzenaKulis, PeterBocock, Jim Lynch, MartaMichalska and EmilyEvershed. The process leadingto the report was highly participatory, The scope ofthe work was developed inconsultationwith GovernmentandPolish academics. Early findings ofthe backgroundpapers were presented in a technical workshops held inMarchin Warsaw to which a number of selected experts from the Government, policy makers, civil societies and academia participated as presenters and discussants. The overall messages emerging from the report were discussed in more details in a second workshop held in July and open to a wider audience. This provided a very productive exchange of views and results which has fed extensively into this final report. Our thanks go to the participantsto the workshops. This Report was undertaken under the guidance of Mr. Roger Grawe, Country Director, Ms. Cheryl Gray, Sector Director, and Mr.Asad Alam, Sector Manager. The Peer Reviewersfor the report were Mr. Ryszard Michalski, (Deputy Minister of Finance, Government of Poland), Ana Revenga (EASHD), and Michal Rutkowski (ECSHD). In addition the report has benefitedfrom comments and suggestions from Kyle Peters, Bernard Funck, Mamta Murthi, Jan Rutkowski, Chris Hall, Ryszard Petru, Thomas Laursen and Mukesh Chawla. The team is grateful to the entire Warsaw office for their supportand advise at various stages of the project. Backgroundpapers to this volume are available from Pierella Paci of the Poverty Reduction and Economic Management Unit, Europe and Central Asia Region. Ms. Paci can be reached by phoneat (202) 458-2333. ix EXECUTIVESUMMARY 1. Poland was an early comer to the transition process and a strong reformer. What came to be known as the "Polish model of transition" brought rapid changes to the economic system and, after an initial "big bang," resulted in high growth rates and rapid employment growth. At the same time the potential social cost of the "shock therapy" adopted was mitigated by: (i)a generalized easy access to a generous social benefit package; and (ii)a relative drop in food prices that increased the relative purchasing power o f the poor. The combination o f these two factors kept the growth in the inequality o f consumption to a minimum during the middle o f the 1990s.' With highgrowth rates and only a slight increasein inequality, absolute poverty declined sharply over this period-from 18 percent in 1994to 12.6 percent in 1998, 2. The loss of export markets in the East as a consequence o f the Russian financial crisis triggered a new round of enterprise restructuring to curtail falling profitability. This time, the resulting improvements inproductivity were brought about in large part by reducing employment. At the same time, expenditure on social transfers to become fiscally unsustainable andthreatened to limit the country's growth potential. Thus, as economic growth declined progressively to a meager 1 percent in 2001, inequality continued to slowly increase led by the increase in the dispersion o f labor income which was associatedwith the sharp drop in employment2 3. Low growth rates and growing inequalities combined to increase poverty after 1998 - from 12.6 percent in 1998 to above 15 percent by 2002. Moreover, poverty has increasingly become a "chronic" phenomenon associated with lack o f skills, long-term unemployment and residence in small towns andlor particular regions. Thus, recent years have seen a growing pool o f hard-core poverty emerging as a correlate o f the increase in long-term unemployment and labor market mismatches. The risk o f falling into this group i s particularly high for women, individuals with low education and those living inrural areas. Inaddition, the transformation of the economy brought about a new territorial diversity that is connected to the decline in agricultural production and especially the collapse o f collective (state) farms. 4. At the same time the social benefit system has come under increasing pressureto reduce expenditure and has grown increasingly inefficient intargeting the poor. In2001, over 50 percent o f the benefits paid - net of old-age pensions - did not reach who neededthem most. Although the social insurance component of these benefits - e.g. unemployment benefits - is clearly not designed to target the poor, the extent of the spill-over raises concerns about the ability o f the systemto serve as an adequate safety net for the emerging hard-core poor and suggests the need for aradical reform. 5. By way o f contrast, the European Union (EU)-which Poland is set tojoin in2004 -has increased its focus on reducing social exclusion and welfare inequality via increasing employment opportunities, in the Lisbon Treaty. Thus the imminent EU accession presents Poland with the challenge o f reversing the trends of the last decade and closing the gap between 'TheGini coefficientsfor householdconsumptionincreasedonly slightly from 0.25 in 1994to 0.26 in 1998and remainedlowerthan inother CentralEuropeantransitioncountries. The Gini coefficientsfor householdincome, however, were andremainedthe highestamongthe EuropeanOECD countriesexcept Turkey (OECD, 2003). The Gini coefficient for householdconsumptiongrew from 0.26 to 0.28 over 1998- 2002 while that for household labor income rose from 0.32 to 0.35 andthe employment ratedeclinedfrom 66 percent in 1994to 60 percentin2001. X the "two Polands" that have emerged over the last decade. The experience of the mid-1990s shows clearly that a retum to the high growth-high employment scenario is essential to achieve this objective. As economic growth is reaching again enviable rates, this report attempts to identify some measuresthat may help Polandback on a pro-poorgrowth path. The Link Between Poverty and Growth 6. The report finds that in Poland poverty responds well to economic growth. Over the last decade the average estimated elasticity of poverty with respect to growth in average consumption from the HouseholdBudget Survey (HBS) has been 3.57 with a peak of 4.11 in 1999.3This value compares well with the estimates for other transition countries and with those typically found in other regions(Bruno, Ravallion, and Squire 1998; Ravallionand Chen, 1997).4 7. The relatively high degree of responsiveness of poverty to economic growth is qatger surprising in the context of the dramatic economic transformation experienced over a ihort period, which is likely to have generated a number of winners and losers. But, as noted above, the potential increase in inequality was contained by a sharp increase in public expenditure on social transfers and a sizable relative drop in food prices. Indeed, as expected, inequality in the distribution of consumption grew over the decade - somewhat more rapidly than in other CEE countries. The relatively high growth rates of the pre-1998 period and the relatively small increase in inequality resulted in a reduction in poverty. By contrast, afier 1998 mean consumptiondeclined in all quintilesexcept the highest, and the reduction was particularly severe at the lower end of the distribution. The decline in average consumption and the increase in inequalitycombinedto increase povertyby about 3 percentage points. 8. Ifthischange is decomposedintoagrowthandaninequalitycomponent, it isevidentthat economic growth was the main driving force in poverty reduction in the first period (1994-98). During these years the economic growth effect (a reductionof 5 percentage points in the poverty headcount) far outweighed the negative effect of the increase in inequality (an increase of 1 contrast, during the subsequent period, 1998-2002, slow - or negative - growth and rising percentage point), resulting in a cumulative decline in poverty of about 4 percentage points. By inequalitybothcontributedto the increase in poverty notedabove. 9. Underlying the slowly rising inequality in consumption experienced over the last decade was the growing inequality in income in general and labor income in particular - the Gini coefficients for consumption increased from 0.25 in 1994 to 0.28 in 2002. Interestingly, this growing inequality is linked to wider differences across households in employment status and employment opportunities rather than to the more unequal distribution of wages that one would associate with labor market liberalization. The two main factors behindthis growing inequality in Jabor income are geographical differencesand skill differentials. In 2001 nearly 20 percent of the inequality was accounted for by differences between different skill groups, while 12 percent was due to differences across regions. These estimates are in line with the value of 3.5 given in World Bank, 2002. To give a few examples, the growth elasticity of poverty for Romaniawas estimated at 3 in 1996 and 1997 but has declined since then to below 2 (World Bank, 2003). An average elasticity of 3.7 was also estimated for Croatia. However, the limited information available suggests much lower responsiveness in other countries. Estimates of around 2 were derived for Russia(World Bank, 2002) and less than 1 for Armenia, Azerbaijan and the Kyrgyz Republic.. xi Figure I : Decompositionof Changes in Poverty, 1994-2002 3% 2% 2k 1% 0% 2 = -1% -2% 0 -3% 14% .5% 199411998 199812002 199412002 total povertychange due to growth 0due to inequalit) Source: Authors' calculationsbased on HBS. What Is the ExtentofPoverty? 10. Usingour methodology, in 2001 over 14percentofthe total population-or morethan 10 percent of households- lived in "moderateyypoverty in P01and.~This meansthat poverty affected over 5.5 million people. The extent of "deep" poverty was also considerable, reaching 8.6 percent or about 3.5 million people, and extreme povertywas also significant (headcount index H = 3.2 percent). At the same time, poverty depth was moderate. The poverty gap for moderate poverty has been estimated at around 0.5 percent of GDP (poverty gap index less than 20 percent), while the gap for deep povertywas 0.25 percent of GDP (gap index 18 percent). 11, Both moderate and deep poverty headcounts declined sharply bekeen 1994 and 1998 and increased consistently after that date. The poverty decline in the middle of the decade was more pronounced than the poverty increase that came later. In 1994-98, according to our methodology, the moderate poverty headcountdropped from 18 percentto 12.6 percent. Who Are the Poor inPoland? 12, Over the last decade, povertyhas beendecreasingwith age.6 It has also beenincreasingly associatedwith the following factors: 0 Living inthe north, northwestand southeast andlor in small towns; Unemployment; 0 Lack of education; 0 Havinga large number ofchildrenor dependents inthe family. . aggregateconsumption, thedifferencesbetweenruralandurbanareasandthehigherpovertyrisk 13. It is particularly important to note that, using the World Bank standard definition of . of farmers found in previous studies is considerably reduced. The higher risk of poverty in rural . areas appears to be the result of extremely high poverty among former PGR (state farm) workers rather than private farmers. Moreover, in the case of private farmers the poverty risk decreases sharply with land size. This suggests that the problem is not low agricultural productivity,but is rather (i)limited access to land for private farmers and (ii)lack of employment for former PGR workers. The poverty line for "moderate poverty" is PPP $6.33 a day; the line for "deep poverty" is PPP $5.50 a day and that for "extreme poverty" is the internationally used $4.30 a day. However, some evidence is emerging of a recent increase in poverty amongthe elderly xii 14. A comparison ofthe correlates of poverty over the last decade suggests that the profile of poverty has remained relatively stable over time, with changes in poverty incidence being determined by fluctuations in the unemployment rate. However, in 2000-01 the position o f farmers improved slightly relative to other groups, and the relative importance o f education in moving people out o f poverty has increasedover time. 15. Finally, the analysis of two panel sub-samples of the HJ3S suggests that the 1990s saw an increase inthe incidence of chronic, long-term poverty and a slowing down o f the movement out o f poverty. This trend suggests the emergence o f a growing hard-core group o f chronically poor households that are becoming increasingly excluded from the process of economic transformation and are unlikely to benefit from future economic growth. The road to chronic poverty and social exclusion is marked by the same milestones as the roadto "transient" poverty and closely follows the increase in long-term unemployment experienced in Poland. Geographical location and poor educational attainments are not only the main factors that lead individuals into poverty. They are also the main barriers to their moving out of poverty, because they adversely affect employment prospects. This suggests the existence of a growing gap between the Poland o f long-term unemployment and chronic poverty and the rest of Poland, in which people are unlikely to experience poverty duringtheir lifetime. The Strong Link between Income Poverty and Other Dimensions ofPoverty 16. There is a very close relationship between income poverty (as measured by household consumption) and other dimensions of poverty, such as access to, and quality of, such social services as education and health, with rural areas and the poorest regions receiving significantly fewer resourcesthan the rest ofthe country (World Bank, 2002). 17. While there is little evidence o f a systematic relation between poverty and ethnicity andlor gender, the evidence suggests a strong link between poverty and risky behavior, especially in rural areas. One type of behavior that is of particular importance is alcohol abuse, which affects around 3 to 4 million people, making it the most troublesome social problem after unemployment (Sieroslawski, 1998). Strong regional inequalities also exist in access to informal safety nets, with the poor inhabitants o f villages that were formerly established to house collective farm workers being largely excluded from both local and broader social networks. In these areas, neighbors can provide little help as they tend to be equally poor. In addition, most former collective farm workers are not local to the regions in which they live and have no access to the informal safety net that inPolandi s providedby the immediate family. 18. It is also worth noting that the conclusion regarding no direct link between poverty and gender is based on the comparison of poverty incidence in female-headed and other households. This is clearly a very limiting definition o f gender inequality, and a clear disadvantage emerges for women when other dimensions are considered. Particularly striking is the extent o f gender inequalities in the labor market, with women being substantially more likely than men to be among the long-term unemployed and to receive substantially lower wages for the same job descriptions despite their comparable productivity endowments. Poverty and Labor Market Outcomes 19. The poverty diagnostics presented above clearly show the important role played by employment status in determining the probability of falling into poverty. At the aggregate level this is also shown by the close correlation between the trends in poverty incidence and the employment rate. In addition, this report highlights the importance of growing inequalities in xiii labor income-le,, the amount o f household income derived from labor--in explaining the growth o f inequality over the last decade. 20. Wage inequality remained roughly steady from 1992 to 1998 and has increased only slightly since. This small increase in wage inequality at a time o f increasing labor market deregulation may appear surprising, especially in lighto f the growth of private employment from little over a quarter o ftotal employment in 1994to almost 60 percent by 2002. However, it could be explained by a number o f factors. Important among these factors are: (i)the relatively high level of minimum wages; and (ii) related substantial and progressive drop in employment the opportunities for low-skilled employees, which has resulted in the wage distribution being truncated downwards. Inaddition, a substantial increase inthe supply o f highlyeducated labor - inresponseto the initial increase inreturns to education -has contained the increase inwages at thetop end ofthe distribution. What I sBehindtheRecentPolishJoblessGrowth? 21, Ifgrowingearnings inequality is notthe cause ofthe risinginequality inhousehold labor income, then the explanation must be the polarization o f employment away from worse-off households and in favor of better-off ones. The factors behind the decline in employment are complex. On the one hand it is linked to the intensive industrial restructuringo fthe early 1990s- and the associated reallocation of labor leading to skill and geographical mismatches - and the elimination of labor hoardingand the sharp increaseinproductivity o fthe mid-1990s. 22. On the other hand, an important cause o f the slow-down increase in job creation experienced since the late 1990s is the relatively high-and increasing - cost of doing businessin Poland, which results from a combination of high taxation, high labor costs relative to productivity and the highcost of entry that are associatedwith administrative barriers, corruption, etc.. Compared to other transitional and OECD countries, Poland has one o f the highest payroll taxes (48 percent) (Riboud et al. 2002).7 In addition, between 2000 and 2003 - at a time o f declining employment - labor costs inPolandhave increased by 21.7 percent, 11.5 percent faster than the EU(15) average but slower than that inthe other Central European Accession countries, except for Lithuania.' 23. Partial deregulation in the goods market may be an additional possible explanation. The radical economic transformation o f the early 1990s has resulted in massive restructuring and some privatization o f former state firms but the process of deregulation and privatization has progressively lost momentum over the last decade and much remains to be done. Recent literature suggests that the positive effects of product market deregulation may not be felt in the labor market when deregulation affects only part o f the economy - for example, because the rest of the system remains heavily regulated. In this case, employment in existing restructured firms will fall butthe drop may not be compensated by adequatejob creation in incumbent f m s , with adverse effects on unemployment. This mechanism can partially explain Poland's sluggish employment performance and deserves to be studied indetail. 