and are insufficient to visibly lessen regional imbalances. The key to economic growth and thus better labor market conditions in depressed regions is investment and the consequent job creation. Thus, the challenge facing depressed regions is to attract investment, which requires creating incentives for firm entry, developing infrastructure, and investments in human capital to improve labor productivity.

To conclude, there are large regional unemployment disparities in transition economies, driven by region specific labor demand shocks as well as by regions’ structural characteristics. Particularly, the response to these idiosyncratic shocks depends on structural factors, such as the sectoral structure, presence of strong urban centers, the skill composition of the labor force, and the development of the infrastructure. Regional unemployment inequalities tend to be persistent, pointing to the weakness of equilibrating mechanisms, such as wage adjustments and labor mobility. However, they may also reflect regional differences in steady-state unemployment levels. To overcome these disparities depressed regions need to be turned into attractive locations for private firms to invest and create jobs. This in turn requires public investments in infrastructure and human capital.

# **III. WAGE DEVELOPMENTS**

Economic transition has been associated with profound changes in the wage level and structure (relative wages). Changes in the wage level represented a response to the changing level of output and productivity. Changes in the wage structure reflected changes in the wage setting mechanism (from bureaucratic and centralized one to a market based and decentralized one) as well as changes in the relative demand for and supply of different types of labor. A direct consequence the changes in the wage structure has been an increase in wage inequality. In the ensuing part of this section we analyze these developments in turn.

# **Real wages have been growing in all transition economies since the mid 1990s**

After an initial sharp drop in the early 1990s, real wages in virtually all transition economies have been growing at a pretty high rate since the mid 1990s, following gains in labor productivity.<sup>9</sup> However, the pattern of wage adjustment has differed considerably across ECA sub-regions. Generally, the wage drop has been much deeper in the CIS than in CEE. While in the CIS real wages are currently at around 50 percent of their pre-transition level, they close to it in CEE (Figure 10). After all in a few CEE countries wages are already higher than before the transition. Coupled with the earlier analysis of employment dynamics, these data suggest that while in CEE the brunt of adjustment to the transition shock was borne by employment, in the CIS it was borne by wages.

> 9  In most transition economies real wages are still lower than before the transition, but this result needs to be treated with caution.  The actual real wages decline was most probably much less then the measured one  This is due to the fact that the pre-transition level of real wages was overestimated in most of the transition economies.  This overestimation resulted from prices being set at below-the equilibrium level, as attested by pervasive consumer good shortages.  If prices were set so as to equate the demand for and the supply of goods, as it is the case in a market economy, then real wages before the transition would be correspondingly lower.  In other words, real wages before the transition were often not quite “real” in terms of consumer purchasing power.  If this factor were taken into account, the reported wage drop would be much less, although the degree of the correction varies by country.  In addition, wage data are likely to be affected by wage arrears and non-payment of wages, a problem particularly pronounced in CIS (particularly at the early stage of the transition).  Finally, a widespread practice of underreporting of wages to avoid tax payments also means that the actual wage growth during the transition is likely to be underestimated.

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