Beblavy, Miroslav

English

Policy Documentation Center

INEKO (Slovakia) + ICPS (Ukraine): Transfer of Economic Reform Know-how to Ukraine, 
SlovakAid project Oct 6, 2004 
 
 1 
Policy Brief nr.1 
 
 
Social Security and Poverty Reduction Reforms in Slovakia and in the rest 
of the Central Europe 
 
 
Miroslav Beblavy, Ministry of Labour, Social Affairs and Family (Slovakia) 
 
 
This paper summarizes, in an extremely brief fashion, experiences of Slovakia and other 
Central European countries (Czech Republic, Hungary and Poland) in reforming their social 
security systems, with focus on poverty reduction. The paper proceeds along the following 
logic. First of all, it examines preconditions for successful reduction of poverty – 
macroeconomic stability and sustainable growth. It then looks at definition of antipoverty 
objectives and selects ones appropriate to the Central European and Ukrainian situation. It 
then focuses on potential instruments to achieve these objectives in the area of employment 
and social inclusion. 
 
The experience of Central European countries shows that macroeconomic stability is 
absolutely necessary, but not in itself sufficient to achieve a successful reduction of poverty. 
If fiscal and monetary policies are unsustainable or make the economy vulnerable to external 
and internal shocks, it is generally the poor and the vulnerable who pay a disproportionate 
part of the price. Fiscal deficit, high inflation, high interest rates and uncertain currency hurt 
the economy as a whole everywhere in the world, but they hurt the poor in transition countries 
more for two reasons. Transition countries usually lack markets where individuals and firms 
could protect themselves against macroeconomic instability (currency hedging, diversified 
investment portfolios) and where they exist, the poor and the less educated usually do not 
have the social capital and the skills to protect themselves. In other words, the poorer part of 
any society needs stability more than other groups.  
 
There are two essential features of macroeconomic stability relevant to transition countries - 
sustainability of the public finance and adequately anti-inflationary monetary policy. Lack of 
either one sooner or later requires a massive policy correction and it is the experience of 
Hungary after the 1994 crisis, of the Czech Republic after the 1997 crisis, of Slovakia after 
the 1998 crisis and of Poland during the recession of 1999-2001 that delayed adjustment tends 
towards overshooting, exacerbating effects of any necessary fiscal restructuring, particularly 
on the poorer elements of the society.  
 
The second precondition for a successful poverty reduction policy is a high level of 
sustainable growth, but such a topic is beyond the scope of this paper. Therefore, I would just 
point to one aspect of sustainable growth important for poverty reduction policies - 
diversification of the economy and attenuation of the economic cycle. Economies based on a 
small number of crops or industries which face a highly cyclical world market are bound to go 
through very sharp cycles of growth and decline in external demand. Slovakia was such an 
economy in mid-1990s, relying on its export of steel, chemical products and other 
intermediate manufactures. These disturbances have similar effects on the poor as overall 
macroeconomic instability.   
 
INEKO (Slovakia) + ICPS (Ukraine): Transfer of Economic Reform Know-how to Ukraine, 
SlovakAid project Oct 6, 2004 
 
 2 
Now let us turn the attention to actual aims of poverty reduction policies. While it can seem 
that defining objectives of poverty reduction is a straightforward exercise, it is the experience 
of Central European countries that both the public and the policy-makers emphasize 
inappropriate and misleading objectives within the context of middle-income economies such 
as Ukraine.  
 
First of all, how should we define poverty? There are two schools of thought in economic and 
social policy. The first one focuses on relative poverty – for example, the European 
Commission looks, in some of its assessments, at what percentage of the population has 
income below 60% of the median income in the country. The second school bases its analysis 
on absolute poverty – setting a benchmark of subsistence (such as USD 2 per day) and then 
determining what percentage of population in individual countries is below the benchmark. 
While both yardsticks are of value, I would argue that it is the second one that makes sense 
for poorer and rapidly growing countries. Relative poverty measures look at equality within 
any society rather than at actual poverty of individual. Based on this yardstick, more people 
are poor in Britain than in Bulgaria or Romania. Also, inequality tends to rise in rapidly 
growing countries, which is not a cause for serious concern as long as fruits of growth are 
distributed across the whole population even if not absolutely equally.  
 
Secondly, employment and unemployment tend to be key objectives of any antipoverty policy 
as risk of poverty is very closely correlated with unemployment in transition countries (of 
course, with the exception of the elderly). Most societies focus on the unemployment rate. 
While this, in theory, has the advantage of measuring the available labor force and 
concentrating the attention of policy-makers on those who want to work, but cannot find it, in 
practice this is not so. What is truly important for the economy is how many people actually 
work as measured by the employment rate (for example the % of people between 15 and 64 
who are in employment), because only these people actually produce goods, service and 
taxes. More importantly for the social policy, focus on formal unemployment rate creates 
incentive to promote economically and socially wasteful policies such as early retirement, 
easy access to the disability status etc. This is not a trivial issue. Slovakia and Hungary have 
the same employment rate of approximately 57%. However, Slovakia has a much higher 
unemployment – higher by 10% according to some measure. While this creates additional 
social pressure in Slovakia at the moment, this country will find it much easier to expand its 
labor force as the economy continues growing. For Hungary, it will be much more difficult to 
get people back into labor force from retirement or disability. At the same time, the Hungarian 
system is much more costly as the pensions are usually significantly higher than 
unemployment benefits.  
 
