Mikrukova Olha

Inequality, Income and Poverty in the Transition: the Case of Ukraine

The goal of this paper is to describe what happened to the inequality, to

the real incomes of the population, and to poverty during the transition in

Ukraine. A major purposes of the paper are: to review the key features of

income composition, inequality and social policy in the former Ukrainian

system; look at what happened to the population’s real income - its size and

composition - during the transition; analyze the inequality and the change in the

relative position of different social groups during the transition; assess what

happened to poverty under the twin impact of declining income and growing

inequality; discuss social policy and social security issues related to the

transition.

Sources, Surveys Used and Data Problem

In this paper, we utilize various surveys conducted in Ukraine, which are

specifically focused on income, inequality and poverty. We also rely on

previously published data. The data derived from both sources pertain to the

period from 1990 to 1999. All data on incomes and expenditures come from

household budget surveys. The quality of surveys has not improved, and their

reliability may have deteriorated as circumstances changed. For example, while

the surveys may have once offered a more or less accurate picture of households

employed in the state sector, the decline in the size of that sector has

significantly reduced the importance of that information. The quality of pre-

transition Soviet official Family Budget Surveys was not satisfactory, there was

a pressing need to revise the surveys and, often, to undertake entirely new ones.

In Ukraine new survey instruments were introduced through the cooperation of

international agencies ( the World Bank, in particular).

Inequality and income composition in former Ukraine

Features specific to socialism are more apparent when the average income

composition for former socialist countries is contrasted with income

composition of developed market economies and of developing countries.

There are such features:

1. The share of primary income, that is, income that results from

economic activity ( labor, capital, entrepreneurship), was smaller in

socialist Ukraine than in market economies or developing countries.

This is a reflection of three phenomena: virtual absence of property

incomes; absence of occupational pensions ( which are considered pert

of primary income); and greater importance of income redistribution,

whether via the state (social transfers in socialist countries represented

19 percent of gross income as compared with 14 percent in market

economies) or privately ( 6% in socialist countries as compared with

1% in market economies).

2. Much lower direct taxation under socialism ( personal income taxes

plus employee-paid payroll tax): 10% of gross income as compared

with 25% for market economies. Total payroll taxes were high,

however ( between 40 and 50% of net wages), and the overall tax

burden was not much different trom that found in market economies.

3. Child benefits were more important in social countries than in market

economies ( 4% of gross income as compared with 1%).

4. Overall income distribution was more egalitarian than in most market

economies after allowing for (1) fringe benefits and various forms of

implicit income received by the nomenklatura and (2) direct subsidies.

The distribution of direct subsidies generally favored the poorer

segment of the population. Element (1) pulled income inequality up

while element (2) pulled income inequality down. When both

nomenklatura benefits and subsidies were added to measured income,

overall inequality did not change much. The Gini coefficient was 23. It

was similar with very egalitarian Nordic countries, but definitely below

inequality in other OECD countries, or other countries at similar level

of development.

5. Cash social transfers were distributed almost equally per head in

socialist countries in contrast to some market economies where such

transfers were more focused on the poor.

Transitions Changes

Conceptually, we can divide huge social costs of transition into two

categories.

First, costs associated with decreases in output due to systemic changes (

that is, the transition to market economy) and to macroeconomic stabilization.

These costs are expressed in lower incomes, higher inequality, and greater

poverty.

Second, job-loss costs associated with the transition. Job-loss is

sometimes accompanied by poverty but not always. Unemployment is a distinct

issue from poverty.

We shall deal only with the first type of costs. The unemployment is

discussed only to the extent that it affects poverty and inequality.

Income, Inequality and Poverty: changes and relationship during

transition

Officially reported GDP is now less than 40 percent of its 1989 level - a

decline twice as severe as than in the United States during the Great Depression,

and worse than that in many other Central and Eastern European countries.

Many factors including initial conditions and external shocks, subsidies to

failing enterprises, monetary expansion, and heavy borrowing have contributed

to Ukraine’s economic decline and growing poverty.

