Question:

Research paper about Employment and unemployment in Slovakia and other transition Economies

Answer:

Title: Employment and unemployment in Slovakia and other transition Economies

 

Introduction

Slovakia is one of the countries in Central and Eastern Europe that had been in the Soviet Union prior to its break-up. Slovakia joined the European Union and is currently enjoying the lowest unemployment rate in over two decades at 13.5%. However, this has not always been the case especially immediately after the break-up of the Soviet Union (Banerjee & Jarmuzek, 2010). The term paper investigates some of the major causes of unemployment during the transition to the market-driven economy.

As the economy of the Slovak Republic moved from the planned economies of the communist Soviet Union to the market-oriented economies, substantial reallocation of labor had to take place. Over the years, dramatic changes in the structure of employment have taken place. The changes have been marked by a move away from the structures characterized by economic activity, ownership and size that constituted the employment structures in the Soviet Union. In the planned economies, employment was concentrated in the heavy industries and it mostly emphasized on large conglomerations and the public sector. Non-agricultural self-employment was not existent. Less attention was paid to the consumer-driven markets (Boeri & Terrell, 2002). The paper seeks to explore the relationship between the changes and the effects that they had on the unemployment levels in Slovakia.

It is hypothesized that the rise in Unemployment in Slovakia was not as a result of mass layoffs from state enterprises but rather as a result of low absorption rates of workers to jobs in the private sector. Most of the unemployment in the Slovak Republic was occasioned by the shift from the old pattern of state-produced products to the private-sector dominated economy. The unemployment levels in Slovakia rose because the subsidies that were offered in the planned economies were cut leading to a decrease in demand for labor in the companies, leading to increased unemployment. The emerging private sector could not absorb the excess supply leading to surplus labor (Rizov, 2004). The aim of this paper is to show the relationship between the layoffs and the effects that they had on the absorption of labor in the private sector.

In the restructuring of the labor market, the resulting friction led to a short term rise in unemployment levels in Slovakia. The level of the first peak in unemployment rate got to 14.6% within the first four years. The member states of the former Soviet Union attained peak unemployment levels later, although the long-term unemployment rate remained lower than the levels experienced in Slovakia and other Central and Eastern European countries.

Currently, Slovakia and other countries of central and Eastern Europe are experiencing significant employment adjustments characterized by rapid changes in employment structures and high unemployment levels. The countries of the former Soviet Union have a slow structural change and a gradual build-up of unemployment levels. This term paper’s objective is to distinguish and account for the variance in the employment structures of Slovakia and other countries of central and Eastern Europe.

In Slovakia and other countries of central and Eastern Europe, there has been a wide range of experiences in the movement of labor. A relatively little decline in unemployment has been observed, together with marked reductions in labor productivity. The employment structure in Slovakia has been reduced in both industry and agricultural sectors. This is in stark contrast to the former Soviet Union, which has been growing at a much slower pace, with most of the employment reallocation taking place in the agricultural sector. The employment share in the service sector has expanded by over 10% in the Slovak republic. In the same sector, the share has expanded by less than 5% in the Soviet Union.

Slovakia experienced significant employment adjustment with rapid structural change accompanied by high unemployment levels which were mainly long term. This is in contrast to the experiences of the former Soviet countries whose employment responses to output changes remained low and with slow structural changes and a more gradual build-up of unemployment levels.

As Slovakia makes significant progress economically after joining the European Union, there has been reduction in unemployment especially in the urban areas and more so among the younger generation. The country’s younger generation is made up of educated and energetic men who have skills that enable them exploit the opportunities offered in the emerging private sector. The aim of this term paper is to determine the main gainers and losers in terms of employment within the new economic dispensation as well as to expound on the policy changes that Slovakia and other countries of central and Eastern Europe have made to address the discrepancies.

The major causes of unemployment during the transition to the market-driven economy

Institutional asymmetries and macroeconomic policies

The transition of the Slovakian economy from a planned economy to a free-market economy was characterized by substantial reallocation of labor. As a planned economy, employment in Slovakia was mainly concentrated in heavy industries, ordinarily away from the preferences of customers (Boeri & Terrell, 2002). In this economy, the small business sector was absent. However, with the transition of the Slovakian economy into a market economy, some changes in labor allocation started to occur, with the main changes being associated with the newly created transitional model known as the Council for Mutual Economic Assistance (CMEA).