24. Finally, an important potential factor is the apparent increase in structural unemployment experienced over the last decade as a result o f massive changes inthe demand for and supply of skills which are by no means uniform across Poland's regions. Voivodships vary substantially in 'Careyand Tchilinguirian (2000) estimatedthe average effectivetax ratefor labor inthe period 1991-95as 42.06 percent. The 2003 figure refers to the third quarter, which is the most recentperiodfor which information is available. xiv terms o f unemployment and skillleducation mix and the two variables are strongly correlated. Differences in educational. attainment account for at least half o f the regional variation in Polish unemployment rates. 25. The differences in the unemployment rate explain only a part o f the regional relationship between unemployment and skills levels. In addition, lower skilled workers tend to experience longer periods o f unemployment. Thus, part of the skill-unemployment regional correlation may have to do with regional differences infactors that affect the individual's chances of findingwork once he or she becomes unemployed. On the supply side, such factors include: (i) those that affect reservation wages, such as a highreplacement ratio; and (ii) those that inhibit geographical mobility, such as housing market constraints and length of entitlement to unemployment benefits. On the demand side, an important element is regional differences in average labor productivity that are not adequately reflected in differences in labor costs, owing to factors such as the nationwide minimumwage. What I s the Role of Social Benefits inPoverty Reduction? 26. As mentioned above, during the "big bang" years the social transfer system came to be usedas a way o f maintaining social cohesion rather than as a way of supportingthe income levels of those most in need. Today the system and its underlyingobjective remain largely unchanged. The average amount received in social transfers per capita has increased over time and so has the percentageo f the population relyingon transfers to keep them from falling into poverty. Without social transfers, the poverty rate would be over twice the estimated rate. 27. However, the current system i s extremely costly and inefficient. Excluding old-age pensions from the calculation, this report estimates that, despite recent efforts to increase the efficiency o fthe system, the following problems remain: 0 26 percent o f benefits paid are in excess of the amount necessary to bring household consumptionto the poverty line level 0 30 percent (an equivalent of 2 percent of GDP) o f total expenditure is estimated to go directly to non-poor households 0 the average size o f social transfers per capita in the poorest decile i s the second lowest after the top decile. Policy Recommendations 28. Based on the findings o f the analysis, this report puts forward a number o f recommendations designed to bringPolandback onto the pro-poor growth path o f the early 1990s and closer to the Lisbon targets for employment and social inclusion. These recommendations are summarized inBox 1. xv Box 1: MainPolicy Recommendations Improve employment opportunities for the population by: 0 Increasinglabor demand by: o Introducing regional differentiations inthe minimumwage; o Reducing non-wage labor costs; o Reducing administrative barriers to "doing business" and improving governance; o Speeding up the process o fprivatization and liberalization o f goods, labor and other markets. e Increasing labor supply by: o Reducing the highreservation wages of unskilled rural workers; o Reforming social transfer systems so as to reduce the existing "unemployment trap"; o Increasingthe skills level o fthe labor force, especially indisadvantaged regions. e Reducing labor market mismatch by: o Improvingjob search assistance; o -- Encouraging mobility via a policy mix that includes; Equalizingthe length o f entitlements to unemployment benefits acrossthe country; -- Reducing housing marketrigidities; Improvingaccess to transport; and Providing mobility grants. e Encouraging entrepreneurship by providing selective training andimproving access to credit for groups with the highest unemployment levels - Le., women, people living inm a l areas. Improve the targeting o f income support benefits so as to provide an effective safety net for those who cannot benefit f'ully from economic growth and increased employment opportunities, Target social transfers towards income-support by shiftingthe emphasis away from disability pensions and pre-retirement benefits to income-related family benefits and considering the possibility of having these benefits conditional on: (i) children attending secondary or tertiary education; and/or (ii) householdheads working a minimumnumber o f hours -Le., 16hours a week. Increasethe capacity for poverty monitoringby: (i) providing public access to HBSindividualrecord; (ii) improving the HBSquestionnaire to allow more accurate aggregate consumption figures to be calculate; and (iii) expandthe panel component o fthe survey. xvi 1. INTRODUCTION 1.1 Poland is the largest o f the countries set to enter the EUinMay 2004. It is also a country with profound regional inequalities closely linked to historical divisions and the reshaping of its borders in 1945. It accounts for over 50 percent o f the cumulative population o f the ten acceding countriesgand also for about 50 percent o f their cumulative GDP. 1.2 Poland was an early comer inthe process of economic transformation that swept through Central and Eastern Europe in the 1990s and a strong reformer. A "shock-therapy" program implemented during the early 1990s enabled the country to quickly transform its economy into one of the most dynamic and robust in Central and Eastern Europe. However, there was concern that the economic upheaval associatedwith these reforms could result in a substantial increase in find evidence of rising inequality - at least inthe initial years of transition - and concluded that inequality in living standards and a considerable increaseinpoverty. Infact, early studies did not the wide use o f social transfers played a crucial role in alleviating inter-group conflicts as well as mitigating the potential increase in inequalities (IMF, 2000; OECD, 1997, World Bank, 1999). Indeedsome claimed that it was the substantial redistributive role played by the benefits system that enhanced Poland's growth during early transition by fostering socio-political stability at a time of dramatic economic reforms (IMF, 2000). Others, however, warned that the high level o f social transfers would, in the long term, limit the country's growth potential and, indirectly, increase poverty. 1.3 As Poland becomes a member o f the EU, it faces increasing pressure to reduce fiscal imbalances while also working towards reducing social exclusion and welfare inequalities via increasing employment opportunities, as set out by the Lisbon strategy which is detailed in Box 1.1. Combining these two objective may prove to be a serious challenge for Polish policy makers. This report is designed to help addressthis challenge. A. THEOBJECTIVESAND SCOPEOFTHE REPORT 1.4 This report buildson the wealth of existingliteratureon livingstandardsand inequality in Poland and is intended to continue the ongoing debate. The focus is on lack o f access to economic opportunities as the most important dimension o f poverty in Poland and one that is strongly associated with social exclusion, vulnerability and other dimensions of poverty. The findingso fthe report are basedon a variety o f data sources. Inadditionto publicly available data from aggregate and sectoral sources, it relies heavily upon several primary sources of micro- economic data such as surveys o f households and individuals. In particular the Household BudgetSurveys (HBS) andthe Labor Force Survey are extensivelyused. The CzechRepublic,Cyprus, Estonia, Hungary, Latvia, Lithuania,Malta, Slovak Republic, Slovenia, andPoland. 1 Box 1.1: The LisbonStrategy In March 2000, the European Council in Lisbon set out a ten-year strategy to make the EU "the world`s most dynamic and competitive economy". The leading principle of the Lisbon Strategy is that a stronger economy will drive job creation alongside social and environmental policies that ensure susta~nable development andsocial inclusion. * Objectives inthe area of social inclusion: Annual increase inper capita investmentinhumanresources Halvingthe number of 18to 24 year olds with lower-secondarylevel education Reducingproportion ofthe population-now 18%or 60 million people - atriskofpoverty (without socialtransfersthis rate would havebeen26%) Stimulating the take-up of lifelong learning Strengtheningequal opportunities for the disabled Promoting gender equality, a goodworking environment and involvement of socialpartnersin managingchange Promoting corporate social responsibility Adapting pensionandhealthcarei long-term care systems to an ageingpopulation with the twin objectives ofensuringquality and financial sustainability Objectives in the area of employment: Raisingthe employment rate from 61%to 70% by 2010 Reducingby 2010the average level of unemploymentinthe EUto the levels already achievedby the bestperforming countries(around4%) Increasingthe number of women inemployment from 51%to over 60% Increasingthe employment ratefor older workers (55-64) in2010 to 50% Raisingby 2010 the retirementage by five years Raisingthe availability of childcare by 2010 for 90% ofchildren (3 years t)and 33% of children under 3 Removingbarriersto mobility betweenandwithin Member States (e.g. recognition of qualifications, pensionportability, better provision of information, etc.) Improvingquality at work, inparticular the working environment and health and safety Progresstowards Lisbongoals in the areas of employment and social cohesion (Europe15 averages) Lisbon Barcelona (2002) EU2010Target (2000) Employment a. Overall (% active population) 63.2 63.9 70 b. Women 52.8 54.7 60 e. Older workers (55-64) 37.2 38.3 50 SocialCohesion a. Riskofpoverty (after social 18 18 transfers) Communicationfrom the Commission to the Spring EuropeanCouncil inBarcelona, The LisbonStrategy- Making ChangeHappen. Brussels, 15.1.2002.COM(2002)14. 2 1.5 The report's main objectives are to: (i) describe what happenedto Polish living standards after the "shock therapy" o f the early 1990s and in the less prosperous last five years; (ii) highlightthe main factors behind the recent increase in poverty and inequality; (iii)identify the main risk factors associated with social exclusion and "transient" and "permanent" poverty in pre-accession Poland; (iv) address the growth of a hard-core of chronic poverty; and (v) point to policy measures that may help Poland to move closer to the Lisbon targets for employment and social inclusion. B. THESTRUCTUREOFTHEREPORT 1.6 This report consists of two volumes. Volume 1 presents the main findings and their policy implications. It begins with a general overview o f the macroeconomic climate and its changes over the transition period. It then moves on to address the links between economic growth and poverty reduction inthe high growth years (when poverty declined considerably) and in the following slow-down in growth (during which poverty increased). A description of the poverty profile and its changes over the last decade follows and leads to an analysis of the strong link between skills levels, employment opportunities and social inclusion as a way of avoiding poverty. Particular attention i s paid to the growing divide between the chronically poor and the rest o f the population. The role o f social transfers as an important safety net for the most vulnerable (but also a potential barrier to effective long-term poverty reduction) i s then discussed, along with the role currently played by civil society and informal networks as non-governmental safety nets. Finally some options are presentedon policies that may help to bringWarsaw closer to Lisbon-Le., to the EUtargets for employment, social inclusion and reductionininequalities. 1.7 A collection of 14 background papers provide more detailed analysis of the issues discussed in this report. The chapters are organized into four parts which are designed to bring together chapters with similar focus. The main findings o f the chapters are summarized in a matrix presented as an Appendix to this report. Given their number and the volume of information, the backgroundpapers will be made available only upon request. 3 2. THE ECONOMIC BACKGROUND 2.1 The first post- communist government elected in early 1989 inherited: (i)an economy that lagged behind that of Western Europe despite intense industrialization programs and many modernization-oriented ventures; (ii) the challenge of high inflation rates, unsustainable fiscal deficits; and (iii)an educational system dominated by basic vocational education designed to satisfy the demand for semi-skilled manual labor resultingfrom the industrialization process. 2.2 The fifteen years that followed saw a major transformation of the economy and massive improvements in many macroeconomic indicators but much remains to be done. The milestones o f the economic transition o f Polandcan be grouped into three distinct periods: (i) the years ofthe "big bang" 1989-93; (ii)the high growth rate years 1994-98; (iii) years of economic slow- the down, 1999-2002.`' A. THE"BIG BANG" 2.3 With the adoption o f the "Balcerowicz Plan" in January 1990, the new Mazowiecki government chose a path of deep structural reforms designed to quickly turn Poland into a free market economy where the private sector would flourish and government intervention would be limited. In 1990 the government implemented a comprehensive reform program - the Government Program for the Reconstruction of the Economic System. The program soon became known as the "Polish model of transition'' and was characterized by the so-called "shock therapy" approach to economic reform. Polish policymakerstook huge risks by makingthe zloty convertible, fixing the exchange rate, and lowering import barriers. 2.4 With privatization lagging behind, many predicted a crisis based on the notion that enterprises would not be able to cope with market conditions, which would lead to politically unacceptable mass bankruptcy and social upheaval. This did not happen. On the contrary, Polandturned out to be unique among the large early reforming European transition countries in having an unbroken record o f growth once expansion resumed after the initial output collapse. By 1993, inflation had been significantly reduced andthe budget deficit had been brought down. Stabilizationhad achieved its objectives of loweringthe fiscal deficit and inflation and settingthe stage for economic growth. 2.5 However these results hadbeen achieved at the expense of a significant contractionof the economy, a sharp reduction in employment and a significant fall in real wages brought about by pricelexchange rate liberalization. The drop in employment was particularly severe inrural areas where collective farms cpllapsed and employment in mining and industry dropped dramatically. The key to maintaining socio-political stability and support for reform inthis context was the use of an extensive social safety net program designed to contain the adverse impact o f stabilization on the poor. ''The macroeconomic developmentso fthe past decade are described inmoredetail inchapter 2 of Background Papers. 4 B. THEHIGH GROWTHYEARS 2.6 Between 1994 and 1998 the Polish economy grew at an annual average rate of above 6 percent. Many factors can account for this growth record, including consistent economic policies despite frequent changes of government. At its core, this meant maintaining a combination of hard budget constraints for enterprises, a competitive real exchange rate, and a post-privatization governance structure that allowed business to flourish. Indeed, the primary engine of growth was the private small and medium enterprise manufacturingsector. There were significant inflows o f foreign direct investment and employment continued to increase until 1997. 2.7 Inthe meantime the relative prices of food declined substantially. In addition, as a way o f maintaining socio-economic stability, the government retained the overly generous social transfer network of the pre-transition era; a systemthat guaranteedeasy access to social safety net programs to redundant workers and those most affected bythe transformationprocess. 2.8 The combined effect o f these trends was a continuous reduction in poverty from 18 percent in 1994 to 14.8 percent in 1998 usingour methodology." At the same time, inequality in consumption and income increased only slightly with the Gini coefficients for consumption increasing from 0.25 in 1994 to 0.26 in 1998. However, by the middle o f the 1990s the large volume of social transfers that continued to be paid and the slowdown in economic transformation generated increasing concerns about the long-term sustainability o f the "Polish model o f transition". C. THEECONOMICSLOWDOWN 2.9 The loss of export markets in the East as a consequence o f the Russian financial crisis triggered a new round o f enterprise restructuring to curtail falling profitability. This time, the resulting improvements inproductivity were brought about inlarge part by reducingemployment. This reduction, together with the increased numbers of newcomers to the labor market owing to the baby boom o f the early 1980s, led to significant increases in unemployment. As o f April 2003, over 3.2 million people were unemployed(18.4 percent o fthe labor force). 