Last but not least, poverty is easier to bear and its social costs are minimized if poverty tends 
to be of short-term nature, is not reproduced across generations and individuals feel they can 
realistically rise from it.  
 
To summarize, for the Central Europe and probably for Ukraine, it makes sense to 
focus on three key objectives of antipoverty policy: increasing employment rate, 
reduction of absolute poverty and prevention of long-term poverty and improvement in 
social mobility. 
 
Now that we have explored key preconditions for poverty reduction and made our objectives 
clear and specific, let us focus on ways to achieve them.  
 
INEKO (Slovakia) + ICPS (Ukraine): Transfer of Economic Reform Know-how to Ukraine, 
SlovakAid project Oct 6, 2004 
 
 3 
Our discussion of instruments will be divided essentially into two parts. The first one is 
concerned with stimulating employment in the formal economy. The second one focuses on 
other specific policies of social inclusion that seek to reduce absolute poverty and its 
reproduction in addition to a robust employment policy. 
 
Stimulation of employment in the formal economy is a lynchpin of any antipoverty strategy in 
middle-income countries such as Ukraine. The strategy must focus both on migration of jobs 
from the informal economy to the formal one as well as creation of jobs in the latter. It is 
important to emphasize that any repressive element (police, tax authorities etc.) must play 
only a complementary part in the strategy. The key is to make creation of jobs in the formal 
economy more attractive. This can be usually achieved by a mixture of the following: 
 
- change in tax system.  
These steps usually include decrease of tax rates, broadening the tax base, improvements 
to tax administration to achieve better collection, shift of taxation from labor to 
consumption and introduction of tax systems that make avoidance more difficult. In other 
words, successful strategies usually entail elimination of most if not all targeted breaks 
and subsidies in taxes in favor of a relatively low rate for everybody; focus on VAT and 
excise taxes as the key source of revenue; reform the expenditure side to allow a 
corresponding decrease in the revenue and relatively low rates of personal income tax and 
social security contributions. Slovakia is a good example of this strategy – it has unified 
its VAT at 19% as of January 1, 2004, allowing it to create a unified flat personal income 
tax of 19%, eliminate double taxation (such as dividend tax) and cut social security 
contributions by more than 3 percentage points.  
 
- incentives for individuals to participate in the formal economy.  
As long as there is limited relationship between payments made by the individual (taxes 
and social security contributions) and what he gets back from the state, there is no 
incentive to participate in the formal economy as there is nothing in return. Therefore, 
reforms in Central European countries have contained elements that strongly link social 
payments by the state to contributions by the individual. In Hungary, Poland and Slovakia, 
the so-called second pillars of the pension system have been set up where a significant 
part of contributions is diverted into individual pension accounts. Even in the remaining 
public pay-as-you-go pension systems, there is a tendency to strengthen the link between 
contributions and pensions, sickness benefits and other payments, again with Slovakia 
being a prime example and the Czech Republic now also contemplating strengthening the 
link.  
 
- access to business and individual financing.  
One of the great barriers to business development and economic growth in developing and 
transition countries is insufficient access to financing, be it in forms of loans or capital 
infusions. As Hernando de Soto has identified, these problems are to a large extent related 
to problems in having a collateral, which is, in its turn, caused by faulty legal systems and 
unclear property rights. Most people even in poorer countries have assets, sometimes very 
significant ones, but either their ownership is not formalized or there are problems in 
pledging it effectively as a collateral for loans. The other frequent problem is general 
underdevelopment of the banking sector, extensive state involvement in banking activities 
as opposed to banking regulation and “protection” of borrowers from creditors which 
makes private banks reluctant to lend. Radical restructuring and privatization of banks has 
been, sooner or later, a key pillar of all successful economic policies in Central Europe. 
INEKO (Slovakia) + ICPS (Ukraine): Transfer of Economic Reform Know-how to Ukraine, 
SlovakAid project Oct 6, 2004 
 
 4 
The countries that have done it sooner – such as Hungary – have been more successful 
and did it more cheaply than laggards such as Poland, the Czech Republic or Slovakia. 
Slovakia has been a world leader in setting up a working system for using movable 
property (trucks, cars, inventory etc.) as collateral. Use of mortgages as a source of 
financing for business start-ups has been ever more frequent in recent years. The clear 
message is that creating these systems allows many more people to start or develop a 
business than any specialized state lending or grant programs and is much cheaper, and 
these small businesses tend to be principal drivers of employment in the formal economy. 
Additionally, such systems also create a huge incentive for existing informal economy 
businesses to switch to a formal sector because there are rewards for owners, such as 
access to bank financing.  
 