Human suffering has been the greatest cost of slow structural reforms in

Ukraine. Family incomes have declined, and health standards have deteriorated.

The sharp decline in Ukraine’s human development index - which reflects life

expectancy at birth, adult literacy rates, gross school enrollment, and real GDP

per capita - provides dramatic evidence of the pain that slow structural reform

has caused. In 1991 Ukraine’s human development index placed it at 32nd place

among 175 countries, but by 1995 it had dropped to 95th in this same group.

During this same period Ukraine has had to deal with a variety of environmental

problems, including the aftermath of the 1986 Chernobyl disaster.

With an average income of $ 2,760 per person in 1990, Ukraine enjoyed

the third highest standard of living among current members of the

Commonwealth of Independent States (excluding the Baltic’s). At the time

Ukraine was richer than two-thirds of the countries in the world, at least

according to official statistics. ( Living standards were overstated by official

statistics for at least two reasons. Fist, although the incomes were paid, long

queues were mute evidence of the fact that the money exceeded what was

actually available to buy, and thus money incomes did not reflect real incomes.

Second, the exchange rates used to convert rubles into dollars were artificially

established by the Soviet authorities.)

Of even greater than income levels is the 40 percent of Ukrainians now

estimated to be living below the poverty line. Estimates of household

expenditures from a 1996 World Bank study paint a brighter picture, showing

only 30 percent of people living below the official poverty line. But yhe official

Ukrainian poverty line at the time, equivalent to about $ 0,80 a day, was

certainly set too low, and so understates the incidence of poverty.

The World Bank normally uses poverty lines of $1 and $2 a day to

measure destitution and simple poverty in its low-income member countries.

Which generally lie in temperate or tropical climates. For transition economies,

which tend to be more urbanized and have colder climates ( thus requiring more

spending on public transportation and heating). The cutoff is normally $4 a day.

By this criterion, about 75 percent of Ukrainians were living below the poverty

line ( on a purchasing power parity basis) in 1997.

Growing income inequality also creates social and economic concerns.

During the Soviet era Ukraine ( and Belarus ) had the most equal income

distribution of the republic, as measured by the Gini coefficient. This common

measure of inequality stood at 23 for Ukraine and 26 for the Soviet Union as a

whole. Similarly, the richest 10 percent of Ukrainians earned 3.88 times as much

as the poorest 10 percent, compared with 5,66 for the Soviet Union as a whole.

By 1997 income inequality had increased significantly. Such a change is

normal, even desirable, as a country moves to a system where income

differentials provide incentives for people to get more education, work harder,

and take on more responsibility in exchange for higher incomes.

A final area of concern is the incidence of poverty across population

groups. From a policy perspective this pattern is important because it suggests

the social protection measures that would have the greatest impact on reducing

poverty at the least possible cost. The most vulnerable group in Ukraine is

families with more than three children - especially if the family is headed by a

single parent, usually a woman ( Table 1).

Table 1. Poverty incidence in Ukraine

Indicator

Poverty headcount index

Average 30 Number of children

0 27 1 32 2 34

3 or more 48

Number of people over 65

0 23 1 34

2 or more 49

Dependency ratio ( children and elderly ) 0 16

0.25-1.0 31 1.25-2.00 44

2.25+ 67 No active adults 39

Rural / Urban Rural 27

Semi-urban 28 Urban 33

Regional distribution South 26 West 28

Central 29 East 35

Education Primary or less 37

Secondary 31 Special. Sec. 27

Higher 20 Source: World Bank (1996), Poverty in Ukraine.

Changes in income family composition show in Table2.

Table 2. Income Family Composition and Families Expenditures, %

1990

1997

Indicator

all by social group all by kind of living place

families

workers

farmers

families

urban

rural

total income

100.0 100.0 100.0 100.0 100.0

100.0

including: labor income (wages and salaries)

67.5 78.1 59.4 44.1 64.1 23.2

social benefits (pensions, stipends, family an child allowances, subsidies, other soc. tran.)