2.10 These developments coincided with a shift in monetary policy in 1999 following the creation of an independent Monetary Policy Council (MPC). Inflationtargeting became the main anchor of monetary policy. When inflation rebounded into double digits during 1999 and 2000, the MPC progressively tightened monetary policy by raising its rediscount rate to a peak o f 21.5 percent inAugust 2000. As a result, and incombination with possible over-investment duringthe high growth years of 199411998, domestic demand, and in particular investment, declined significantly startinginthe second half o f 2000 and employment continuedto fall. 2.11 A strong rebound inexport growth during2000 initially contributed to maintainingGDP growth for that year at an acceptable level o f 4 percent, as shown inTable 2.1. However, owing to the global slowdown in 2001, Poland could not sustain export growth sufficiently to keep overall economic expansion at a highlevel. Growthrate has averaged only 1percent in2001 and 1.4 percent in2002 and employment plummeted (See Table 2.1). This was reflected ina decline in average consumption overall and a shift in the consumption distribution away from the poor. The latter mainly reflected increased inequality in labor income, driven at first by raising skill premium andthen by a reductiono f employment opportunities for the unskilled. ' IThe comparablefigures usingGUSmethodologyare 20 percentin 1994 and 15.2 percent in2001. 5 Table 2.1: MainMacroeconomic Indicators 1997 1998 1999 2000 2001 2002 2003 GDP growth, % yly 6.8 4.8 4.1 4.0 1.0 1.3 3.7 Private consumptiongrowth, % yly 5.2 2.7 2.0 3.3 3.0 Gross fixed investment growth, %yly 21.7 14.2 6.8 2.7 -9.8 -7.2 1.0 Unemploymentrate, e.o.p., % 10.3 10.4 13.1 15.1 17.4 18.1 17.7 Poverty headcount, % o f population 14.7 13.1 14.3 14.8 15.6 16.6 .. General govt. expenditures, % ofGDP 43.5 41.9 42.7 41.1 43.9 44.5 46.9 General govt. budget balance, % o f GDP -2.8 -2.4 -3.1 -3.0 -5.1 -6.0 -6.3 Consumer price inflation, % yly 13.2 8.6 7.3 10.1 5.5 1.9 0.9 NBP refinancing rate, % 28.0 21.0 21.5 24.0 16.5 9.75 6.0 Current account deficit, % o f GDP -2.9 -4.2 -7.2 -6.1 -3.9 -3.5 -3.0 Externaldebt, % o f GDP 35.5 36.0 42.4 40.3 38.1 40.7 .. Source: GUS, e.0.p -end o fperiod, 2003 -forecast or latest available. 2.12 As economic growth declined, inequality continues to increase, led bythe increase inthe dispersion of labor income associatedwith the sharp drop inemployment. Low growth and rising inequality combined to produce the continuous increase in poverty experienced since 1999. UsingGUS definition o f consumption, poverty incidence increased from 14.3 percent in 1999 to 16.6 percent in2002. At the same time the Gini coefficient for aggregate consumption increased by a full percentage point from 0.26 to 0.27. The factors underlying the increase in inequality resulted inpoverty becoming increasingly a `chronic' phenomenon associatedwith lack of skills, long-term unemployment and residence in small towns, especially indisadvantaged regions. The transformation of the economy has emphasized old territorial divisions and created new ones, reflecting the decline o f agricultural production and especially the collapse o f collective (state) farms. To some extent the problems o f poverty and low growth spread from the eastern part of the country to the northernandnorthwestern regions. 2.13 At the same time public expenditure on social benefits begun to place a growing burden on public finance, leading to a widening fiscal deficit since the turn of the century. By 2001, a substantial share o f net government borrowing was financing government recurrent expenditures. This trend continued in 2002 and the budget for 2003 shows little sign o f improvement (See Table 2.1). 2.14 Given Poland's already relatively high level of taxation, the emphasis for fiscal stability is on reducing public spending. In2001,44.4 percent o f this expenditure went to "social security and welfare." Thus the focus is on reducing the extensive use o f safety nets. The challenge is to achieve this objective while avoiding the potential deterioration o f the living standards of those who have been left behindby the process o f economic transformation and are not likely to benefit immediately from a restoration of economic growth. Thus, what is required is a considerable improvement of the targeting o f social transfers so that limited resources can be channeled to the most vulnerable. D. EUACCESSIONANDTHECHALLENGEFORTHEFUTURE 2.15 Poland is set to join the EU inMay 2004. This provides a great opportunity for moving back onto the pattern o f high employment growth that prevailed at the beginning o f the 1990s. However, the challenges are considerable as Poland will need to move considerably closer to other EUcountries with respect to a number o f indicators, as highlighted inBox 1.1. 6 2.16 Table 2.1 above shows the prospects for growth in2003 to be good. Growth for 2003 was estimated at 3.7 and in 2004 is projected to be at around 4.3 percent, indicating a budding recovery and reflecting continuing strong export performance, especially in exports to the EU, and a clear resurgence in industrial production. Investment appears to have grown for the first time since 2000 and over the last few years, the growth of the current account deficit appears to have declined and consumer price inflation is a record low. Assuming the growth o f inequality will remaining at the average level experienced over the last five years, this should reduce poverty by 6.4 percent, lowering it by 1.5 percentage points to 15.1 percent in 2004. However, government expenditure as a percentage of GDP is predicted to continue to rise together with the budget deficit. This is a major concern. 2.17 A returnto long-term robust growth requires a stablemacroeconomic environmentwith a balanced fiscal-monetary policy mix. To prevent the re-emergence o f economic imbalances, fiscal consolidation and the reduction o f overall deficits are needed to complement the recent monetary easing. A parallel reduction inthe size o fthe government budget would provide greater space for private sector development. Together with an additional and necessary reallocation of government expenditures from consumption to investment, these policies would significantly strengthen Poland's growth prospects. 2.18 However, the experience o f the last decade has shown that for growth to be poverty- reducing it needs to be reflected in comparable growth in employment. In the Polish case the challenge i s in reducing the high cost o f labor relative to productivity, especially for unskilled workers. These costs are kept artificially highby a nationally set bindingminimumwage and by a high tax wedge. The experience of the last five years has shown that, given the downward rigidity o f labor costs, any slow-down ingrowth results inmassive shedding o f low skilledjobs. 2.19 This is not a new phenomenon. Something very similar happened inother EUcountries inthe late 1970sand early 1980s. Spain and Portugalare particularly obvious examples. Onthe positive side, the experience o f these countries has suggested that, while in the short-run labor sheddinghas massive adverse effects on employment and poverty, it does lay the foundation for subsequent higher incomes through the large increase in productivity it generates. To date Spain and Portugal are the two EU countries with the highest continuous growth in recent years, The keyto their successhas beenputtinginplacethe rightmix of economic reforms, not simply inthe labor market but across the economy as a whole, and especially in the product market and inthe previously highlymonopolized infrastructure sector. 2.20 Onthe eve o f EUaccessionthe challenge for Poland is to follow in the footsteps o fthese more established members and continue the radical reform program begun- but not completed - inthe early 1990s. 7 3. THE GROWTH-POVERTYLINK 3.1 There seems to be wide consensus that poverty in Poland declined in the high growth period 1994-98 but then increased sharply (see Figure 3.1) even though the growth rate remained positive, albeit much lower. The key to understanding this result may lie instatistics as well as in the changes in inequality experienced duringthis period. Figure3.1: Trends in Growth and Poverty mPovertychange.-GDP growth Source: Authors' calculationbasedon HBS. A. A STATISTICAL ARTIFACT? 3.2 Firstwe should note that household consumption as captured by the Household Budget - Surveys (HBS) - seem to have performed much worse than the National Accounts Statistics (NAS) would suggest. This difference persists even when the figures for changes in aggregate private consumption are considered rather than GDP growth. This is not a phenomenon unique to Poland and may be explained by the unusually high investment accumulation experienced in Poland over the 1990s and by the relatively high export rate,I2 Reconciling these two series is beyond the scope of this report but it is important to note that the H B S shows declining values o f average per capita consumption for the period 1999 - 2002 while the NAS data show moderate positive growth (Figure 3.2). Hence the estimates o f poverty, which are based on the HBS, showed increases in poverty in these years despite the positive consumption growth rates shown bythe nationalaccounts data, Richard(2003) 8 I Figure3.2: Private ConsumptionGrowth in NAS and HBS, 1995 2001 - 9% - 8% - & 7% - 6% - 2E; 5 % - 4 % - 7 -2% 1 "94-'95 '95-'96 '96-'97 '97-'98 '98-'99 '99-'00 '00-'01 '01-'02 .Private consumption(NAS) OMean consumption per capita (HBS) Source: Authors' calculations basedon HBS. B. BUTINCREASED INEQUALITY ISALSOA FACTOR 3.3 However, this i s far from the whole story. Average consumption per .capita based on I I B S data increased immediately prior to 1998 and started to decline only after that year. Also during 1994198 poverty declined but at a much lower rate than the rate o f growth. This is not altogether surprising. As mentioned in the introduction, one would expect that the dramatic economic transformation o f the "big bang" years would have generated winners and losers affecting the living standards o f many. Figure 3.3: Inequality, 1994-2001 0.285 0.13 'C8 0.280 Q I_ ¶ $ 0.275 0.12 0.270 !?0 0.265 0.11 g3 0.260 0.255 0.10 *Q 0.250 0.245 _. VI 0,240 0.09 3 c -Gini coeff, LHS +Mean log deviation, RHS Source: Authors' calculationsbased on HBS. 3.4 Indeed, as expected, the inequality inthe distribution o f consumption also grew over the decade, as shown in Figure 3.3, with Gini coefficients increasing from 0.25 in 1994 to 0.29 in 2002 but remained in line with that in other CEE countries (see Table 3.1). Until 1998 average consumption increased in all percentiles leading to a reduction inpoverty, despite the increase in inequality. This i s evident from Figure 3.4 which shows the growth incidence curve for the period 1994-98 consistently above zero, indicating an increase in the consumption level of the 9 whole population. The resulting reduction in poverty was achieved despite the fact that the increase in consumption was higher at the top end of the distribution than at the bottom end. Thus over the period 94-98 there was weak pro-poor growth in the sense that the consumption growth rate o fthe poor was positive, although lower than for the top deciles. Table3.1: InternationalComparisonsof Consumption-Basedand Income-BasedMeasures of Inequalityfor AccessionCountries Country Consumption-basedMeasure Income-based Measure Gini Coefficient Gini Coefficient Poland* 0.29 0.32 Hungary 0.28 0.25 Latvia 0.34 0.32 Slovenia 0.28 0.25 Bulgaria 0.27 0.41 Romania** 0.29 d a Source: World Bank (2002) unless otherwise stated ***Authors'calculationsfrom 2002 HBS World Bank(2003). Figure 3.4: Growth IncidenceCurves 15% 10% 5% 0% -5% -10% -\f -15% J 0 10 20 30 40 50 60 70 80 90 100 ****~*~1994/199 -199412002- -199812002 Source: Authors' Calculationsbased on HBS. 3.5 By contrast, Figure 3.4 shows that the period 1998-2002 saw a decline in mean consumption, which affected all quintiles except the highest and was particularly severe at the lower end o f the distribution. The decline inaverage consumption and the increase in inequality combined to increasepoverty by about 2.5 percentagepoints over the period 1994-2002. 3.6 Given the relatively highsize of the elasticity and the optimistic predictions for growth in 2003 and 2004, the prospects for poverty reduction inPoland are good. Assumingthe increase in inequality to remain at the average value experienced over the last five years, this should reduce poverty by 6.4%, lowering it by 1.5 percentagepoints to 15.1% in2004 3.7 Figure 3.5 decomposes the changes in poverty experienced over the last decade into a growth component and an inequality component, It is evident that economic growth was the main driving force in poverty reduction in the first period (1994-1998). During these years the 10 growth effect (- 5 percentage points) far outweighed the effect of the increase in inequality (+1 percentage point), resulting in a cumulative decline in poverty of about 4 percentage points. During the subsequent period, 1999-2002, growth and inequality both contributed to an increase in poverty of about 3 percentage points. Over the last decade the average estimatedelasticity of poverty with respect to growth in average consumption from the Household Budget Survey (HBS) has been 3.6 with a peak of 4.1 in 1999.13 This value compares well with the estimates for other transition countries and those typically found in other countries [Bruno, Ravallion, and Squire(1998); Ravallion and Chen(1997).14 I Figure3.5: Decompositionof Changes in Po~efty,1994-2001 -.- 3% fig 2% 1% 0% $ -1% ;;;-2% g g -3% -4% -5% -6% 199411998 199812002 1994l2002 mtotal povertychange mdueto growth ndueto inequality c. WHAT I SBEHINDTHEINCREASE ININEQUALITY? 3.8 Changes in inequalities of consumptioncan be the result of a number of factors of which four important ones are changes in (i) the distribution of original income; (ii) progressivity of the the tax andbenefit system; (iii)the distribution of consumptionand (iv) the realtive prices of the basket of goods bought by householdat differentpoints inthe income distribution. 3.9 Unfortunately the Polish HBS has very limited information on household savings. Thus the analysisbelow focuses onthe other factors highlightedabove. Changesinthe distributionof originalincomeand its components. 3.10 Original income refers to the incomethe householdhas before payingtaxes andreceiving benefits other than old-age pensions. As showns in Table 3.2, over the period 1994-2002 inequality in original income increased by around 7 percent from 0.38 in 1994 to 0.41 in 2001. The increase was also surprisingly moderateconsideringthe extent of transformation the country ''These estimatesare inline with the value of 3.5 given in World Bank (2002). 14 Just to give few examples, the growth elasticity of poverty for Rumaniawas estimatedat 3 in 1996and 1997but has declinedsinceto below2 (World Bank, 2003). An average elasticityof 3.7 was also estimatedfor Croatia(World Bank (2002).Howeverthe limited information availablesuggestsmuchlower responsiveness inother countries. Estimates o f around2 were derivedfor Russia(World Bank, 2002) and less than 1for Armenia, Azerbaijanand the Kyrgyz Republic(World Bank 2003). 11 went through. It was particularly so considering that it occurred entirely after 1998 with inequality inoriginal income fluctuating around a stablevalue inthe highgrowth years 1994-98. 3.11 Table 3.2 also shows the main sources of inequality and the main factors behind the increase. Inequalities in labor income were and remain, a major source o f inequality in orginal income. In addition their relative role inthe overall inequality has increased over time until2001 (from 70.5 percent tpo 72.3 percent) only to decline slightly in2002. The combination of incresed inequality and the growing share o f this inequality that is due to labor income dispersion resulted in a increase in the Gini coefficient for this component of income of 8 percent, higher than for overall income and for any other component. Table 2.7: IncomeInequalityand Decompositionby IncomeSources, 1994-2002 GiniCoefficients: 1994 1995 1996 1997 1998 1999 2000 2001 2002 OriginalIncome* 0.379 0.377 0.386 0.395 0.3657 0.377 0.395 0.395 0.407 ofwhich: Labor income 70.5% 68.9% 70.8% 71.6% 72.1% 73.7% 74.1% 72.3% 69.9% Old age pension 15.1% 16.5% 15.9% 16.0% 16.4% 16.4% 15.3% 17.8% 18.8% Incomefromfarm 10.1% 11.6% 9.3% 8.9% 7.6% 6.4% 6.2% 5.7% 6.6% Other income 4.3"/. 3.0% 4.1% 3.5% 3.9% 3.5% 4.4% 4.3% 4.7% DisposableIncome** 0.308 0.304 0.312 0.323 0.293 0.298 0.311 0.308 0.317 Coefficients***: Concentration Labor Income 0.389 0.382 0.396 0.402 0.377 0.398 0.420 0.414 0.421 Old age pension 0.394 0.408 0.404 0.410 0.380 0.385 0.372 0.407 0.423 Incomefrom farm 0.332 0.358 0,326 0,371 0.290 0.273 0.292 0.287 0.338 Other income 0.307 0.254 0.320 0.289 0.293 0.265 0.304 0.280 0.295 Method decompositionof the Gini coefficientinto components, rankingby original income, see Chapter 2 inVolume 2 for mathematicalrepresentation *** Beforetaxes and benefits. *** After taxesandbenefits Householdrankedby original income. Source: Authors' calculationsbasedon HBS. 3.12 Overall, the last decade has seen a marked increase inthe number o f households with no earnings (from 10 percent o f household to 12 percent, an increase o f 20 percent). The economic restructuring of the early 1990s led to massive job destruction. In the mid-1990s the sharp expansion of output (25 percent) also led to a rise in total numbers employed (Figure 3.6) amounting to employment creation of 6.3 percent. However, the newly created jobs often required skills different from those of laid-off workers and were often based in different locations. Since 1998, firms have managedto maintain their productivity only via further lay-offs (8.5 percent cumulatively) but without compensatory employment generation. This has lead to large pockets o f unemployment that tend to be geographically concentrated and affect predominantly individuals with low levels of education. Thus, skill differentials across households accounted for nearly 20 percent o f inequality in 2001 (see Table 3.3) while regional inequalities accounted for nearly 12percent. 