metadata: authors: 0: author: Commander, Simon
1: author: Jackman, Richard
count: Russian Federation
docna: 0: docna: Providing social benefits in Russia :
            redefining the roles of firms and government
docty: Policy Research Working Paper
subtopic: Macro-Fiscal Policy,Economic Adjustment and Lending,Urban Housing and Land Settlements,Health Care Services Industry,Disability,Public Sector Economics,Urban Governance and Management,Urban Housing,Public & Municipal Finance,Educational Sciences,Services & Transfers to Poor,Economic Assistance,Access of Poor to Social Services,Municipal Management and Reform,Intergovernmental Fiscal Relations and
            Local Finance Management,Public Finance Decentralization and
            Poverty Reduction
teratopic: Health, Nutrition and Population
abstracts: cdata!: Russian firms commonly provide many
            nonmonetary benefits to workers, including such benefits as
            housing and some aspects of education and health care.
            Nonmonetary benefits may amount to 35 percent of labor
            costs, which is high compared with OECD countries. In a
            market economy, most of these benefits would be provided by
            local governments. The authors explain why the obvious
            solution - transferring social benefits and services from
            firms to local government or other agencies - is not so
            simple. At the same time, they outline the inefficiencies
            associated with firms providing such services and benefits.
            They explore the issues involved in calculating how social
            benefits should be divided between firms and the government
            and identify problems and options associated with the
            transition to a new division of rights and responsibilities.
            The main problem is housing. After a government decree in
            February 1993, steps have been taken to accelerate
            privatization, but they have been piecemeal. The main
            stumbling block is the financing and management of common
            property. The problem of free riders and the lack of an
            appropriate institutional setting is likely to exacerbate
            the problems of who handles and pays for common maintenance.
            The authors argue that a more systematic general program of
            divestiture in housing is essential. Part of this must be an
            explicitly new institutional arrangement for addressing the
            management problem. The quality of the housing stock varies
            greatly, so they suggest a scheme and possible financing for
            dampening the large scale effects of privatization and for
            ensuring a minimum level of quality for divested housing
            stock. They discuss the divestiture and related financing
            problems in a number of settings. What happens, for example,
            in a company town when the company ceases operation? Who
            covers benefits for the workers left without a job? What
            compensatory financial supports are provided in such a town,
            given existing budget arrangements?
geo_reg_key: 517208,517198,82689,517190,517191
repnme: repnme: Providing social benefits in Russia :
            redefining the roles of firms and government
display_title: Providing social benefits in Russia
            : redefining the roles of firms and government
listing_relative_url: /research/1993/09/698860/providing-social-benefits-russia-redefining-roles-firms-government
topicv3: Education m1327048 470,Social Assistance m1327201 1466,Local Finance m1327383 874,Land and Housing m1327648 817,Health m1504661 3480
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Health, Nutrition and Population
origu: World Bank Institute
no_of_pages: 45
model_extractions: <!-- Start of picture text -->
| ~~Policy Rud |o<br>National Eoonombc Manwagment<br>WPS 1184<br><!-- End of picture text -->

This paper-a product of the National Economic Management Division, Economic Development Lnstitute - is part of a larger effort in the Bank to understand the functioning of labor markets in transitional economies. The study was funded by the Bank's Research Support Budget under research project "Labor Markets in Transitional Socialist Economies" (RPO 677-30). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact **Olga** del Cid, room M3-047, extension 35195 (September 1993,41 pages).

Russian firms commonly provide many nonmonetary benefits to workers, including such social benefits as housing and some aspects of education and health care. Nonmonetary benefits may amount to 35 percent of labor costs, which is high compared with OECD countries. In a market economy, most of these benefits would be provided by locr, governments.

Commander and Jackson explain why the obvious solution -transferring social benefits and services from firms to local governrent or - other agencies L not so simple. At the same time, they outline th^ inefficiencies associated with firns providing such services and benefits. They explore the issues involved in calculating how social benefits should be divided between firms and the government and identify problems and options associated with the transition to a new division of rights and responsibilities.

The main problem is housing. After a govermnent decree in February 1993, steps have been taken to accelerate privatization, but they have been piecemeal. The main stumbling block is the financing and management of common property. The problem of free riders and the **lack** of an appropriate institutional setting is likely to exacerbate problems of who handles and pays for common maintenance.