13.4

7.9

8.5

9.9

11.1

8.6

private sector income

10.5 2.5 28.8 27.5 3.5 52.7

other income

8.9 11.5 3.3 18.5 21.3 15.5

total expenditure

100.0 100.0 100.0 100.0 100.0

100.0

including: food

32.8 30.2 32.8 56.6 47.5 66.1

goods

31.4 34.3 27.4 16.6 17.6 15.5

including: closing, shoes

17.6 19.2 15.6 6.9 8.0 5.8

furniture

6.5 7.6 4.2 2.0 2.5 1.4

bicycles, motorcycles

1.5 1.6 1.9 0.6 0.5 0.7

alcohol drinks

2.7 2.4 3.3 1.1 1.1 1.0

service

8.0 9.0 4.3 12.6 18.6 6.4

taxes

7.2 9.6 1.7 4.3 7.4 1.1

other

6.5 5.0 9.4 7.9 5.9 10.0

financial family income (interest, insurance)

11.4 9.5 21.1 0.9 1.9 -0.1

Sources: State Statistics Committee

Social Policy and Social Security Issue in Transition

The key issue that faces policymakers designing safety net programs in

transition economies is choosing between the following two concepts of social

assistance. The first is the northwest European concept. Its key features are:

• there is an official poverty line;

• income below the poverty line and assets below a certain minimum are

a sufficient condition for welfare eligibility;

• social assistance offices try, in principle, to cover the entire gap

between the poverty line and income, and that gap is filled with cash.

Such a concept can be termed the minimum income guarantee (MIG)

system.

The overall cost of means-tested benefits is typically between 0.75 and

1.5 percent of GDP and benefits account for about 2 percent of household

disposable income. No transition economy has such a system.

The second concept of social assistance is what exists in transition

economies – shorn of the enterprise-based welfare still present. The system

differs from MIG in the following respects.

First, although income testing is an integral component of the system,

having an income less than the poverty line is a necessary but not sufficient

condition for receiving social aid. Additional criteria must also be fulfilled.

These criteria are related to households’ low earning capacity ( almost zero

elasticity of labor supply ): single-parent status, presence in the household of

handicapped or elderly members; or «dysfunctionality»: alcoholism in the

family, drug abuse, mental incapacity.

Second, social assistance in transition economies is viewed as a temporary

relief and is often provided in-kind – for example, through hot meals or food

vouchers, drugs, child care assistance, payment for kindergartens, payment of

utilities and rent, provision of wood and coal, and so on.

Third, categorical social assistance in transition economies plays a more

important role than under MIG – for example, through state pensions for the

aged, family allowances, additional allowances for large families, milk and food

for school children, and special assistance for regions with a high concentration

of poor. Although most countries have categorical programs are smaller,

particularly when compared to Ukraine, where practically all social assistance is

(still) based on indicator (categorical) targeting.

Fourth, social assistance in transition economies does not aim to cover the

entire difference between the poverty line and actual income. The amount

covered depends on the judgment of local social assistance workers. Such

systems may be called income testing as screening (ITS) systems to indicate that

income is tested in order to screen applicants, but that there is no minimum

income guarantee. In Ukraine a «weaker» form of ITS system is applied.

Although social workers are supposed to observe official poverty lines, much is

left to the workers’ discretion; moreover, implementation depends on local

availability of funds.

Politicians and government officials often argue that a slow pace of

reform in Ukraine is needed to preserve social peace. The Ukrainian authorities

are not alone - countries around the world share this concern when faced with

making profound changes in economic and social structures. A good social

safety net is thus vital to the success - and the feasibility - of reforms. Ukraine

has a social safety net, but spending in real terms on social protection has

dropped. More importantly, the system leaves important segments of the

population in poverty while supporting some who are not impoverished.