12 Figure3.6: Trends in Employment and Poverty m 16.0 6.5 -8 Q 15.5 6.08 L 15.0 n w6 14.5 5.5g 2 14.0 5.0 `94 `95 `96 `97 `98 `99 '00 `01 `02 -0-No.ofEmployed(LHS,inn) -Q-No.ofpoor(RHS,mn) Source: Authors' calculationbasedon HBS. Table 3.3: Decomposition of Theil Inequality Index (Inter-Group Inequality), 1994-2001 1994 1995 1996 1997 1998 1999 2000 2001 Theil index 0,100 0.095 0.097 0.107 0.110 0,114 0.120 0.120 Decomposition Regional Within groups 0.092 0.087 0.089 0.097 0.097 0.100 0.104 0.106 Betweengroups 0.008 0.008 0.008 0.010 0.013 0.014 0.016 0.014 Share of between groups 7.9% 8.3% 8.1% 9.4% 11.5% 12.5% 13.0% 11.6% Education Within groups 0.087 0.083 0.084 0.092 0.093 0.095 0.097 0.097 Betweengroups 0.013 0.012 0.130 0.015 0.017 0.020 0.023 0.023 Shareof between groups 13.0% 12.9% 13.4% 13.8% 15.9% 16.5% 19.5% 19.1% Age Within groups 0.098 0.093 0.095 0.105 0.107 0.111 0.118 0.118 Betweengroups 0.002 0.002 0.002 0.002 0.003 0.003 0.002 0.002 Share o f between groups 1.7% 2.2% 2.2% 2.0% 2.5% 2.4% 1.5% 1.7% Source: Authors' calculationsbasedon HBS. 3.13 The increase in inequality in labor income was high enough to offset the equalizing effects of: (i)a shift o f the tax system from regressivity to very mild progressivity; (ii) a benefit system that increasingly benefits the poor; (iii)a considerable reduction in the relative price of food which should have increased the relative welfare of the poor; and (iv) the decline of nominal and real interest rates, which - combined with increased access to credit could have increased - poor people's ability to smooth consumption. 13 4. THE PROFILE OFPOVERTYOVER THE LAST DECADE A. THEMETHODOLOGY USED 4.1 The methodology used to derive the poverty profile inthis report differs from the earlier literature in a number of ways. Firstly, all aggregates have been expressed in real terms (inJune prices of a given year), and equalized with the use of local equivalence scales which are fixed in the social benefit system, and are close to the OECD scale,'5 However the main differences are in:(i) consumption aggregates; and(ii) prices used. the the Moving Closerto the Concept of ConsumptionFlow 4.2 Most poverty studies in Poland have used the "consumption aggregates" calculated by Government Statistical Office (GUS) and recorded in the H B S dataset. However, owing to the limitations of the HBS data - as described in Box 4.1 - these aggregates: (i)include the full value o f durables acquired during the relevant period but exclude the value of previously acquired durables available to the household; and (ii)include rents paid but exclude the value o f housing if the household i s owner-occupied. They are therefore closer to a concept of total expenditure than to the consumptionaggregates on which World Bank poverty analysis is generally based.16 4.3 This report adopts a proxy of welfare that is closer to the concept ofJow of household consu~ptionthat occurred during the relevant period. In addition to the consumption o f non- durables and services - including auto consumption-this definition should include the imputed value of the durables available to the household and the imputedvalue o f housing. However, the limitation o f the current version of the H B S makes the imputation o f these values rather complex and in some cases ad hoc. Thus as far as possible for 2001 we report on two poverty diagnostics -onethatincludestheimputationsfordurablesandhousingandonethatisnetoftheexpenditure on these items incurred over the period. For technical reasons, the imputations have been done for 2001 and consumption net o f durables and rent has been usedfor past periods. 4.4 The consumption aggregates derived from the second definition clearly generate average consumption figures that are consistently lower that those derived from GUS. In addition the spread of the distribution of consumption is likely to be smaller, becausethe consumption levels of the better off are likely to be affected most by the omission o f durables. Using the first definition, on the other hand, does not have any apriori effects on average consumption and the IsPer capita estimateshave also been usedto facilitate internationalcomparisons. l6Occasionally an income approach has been used in other studies, and in some cases a multidimensional analysis o f poverty has beenconducted See for instanceGUS (various years), GUS (ZOOO), Panek(2001), Panek (1996). 14 direction o f the change in the spread of the distribution is not clear-cut. The poverty lines have been adjusted to reflect the relevant definition of the consumption aggregate.I7 Box 4.1: The Polish Household Budget Survey e The survey is conductedregularly bythe CentralStatisticalOffice (GUS). e Since 1993, the annual HBS sample has included over 30,000 households, or about 100,000 individuals. e This is large enough to provide various profiles which reflect social, regional or demographic characteristics of individuals. It also allows for making multi-layer classifications ofhouseholds e Eachhouseholdis surveyedduring a single month. e The survey provides data on householdincome (from various sources), expenditures(over 200 items), type of residence, housing conditions, durables, land area (if any), etc. Fairly detailed information is also given for each householdmember: age, sex education, relation to the household head, and individual source of income (for working persons: type of employment, sector and branchof the economy; for social beneficiaries: benefit type and its level; for the unemployed:also unemploymentduration). e Ithas apanel component with households interviewed for a total periodof four years. This will provide a unique opportunity to distinguish permanentversus temporary poverty and to identify the characteristics ofthe "permanently poor". Shortcoming of the survey: e Monthly rotation of households produces three problems: seasonality, inflation, and coverage of infrequent expenditures. e Data on durables do not permit comparison of accurate consumption aggregates, as they provide only information on whether the householdhas a particular type of durable, and how many items-without information ontheir quality, age and original and current value, e Informationon usage value of housing is absent unless the house is rented. This could lead to a very distorted picture ofconsumption. e The panel covers a period that is too short to allow adequate analysis of the characteristics and profile of chronic poverty, a phenomenonthat is becoming increasingly important in post-transition Poland. UsingRegionalPrices 4.5 Previous poverty analyses in Poland have used national average prices in poverty diagnostics and the CPI deflator when comparing poverty over time, Given high and growing disparities between regions, differences inprices are likely to partly compensate for differences in nominal income levels; poorer regions have lower prices and the difference has increased over time. The H B S shows moderate price variation across voivodships (+/-3.5 percent) and a more significant variation along urbdrural and largelsmall-town dimensions (with prices inrural areas being 4 percent lower than the national average and those inmetropolitanareas 9 percent higher). l7Itis important to note that although the diagnosticsof this report focus on the revised consumptionaggregates, the GUS methodology is also usedfor comparability purposes. As expected, the flow of consumptionaggregate revealsa considerably lower level of inequality thanthe total expenditure method(2001 Gini coefficientsare equal to 0.283 and 0.344, respectively). It also shows smaller rural-urbanandregionaldifferences. 15 The overall variation in prices ranges is from -5 percent to +11 percent, with the level o f prices negatively correlated with regional poverty rates. Using region-specific prices is essential to derive an accurate profile o f poverty. Thus consumption aggregates have been deflated with regional price deflators reflecting individuals' place o f residence, such as locality type and voivodship. Usinga "Poor Price Index" 4.6 In addition, from 1997198 onwards food price and overall inflation started to diverge considerably. This increased the relative purchasing power of the poor, whose share of food in consumption is relatively high." Data from the HBS shows that between 1998 and 2002 the relative purchasing power o f the poor improved by 5.5 percent. 4.7 Thus, using a CPI deflator when comparing poverty over time may give misleading poverty trends, since the CPI basket is closely aligned with the consumption basket o f an average household, which has a lower share of food items than that o f the poor. We therefore compare the patterns emerging from the use of the CPI deflator with those resulting from using a "Poor Price Index", which uses the typical consumption basket o f a poor household. Poverty Lines and Poverty Indicators 4.8 Two country specific poverty lines have been used: the social assistance threshold (equivalent to PPP $6.33 per day) for "moderate" poverty, and a subsistence minimum basket (PPP $5.50 per day) for "deep" poverty. Additionally, an international poverty line o f PPP $4.30 a day has been used for international comparison, although in the Polish context this represents "extreme" poverty. 4.9 Contrary to the majority o f other studies, the poverty lines have been set for 2001, and kept constant inreal terms with the use of annual CPIs for the whole period under investigation. Also, the lines have been adjusted to adequately account for the alternative definition o f welfare aggregatesused. 4.10 The poverty indicators used are the headcount, depth and gap indices, and logit functions havebeen estimated to identify the impact of various factors on poverty. B. THE EXTENTOFPOVERTYINPOLANDANDITSTRENDSOVERTIME 4.1 1 Usingour methodology -basedonconsumption flows and regionalprices -in2001 over 14 percent of the total population, or more than 10 percent o f households, lived in "moderate" poverty in Poland - Le., below PPP $6.33 a day. This means that poverty affected over 5.5 million people. The extent of deep poverty - PPP $5.50 a day - was also quite considerable, reaching 8.6 percent or about 3.5 million people, and extreme poverty was also significant (headcount index H= 3.2 percent). At the same time, poverty depth was moderate. The poverty gap for moderate poverty has been estimated at around 0.5 percent of GDP (a poverty gap index of less than 20 percent), while the gap for deep poverty was 0.25 percent o f GDP (gap index o f 18 percent). These indicators are similar to those published by the Central Statistical Office (which are derived from the total expenditure concept), although ours are slightly higher, due to the different definition o f living standards. Accordingto the HBSdata, the first 15 percentiles ofthe populationdevote about two-thirds oftheir budgetsto food, while for the wholepopulationthis proportionis less than 50 percent. 16 4.12 The main trends in headcount poverty over the period 1994-2001are presented in Table 4.1 where "GUS" indicates that the calculations are based on the consumption aggregates as computed by GUS. "GUS regional" refers to the same consumption aggregates but allows for regional differences in prices, and the W3 indicator excludes expenditure on durables and rents, The patterns that emerge are clear and robust to different definitions. Both moderate and deep poverty headcounts declined sharply between 1994 and 1998 and increased consistently after that date. The poverty decline in the middle o f the decade was more pronounced than the poverty increase that came later. In 1994-98, the GUS moderate poverty headcount dropped by 7 percentage points, from 20 percent to 13 percent, while the rise in 1998 - 2001 was equal to 2.3 percentage points. According to our methodology, the decline was less sharp, from 18 percent in 1994to 12.6 percent in 1998, and so was the increasethereafter. Table 4.1: Povertyin 1994 2001: An Overview - Headcounts(%] L S concept 1994 1995 1996 1997 1998 1999 2000 2001 Moderatepoverty GUS 20.0 18.3 16.1 15.0 12.9 14.9 15.1 15.2 GUS (regional) 19.2 17.3 15.3 14.2 12.0 14.0 14.3 14.2 WB (regional) 18.0 16.9 14.6 13.6 12.6 13.5 14.5 14.8 Deep poverty GUS 12.4 10.8 9.5 9.1 7.7 8.9 9.2 9.6 GUS (regional) 11.7 10.2 8.8 8.3 7.0 8.1 8.6 9.0 WB (regional) 10.5 9.6 8.2 8.0 6.8 7.7 8.6 8.9 Note; For methodology see Section 1andMethodologicalAppendix.. - Source: HBS 2001, own computation.See also Table A16. 4.13 International comparisons o f poverty are always difficult for a number o f reasons, including the definition of the poverty line and of the consumption aggregates. However, using the international poverty line o f PPP $4.30 a day, and using World Bank estimates, Table 4.2 shows that poverty in Poland is higher than in the Czech Republic, Slovakia and Slovenia, and close to most of Hungary but well below the levels prevailing inother accession countries. Table 4.2: Absolute PovertyRatesof SelectedAccessionCountries,SelectedYears, 1995-99 Country Survey Year HeadcountIndex $4.301day Poland" 2002 3.8 Romania 1998 44.5 Latvia 1998 34.8 Bulgaria 1995 18.2 Lithuania 1999 22.5 Slovak Republic 1997 8.6 Estonia 1998 19.3 Hungary 1997 15.4 Czech Republic 1996 ` 0.8 Slovenia 1997198 0.7 Source: World Bank (2002) unless otherwise stated. * Authors' calculations from HBS. 17 4.14 The Polish literature shows a general consensus on the main correlates of poverty and these conclusions appear to be robust to changes inthe poverty line, the equivalence scale and the methodology used. The mainfindings are summarized inBox 4.2. c. WHOARE THEPOORINPRE-ACCESSIONPOLAND? 4.15 The Polish literature shows a general consensus on the main correlates of poverty and these conclusions appear to be robust to changes in the poverty line, the equivalence scale and the methodology used. The mainfindings are summarized inBox 4.2. I Box 4.2: Findingsof Existing Literature Poverty is predominantly rural and is linkedto unemployment, low education and number o fchildren. ~ However, it includes some features worth noting: o the rural-urban differential is substantial; o children, and especially rural children, are at particularly highrisko f poverty; o the linkwith unemployment is more pronounced for the urbanpoor, while rural poverty seems more tied to the low labor market productivity of the "working poor". o regional disparities are particularly large; o poverty is not very deep, but it appears to affect a hard core o f `chronically poor'; o social safety nets are complex and seem to be poorly targeted; o poverty is often associated with social exclusion andrisky behavior, such as alcoholism. 4.16 Using the new methodology changes the profile of poverty somewhat. Similarities and differences in core diagnostics between the findings of this report and previous studies are highlighted in Box 4.3. Box 4.3: Main Poverty Diagnostics In accordancewithpreviousfindings we findthat: Large geographical variations exist in the incidence of poverty; the north, northwest and southeast had higher poverty rates than the rest o f the country. Rural poverty dominated, but this appears to be the result o f extremely high poverty among former PGR (state farm) workers rather that private farmers. 4 Unemployment is the most important single cause o fpoverty. Lack o f education and a large number o f children or dependents inthe family are additional important factors. Poverty risk decreases with age despite some evidence o f recent increases in poverty among the elderly. No significant difference exists in poverty risk between female-headed and male-headed households. However, using the WorldBank standard methodology: The differences between rural and urban areas, as well as between the regions, are less pronounced; The higher poverty risko f farmers inconsiderably reduced. 18 4.17 The findings suggest that poverty in2001varied significantly across regions as shown in map below. As shown in Map 4.1, the North, South-West and South-East - namely the Warminsko-mazurskie, Pomorskie, Zachodnio-pomorskie, DolnoSlqskie and Lubelskie voivodships -had higher poverty rates than the center of the country (the beltwhich begins inthe North-East and ends at the South). Map 4.1: Moderate Poverty 2001(WBO) Povertyrate [%I WBO 18 98 20 28 16 65 18 98 15 23--- - 16 23 65 [? 1066 - 13 83 13 83 15 Source: HBS2001, owncomputation. 4.18 In 2001 rural poverty was significantly higher than urban poverty independently of the welfare measure used as evident from Table 4.3. However, the difference in poverty incidence declines considerably if regional prices are used with the relative incidence declining from 2.4 times to 2.1. The gap diminishes further when the consumption aggregates are calculated according to the World Bank methodology, with the relative incidence dropping to 1.7. Moreover, indirect statistical evidence shows that this result i s driven by the very high incidence of poverty among former PGR (state farm) workers. Finally Fig 4.1 shows that among urban areas, there is also a strong pattern associated with town size, with the smaller towns having higher poverty rates. 19 Table 4.3: PovertyinRuraland UrbanAreas Place of Headcounts [%I inpoverty p!?jPopulation residence GUS GUS(reg;) WB GUS GUS(red WB ModeratePoverty Urban 9.9 10.0 11.6 39. 42.3 47.1 Rural 23.2 20.7 19.8 60.9 57.7 52.9 ruralhrban 2.4 2.1 1.7 DeepPoverty Urban 5.9 6.1 6.7 37.3 40.6 45.6 Rural 15.2 13.5 12.1 62.7 59.4 54.4 ruralhrban Note: For methodology see MethodologicalAnnex in(reg) uses regionalpricesand WB -2.6 2.2 1.8 refer to the World Bank consumption aggregateswithout imputations. Source: HBS2001, own computation. See also Tables A5 andA15. Figure 4.1: Moderate Poverty by Place of Residence, Poland 2001 Rural 20000- 20-1OOwO 100-200 200-500 500000+ 000 000 Placeof residence 1 CSO CSO rea ClWB2 1 Source: Authors' calculations based on HBS. 4.19 The strongest correlate o fpoverty is the employment status o fthe household headandthe other adults inthe household. The average poverty risk for households headedby an unemployed person i s 48 percent while the risk for those headedby an employed individual is only 12 percent. Another important correlate of poverty is low educational attainment and the presence o f a large number of children or dependents inthe family (four or more). Poverty risk decreases with age although there is some evidence o f an increase in poverty incidence among the elderly aged over 70. Ingeneral, farmers are poorer than employees in urban areas (headcounts equal to 15 percent and 13 percent, respectively), but the link between working in agriculture and poverty i s much weaker than it appeared to be in previous studies. Amongst farmers, farm size is a significant correlate o f poverty. The larger the land area, the smaller the risk o f poverty; farmers with more than 15 hectareshave lower poverty ratesthanthe national average. 4.20 Poverty headcounts for female headedhouseholds are, on average, somewhat higher than those for male headed households, but the difference is not significant once other differences in characteristics are considered. For singles, however, the situation is quite different, with 20 headcounts being significantly higher for men than for women. This i s due to much higher inequalities in living standards between male-headed households and their female-headed counterparts. In 2001 the Gini coefficient o f aggregate consumption for single men was 0.279 versus 0.223 for single women. 