Commander and Jackson argue that a more systematic general program of divestiture in housing is essential. Part of Ltis must be an explicit new institutional arrangement for addressing the management problem. The quality of the housing stock varies greatly, so they suggest a scheme and possible financing for dampening the large-scale effects of privatization and for ensuring a minimum level of quality for divested housing stock.

They discuss the divestiture and related financing problems in a number of settings. What happens, for example, in a company town when the company ceases operation? Who covers benefits for the workers left without a job? What compensatory financial supports are provided in such a town, given existing budget arrangements?

The Policy Research Working Paper Series disseminates the findings of work under way in the Bank. An objective of the series is to get these findings **out** quickly, even if presentations are less than fuDy polished. The findings, interpretations, and conclusions in these papers do not necessarily represent official Bank policy.

Produced by Lhe Policy Research Disseniination Center
# **Providing Social Benefits in Russia: Redefining the Roles of Firms and Government**

Simon Commander and Richard Jackman* World Bank

* We thank Annette Brown, Qimiao Fan, Jeni Klugman, Peter Knight, and Paulo Vieira da Cunha for detailed comments on an earlier version.
Benefits in Russia

# TABLE OF CONTENTS

||**Page**|
|---|---|
|Introduction|3|
|Firm Benefits- A description|_5_|
|Costs of Benefits|7|
|The Divestiture Problem|10|
|Housing Benefits- Incidence and Costs|14|
|Housing-<br>Some Possibla Responses|19|
|Types of Firms and their Settings|25|
|Company Towns|27|
|Conc.usion|28|
|Appendix 1: A Model of the Company Town|30|
3 Benefits in Russia

# Introduction

Russian firms commonly provide a range of substantial range of non-monetary benefits to workers, including a number of important social services such as housing and some aspects of education and health care. Some also supply services not simply to their workers but to the local community as a whole, for example sewerage, hospital buildings or other public infrastructure. Taken together, nonmonetary benefits and services may amount to something of the order of _35%_ of total firm labour costs, which is large in comparison with firms in most OECD settings. While the types of benefits and services range widely across firms, it is a reasonable generali6ation that most in a market economy would normally be the responsibility of local government rather than of a commercial firm.

There is a presumption that Russian firms shotuld transfer the socia. services and berefits they currently provide to local government or some other agency. At their simplest, the arguments are that Ru.sian firms will not be able to compete effectively in the market if they are at the same time burdened with having to run various social services, and that, at least in some contexts, enterprise closure could lead to a collapse in the provision of essential services if these had previously been provided . ne enterprise. In Dractice, the situation is rather more complex, and the probpects for achieving benefits from divestiture in the absence of parallel reforms of the housing and local government finance systems are much less clear-cut than these simple claims suggest. Most c'iiously, it will not help an enterprise to be divested of its services if it then has to pay as much in taxation to the local government as it previously paid in direct costs. Nor will it help people in a compaiy town to have entrusted services to a local government when the closure of the company would precipitate a corresponding collapse of local tax revenues.

Thus it may be helpful to examine explicitly the question of the appropriate assignment of functions between public agencies, such as lsZai government, and the firm sector. There are a number of potential inefficiencies associated with firm provision of social benefits: (i) To the extent that the services constitute a net burden, rather than a benefit of employment to the workers (see section 3 below), this net burd-!i **may** fall differentially on different firms, hence distorting competition between
Benefits in Russia 4 them. It would be the objective of a well-designed tax system that the costs of supporting local public services would be borne by non-distorting taxes (Wallich et al., 1992).

(ii) If firms pay the costs of social services for their workars, they may become reluctant to hire or to employ workers in "high risk" groups, e.g. women with young children.

(iii) If changing jobs means the loss of access to social benefits, or the disrttption of access, firm-linked benefits will hinder labour mobility.

(iv) There are arguments for managerial specialisation. Firms, it is argued, should have a set of objectives dominated by considerations of productive efficiency and profit maximization. There-may also be arguments for having provision of a service such as education, health or housing under a single management rather than these act:vities scattered around among many providers.