- regulatory environment, particularly labor market legislation.  
It is paradoxical that poorer countries with weaker state tend to have much more 
complicated regulations, especially in the labor market. A survey shows that some of the 
poorest countries in the world (e.g. in Africa) have some of the most rigid labor market 
legislations. Of course, this has the double problem of both not being enforced very well 
and driving employers into the informal economy. It is therefore essential to have labor 
legislation that is actually applicable in a given country under given circumstances and 
that does not prevent employers from hiring individuals by making it very expensive to 
lay off them when necessary. At the same time, the experience of Central Europe shows 
that decrease of employment in large, formerly state-owned enterprises cannot be stopped 
or prevented, only slowed down. The delay is usually either very expensive for the 
government (if it pays enterprises subsidies to retain employment) or can bring the whole 
enterprise under (if the government forces the employer to preserve employment). In the 
end, the money would be much better spent on retraining, infrastructure or social 
assistance. With this in mind, Slovakia has in 2003 reformed its Labor Code to increase 
flexibility in working time and in hiring and firing and to limit trade union power.  
 
In addition to a robust employment policy, there are other policies of social inclusion needed 
to reduce absolute poverty and its reproduction. Such policies take many forms appropriate to 
local circumstances, so let us discuss principles on which they should be based rather than 
policies themselves. 
 
The principal issue with regard to the Ukrainian experience is the issue of in-kind transfers, 
especially the so-called privileges. Central European countries have never had an extensive 
privilege system to begin with and they have progressively sought to eliminate whatever 
privileges remained and made sure that the government is paying for the ones that remain. 
There are several reasons for this approach. Non-monetary privileges tend to be costly either 
for the government or for the provider, they are usually badly targeted and overly generous. 
At the same time, they tend to create traps for individuals because they very often cannot 
change housing, job or something else without effectively losing a part of the privilege. 
 
On the other hand, some Central European governments (e.g. in Poland or Slovakia) have 
emphasized in-kind and conditional financial transfers as a complementary instrument for the 
poor in addition to basic poverty relief. Provision of shelter or food for the long-term 
unemployed by municipalities, subsidizing school lunches, textbooks and other necessities for 
poor children, housing subsidies conditional on payment of rent and utility prices or child 
benefits conditional on school attendance are all part and parcel of welfare systems in these 
countries. In-kind and conditional financial transfers can be efficient if there is a high 
INEKO (Slovakia) + ICPS (Ukraine): Transfer of Economic Reform Know-how to Ukraine, 
SlovakAid project Oct 6, 2004 
 
 5 
probability that unconditional cash transfers would not be spent in a way that reduced future 
poverty (such as education or housing costs) and if they complement a basic financially-based 
welfare system. 
 
One issue that has been of paramount importance in the EU as a whole and in Central Europe 
in particular is designing tax and benefits systems so as to create incentive to work. Slovakia 
and Germany have started ambitious reforms in this area in 2003 and 2004, with the Czech 
Republic now following. These reforms, such as tightening of the welfare benefits, 
conditionality of welfare benefits on public works, child tax credits and cuts in social security 
contributions seek to make work pay, even work with relatively low salaries. In Ukraine, due 
to the low level of unemployment benefits, this issue is likely to be somewhat less relevant 
than the others mentioned here.  
 
Another important issue concerns the targeting of social programs. Middle-income countries 
such as Ukraine cannot sustain the same level of taxation as EU countries and, at the same 
time, grow strongly enough to reduce poverty. Therefore, it is very important to avoid 
universal welfare states of the nature that many Western European countries have and to 
target social programs accordingly. There is a widespread illusion that since almost everyone 
is poor in countries such as Ukraine, the state needs to subsidize all. This illusion ignores the 
fact that, in the end, subsidies are financed out of taxed paid by the same poor citizens but 
decreased by all the costs and inefficiencies of the government. In this respect, successful 
non-European countries such as Chile or Korea can be a better role model. Housing, health-
care and education programs need to be carefully targeted to a guarantee of minimum care 
and access that is in line with what the country can afford. A very good targeting method is to 
focus on children from lower-income households. Integrated, effective and efficient programs 
from childbirth to adulthood that ensure reasonably equal access to health care, nutrition and 
education for all children have been shown to be among the best investments a public sector 
can make.  
 
In the conclusion, let me emphasize one issue where no Central European country has been 
very successful, which is likely to be relevant for Ukraine. There is a high number of losers in 
transition who are above 45 and very often with quite low levels of education. Ability of such 
individuals to adjust to the new environment, especially if they lose their jobs is limited. Their 
reintegration into the labor market has not been very successful and they either remain among 
the unemployed (e.g. in Slovakia and Poland) or have been sent into disability or early 
retirement (Czech Republic, Hungary).  


Social security and poverty reduction reforms in Slovakia and in the rest of the Central Europe

Abstract

Similar works

Full text

Available Versions

Policy Documentation Center