4.21 Usingthe consumption$ow definition o f welfare slightly changes the profile of poverty. However, the main differences are derived from the use of regional prices derived from the H B S rather than national averages. Introducing regional prices considerably reduces regional differentials in poverty incidence. More importantly it also changes the ranking of some voivodships although some remain consistently very close to the top of the list - with the highest headcounts - and others remain amongst the richest. Using the new methodology also reduces the ruraVurban differential and the poverty risk of farming households relative to others. This is shown in Table 4.4 which reports the estimates for headcount poverty and relative poverty risks for different categories of workers according to the different definitions used. The second column of the table reports the findings based on the consumption aggregates currently defined by GUS and national price figures. The third uses GUS aggregates but allows for differences in regional prices. The third is calculated using consumption aggregates net o f current expenditure on durables and imputed rents. Finally the fourth includes the imputed value of durables and rents. Table 4.4: Poverty by EmploymentCategories Socio-economic category of Deep poverty Moderate poverty household GUS GUS reg I i WBO WB2 GUS GUS regI WBO WB2 Headcount [%I WorkedEmployee 7.31 7.17 7.63 7.51 11.75 11.40 12.87 12.55 FarmWorker 12.11 10.81 9.36 9.06 20.43 17.79 16.74 15.95 Farmer 13.34 10.58 11 8.76 7.57 23.48 19.03 16.33 14.70 Self-employed 4.91 4.87 5.19 4.34 8.62 8.72 Ii:1 8.52 8.00 Retiree 5.46 4.98 i 5.13 4.79 8.68 8.10 9.10 8.26 Disable / Survivor 14.38 13.40 i 12.79 12.24 21.31 20.55 20.97 20.03 Living on SOC transf and part-time 29.69 28.96 I 27.71 28.96 41.21 40.04 ii: 40.79 40.71 TOTAL 9.60 9.01 8.86 8.60 15.17 14.24 i 14.84 14.24 Relative to TOTAL WorkerlEmployee 0.76 0.80 0.66 0.87 0.77 0.80 0.87 0.88 FarmWorker 1.26 1.20 1 1.06 1.05 1.35 1.25 1.13 1.12 Farmer 1.39 1.17 0.99 0.88 1.55 1.34 1.10 1.03 Self-employed 0.51 0.54 0.59 0.50 0.57 0.81 0.57 0.56 Retiree 0.57 0.55 0.58 0.56 0.57 0.57 Ijj1 0.61 0.58 Disable / Survivor 1.50 1.49 1.44 1.42 1.40 1.44 1.41 1.41 Living on SOCtransf and part-time 3.09 3.21 ii1i1 3.13 3.37 2.72 2.81 jj 2.75 2.86 TOTAL 1.00 1.00 ! 1.00 1.00 1.00 1.00 i 1.00 1.00 4.22 It is clear that simply allowing for regional differences inpurchasingpower considerably reduces farmers' higher relative risk o f falling into poverty. Their relative risk o f deep poverty is reduced to below the average when the more rigorous definition of consumption aggregates is adopted. By contrast, the relative poverty risk of farm workers remains well above the average. This is an important finding since it suggests that it is not working inagricultureper se that leads to poverty but rather lack of access to private land. 21 D. HASTHEPROFILEOFPOVERTYCHANGEDOVER THEDECADE? 4.23 Comparing the correlates o f poverty over the last decade suggests that the profile of poverty has remained relatively stable over time, with poverty changes determined mostly by fluctuations inthe unemployment rate (Figure 4.2 below). However, in2000-2001 the positiono f farmers improved slightly relative to other groups and the relative importance o f education in moving people out o f poverty has increasedover time (see Chapter 4 of the Background Papers for more details). Figure 4.2: Poverty and Unemployment, Poland 1994 2001 - C 2 13 n0)11 I 5 4 I I 1994 1995 1996 1997 1998 1999 2000 2001 -.h-Mediumpoveriyrates--CRegisteredunemploymentrates Source: 4.24 Finally, the analysis o f two panel sub-samples o f the H B S (1994-1996 & 1997-2000) suggests that the 1990shave seen an increase inthe incidence o f chronic, long-term poverty and a slowing down o f movement out of poverty. This trend suggests the establishment of a growing cchard-~~re7'group o f chronically poor households that are becoming increasingly excluded from the processof economic transformation andare unlikely to benefit from future economic growth. 4.25 The road to chronic poverty and social exclusion is marked by the same milestones as the road to "transient" poverty and closely follows the increase in long-term unemployment experienced in Poland. Geographical location and poor educational attainments are the main factors leadingto poverty. They are also the main barriers preventing individuals and households from moving out o f poverty becausethey adversely affect employment prospects. E. MULTI-DIMENSIONAL OFPOVERTYASPECTS 4.26 There is a very close relationship between income poverty (as measured by household consumption) and other dimensions o f poverty such as access to, and quality o f social services, with rural areas and the poorest regions getting significantly fewer resources than the rest of the country (World Bank, 2002). The similarities in the geographical patterns of some poverty indicators are illustrated by a series o f maps presented in Chapter 5 o f BackgroundPapers. Given the importance o f education for patterns of employment it is essential to report on the geographical distribution o f educational opportunities. 4.27 Various other dimensions o f poverty have been analyzed in the Polish qualitative literature. Amongst these are the ethnic and gender dimensions as well as issues associatedwith vulnerability, social exclusion and risky behavior, as discussedbelow. 22 DifferencesinEducationalAttainments 4.28 The average years of completed schooling in Poland are extremely high, exceeding the OECDaverage at all levels except pre-school, However, the differences acrossboth consumption deciles and place o f residence in enrolment in upper secondary and tertiary education are very large by international standards (World Bank, 2002). Inaddition there are systematic differences in the type of secondary education received by those enrolled, with children from poor households and rural areas concentrating disproportionately on basic and secondary vocational training while urban and better off children tend to receive "academic" education. In addition to differences in the subject matter emphasized, schools also differ substantially in the resources they receive and the quality o f education in basic skills, with quality in rural areas being extremely poor (World Bank, 2000). TheEthnicDimension 4.29 According to the Polish literature, belonging to an ethnic minority i s not a risk factor for poverty. This may result from the fact that, compared to other European states, Poland i s a very homogeneous country. It is estimated that no more than 3 percent of the total number o f the country's residents represent national minorities (which include Ukrainians, Belorussians, Lithuanians, Slovaks, Germans, and Roma). The largest national minority groups are the Ukrainians and Germans. The numbers of those groups can only be estimated (about 3 million for each Although ethnic minorities in Poland are rather small, they are relatively well organized.*O In addition the 1990s were characterized by the rapid development of special education opportunities for some national and ethnic groups at the primary and secondary school levels (UNDPICASE 1998). 4.30 Only the Roma (25,000 according to the Office for Immigration and Foreigners) do not have their own schools with their native language, and separate classes are provided only rarely. This is the result o f the assimilation policy introduced in the communist era, which has left the Polish Roma in a quite different position from their counterparts in Hungary or Slovakia. It i s also interesting to note that a high degree o f income inequality appears to exist amongst the Polish Roma, because of their tendency to live in relatively closed communities (Laskowska- Otwinowska, 2002). The GenderDimension 4.3 1 The association between gender and poverty also appears to be rather weak. Moreover, over the past decade women's participation in the new economy has grown rapidly relative to men's. Between 1985 and 1998, the number of women with their own registered company (exclusive of farming) grew five-fold, while the equivalent number for men barely doubled. In rural areas, a wide variety o f business initiatives were launched by young women, especially in crafts, agro-tourism, and processing and sale of farm produce. The share o f Poland's female self- employed is one o f the highest inEurope as described insome detail inChapter 7 o f Background Papers. The shortly to be released population census of 2002 will provide better information on the number of national *'minorities. With the exception of Ukrainians, due probably to their displacement to the northempart of Poland in connection with the "Vistula Campaign" following World War 11. 23 4.32 However, traditional gender stereotypes hamper women's participation in economic activity and impede gender equality in the area o f labor legislation and social security. Women still face a greater threat of unemployment - particularly long-term unemployment - than men. Moreover, average female wages remain significantly lower than male wages, although inrecent years this gap has been gradually narrowing, especially in the private sector and in small companies. Much o f the differential is explained by female employment being largely inthe low- paid public sector. Finally, expected retirement benefits for women and men are not equal, owing to different statutory retirement ages for women (60) and men (65), and thus differing lengths of employment history. In addition, there is increasing evidence of violence against women and children inthe family, often associatedwith the growing pool o fthe "hard-core" poor. The GrowingThreat ofAlcoholism 4.33 Violence inthe family is often linkedto growing problem o f alcohol abuse which affects around 3 to 4 million people, making this the most troublesome social problem after unemployment, especially in rural areas (Sieroslawski 1998). Children are particularly vulnerable to the effects o f adult drinking, which often leads to family breakdown and the institutionalization of children. The number of children living away from their families increased to over 10 percent duringthe transition period (Kolankiewicz 1999). F. POVERTY,VULNERABILITYAND SOCIALEXCLUSION 4.34 There is a large overlap between different dimensions o f poverty which leads to a vicious circle made up of geographical location, poor educational attainments, lack o f employment and poverty. This circle results in individuals from poor regions and rural areas acquiring lower skills, having lower employment opportunities and beingmore vulnerableto poverty. 4.35 The crucial question is whether the higher vulnerability o fthis group also results insocial exclusion. The evidence on this issue is limitedbut it seems that the increase inpoverty over the last few years has strengthened the pre-existingnetworks available to the poor as informal safety- nets. Nevertheless, these networks are clearly excluding some o f the most vulnerable people. It is also worth noting that these networks are not considered as an alternative to social transfers but as a welcomed addition to an effective system o f social benefits. InformalNetworksand SocialExclusion 4.36 Informal support networks as an important component o f social capital have become more significant at times o f rising poverty. In these networks, a special role is played by the family. In Polish society, for historical and religious reasons, the family has always been an important institution o f support. However, while until the 1980s it was adult children who financially supported their parents, today the burden has shifted onto the shoulders o f the older generation, and it is pensioners who help their children and grandchildren invarious ways. 4.37 For the most part, the poor have extensive support groups within networks o f informal social relations but "relatively small family capital, measured by the number o f influential or affluent persons". Their social contacts are above all determined by family relations (83 percent), less often by relations with friends (62 percent) and neighbors (61 percent), and least often by work contacts (23 percent), reflecting their low employment rates. Total social isolation, expressed as a complete absence o f informal social contacts, is very rare amongst the poor (6 percent) and predominatelyaffects single men. 24 4.38 However, the picture is quite different for the poor inhabitants of villages formerly established to house collective farm workers. These appear to be largely excluded from both local and wider social networks. In these areas neighbors can provide little help as they all tend to be equally poor. In addition, most former collective farm workers are not local to the regions inwhich they live andhave no immediate family close by. 4.39 For them only three formal institutionsplay an important role: 0 local government centers for social assistance, 0 schools, which offers supplementary meals for poor children, and unemployment offices that provides accessto free health services. Civil Society Organizations as Informal Safety Nets 4.40 Over recent years the number o f civil society organizations has grown fast. They are now encouragedto cooperate closely with public administration institutions and businesses, as well as with non-formal social institutions (such as the neighbors' assistancenetwork that remains strong in Poland). The sector experienced its most dynamic growth in the mid-l990s, when the membership in NGOs reached 13 percent of all Poles, only to fall to 10 percent in 2002, However it remains dominated by small organizations (with over one-third employing only 1-5 people) and in many organizations volunteers working for the poor are often simultaneously members o f the organization and beneficiaries. 4.41 Almost one-third of civil society organizations' income comes from public funds, while the rest comes from contributions and private donations that have been growing in recent years. Nevertheless a number o f the small NGOs that operate in the field o f social welfare are facing substantial financial difficulties, despite using available financial, material and organizational resources in a very effective way. Several examples exist o f organizations that have been very successful in providing non-governmental safety nets for the very poor. Reflecting Polish tradition, social aid organizations tend to be linkedto the Catholic Church. 25 5. SKILLS,EMPLOYMENTAND SOCIAL INCLUSION: AN EVERSTRONGER LINK 5.1 The poverty diagnostics presented above clearly show the important role played by employment status indeterminingthe probability of falling into poverty. Inaddition, the analysis of inequality in Chapter 2 in Background Papers shows the importance of inequalities in labor income in explaining the growth of inequality over the last decade. Thus, understanding the trends in labor income inequality and their determinants is an important factor in: (i) understanding recent trends in poverty in Poland; and (ii)formulating an effective strategy to increasethe living standards o fthe most vulnerable. A. WHAT IS BEHIND THE INCREASEININEQUALITY INHOUSEHOLD INCOME? LABOR 5.2 The increase in inequality in labor income discussed earlier does not so much stem from a widening earnings distribution as from a reduction in the employment rate o f the members of worse-off households. Wage InequalityhasnotIncreased Substantially Over Time ... 5.3 Wage inequality remained roughly steady from 1992 to 1998 and has increased only slightly since. This small increase in wage inequality at a time of increasing labor market deregulation is surprising, especially inlight of the growth o f private employment from little over a quarter of total employment in 1994 to almost 60 percent by 2002. One important reason why the increase in inequality has been contained is the fact that low-skilled employees have progressively dropped out o f the labor force. In 1994, nearly half o f employees were unskilled; this proportionhaddeclinedto under 44 percent by2002 dueto: e Considerable labor market outflows o f low-skilled workers at both ends of the age distribution including older, less-qualified workers leaving the labor force and young people delaying entry to seek higher levels o f education than previously; and e A sharp drop injob creation for unskilled workers. 5.4 Other potential explanations are: (i) relatively high level of the minimumwage which the has prevented the earnings distribution from spreading at the bottom end; and (ii) the fact that a substantial increase in the supply o f highly educated labor - in response to the initial increase in returns to education-has contained the increaseof wages at the top end o f the distribution. 5.5 The change in the skills composition o f the employed population was largely accomplished by 199819. Thus, the more recent slight rise in wage inequality is linked to the continuing effects o f labor market deregulation, no longer offset by falling participation. ...but EmploymenthasDeclined Considerably 5.6 If growing earnings inequality is not the source of the growing inequality, then a polarization of employment away from the worse-off households and in favor o f the better off must be the explanation. The dynamics of total employment in Poland over the last ten years 26 support this interpretation. These dynamics are best described by two cycles-one through 1994, and a second with a peak in 1998 (Figure 5.1). The first cycle is in line with the employment dynamics o f transition economies, and is not surprising. However, the total employment changes over the second cycle are impressive, as it is clearly visible in Figure 5.1 (left scale). Whereas Poland gained almost 1 million jobs between 1994 and 1998, it lost almost 1.5 million jobs between 1998 and 2002, a period during which unemployment increased by almost 8 percentage points. It is also important to note that - as expected - employment declined sharply inthe public sector while it increased inthe private sector. Interestinglythe rate o f decline inthe public sector was higher after 1998. At the same time the rate of increase in private employment declined sharply after that date. Figure 5.1: Trends in Privateand Public Employment overthe Last Decade (,OOOs) 15500 10000 (right scale) 9000 15000 s 5 8000 *o z 14500 4 . -.