(v) In a company town, or a town dominated by a single industry, the closure of the company or industry will have the additional consequence of disrupting the provision of local social services.

Prior to discussing in more detail the arguments for specific benefit programmes and their methods of implementation, Tie attempt to give a short overview of the type of benefits currently provided by firms before attaching costs and/or income flows to those benefits. In t'is way, we hope to provide some measure of the share of benefits costs in total labour charges from the cost perspective of the firm while also picking up the effective distribution of labour income. In addition, we provide a more extended discuss:Lon of one crucial component of benefits -- the housing programmes run by a significant minority of firms. The data are generated from the two rounds of the World Bank firm survey carried out in the Moscow region in November 1992 and April 1993 2. The information relates for the most part to 1991 and 1992, but also in part to the first quarter of 1993. Because the sa7ple is both small and localized, obvious caveats concerning the represertative nature of our results arise. Further, while the conclusions do not seem inconsistent with information generated by larger samples and more aggregate data, bv concentrating on the Moscow region we

- The survey covered 41 firms in the Moscow area. For a more extended discussion of the results see, Commander et al (1993).
Benefits in Russia 5 have effectively ignored regional diversity and, in particular, issues relating to more rigid labour market settings, such as company towns or regions with significantly higher-than-average negative shocks to output. While this empirical gap is a major shortcoming, we attempt to incorporate in Section 7 some considerations appropriate to company or one-industry towns.

.: Firm Benefits - A Description A listing of the types of benefits provided by firms in the survey is given in Table 1. It can be seen that a significant proportion of the labour force continues to have entitlements to child care, paid vacations, housing and holiday homes. Benefits are both varied and pervasive across all firm size classes. Further, there is a positive association between firm size, as mea3uled by employment, at.d range of benefits. Larger firms generally provide more benefits end these likely include not only housing but also access to health care facilities (commonly in-firm) and other social functions, such as pre-school education. The absence of housing programmes among several of the largest firms in our sample may not be representative. Other evidence, including larger surveys, point to housing programmes as an almost defining feature of larger firs Lu. This _iJ_ more likely to be true for firms t>at act as locally dominant employers and in company-towns '. Here, the functions normally assigned to local authorities in OECD contexts are almost completely absorbed within firms.

But while the motivation for provi.ing a wide scale of benefits at larger firms had economic content, particularly in the Uesire to attach workers and zeduce turnover, it is important to appreciate the non-economic factors behind the phenomenon. Indeed, concepts such as prestige and benevolence have been and remain important considerations and, in some sense, enter directly into the utility function of managers of state firms. This may explain in part the slow pace at which managers are currently shedding such benefits, given the nontrivial costs attached to their provision. Indeed, without appreciating the underlying idea that the firm has an explicit social function and set of responsibilities, we are unlikely to understand the current responses. Among smaller firms with less local labour market dominance, the evidence See Standing (1992a)
6 Banefits in Russia suggests that firm provided benefits may not exceed those supplied by local authorities. Indeed, in our sample for housing, child care and health facilities, firm expenditure at local level was comparable or in excess of local .shority or non-firm expenditures in only 10-30% of cases, depending on the function (Table 3). As these items constitute the major expenditure charges on the benefits side, this cautions against a simplistic view of the scale of firmlevel functions.

From the survey we are also able to get some handle on the response of firms to the current and future provision of benefits. Several results stand out. First, larger firms offeiing wider benefits and higher aggregate benefit costs ha'7e begur to scale back these obligations. By end-1992 cver 35% of firms with housing prcgrammes had either reduced or suspended those programmes and a further 10% intanded to reduce them in 1993. For other social functions -- kindergartens, access to polyclinics -- between 10-20% of firms had started to reduce availability. In a significant number of cases in the survey, firms had begun to increase cost recovery by raising user fees, generaliy by applying differential tariffs for non-employee access to services. Thus, while there is a clear preference in all firm size classes to dispense wiT.h, or curtail, the range of benefits, most of this has yet to happen; being expressed as a projection for 1993. More strikir.g is the generally sluggish adjustment of benefits by firms, though, of course, we have no way to correct for quality of services or rationing. Part of the likely reason behind this inertia is the reasonably buoyant financial position of most sample firms in 1992 4. And indeed we find that there is a loose correlation between current profitability and benefits provision. However, most of this is captured -- as we discuss below -- by changes to housing programmes. A furthe? set of reasons concern the institutional difficult les associated with transfer, especially where municipal administrations, themselves often facing tighter budgets than firms, have been unwilling to take over the functions, exerting moral and other suasion on firms to maintain social activities (see Box 1).