During the transition into the market economy, there was an outflow of labor from state-owned industries to newly created private enterprises, most of which operated on a small scale basis. This form of operation contrasted sharply with that of the heavy, large, state-owned industries. According to Boeri & Terrell (2002), the problem with Slovakia’s labor disparity during the transition is best analyzed from the perspective of how well the tasks of reallocating labor were carried out.

Decline in labor productivity

During the transition to a market economy, unemployment disparities have existed even within Slovakia (Jarmuzek & Banerjee, 2009). This situation has continued to exist in spite of the fact that most of the country’s sectors have continued to record positive growth since 1995. Moreover, labor productivity has been increasing just as considerably as the GDP growth per capital. However, pundits observe that the disparities existing in Slovakia cannot be said to be higher compared to those of other countries that had recently joined the European Union.

Slovakia joined the European Union in 2004, and the country adopted the Euro in 2009. With the resulting increase in trading activities within the Euro zone, the country has started recording growth in the labor market. In an assessment of labor productivity in the context of the country’s membership in the EU, Jarmuzek & Banerjee (2009) note that this indeed was the main driver of economic growth in all regions within Slovakia. However, the Total Factor of Productivity in the eastern regions differed from those of the western regions. Jarmuzek & Banerjee (2009) link the increase in labor productivity in the western regions to advancement in technology and knowledge inflows in the form of Foreign Direct Investments. In the eastern regions, growth is attributed to the restructuring of government-initiated processes.

According to Jarmuzek & Banerjee (2009), there was a marginal decline in labor productivity between 1995 and 2001. This contrasts sharply with the significant gains that were made between 2002 and 2006. When the situation is assessed from a regional perspective, the resulting image may not be clear. However, on the whole picture, between 1995 and 2000, the ratio of unemployment to the population has declined, although it has appeared to pick up in subsequent years.

Sensitivity to wage cuts

The state of sensitivity to wage cuts has arisen largely as a consequence of Slovakia’s recent adoption of the Euro. However, since the euro in 2009, there may not be much to say by way of transition into the free-market. This is because the process of switching into the new market system has been long, having been triggered in the early 1990s after the collapse of the former Soviet Union.

Nevertheless, this sensitivity, also known as wage rigidity is an indication of a long-standing trend, whereby the rate of absorption of workers into the private sector has been low. Gertler & Senaj (2009) observes that since Slovakia adopted the Euro, employees in the country are more likely to be increasingly sensitive to wage cuts. However, after exploring the issues of both downward wage rigidity and wage flexibility, Gertler & Senaj (2009) conclude that Slovakia possesses low downward wage rigidity and high wage flexibility. Gertler & Senaj (2009) also observe that the decision for the adoption of the Euro in 2009 was favored by the existence of flexible wages.

Variations in the employment structures of Slovakia and other countries of Central and Eastern Europe

Boeri & Terrell (2002) think of labor reallocation during the transition by looking into the two categories of countries: those that were created after the break-up of the former Soviet Union, and those countries that form the central and Eastern Europe. For the countries that formed the former Soviet Union, the level of employment decline was little. In these countries, the economies experienced a sharp decline at the beginning of the transition before the trend started to level up afterwards. For these countries, the levels of real wages and labor productivity decreased considerably. In these economies, it was common for small reallocation of jobs between the newly created industry sectors and the old ones. This contributed greatly to a large unemployment pools turnover.

In the second category of economies, that is, those of central and Eastern Europe, employment rates fell sharply during the early days of the transition. This decline led to productivity decline. However, for these economies, earlier economic recovery was experienced compared to the former Soviet Union countries. On the general picture, these economies have been characterized by rapid structural change. This change has led to the creation of an unemployment situation that appears desperately stagnant (Boeri & Terrell, 2002). However, (Boeri & Terrell, 2002) note that two countries: Czech Republic and Estonia fall on the border between countries of the Eastern and Central Europe and those of the Former Soviet Union. Whereas Czech Republic has all along exhibited a relatively longer period of low employment, Estonia has been displaying a marked labor reallocation since the start of the transition era.