- al _. w E 7000 .- 0 t z0 3 6000 14000 5E Lu I z0 4 - 5000 4 . 13500 1). 0. 4000 13000 3000 - - 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1- total employment- w privatesector statesectcs I Source: Authors' calculationsbasedonLFS, 5.7 Table 5.1 shows that the drop - which cuts across different age groups and both genders-has further increased the pre-existing gap between Polish employment performance and that of its EU counterparts and has brought Poland further away from the Lisbon employment targets. In 1997 the total Polish employment rate was less than 2 percentage points below the EU average and well above some of its immediate competitors, such as Hungary, Ireland and Spain. By 2001the gap between Poland andthe EUaveragehad increased to over 10 percentage points and Polish employment had fallen nearly 17 percentage points below the Lisbon target o f 70 27 percent. Similar trends are evident in female employment rates, which are currently over 12 percentagepoints away from the Lisbon target of 60 percent. Table 5.1: InternationalComparisonsof Labor MarketIndicators Country Total Female Labor Cost Index* Life-long Employment EmploymentRate Learning Rate ~...._ 1997 2001 1997 2001 2002 2003** 2001 EU(15 countries) 60.7 64.1 50.8 55.0 110.4 109.1 8.4*** Euro-zone 58.6 62.1 48.0 52.3 111.3 108.9 5.5*** Greece 55.1 55.4 39.3 40.9 1.4 Spain 49.4 57.7 34.4 43.0 117.0 119.7 4.9 Ireland 57.5 65.7 45.9 54.9 120.6 Portugal 65.7 68.7 56.5 61.0 106.5 110.8 3.3 CzechRepublic 65.0 56.9 132.1 129.6 Estonia 61.0 57.4 128.7 143.0 5.2 Hungary 52.4 56.5 45.4 49.8 143.4 135.5 3.O Lithuania 57.5 56.2 104.3 112.0 3.6 Latvia 58.6 55.7 121.0 128.4 Slovenia 62.6 63.8 58.0 58.8 7.6 Slovakia 56.8 51.8 135.6 133.9 Poland Note: * Labor 58.9 53.4 51.3 47.7 117.7 121.7 4.8 costs include gross wages andsalaries, employmentcontributionsandtaxes net of subsidies connectedto employment. ** 2003 data *** refer to 31dquarter. estimatedvalue. Source: Eurostat 2003. B. WHAT ISBEHINDPOLISHRECENTJOBLESS GROWTH? 5.8 The factors behind the decline inemployment are complex. Onthe demand side they are linkedto the intensive industrialrestructuringofthe early 1990sand the associatedreallocationof labor leading to skill and geographical mismatches, the elimination o f labor hoarding and the sharp increase in productivity o f the mid-1990s. Labor market institutions are likely to play an important role but the story is multifaceted. 5.9 On the one hand, following the changes in the Labor Code implemented in 1996 and again in 2002, Poland's Employment Protection Legislation (EPL) is not rigid by international standards, even though the legislation on collective dismissals has been tight inthe past, and may have helped to delay restructuring in large firms, which hoarded labor up to the 1998 recession (Riboud et al, 2002). In addition Poland features a fairly decentralized wage bargaining system and an institutional set-up that is appropriate for accommodating firm-specific shocks. 5.10 Nevertheless there i s some evidence of real wage resistance inthe aftermath of the 1998 recession.21 This resistance i s not the result of excessive union pressure and ill-functioning collective agreements. On the contrary, the Polish labor market has been characterized by a dramatic decline in union presence, sustained delays in wage payments, and a decline in the number o f collective agreements. The downward rigidity o f wages that has been experienced over the last years is linked predominantly to the existence o f bindingminimumwage. Although 21This was evident in the fact that positive real wage growth was observed in sectors that experienced marked reductionsinemployment growth. 28 its real value relative to the average wage have been falling throughout the transition, it continues to remain a strong impediment to wage flexibility at the lower end o f the distribution because it still representsa highproportion o f the median wage, especially in regions with large proportions of unskilled workers. 5.11 Downwards wage rigidity combined with high non-wage labor costs to raise the labor cost index for Poland in 2002 to 117.7, well above the EU average o f 110.4, though lower than that o f other CEE countries (except Lithuania) and other relevant EUcountries (Table 5.1)?2 In addition, between 2000 and2003 -at a time of declined employment-labor costs inPolandhave increased by 21.7 percent, 11.5 percent faster than the EU(15) average but slower than in the other Central European Accession countries except Lithuania.23 Underlying the high non-wage labor costs are Poland's very highpayroll taxes (48%). Employers' contributions calculated as a percentage o f gross wages in Poland are one of the highest among CEE countries and the second highest inthe OECD, after the nether land^).^^ This hightax burden is likely to discourage both labor supply andjob creation. increasing - costs o f doing business inPoland. An important role is also played by the high cost 5.12 The high labor cost index i s only one o f the factors leading to the relatively high- and of entry that are associatedwith administrative barriers, corruption, etc.. 5.13 Partial deregulation inthe goods market is an additional possible explanation for the lack o fjob creation. The positive effects o f goods market deregulation on employment work mainly inthe mediumterm, when the reduction inprices-derivedfrom firms' lower overall mark-ups - more than offsets the initial reduction in rents in incumbent firms. In addition, the situation becomes more complicated if deregulation affects only part o f the economy, for example because the rest of the system remains heavily regulated. Inthis case, employment in existing firms may fall, with an adverse effect on unemployment. Over the last four years, privatization in Poland has progressively lost momentum and much remains to be done. Thus partial deregulation may indeed partially explain sluggishemployment performance. 5.14 On the supply side the main constraints to employment growth are the high reservation wage, the low skilled level o f the population especially in some regions and the limited geographical mobility. These are analyzed in more details below. c. THEROLEOFREGIONALVARIATIONS AND IMBALANCESINTHE SUPPLY AND DEMAND FOR SKILLS 5.15 The share o f workers with only primary education in total employment has declined by 14 percentage points over the last decade (from 27 percent to 14 percent). These changes are by no means uniform across Poland's regions. Poland i s not alone in facing difficult regional imbalances in employment after the rationalizatiodprivatization o f old staple industries, and lessonscan be drawn from other countries. 5.16 Voivodships vary substantially in terms o f unemployment and skillsleducation mix and the two variables are strongly correlated - Le., voivodships with lower-educated populations have higher unemployment rates. Differences in educational attainment account for at least halfo f the 22Carey andTchilinguirian (2000) estimatedthe averageeffectivetax ratefor labour inthe period 1991-1995as 42.06%. 23The 2003 figure refers to the third quarter, which is the most recentperiodfor which information is available. 24See Riboudet a1(2002) and OECD (2001), chart 2 p. 105. 29 regional variation in Polish unemployment rates. Thus an important part of the regional distribution o f unemployment appears to be caused by "the race between technological development and education" (Tinbergen, 1975). Table 5.2: Changesinthe Distributionsof Employment,Population* and Unemploymentby levelof CompletedEducation,1992-2002 Tertiary Secondary Lower Vocational Primary or lower Share inemployment in 1992 13.6 27.7 31.4 27.3 Share inemployment in 1999 15.6 34.2 35.2 15.0 Share inemployment in2002 18.3 34.0 34.0 13.6 Change in employmentshare 92-02 4.7 6.3 2.6 -13.7 Share inpopulationin 1992 10.6 26.6 29.5 33.3 Share inpopulationin 1999 10.5 29.7 31.0 28.8 Share inpopulationin2002 11.8 29.8 31.0 27.1 Change inpopulationshare 92-02 1.2 3.2 1.5 -6.2 Share inunemploymentin 1992 5.2 28.9 42.9 23.0 Share inunemployment in 1999 5.5 30.9 42.0 21.5 Share inunemploymentin2002 6.6 30.2 42.9 20.2 Changein unemploymentshare 92-02 1.4 1.3 0.0 -2.8 *IPopulationaged 15-60. Source: Authors' calculations basedon PLFS. 5.17 Unemployment differences by skills level are more or less universal and are usually attributed to skills differentials in non-wage labor costs, particularly adjustment costs. InPoland these skill-based unemployment differences are substantial (See Table 5.2) with workers with lower vocational qualifications representing 43 percent of the unemployed and less than 30 percent of the population. These differences also explain part, but not all, of the regional relationship between unemployment and skills. In addition lower skilled workers tend to experience longer periods o f unemployment (See table 5.3a and 5.3b). Thus part of the skills- unemployment regional correlation is to do with regional differences in factors that affect an individual's chances of finding work once he or she becomes unemployed. On the supply side, such factors include: (i)those that affect reservation wages, such as welfare benefits and minimum wage; and (ii)those that inhibit geographical mobility, such as housing market constraints. There also appears to be some support for the theory o f education-based mismatch, according to which regional skills-unemployment relationship can be attributed to an excess supply o f unskilledlabor-Le., mismat~hunemployment, 30 Table 5.3a: LongTerm Unemploymentby CompletedEducationLevel, Spring2002 Completededucation level Percentageof employees not working oneyear earlier University 5.8 General Secondary 5.2 Lower Vocational 7.5 Primary 12.0 Notes: The samplewas employeesaged between25 and45. Source: Authors' calculationsbasedonPLFS, spring2002. Table 5.3b: Average UncompletedUnemploymentDuration by EducationalAttainment, 1998and 2002 Average uncompletedunemploymentduration (months) Completededucation level November 1998 Spring2002 Tertiary 9.2 12.0 Secondary 12.8 14.8 Lower vocational 12.2 15.5 Primary or less 13.5 17.3 Source: Authors' calculationsbasedon PLFS, November 1998 and spring2002. 5.18 Finally the question arises as to why excess supplies o f labor (and thus lower wages) do not generate inflows o f capital as firms exploit wage advantages. The economic geography literature points to a number of potential reasons (see Background Papers, Chapter 5). There are a number o f possible reasons for this, ranging from poor infrastructure to low human capital. However, a particularly important factor is that these potential wage advantages are considerably reduced by the existence o f nationwide binding minimum wages that significantly limit the downward flexibility of wages in highunemployment regions. D. THEGROWTH LONG OF TERMUNEMPLOYMENT MAYALSO BEA FACTOR 5.19 As mentionedearlier new entries into unemployment inthe second halfo fthe 1990swere substantial with a marked rise in 1994-5 and 1999.. Not only successive waves o f labor shedding, but also demographic factors -namely the entry inthe labor market of increasingly large cohorts of school-leavers -are likely to have played an important role. Figure 5.2 shows that a key factor behindthe decline o f Polish unemployment inthe 1994-7 period was the risingoutflows tojobs. Reductions in unemployment have therefore been driven mainly by increases in the number o f people findingjobs. Thus thee unemployment rate went down dramatically inthe 1995-7 period as outflows tojobs almost doubled compared to their levels in 1993. 5.20 However, outflows into jobs declined after 1998 while new entrants into unemployment continued to increase, leading to a new peak in registered unemployment in 2002.25 Absorption of these unemployed into the labor market will require a strong increase in flows from unemployment to employment. This means stronger labor demand but also greater responsiveness of the job placement rates to vacancy creation which n turn requires increased mobility and a reductioninlabor market mismatches. 25 This is described in more detail in Chapter 9 in BackgroundPapers and shown in Figure 5.2, which illustrates a numberoftrends 31 Figure5.2: The EvolutionofPolishUnemploymentSincethe Inceptionof Transition, 1990-2002 250000 1 20 -150000 ' L O 1-monthlv inflows I m o n t h l v oufflows to iob +unem~lovment rate1 Source: Labor Force Surveys for unemployment rate; Unemployment Register for data on unemployment inflows andoutflows. IncreasingLabor DemandMay not beEnough 5.2 1 Thus, Polishunemploymenthas continued to increaseinrecent years, as the likelihoodof findingjobs has declined and the length of unemployment spells has increased. The risk is that, under such conditions, a vicious circle i s set in motion, whereby long-term unemployment induces declines in effective labor supply, and this reduces the scope for wage adjustment, inhibitingthe re-absorption into work of the unemployed-which inturnmeans more long-term unemployment and poverty. In other words, long-term unemployment can become self- perpetuating. Indeed the results of our analysis clearly show that outflows to jobs are highly responsive to an increase in the number of the newly unemployed, while those staying out o f work longer have hardly any effect onjob findingrates.26 5.22 There are theoretical arguments for However, in the Polish case the negative duration effect may be simply the by-product of heterogeneity in the two pools. This is confirmed by the fact that longer durations ofjoblessness affects predominately individuals with low educational attainments and those living in geographical areas where job creation i s at a minimum, as shown inTable 5.4 below. 26These results are generated from estimates of a matching hnction in which we allow the two pools, Le., the long- term and short-termunemployed, to exert a different effect on the overall probability of findingjobs. [See Background Papers, Chapter9 for moredetails]. 27 For instance,a long durationof unemploymentmaybe associatedwith the loss of skills (Pissarides, 1992) andlower search intensity. Alternatively, employers may be tempted to use the length o f unemploymentas a screening device (Blanchard, 1991), inwhich case a larger proportionof long-termunemploymentinthe overall pool ofthe unemployed may by itselfreduce outflow rates. 32 Table5.4: The ChangingProfileofPolishLong-termUnemployment,1992-2002 Irate 2002 U Share inU Sharein LTU LTUrate Relative riskof I beinginLTU* POLAND 20.41 11.05 0.541319 Women 20.60 47.64 52.74 10.78 0.523301 Youth 15-24 43.77 27.79 22.82 17.01 0.388622 Primaryllow 26.76 20.39 22.90 12.92 0.482810 education Ruralarea 17.67 44.78 48.08 8.21 0.464629 Familieswith 34.42 68.63 43.63 15.01 0.436084 children 1992 POLAND 15.97 4.82 0.3018 16 Women 14.78 50.26 52.19 4.45 0.301083 Youth 15-19 31.15 8.29 7.25 6.20 0.199037 Unskilled 15.84 7.26 8.00 6.23 0.393308 PrimaryAow 12.08 23.28 23.29 5.26 0.435430 education * Forany givengroupthis is definedas the ratio of long-termunemploymentover total unemployment. Source: Average yearly data from PolishLaborForce Survey. 5.23 The data inTable 5.4 show that the increaseinPolishunemploymentcan be substantially accounted for by the rise o f the long-term unemployment rate, which was about 5 per cent in 1992 and rose to 11per cent in 2002. The risk of long-term unemployment climbed from 30 per cent to more than 50 per cent over this ten-year period. The table also shows that Polish long- term unemployment has become increasingly concentrated in specific groups. This can be better grasped by looking at the last column on the right-hand-side o f the Table which displays relative risk values.28 Among the most vulnerable groups are women, persons with low levels of education and people living in rural areas. Although the share of these "vulnerable" groups in Polish unemployment did not increase from 1992 to 2002, their relative position in the labor market would seem to have deteriorated markedly over time. Wage Expectations, Social Transfers,UnemploymentDurationand LaborMobility 5.24 Some indication o f the role played by duration o fjoblessness inthe persistence of Polish unemployment may come from analyzing data on the so-called "reservation wage" o f unemployed individuals (the lowest wages at which they would take up job offers) which is available from the Labor Force Survey (LFS) as detailed inBox 5.1 below. 5.25 Usingregressionanalysis we findthatz9: e Wage expectations are consistent with actual market wage premia - Le., individuals with only primary or no education have a reservation wage that i s 10% lower than that of individuals with secondary education. For any givengroupthis is definedas the ratio of long-termunemploymentrateover total unemployment. 29See Chapter9 inVol. 2 for moredetails. 33 e The fact of living in a rural area involves a 5 percent reduction in wage expectations, except when the individual is a recipient of unemployment benefits or income maintenance social benefits. e The unemployment duration variable does not significantly affect wage expectations of jobseekers. Receiving unemployment benefit (or social benefits) may counter the effects of local labor market conditions on the reservation wages of individuals. Box 5.1: Information on Wage Expectations The LaborForceSurvey(LFS) carried out inPolandsince 1992 contains a question on the lowestpaythe intervieweeis willing to acceptwhenofferedajob. e The average reservationwage is about halfof the actual average wage and nearly one fourth largerthanthe minimumwage. The question on the reservation wage is also formulated in such a way as to fmd out whether or not the jobseeker has inmind employment away from the area ofresidence (and thus is likely to involvesome compensationor premiumfor the costs of mobility) or employment involving reducedworkingtime, e,g., part-timework. e By checkingall these factors, it is possible to get some comparable informationabout the reservationwage of individuals. Indications as to the reliability of such data come from matching observations about the same individual over time and comparing reservation wages stated when still searching for ajob with the actual acceptedwages. Significantly, for those finding a job shortly (within two months) after the interview in which they stated their wage expectations, the ratio ofthe acceptedwage to the reservationwage is closeto unity. 