Social Sector Reform in Transition Countries

• Author: Christian Keller/Peter S. Heller
• Position: Economist in the Stand-By Operations Division of the IMF's Policy Development and Review Department/Deputy Director of the IMF's Fiscal Affairs Department

Transition countries need to reform their social sectors to promote the welfare of their citizens and spur economic growth. In part, this means building up and redesigning social safety nets and addressing problems in such areas as social insurance, budgetary transfers, health care and education, labor markets, and tax administration. It also requires cutting some benefits and privileges.

The transition process has given rise to major economic and social challenges in the former centrally planned economies, as employment and income have fallen and income inequalities have widened. Social indicators such as life expectancy and school enrollment have deteriorated, and the incidence of poverty has increased. Although it is difficult to measure these developments, and the gravity of the problems varies considerably from country to country and across different population groups, economic and social decline has been traumatic in most transition countries.

The initial years of transition

Unlike most developing countries, transition countries had well-developed social sectors before the onset of transition. Their social safety nets covered the same risks as social insurance plans and transfer programs in developed countries, and considerable resources were devoted to health care and education. But the transition countries' institutional arrangements-which provided "cradle-to-grave" protection to the entire population-had been designed for a very different economic system. Incompatible with the incentive mechanisms of a market economy and ill prepared to cope with the enormous pressures that emerged in the transition to a market economy, existing social sector institutions and policies were significantly eroded and severely affected by the transition process.

First, the real value of social transfers was reduced by inflation. With the purchasing power of benefits becoming dependent on indexation mechanisms or politically motivated ad hoc adjustments, insurance schemes and welfare programs failed to protect the vulnerable from poverty. Rapid price increases affected the health and education sectors. Medical supplies and drugs were no longer affordable for some.

Second, social insurance systems were being used for purposes other than those originally intended. For example, countries sought to deal with surging unemployment caused by declining economic activity, privatization, and enterprise restructuring by forcing public pension schemes to absorb older workers through early retirement schemes and by relaxing the eligibility criteria for disability benefits. Such policies were reflected in these countries' very low average retirement ages and the excessively large share of pensioners receiving disability benefits. The ratio of contributors to pension plans to the number of pensioners deteriorated as a consequence.

In addition, large segments of the population were granted special privileges in the form of reduced rates for energy, telephone service, housing, communal services, and transportation. Too low to cover costs, such rates not only generated losses for service providers and, in turn, put pressure on the budget but also encouraged overconsumption and misuse.

Third, resource allocation in the health and education sectors became skewed. Trying to free themselves from dealing with mounting costs for health care and education, central governments decentralized public hospitals and schools, passing responsibility for them to local governments. The merits of decentralization notwithstanding, local governments were not in a better fiscal position to support these facilities-hospitals with excess bed capacity, extensive spa and recreation services, redundant health practitioners, and schools with many teachers and small classes. Their task was complicated by demands for higher wages, as workers tried to...