**|Policy,, Research, and External Affairs**

**| NtioalEconomic Management**

# WPS 736

This paper -- a joint product of the National Economic Management Division, Economic Development - Institute and the Macrocconomic Adjustment and Growth Division, Country Economics Department was prepared for a seminar on Central and Eastern Europe: Roads to Growth, sponsored by the Austrian National Bank and **lihC** International Monetary Fund, and held in Baden, Austria, Apiil 15-18, 1091. Copies are available free from the World Bank, 1818 **II** Street NW, Washington DC 20433. Please contact Olga lDel Cid, room M7-047, extension 39050 (38 pages).

Certain inherited features ol the socialist economies - socialized ownership, full employment, restricted job mobility, and de facto wage indexation - mean that drastic refonn of the labor market must figure prominently in overall economic reform.

The qucstion is how to implement that range of reformiis to ensure compatibility. One such tension relates to the fact that governments must demonstrate their commnitmeart to a more passive role in the economy while rnaintaining direct controls over wages and possibly job decisions.

Commander, Coricelli, and Staehr focus on the implications for wage bargaining and policy of inherited ownership arrangements and rules about wage selting during the transition.

**In** imposing unemployment on the system, by repudiating tlhe soft budget constraint, th1e refonning governmentt tries to teach workers and managers that behind it all lies a Phillips curve. But fiscal and political constraints limit the govemmen t's tolerance (if not stimulatiop) of - unemployment so agents may be skeptical about government adherence to announced policy.

Commander, Coricelli, and Staehr discuss the strong tendency toward overemployment and wage drift in socialist systems. They focus on the market-based transitional economy, exemplifled by Poland since 1990, settinig up a series of models capturing the behavior of workercontrolled firms.

They develop a simple policy game in whichi government policy is conditioned on output, through a subsidy instrument. This reflects the problemn typically faced by reforming govemments of whether to enforce a hard budget constraint (and hence tolerate higher unemployment) or whether to resort to subsidies and associated departures from fiscal targets.

Given **thc** commitment to p.ivatization and the consequent uncertainty about future claims on capital, they also develop -in a two-period model the conditions under which the workercontrolled firms will deplete capital stock, possibly through excessive wage growth. They indicate how an appropriate tax rule - in this case, a wage-per-worker rule can restrain decapf alization. They also discuss the possible utility of contingent claims on capital-- such as vouchers - in offsetting capital depletion promoted by uncertainty about property rights.

Finally, they emphasize the way wage tax rules can affect employment and wages and how critical is their design. A wage bill tax, as used in Poland through 1990, not only reduces employment but will probably raise wages. By contrast, a wage-per-worker tax will tend to raise er.ployment and lower wages. These effects are ikely to be reinforced in a two-sector context, where worker-controlled firms and private firms coexist and where relative wage considerations are important.

The- conclude thiat because of the inherited ownership structure and the uncertainty associated with reform, market-based regimes will continue to need centralized controls over wages in worker-controllllled firms (the socialized sector). Unemployment and an expanding private sector alone are unlikely to provide a sufficient restraining mechanism for wages.

The PRE Working Paper Scrics dissenlinates **thc** findings of work under way in the Bank's Policy. Rcsearch. and Extemal Affai s Complexx. An ohjectivc ofthe serics is to gel thesc findings out quickly, cven ifpresentations are less dtan 'ully polished. The findings, interpretations, and conclusions in **these** papers do not necessarily reprcsent official Bank policy.

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