Sickness and old-age are insurable risks. Everyone is likely to suffer these

debilities at some point in their lives. These risks are statistically predictable,

and the common way to protect individuals is to share the risk though insurance.

Ukrainians need to examine the following questions when considering

way to improve the effectiveness and financial sustainability of social protection

system:

•Who pays for the insurance against sickness and old age?

•How do they pay?

•How much do they need to pay?

•How can these costs be minimized?

•How can the services provided under these programs be improved

without increasing costs?

Insurance against the loss of income in old age is commonly believed to

come largely from the Ukrainian government - and to be hopelessly inadequate.

Critics claim that the average monthly pension forces old people to live in

poverty. In late 1998, for example, the official poverty line was 73.7 hrivnyas

per person, but the average pension was only 54 hrivnyas - less than a third of

the average monthly wage. But the situation is both better and worse than the

data would indicate.

On the positive side, most Ukrainians insure against loss of income in old

age not only with pensions, but also in many other ways - including working for

pay after normal retirement age, developing and maintaining family networks

that will support them in old age, and growing their own food in family garden

plots.

On the negative side, the pension system is not financially sustainable and

is running up large arrears. Some pensioners are not even receiving the meager

pensions to which they are entitled. Despite numerous attempts to raise

additional funds, there is no sign that the buildup of arrears is about to be

controlled. Like pay-as-you-go pension systems all over the world, the

Ukrainian system is in crisis. In fact, it faces even more severe problems than

other countries because of Ukraine’s low retirement age, numerous early

retirement scheme, and unfavorable demographic situation - the dependency

ratio is rising rapidly because birth rates are low and the population is aging

rapidly.

Ukraine’s pension system lacks some features of an ordinary insurance

system because there is practically no link between contributions and benefits.

Today’s pension benefits are little more then a minimal social safety net. Yet

despite very low pensions, the pension system is not sustainable because of

massive wage arrears and tax evasion.

Establishing a personified record-keeping system where records are kept

by individual worker rather than by enterprise is already under way, and this is a

good first step toward a sound system of contribution management. The

remaining elements of the future pension system should be introduced gradually

to ensure the security of the system while minimizing the transition costs.

Ukraine has a large informal sector that makes it hard to find any

indicator that would provide an accurate measure of household income and

consumption level. Official information on individual household income rarely

reflects the real wellbeing of the family and thus their need for government

support. In providing social services and benefits it is possible to use three broad

classes of targeting mechanisms.

Individual assessment mechanisms. This mechanism requires that

program managers make decisions based on the eligibility of individual

applicants. Examples of individual assessments options in Ukraine are mean

tests ( in housing subsidy program and some family childcare assistance

programs the eligibility criteria is household income that is below the cut-off

point) and using characteristics of household as the criterion ( e.g. mothers ).

Group or geographic mechanisms. Here groups of candidates are granted

eligibility on the basis of some easily identifiable shared characteristics. For

examples, in Ukraine single pensioners receive pension supplements. However,

the lack of poverty map and reliable regional poverty assessment does not allow

the use of geographical targeting.

Self-targeted programs. Some services and programs are ostensibly

available to all, but are designed in a way that discourages the non-poor from

using them. Three factor usually discourage non-poor from participating - time,

stigma, and low quality.

It is clear that self-targeting should be pursued where possible in

designing social assistance programs in Ukraine, for they involve the lowest

administrative costs, leaving more resources available to help the poor, and they

are least subject to abuse and corruption.

*** Ukraine’s only viable to restoring past living standards is to create a vibrant, export-oriented,

internationally competitive economy based on private sector initiative. To make this possible, Ukraine will need

to undertake far-reaching changes in the role of government, restructure production sector, improve the

investment climate, and provide high-quality education, health, and social protection. The challenge now is to

reach a national consensus on the need for such changes, and then to implement the reforms as swiftly as

possible - before more time is lost and the process become even more difficult. Fundamental structural change

will indeed involve pain, but the pain of not reforming would be even worse.