In summary, preliminary indications from both the survey and other evidence See Commander et al (1993) for more details
**Benefits in Russia**

7 ilggest that firms have widely tried to economize on providing benefits, but the extent of 'ivestiture to date is perha-s less than might have been expected. 2; Costa of Benefits Ltttle ha%rd evidence exists that allows computEtion of the share of benefit costs in firms' labour payments. The survey, however, allows us to get a reasonably detailed picture on this score. First, wages as reflected in the **firms' wage** bills (inclusive of the wage tax) account for roughly 53% of total labour costs. Including bonuses raises this siiare to just over 60% for the entire _sanpls._ The remaining costs are distributed over Pensions, Social Insurance **taxes,** Employment Fund payments and, most significantly, Soci.ai Fund allocations s. The latter amount to over 20% of total labour-related c.sts and around 40% of benefit charges (ie, excluding the wage bill). Wh4.e we observe considarable variance over branches and firm size classes for the respective shares, we do in genetal find a surprising degrece of stability. This is also true for the leve2s. Comparing the first three quarters of 1991 with 1992, real aggregate labour costs fell slightly. Small declines were registered in 70% of branches with, significant ircreases in the remaining 30' Figures 1 to 3 show the path of aggregate labour-related costs and their - components for the period 1991.1 1992.4. The main story is the fair constancy of real labour-related costs. As such, we find considerable corroborative support for the conclusions derived from more aggregated wage data ;. Further, we can pin down reasonable stability in the cost structure allowing us to conclude that, at least for our samvle, benefits have not been usci as a mechanism for significantly raising aggregate labour costs. The path of both the levels and the shares indicates that including benefits costs in total labour costs has no marked effect on the distribution. This holds whether classifying over branch or firm size, as measured by employment or value of fixed assets.

Taken from the income side, we likewise find considerable stability in the The bulk of benefits costs >ave normally been subsumed in Social Fund expenditures. Qimiao Fan has pointed cut to us that firms could also write cenerits into production costs part.y ror tax reasons, as aiso because of restrictions placed on the use of the Soc,al Fund.

See Commander et al (1993b)
8

**Figs** 1-2

WAGES T 8ENEFiTS shcres from<sup>**cct**side</sup> <!-- Start of picture text --> 0! 4<br>0.2<br>1791 209I 3Q 4Q91 I1092 2092 3Q92<br>Wcqe bil i ns. furd E ocicin m fund<br>1;persLcn hrcd e wsci furd<br>WAGE: + EENEEiTS she,es from cos' side<br>C.56<br>C. 4.<br>I C-S1 2 '9t I -A 95 Z9CS Q2<br>l\77 .- t- sv- :::! !=rd<br><!-- End of picture text -->
9 Fig WAGES + BENEITS shares from cost s,de <!-- Start of picture text --> 0.5F<br>0.4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0<br>0.2 0<br>0.1.<br>191 2Q9 391 4c091 1Q92 2Q92 3Q92<br>w3 ce bil :onuiS fUnd socicl ris, tcx emPbYnent fund<br>perion fund so icl fuLd<br><!-- End of picture text -->
10 Beneflts in Russia shares -- wages accounting for roughly 50% of total. labour income, rising to around 65% when factoring in bonus payment3 -- and for the levels. In summary, it seems that benefits, dissociated from more convenitonal cash wage or effortrelated incentives, comprise at current prices approximately 35% if labour income. The dispersion is dampened by the dominant, across-the-board weight (0.6) of Social Fund expenditures in tctal benefits