Multiple perspectives can be used to explain the differences in levels of unemployment during the transition period. The main ones include by-products of institutional asymmetries and macroeconomic policies. For Boeri & Terrell (2002), the main factors include GDP, institutional determinants of unemployment, and asymmetric patterns in labor reallocation. According to Boeri & Terrell (2002), the emergence of non-employment benefits has changed the dynamics of unemployment in Slovakia as well as other countries of Eastern and Central Europe. Other factors that have contributed to the level of unemployment in Slovakia include labor unions, market insiders, and government policies on wages. These factors continue to affect the various paths that policymakers follow in the quest for success in the reallocation of labor during the transition period. Slovakia’s non-employment benefits take the form of both unemployment benefits as well as all the financial benefits accorded by the government to everyone who is not in formal employment. Such benefits normally include liberal social assistance, free access to pensions for people with disability, and early retirement.

A comparison between the countries of the former Soviet Union and those of Eastern and central Europe shows that the latter have all along endeared to commit more resources into non-employment. This, according to Boeri & Terrell (2002), made the distributions of earnings to be affected wages through the creation of a floor under the wages. The effect of these wage floors was felt through continued job destruction especially in the unskilled workforce category coupled with low payments those who were employed in state industries.

Slovakia, being one of the countries of central Europe, was one of the countries experiencing wage floors, which destroyed jobs especially in the unskilled workforce category. Moreover, it was one of the countries whose governments responded by extending start-up income as a stimulant to the establishment of small-business activities. The government also provided incentives that made it easy for people to engage in self employment, thereby creating a richer environment. For a large number of unskilled, unemployed people, this means staying out of formal employment as they pursued emerging small-business opportunities.

Effects of the transition into the market-driven economy on Slovakia’s unemployment levels

Some transition countries have managed to make considerable strides towards progress from the centralized economies to free-market systems (Vlachoutsicos 1999, p. 2). However, for others, such as Slovakia, the transition has been characterized by severe unemployment spells, especially during the early days of the transition (Ham 1998, p. 1124). During the transition, many stakeholders have expressed fears owing to the resulting institutional uncertainty. The main fears arise from the unusual state of being ‘self-responsible and being independent, without the protecting umbrella of the state (Vlachoutsicos 1999, p. 4). There are also fears arising as a result of ‘too many rapid changes’, ignorance of markets, and fear of one’s power after losing a job.

In many post-communist economies, the extent of stability within the market economy tended to be largely dependent on the way local social value systems were embedded in new practices. The new systems had to be designed in such a way that the new market system would fit into them. Successful transition tended to be hinged upon the ability to overcome internal enterprise-related barriers. The fears of various stakeholders needed to be addressed. Moreover, the risk of not being mindful of such critical factors such as experience, prevailing managerial behavior, and skills was so high that any wrong steps could easily bring about a state of wage rigidity.

Indeed, one of the unavoidable consequences of the transition in Slovakia was the shift from ‘labor hoarding’ to a state of open unemployment. Nevertheless, these unavoidable consequences have not prevented some countries of Central Europe to emerge as the most advanced in the course of the transition process. These countries include the Czech Republic, Poland, Slovakia, and Hungary. Undoubtedly, the interaction between the socialist legacy and policy-related choices has had a far-reaching effect on unemployment. However, there are some stark differences with regard to the experiences of unemployment in these countries of Central Europe. For instance, Poland has experienced a rapid rise in the levels of unemployment while in the Czech Republic unemployment level has remained steadily low.

In the economic system of the communist era, which was centrally planned, state-owned firms dominated the economy. They tended to employ more people than were actually required. This practice, known as labor hoarding, was sustained by two main forms of control: low wage rates and an unconstrained ‘wage bill’. With the low wage rates being in place, there was a low level of differentiation in all levels of skills. Regarding the wage bill, there were no constraints on the amount of money that the state-owned firms were allowed to spend.

Interestingly enough many people acknowledged that a period of transformational recession accompanied by open unemployment would be one of the key characteristics of the recession. However, these people were unwilling to predict how strong the effects of this recession would be. Instead, they choose to wait and see. Poland was the first Central European countries to experience this transformational recession in 1992. This was also the time when the country’s aggregate economy began growing.

In market economies, it is common for delays to exist as employment is responding to an output slump. In this case, firms endeavor to minimize their transaction costs that arise whenever they want to hire and fire. In this case, many incentives become available, which motivate the firm managers to wait, particularly they suspect that a prevailing recession is a part of the normal business cycle. In this case, they tend to assume that such a recession cycle s driven by frequent changes in aggregate demand. From this perspective, one is able to notice that it is not surprising for unemployment paths to exist in economies that are in transition. Subsequently, one can attribute the unemployment problem in Slovakia to a low uptake of labor force into the private sector as opposed to the massive layoffs that followed the collapse of planned communist economies.