5.26 Unemployment benefits are paid at a flat rate, established by taking the national average wage as a reference point. Since the cost-of-living in rural areas may be up to 30 per cent lower than in urban areas, it is indeed plausible that receipt o f such transfers reduces search intensity and increases the length o f the search in the rural regions where Polish unemployment is concentrated. In addition, in high-unemployment areas entitlement to unemployment benefits is 18 months as compared to 6 months in low unemployment areas. The combined effect of these policies is a strong incentive to relocate to where employment opportunities are located. 34 6. ATWO-EDGED SWORD: THE ROLE OF SOCIAL TRANSFERS INMAINTAININGSOCIAL INCLUSION 6.1 The earlier discussion of the economic background indicated that during the "big bang" years social transfers came to be used as a way of maintaining social cohesion rather than as a way of supporting the income levels of those most inneed. Today the system and its underlying objective remain largely unchanged. In additionto old-age pensions - which are not analyzed in this report - the system comprises a number of benefits which can be groups under three main headings. The details are provided inBox 6.1. Box 6.1: The Structure of the Social Transfer System Poland's current social transfer system has a complex and cumbersome structure that can be summarized as follows: 9 Old-age pensions:these arenotanalyzedinthis report. 9 Socialprotectionfor the unemployed:thiscomprises two maintypes of benefits: o Unemployment benefits: qualified workers receive amounts that depend on their length o f service with their most recent employers -ranging from 80 percent o f the base benefit for service of less than 5 years to 120percent for service o f over 20 years. The length o f the entitlement depends on the place o fresidence -rangingfrom 6 months inlow unemployment areas to 18 months inareas of highunemployment. By removing the direct linkbetween contribution and entitlement, the regional variation in length of entitlement gives a social assistance flavor to what is clearly a social insurance benefit; o Pre-retirement allowances (discontinued in2001) and pre-retirement benefits: granted to individuals close to retirement, these payments have replaced the former early retirement pensions, The allowances were linked to the level of unemployment benefits, while the pre-retirement benefits are linkedto the accrued old-age pension. 9 Other socialprotectionbenefits:themainbenefitshere are disabil~~pensions. These are intended for individuals who have not yet reached the retirement age but are unable to work for healthreasons. Inthe past disability pensions were frequently perceived as an alternative source o f income for workers who had lost their jobs and were unable to find new ones. This led to (i)one-third o fall pensioners being disability pensioners, and (ii)Polandranking among the countries with the highestpercentage o f citizens claiming disability. The rules for eligibility were made more stringent in 1998. 9 Incomemaintenance:thiscomprisesthree categories ofbenefits: o Family benefits; o Housingbenefits; and o Income-replacement benefits for those out o f work, which include the guaranteed temporary social assistance benefit, the temporaly benefit, and the temporary social assistance benefit. Additional specific benefits are sometimes granted for particular purposes -i.e., medicine, childcare, funerals, etc. 35 A. A N EFFECTIVE INEFFICIENTAND COSTLY SYSTEMOFTRANSFERS BUT Fig 6.1 shows that the average amount received in social transfer per capita has increased over time and so has the percentage of the population relying on transfers to move out of poverty.3o Socialtransfers reducethe incidence of poverty by more than half. Figure 6.1: Povertyand SocialTransfers,* 1994-2002 102 I O 4i Social transfers per capita %of population relying on transfers to close their povertygap * Excludingold-age pensions. Source: Authors' calculationsbasedon H B S 6.2 However, while clearly important for poverty reduction, the social benefit system i s extremely costly and inefficient. UsingHl3S datathe total amount of social transfers - excluding old-age pensions - in 2002 was estimated to reach 6.3 percent of GDP, which is close to government estimates. However, the left-hand panel o f Figure 6.2 illustrates that 26 percent o f receipts are inexcess of the amount necessary to bringhousehold consumptionto the poverty line level (a phenomenon called "overflow") and a further 30 percent (an equivalent o f 2 percent of GDP) appearsto go directly to non-poor households. Figure 6.2: Targeting of Social Transfers (Excluding Old Age Pensions) Who receivessocial transfers 7 Social transfers per capita by consumption deciles YOof resources going to: poor 0non-poor 17overtlow d l d9 -`gIGd8 d7 d6 `0 c fd4 d5 'e d3 d2 d l PLNI month I 0 50 100 ,50 eq. adult Source: Authors' calculationsbasedon HBS 30A clear exceptionto this trendis 1998when socialtransfers per capitadeclinedandso did the the percentageofthe populationrelying ontransfersto movethem our of poverty. 36 6.3 As social transfers include benefits of a social insurance nature - such as unemployment benefits and disability pensions -the expectation is clearly not one o f perfect targeting of benefits to the poor. But given the special role these benefits have come to acquire as consensus builders inthe transition period, the extent of the spill-over to the non-poor is unacceptably high. It is of particular concern that the average size of the social transfer per capita inthe poorest decile is the second lowest after the top decile. Although attempts have been made to reduce the inefficiency of the system, the size o f the leakage has not declined over the last decade. This suggest that the emphasis is more on maintaining the political support o f the "median voter" than on the use of social transfers as effective safety nets for the poor. B. SOMEWORKERSMAYFACEA SUBSTANTIAL``UNEMPLOYMENT TRAP" 6.4 Table 6.1 presentsdifferent replacement ratios of income inand out o fwork for a number o f "typical' families. The ratios are calculated under alternative assumptions about the wage potential o f the unemployed worker. It is clear from the table that workers earning minimum wages face very highreplacement ratios independently of the characteristics o f the household. In particular, while entitled to unemployment benefits a single minimum wage earner has a replacement ratio that is well over 100 percent. All other family types analyzed face replacement ratios well above 90 percent suggesting the existence o f a considerable "unemployment trap" for workers with low skills and those living inpoor, low wage areas. Table 6.1: ReplacementRatiosInand Out ofWork by Family Type andPotentialWage While receivingunemploymentbenefits After entitlement Familytypelpastwage level Entitlement(percent basicbenefit) 80% 100% 120% Single person (average wage) 35.2 40.5 45.8 7.0 Single person (min. wage) 91.8 105.7 119.6 47.0 Parentst-;! children (average wage) 46.2 50.1 54.0 28.5 Parentsi2 children (min. wage) 81.6 88.5 95.4 50.3 Parents+4 children (average wage) 49.2 52.5 55.8 34.2 Parents+4 children (min. wage) 84.8 90.5 96.2 58.9 Single parent+2 children (average wage) 44.4 48.5 52.8 (43.1) 47.5 Singlepare$+2 children (min.wag)e 78.7 86.1 93.7 (76.5) 84.3 Notes: Values including the change of guaranteed temporary benefit in the second and third year of paymentare inparentheses. Source: Authors' simulations (see Chapter 14BackgroundPapers). 6.5 These findings suggest that the current benefit structure may create incentives for the unskilled unemployed in rural areas to remain inactive. The main reasons for this disincentive effect are: (i)the substantial unemployment trap these workers face; (ii)the fact that unemployment and other social benefits are uniform across regions (as noted in the previous section) and household types - i.e., they do not reflect differences in living costs and the earnings potential of household members; (iii)the entitlement to unemployment benefits is longer in regions with high unemployment. Relatively unskilled household members whose potential 37 earnings do not exceed the minimum wage and who receive unemployment benefits face replacement ratios that are very close to - or in excess of - one. In addition, if located in a relatively highunemployment region this household can benefit from this highreplacement ratio for as long as 18 months - Le., three time longer than households in low unemployment regions. This clearly couldact as a strong disincentive to geographic mobility and activejob search. c. BUTTHE "POVERTY TRAP" IS LIKELYTO BESMALL 6.6 However, once the entitlement to unemployment benefits expires, the current social benefit system fails to provide sufficient coverage for the poor. Discretionary temporary benefits provide the only basic transfer to poverty-stricken families. However these have become only a marginal element of the social transfers system reflecting the lack o f financial resources and the fact that their amount and duration is defined in relation to the budget available after all mandatory benefits have been paid. This leaves only two possible sources of assistance: pre- retirement benefits which are available only to qualified older unemployed individuals, and disability pensions. At the beginning o f the 199Os, the disability pension system provided incomes to a large group o f people but reforms have meant that its role as "income provider" is slowly decreasing. Thus pre-retirement and retirement benefits are becoming the main source of income for a growing number of households. In 2002, there were almost half a million beneficiaries. This is imposing large costs on the Labor Fund and diverts resources away from active labor market programs. 6.7 Because of the potential disincentive to work, poor targeting and inability to provide an adequate safety net after the period when unemployment benefits are paid, the generous social benefit system can act as an impediment to poverty reduction rather than as a safety net. 6.8 What is required is a substantial restructuring o f the benefit system that will address the issues o f the inefficiency and highcost o f the system without reducing its effectiveness, Indeed, the experience of other EU countries, such as Spain, suggests that Poland should have already reformed its social transfer system, so as to take better advantage o f the "good" years to put in place arrangements that could cushion the drop in growth (which would have had to come eventually) and especially the impact of the inevitable labor restructuring. The failure to think ahead strategically on this issue is probably partly to blame for the current circumstances. Butthis would make it all that more important to reform existing social safety nets now that growth appears to be picking up again. 38 7. MOVINGCLOSERTO THE LISBONTARGETS 7.1 The main conclusion o f this report i s that growth is the maintool for improving the living standards o f the Polish population ingeneral and the worse-off inparticular. Over the last decade in Poland, the extent and intensity of poverty are highly responsive to growth in GDP and in average private consumption. This is so despite a modest but persistent increase in inequality experienced over the last decade. 7.2 The increase in poverty that occurred during 1998-2002 was the result of the declines in mean consumption that occurred in all quintiles except the top one, and which was particularly pronounced at the bottom o f the distribution. Underlying these declines were: (i)slow growth, which was reflected in a decline in average consumption overall; and especially (ii) a shift in the distribution o f consumption against the poor. The latter mainly reflected increased inequality in labor incomes, driven at first by rising skill premiums, and then by changes inthe probability of employment. Indeed households at the bottom end o f the consumption distribution were hit twice over the 1996-2002 period. First, their relative wages dropped as skill premiums adjusted, and thenthey lost theirjobs. The former effect did not affect poverty considerably becausethe whole distribution was shifting - as mid-1990s growth benefited all quintiles - but nevertheless the change in relative demands for skills took place at this time, putting those with low skills in a disadvantaged position already. 7.3 A decline in the demand for low skilled workers, combined with high non-wage labor costs, meant that as soon as growth slowed, labor market adjustment resulted inmassive shedding o f low skilledjobs. A similar phenomenon took place in Spain inthe late 1970sand early 1980s. The difference between the two countries interms o f poverty outcomes i s that while Spain put in place a new system o f safety nets to coincide with those shifts (hence cushioning the effect on poverty), Poland had to do exactly the opposite: e.g., reduce its safety nets. So it is not surprising that what we have seen in Poland is a substantial increase inpoverty. 7.4 The findings o f this study suggest that poverty is closely linked to lack o f employment opportunities and this i s strongly correlated to the skill level o f the individual and the location slhe lives in. In particular the skills composition o f the location appears particularly important. Thus the main barrier to finding employment and moving out of poverty is: (i)living in a voivodship with a highpercentage o f low income inhabitants and high unemployment rates; and (ii)theeducationleveloftheindividual. Thislinkhasbecomestrongerovertime, withthese variables affecting not only the probability of becoming unemployed - and poor - but also the chances of remaining unemployed for longer and becoming "chronically" poor. The situation appears to be particularly difficult for former state farm workers who not only live in severe poverty but also have limited access to informal networks and informal safety nets. A. GROWTHSCENTRALFORPOVERTYREDUCTION I 7.5 The key to poverty reduction in the mid-1990s was consistent and rapid GDP growth. The prospects of a return to robust growth over the next years suggests good prospects for poverty reduction. However, sustainable economic growth requires a stable macroeconomic environment and a balanced fiscal-monetary policy mix. These should be the policy priorities on 39 the eve of EU accession and could be helped by the potential of a large inflow o f EU transfers promptedby accession. But inorder to utilize the incoming funds effectively, and more generally to improve the conditions for economic growth, Poland needs to take an important initialdecision on whether to put efficiency or redistribution first inits modelo f development. 7.6 The diverse experiences of EUcountries clearly suggest that a trade-off may exist inthis area, especially inthe case o f countries with large regional inequalities. The crucial question here is whether new flows o f funds should be used to target low-income regions, or to increase the potentialof already more affluent "growth poles" (Funck and Pizzati, 2003). B. GOINGBEYOND ECONOMIC GROWTH 7.7 But growth alone will not be enough to move Poland closer to the Lisbon targets. The link between economic growth and employment creation needs to be significantly strengthened by making the growth environment more "labor friendly". This is particularly true for unskilled workers and residents o f Poland's poorest regions. The focus on the need for employment creation calls for a number o f specific interventions on boththe demand and supply sides. 7.8 Over the last decade Poland has seen a large increase in labor productivity driven by employment shedding. While inthe short term this has huge negative effects on employment and poverty, it also lays the foundation for higher incomes and higher growth in the future. Again, the examples of Spain and Portugal are enlightening in this regard: both went through long periods of high unemployment, but having put in place the right mix o f economic reforms not - just in labor markets but also in product markets - they eventually obtained a large payoff. To date, these are the two countries with the highest continued growth rates inthe EU, and the only ones with sustained high rates of employment growth for the last few years. In both countries, the key to reforms has not been so much the labor market as increasing competition throughout the economy, and very especially in the until-then highly-monopolized infrastructure sectors. Labor mobility across regions was also key, as well as efforts to invest in infrastructure and to create a better enabling environment for the lagging regions. This experience i s very relevant to Poland where the process o f liberalization has proceeded much faster inthe labor market than in other sectors of the economy. In particular, the remaining rigidities inthe housing and transport market are an important potentialbarrier for labor mobility and poverty reduction. 7.9 Very relevant i s also the message that highproductivity growth incountries such as Spain and Ireland has laid the foundation for future growth, and is not something one should attempt to "reverse" through the growth of low productivity jobs. With regard to labor mobility, one point of interest is that the social benefit system in Spain had to be reformed significantly inthe midto late 1990s (despite political outcries) to reduce the disincentives to geographical mobility arising from the system o f cash transfers (with transfers all the more generous in poor regions). Similar policies are also required inPoland. C. INCREASING EMPLOYMENT OPPORTUNITIES 7.10 This means interventionson the labor market -onthe demand andthe supply side as well as in the area of labor market mismatch - but also in the product market and in other markets. The main recommendations are summarized in Box 7.1. A detailed list o f recommendations as they emerge from the individual backgroundpapers is provided inthe matrix inthe annex. 