During the transitional recession that occurred in Slovakia and other countries of eastern and Central Europe, there were radical shifts in relative prices, something that is not characteristic of a standard business cycle. Similar shifts were recorded with regard to trade opportunities, thereby exerting enormous pressure for some restructuring work to be done. With this change of environment, many skills had to become obsolete. They were not compatible with the new market-driven economic system. The place of these skills was taken by new ones, relating mainly with finance and marketing. In this new economic system, opportunities for retraining became even more diminished, thereby making further inflows of unemployment unavoidable.

Moreover, even if the problem of reallocation did not occur, labor hoarding had already become endemic in many planned economies. In this regard, one would have expected employment levels to require some adjustment during the start of the transition period. In this context, it is rather difficult for one to explain the difference between a decline in employment levels and a reduction in the level of production during the transition. In Slovakia, the difference between employment reduction and production slump was even more striking than that of Poland.

Some pundits attribute the lag in employment levels in comparison with the growth rate in the course of the recovery phase to labor hoarding. This explains why the GDP continues to rise while a trend towards stabilization is recorded with regard to the employment index. Such a scenario was noticed in 1994 in Hungary, Czech Republic, Poland, and Bulgaria. However, in the case of Bulgaria, a reversal of the situation was observed following the financial crisis of 1997. Towards the turn of the century, both Romania and Bulgaria faced potential problems, whereby GDP growth was weak yet the employment index remained relatively high. As for Slovakia, the prospects appeared much better, owing mainly to the country’s impressive economic growth.

Ham (1998) observes that the unemployment spells in Czech Republic have been remarkably shorter than those experienced in countries of Eastern and Central European economies, notably Slovakia. Ham (1998) attributes the 50% of the difference in the durations of unemployment between Slovakia and Czech Republic to differences in demand conditions and demographics. The other 50% is attributed to proxy-related behavior among firms, institutions, and individuals on the one hand and differences in coefficients on the other. In both Slovakia and Czech Republic, an unemployment system has been in place, and this system has had a negative effect on the rate of exit from unemployment (Ham, 1998). The implication here is that a low level of uptake of labor in the new market-driven system is largely to blame for Slovakia’s high unemployment rate during the transition.

According to Ferragina (2008), two main theoretical models can be used to explain regional unemployment in the transition economies of Eastern and Central Europe: the neo-classical models and Optimal Speed of Transition (OST) models. Neo-classical models attribute spatial differences to institutional rigidities and constraints arising out of the supply side. In this regards, the regions with high unemployment rates and slow growth are typically whose economic structures are backward, and which present constraints with regard to the mobility of factors of production. These constraints make the problem of high unemployment rate persistent.

However, Ferragina (2008) observes that the main problem with such explanations is that they beg the question of why unemployment differences have arisen in the first place. For Ferragina (2008), the most excellent platform for answering this question is the OST literature. In this literature, the high level of labor turnover in regions with high unemployment rates is associated with a high degree of industrial restructuring. As a result, it is impossible to achieve low employment levels through a more gradual implementation of the transition.

Still on regional differences, the relative success of capital cities in comparison to rural areas and suburban towns in achieving low unemployment is attributed to foreign direct investment and trade at the international level (Ferragina, 2008). Contrary to popular belief, empirical literature shows that from the perspective of supply-side factors, wage flexibility in Central Europe is currently not lower in comparison to other EU member states (Ferragina (2008). Moreover, Ferragina (2008) concludes that labor mobility has been having the overall effect of reinforcing rather than changing the unemployment pattern from a spatial perspective.

Whereas some authors focus on regional differences, others choose to highlight the general trend in unemployment rates. For example, Nesporova (2002) comments that in all the transition countries of Central and Eastern Europe, employment performance has been disappointingly poor and the unemployment levels have been persistently high. Nesporova’s remarks arise out of his review of labor market development in several transition economies in this region. Nevertheless, some marked differences arise with regard to the levels of unemployment as well as the rate of progress being made to remedy the situation. As for the effects of unemployment levels on these transition economies, Nesporova (2002) points out that diversity of economic reforms has been inherent as each country has been striving to respond rather uniquely to its peculiar set of circumstances.