40 Box 7.1: Main Policy Recommendations 1. Improvethe employment opportunitiesofthe populationby: Increasinglabor demand via: o Introducingregionaldifferentiationsinthe minimum wage; o Reducingnon-wagecosts; o Improvingadministrativebarriers to "doing business" and improvegovernance; o Speed-upthe processofprivatizationand liberalizationof goods, and labor and other markets. Increasinglabor supply by: o Reducingthe highreservationwages of unskilledrural workers; o Reform socialtransfer systems so as to reducethe existing"unemployment trap"; o Increasingthe skills levelofthe laborforce especially indisadvantagedregions, Reducinglabor marketmismatchby: o Improvingjob searchassistance o Encouragingmobility via apolicy mix that includes: - Equalizingthe lengthofentitlementsto unemploymentbenefitsacross the - country; Reducinghousingmarketrigidities; - -, Improvingaccessto transport, and Providingmobility grants Encourageentrepreneurshipby`providingselectivetraining and improving accessto credit for groups with the highest unemploymentlevels -Le., women, people living inrural areas. 2. Improvethe targetingof socialtransfers so as to providean effectivesafety net for those who cannot benefitfhlly fiom economic growthand increasedemployment opportunities. 3. Target socialtransferstowards socialmaintenancebenefits by shifting the emphasis away fiom disabilitypensions andpre-retirementbenefitsto incomerelatedfamily benefitsand consider the possibility of havingthese benefits conditionalon: (i) children attendingsecondary or tertiary education; andlor (ii) householdsheadworking aminimum number ofhours-i.e., 16 hoursaweek. 4. Increasecapacityfor povertymonitoringby providingpublic access to HBSraw dataand improvingthe HBSquestionnaire to allow more accurate aggregateconsumptionfigures to be calculated. IncreasingLaborDemand 7.11 The analysis o f labor market institutions, and o f employment protection legislation in particular, suggests that no dramatic policy changes are required in the hiring and firing regulations and in the wage bargaining process. Recent changes in the labor code are welcome and point in the right direction. In general, policies for more flexible collective dismissal procedure are likely to be beneficial to Poland, where restructuring and deregulation of large state-owned enterprises i s ongoing. As far as the industrialrelations system i s concerned, Poland features a fairly decentralized wage bargainingsystemthat is appropriate for accommodating firm specific shocks. 41 7.12 However, wage rigidities are clearly an issueto be addressed. Inthis respect an aggregate form of negotiations may be useful for implementing structural reforms while avoiding social tensions, as was to a large extent the case with pension reform, but should not necessarily be used for nationwide wage agreements. More important, however, is the negative effect of a nationwide minimum wage that makes it impossible to match the low productivity of low skill workers. Implementing region-specific minimum wage may be advisable but logistically difficult to implement. The option of making the minimum wage progressively less binding may be preferable. 7.13 Thus, a critical factor for the required increaseinlabor demand will be a pushfor a return to "labor friendly" growth via: (i) a reduction in costs of doing business; and (ii) speedingup the processof privatization and liberalization of both the labor andthe goods markets. 7.14 The cost o f doing business is high and increasing - contrary to a downward trend in the rest o f the EU. It results from a combination o f hightaxation - and labor taxation inparticular - and the high cost o f entry that are associated with administrative barriers, corruption, etc. Compared to other transitional and OECD countries Poland has one of the highest payroll taxes (48%) (Riboud et al, 2002):l In addition, between 2000 and 2003 - at a time of falling employment - labor costs in Poland have increased by 21.7 percent, 11.5 percent faster than the EU(15) average but slower than in the other Central European Accession countries except Lithuania.32 7.15 Partial deregulation inthe goods market may be an additional possible explanation for the sluggish labor demand. The radical economic transformation of the early 1990s has resulted in massive restructuringand some privatizationof former state firms butthe process o f deregulation and privatization has progressively lost momentum over the last decade and much remains to be done. Recent literature suggests that the positive effects of product market deregulation may not be felt in the labor market when the deregulation affects only part o f the economy, for example, because the rest o f the system remains heavily regulated, In this case, employment in existing restructured f m s will fall but the drop may not be compensated but an adequate creation o fjobs in incumbent firms, with adverse effects on unemployment. This mechanism can partially explain the sluggish employment performance of Poland, and deservesto be studied indetails. Interventionson the Supply of Labor 7.16 Two possible actions are proposed here: (i)raising skills levels, especially among unemployed workers inpoor regions and new labor market entrants; and (ii) a reduction inwhat is currently a comparatively high reservation wage especially among unskilledworkers living in rural and poor areas. 7.17 The low level o f skills in the Polish labor market, especially in rural areas, is a major cause of concern for the economic development of the country (World Bank 2002). On the InternationalAdult Literacy Survey (IALS), 75 percent o f Poles aged 16-65 performed below the level required to fully function in a modern market. On the Program for International Student Assessment (PISA), Poland's 15 year-olds ranked 24 out o f 31 OECD and non-OECD countries "CareyandTchilinguirian(2000)estimatedtheaverageeffectivetaxrateforlabourintheperiod1991-1995as 42.06%. ''The2003 figurerefers to the third quarter, which is the most recentperiod for which information is available. 42 in literacy and mathematics and 21 in science. Moreover in both these assessments Poland registeredthe highestvariation in scores between rural and urban areas. 7.18 Addressing this issue comprehensively requires a multi-pronged strategy designed to address the ruraleducational disadvantage by improving school enrolment, the quality of the education system and the relevance of education to labor market demands; and enhancing the skills (and employment prospects) of those who have already left the school system. Both types o f interventions fit well into the current World Bank program on the Knowledge Economy, but it will need to be extended to include traditional education and school age children. The difficulty is in the heavy cost o f comprehensive reform o f the education system. A further challenge is that EUstructural funds are not intendedto be usedto finance education. 7.19 The first of these initiatives requires a detailed action program to upgrade the education system, for which the Ministryo f Education should be responsible. One such plan i s proposed in World Bank (2002) and is in tune with the steps undertaken by the Government to address this issue. An important element o f this plan should be a process o f regulated liberalization of the education system and the prospect of privatelpublic partnership. 7.20 The second i s a less conventional exercise to be deliveredby training and other activities. Generally speaking, a certain degree of skepticism exists on the effectiveness o f retraining programs. However recent evidence suggests well-designed programs can be successful except in cases of retraining of workers affected by mass lay-offs. These programs are particularly successfulfor women. 7.21 Reducing the reservation wage is an equally daunting task in the context o f a social protection system that gives very little incentive to actively searching for work. This objective requires extensive reform o f the system by: (i) making the length of entitlement to unemployment benefit the same across regions; (ii)limiting access to disability pensions and early retirement allowances; and (iii) relating benefits paid to their local purchasing power. In order to reduce the potentialdisincentive effect o f unemployment benefits it i s particularly important to: (i)eliminate the current regional differences inthe eligibility period for unemployment benefit; and (ii) change the structure o f the benefits so that the real replacement ratio i s the same across regions. This will mean paying individuals different benefits depending on where they live. It is also essential that reliance on disability and pre-retirement pensions be reduced. The high costs o f the disability pension system should also be reduced, as this form o f social transfer is a major cause of the relatively highshare o f indirect costs intotal labor costs in Poland. ReducingMismatch 7.22 Finally, given boththe scale o f the problem of structuralunemployment and its growth, it is important to work to reduce labor market mismatch. This could be done by: (i) improvingjob searchassistance and (ii) removing barriers for mobility. 7.23 A type of public service that is usually fairly successful inincreasingemployment among those seeking work isjob search assistance. This is also a relatively cheap type o f initiative that often has a very favorable cost-benefit ratio. But it is typically effective inlabor markets with low structural and long-term unemployment. Hence in itself such assistance is likely to be of limited value inPoland. 43 7.24 Inaddition to bringing labor force skills closer to the needs of employers, labor market mismatch could be reduced by increasing labor mobility. The limited empirical evidence suggests that mobility is very low inPoland, and the few studies that exist point to two important conclusions: (i) the small number of workers migrating from poor to richer regions in Poland are those who are already employed rather the unemployed; and (ii)housing costs are often highlighted as a strong deterrent to mobility, This points to the need to ease the imperfections currently operating inthe housing market and the importance o f liberalizing the transport market. A system o f housing benefits mightbe considered to address this issue. More generally mobility loans and other instrumentscould be usedto promote the mobility o fjobseekers. Combinedwith mobility grants, search assistance becomes a potentially more successful and cost-effective policy, and the Polish government should be encouraged to continue with its attempt to reform the system. The cost of these policies could be financed from EUstructural funds. O f course new routes for migration will open up after EUaccession. Itwill be important to equip Polish workers withthe characteristics that will make it possible for them to benefit fully from this opportunity. Encourage Entrepreneurship 7.25 Recent data suggests the number of self-employed in Poland is high relative to other transition economies and a very large percentage of them appear to be women. This is an important area for future development and one where more analysis may be required. It is important for the government to actively encourage further development of this sector by: (i) reducingbarriers to credit; (ii) facilitating the process o f settingup and registering a business; (iii) providing help in identifying markets; and (iv) improving transport facilities from the most remote areas. The Scope for Active Labor MarketPolicies 7.26 The findings o f this report indicate that the spread o f long-term unemployment inPoland is associated with the deterioration o f the relative position o f specific vulnerable groups, such as women re-entering the labor market, persons with low levels o f education and individuals living inrural areas. We also found that receipt of cash transfers may have a significant effect on the reservation wage o f the ruralpopulation. When unemployment risk is concentrated and receipt of benefits discourages regional labor mobility, there may be a strong case for selective Active Labor Market Policies (ALMPs), on the grounds that they can hardly involve deadweight costs while their substitutioneffects may even be desirable. 7.27 In terms of expenditures, three programs have been of particular importance: training, "intervention works" and public works, Training programs are designed to solve skills mismatch inthe Polish labor market, Workers with redundant or no skills are trained inthose occupations where there is strong labor demand in the expanding sectors o f the economy. "Intervention works" i s a program that in essence gives employers wage or jobs subsidies inan amount related to the level of unemployment benefits ifthey hire an unemployed person; the subsidies are larger the longer this person is kept on in the firm. Public work jobs arejobs directly created by the government, in particular municipalities, targeted mainly (but not exclusively) at the long-term unemployed. Many o f thesejobs are inconstruction and cleaning o f public buildings, parks, etc., Le., they have a low skills content, although in principle both intervention works and public works have been conceived as maintaining or enhancing the humancapital o f participants. 7.28 Since the beginning o f transition the Polish government has applied a wide range o f such policies to combat long-term unemployment. Several studies have investigated their effectiveness by drawing on micro data (Puhani and Steiner, 1996 and 1997; Boeri, 1997; Puhani, 44 2000) and using a variety o f technique^.^^ Their results are not altogether encouraging with respect to the effectiveness of these programs in improving re-employment probabilities. In particular, training programs appear to have only a limited effect on job finding rates and typically public work schemes involve stigma effects which may actually reduce the likelihood of findingajob after participationinsuch schemes. Better results areobtainedfrom wage subsidies, 7.29 However, incentives to take up slots inactive programs are particularly strong in Poland. Workers are entitled to unemployment benefits if they have worked at least 180 days in the preceding year and participating inajobs program-like intervention or public works for at least 6 months entitles a person to another round o f 6-18 months of benefit payment. These policy linkages create strong incentives to participate in ALMPs. The challenge is to ensure that participation is an effective way o f increasing long-term job prospects rather than the effective duration o f the unemploymenttrap. D. SUPPORTINGTHELIVINGSTANDARDSOFTHEMOST VULNERABLE 7.30 While labor-friendly growth i s clearly a priority, it i s important to keep inmindthat, even under the current positive growth scenario, a pool o f people will remain who are unlikely to benefit from this growth and will inevitably be left behind. For these individuals, a comprehensive and adequate system o f income support benefits i s needed. In Poland, a large share of public expenditure currently finances the country's social benefits package, but the government is under increasing pressure to reduce its budget deficit. Thus any reform o f the system is unlikely to include higher spending. This means that the system will need to work within the current budget by improving targeting and effectiveness. As discussed earlier, there appearsto be plenty o f scope for this under the current system. 7.31 The poverty profile described inthis volume suggests large families and children to be a particularly high-risk category, while the elderly are comparatively better off. This suggests the need to shift the emphasis o f social benefits from disability pensions and pre-retirement benefits to income related family benefits. The analysis above has also pointed to the pressing need for: (i)improvingeducationaloutcomesofpoorchildren;and(ii) reducingthe reservation wage of the unemployed inrural areas. 7.32 The social benefit system can be reformed to provide incentives that will help to achieve these additional goals. This could be done by designing a social transfer package which is conditional on: (i)children attending school at secondary or tertiary level; andlor (ii) ensuring that the household headworks a minimumnumber of hours aweek. E. HOWTOMONITORFURTHERDEVELOPMENT 7.33 Having identified policies that could usefully reduce poverty inPoland, it is important to promote initiatives for improving the capacity to monitor future developments. Currently, working on living standards in Poland is both rewarding and frustrating for the quantitatively minded. Poland has a wealth o f information on living standards and labor markets. The Statistical Office of Poland (GUS) regularly carries out a number o f surveys at the individual, household and firm level. The surveys are based on rigorous sample techniques and comprehensive questionnaires. In addition, some of the surveys have a panel component which 33Amongthe techniquesusedare estimates of augmentedmatchingfunctions, simple durationmodels includingprogramintakes, matchingestimators substitutingfor randomizationinlabor marketprograms, etc.), 45 allows analysis of changes over time and makes it possible to distinguishtemporary shocks from chronic conditions. GUS calculates and publishes regularly poverty indicators and a number of additional studies have been carried out over the last decade by independent institutions and academia. 7.34 Data accessibility is a real issue, however. GUS follows a complicated and rather ad hoc procedure indeciding whether to grant policy makers and researchersthe rightto use its data, and insettingthe price-tag associatedwiththisright. Therationale for the final decisionis notalways transparent, and the overall process is slow and highly inefficient. This report has been substantially delayed by the length of this process and was limited in its scope by the fact that: (i) the LivingConditions Survey was made available too late to incorporate it into the analysis; and (ii)accesstorecententerprisedatawasdenied, preventingadequateanalysisofrecentpatternsof job creation andjob destruction. 7.35 Thus the most important recommendation in this area is that GUS adopt a standard procedure for releasing data to the public. This should include public access to the raw data for all interested parties. Access to the data should be granted free o f charge unless specific work is requiredto prepare the data. 7.36 In addition it is recommended that the HBS questionnaire be modified to allow for the imputation of the value o f durable goods and housing. The first of these revisions requires the addition of two simple questions to the current questionnaire: one specifying the age o f the durable and the other its price at acquisition. 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