The unemployment levels characterizing the transition economies have also affected the modes of privatization adopted, macroeconomic policy, the development of small enterprises, progress of independent institutional reforms, and the affinity for foreign direct investment. To understand these effects in a more enlightening manner, there is need for researchers to dwell a lot on demographic factors as well as labor market dynamics. In this way, one can get an understanding of incomes policy, the role of labor market regulation, and the importance of collective bargaining. Such an in-depth analysis would undoubtedly provide impetus and suggestions on the necessary policy improvements and adjustments. For Nesporova (2002), the best way forward would be to increase employee confidence as well as increasing labor uptake within the newly created private sector.

Absorption rates of workers to jobs in the private sector

One key change that occurred during the transition period in Slovakia and other Central European countries apart from the transformation of the labor market policy was the reallocation of labor across sectors. In Slovakia, one of the key aspects of the reallocation of labor across sectors was the transfer of labor from manufacturing and agriculture industries into the service sector (Zecchini, 2000). This was one of the major tasks of the economic restructuring efforts of the former member countries of the Soviet Union. This move greatly influenced the rate at which jobs were being absorbed into the private sector. For many scholars, the low absorption rates of labor into the private sector largely contributed to rising levels of unemployment.

Economically, Slovakia was not fully empowered to oversee a successful process of reallocating labor, since this task had to fall in line with the ‘external’ factors influencing the labor market (Ferragina, 2008). Moreover, owing to the lack of confidence in the private sector, many workers were unwilling to move into the newly created sectors. It should be borne in mind that such a move could only be achieved after workers physically moved from one enterprise to another in search for work. The government lacked proper mechanisms of ensuring that the process of joining the employment environment sector was as smooth as possible. Therefore, the underlying problems of low uptake of workers in the Slovakian private sector has to do largely with economy-wide shocks, of which massive layoffs was just one of the many response mechanisms that the government adopted for remedial purposes.

Conclusion

In summary, the employment trend and unemployment problems encountered in Slovakia during the transition period are typical of the economic challenges that many countries of Eastern and Central Europe faced in the early 1990s. At this time, these economies were transitioning from planned economies characterized by labor hoarding to market-driven economies, characterized by restructuring of the entire labor market. One of the activities embarked on during this restructuring was massive layoffs of employees whose skills became obsolete with the transformation of large state-owned corporations into market-driven private companies.

            Although these massive layoffs contributed to Slovakia high rate of unemployment rate, the main factor that led to the sustenance of this situation was the low absorption rates of workers into the private sector. It is also worthwhile to note there is an abundance of literature on regional disparities on unemployment rates in Slovakia. In this regard, the main suggestion coming out of research on this issue is that consideration should be on adopting specific regional approaches to the unique regional problems labor problems.

 

References

Banerjee, B. & Jarmuzek, M. ((2010) Economic Growth and Regional Disparities in the Slovak Republic, Comparative Economic Studies, 52(3), 379–403.

Boeri, T. & Terrell, K. (2002) Institutional Determinants of Labor Reallocation in Transition, The Journal of Economic Perspectives, 16(1), 51-76.

Ferragina, A. (2005) Mind the Gap: Unemployment in the New EU Regions, IZA Discussion Paper No. 1565, April 2005.

Ferragina, A. (2008) Mind the Gap: Unemployment in the New EU Regions, Journal of Economic Surveys, 22(1), 73–113.

Gertler, P. & Senaj, M. (2009) Downward Wage Rigidities in Slovakia, AUCO Czech Economic,, 4(2), 79-101.

Ham, J. (1998) Unemployment and the Social Safety Net during Transitions to a Market Economy: Evidence from the Czech and Slovak Republics, The American Economic Review, Vol. 88, No. 5 (1998), pp. 1117-1142.

Jarmuzek, M. & Banerjee, B. (2009) Anatomy of Regional Disparities in the Slovak Republic, New York: Penguin Books.

Nesporova, A. (2002) Unemployment in the Transition Economies, London: Blackwell Publishing.

Rizov, M, (2004) Human capital, market imperfections, and labor reallocation in transition, Journal of Comparative Economics, 32(4), 745-774.

Vlachoutsicos, C. (1999) Internal Barriers in the Transition of Enterprises from Central Plan to Market, Working Paper Number 248, July 1999.

Zecchini, S. (2000) Lessons from the economic transition: Central and Eastern Europe in the 1990s, London: Heinemann.