# 3: The Divedtiture Problem

F.:om Ssztion 1 we have seen that firms do indeed provide a wide range of non-monetary benefits. To make thp analysis more tractable, it may be helpful to characterise the activities at issue under three broad titles; we deal with housing in Sections 4-5 below: (1) Services provided for current workers at the firm during the course of their work and as a bqnefit of employment (e.g. subsi'lsed meals in the works canteen, paid vacations, holiday acommodatio- in dachas or sanatoria, bports facilities). Such services cont titute part of the workers' wage package; they can be balanced by a lower cash wage and therefore do (or need) not add to firms' costs. Whether or not workers wish to be remunerated in this way may be open to question, thougb we may note that under current tax laws benefits in kind are not liable for payroll or personal income tax, and hence may be an attractive option for employers. Tax considerations aside, the form of the wage package would appear to be a matter for the workers and the firm concerned and not for public policy and hence, in principle, might be primarily a function of firm level performance and priorities. There is no obvious reason for government to take responsibility for the provision of such benefits for unemployed workers or for those whose employers do not provide them.

(2) Services provided for current workers and their families, for example pre-school education or health clinics. Tnis category differs from the first because the cost of these services can can differ enormously across different workers. In principle, it is important to distinguish between cost differences that arise as a result of insurable risks where the differences in costs incurred Note that by mid-1993 the Social Fund has increasingly become a convenient envelope in which ancillary expenditures of the firm are lumped. This obviously complicates comparison over time.
Benefits in Russia 11 in relation to different workers though large ex post is unpredictable ex ante, as against differences due to identifiable worker characteristics.

Examples of insurable risks which a firm may take on could include pensions, provided that these are computed on an actuarially fair basis, or medical facilities to treat accidents and other unpredictable health problems. If these services would not otherwise be available for the workers, then in principle, as in case (1), the benefit of provision of the services can be balanced by a lower cash wage. The **firm** is in a sense acting as a private insurance company for its workers and can reduce wages by an amount representing the insurance premium. As in case (1), this activity need not add to the firm's costs. Pensions lie outside the scope of -this paper, but as far as health services are concerned the picture is further complicated: o In many localities it appears that a substantial part of the costs of health clinics, in particular wages and salaries of both medical staff and medical supplies and equipment, and in some cases also maintenance and upkeep of buildings, are paid by local authorities even in respect of enterprise based clinics.

> O In general there are other health clinics in the locality which workers from the firm would be able to use them if their own employer did not provide one. Hence, abstracting from differences in quality on which the evidence appears conflicting, there is no benefit to the worker, save that of greater convenience, from employer provision. Essentially, the firm can only pay lower wages to recover the costs of provision in circumstances where the service would either not be available at all, or where the worker would otherwise have to pay for it.

Identifiable risks arise with services such as pre-school education, where even if the firm cannot tell in advance how much taking on a particular worker will cost it, it can very reasonably expect that women with young children are likely to cost it much more than, say, 45 year-olds. Retention of these services in the enterprise leads to a number of potential difficulties, most obviously that, to hold down costs, enterprises are likel. to become reluctant to hire workers from 'high risk' groups. In principle, with competitve markets, the market wage of different groups would adjust to equate the expected total. cost
Benefits in Russia 12 of employing different types of workers to their marginal products, so that, even if equally productive, 'high risk' workers would get paid less. If firms were not allowed, or not prepared, to discriminate in wages in this way, the outcome would be unemployment of high risk groups. If public policy is to shield individuals from the costs of pre-school education or health care, these services cannot be left to the enterprise but would have to be supported from public funds. Even though, amongst large firms, the incidence of such costs per worker may be approximately equal ex post by virtue of the law of large numbers, firms will still have an incentive to hire only low risk workers in order to save on such expenses.

In principle, user fees could achieve much the same result as wage flexibility and hence mitigate some of the adverse incentive problems that differential risk categories might impose. However, the current practice in Russia whereby generally 20% of the cost of pre-school education is borne directly by the parents and the remaining 80% by the parents' employer or employers, though alleviating the financial imbalance between enterprises which provide pre-schools and those that do not, continues to impose a potential financial burden on the eLnployers of workers with young children.

(3) trvices provided for the local community, whether or not employees of the enterprise (for example, provision of public infrastructure, hospitals, or transport subsidies). If access to these services is open to al1 citizens of a locality, they cannot form part of the wage package, unlike cases (1) and (2), and hence, in a mul.i-firm labour market, their cost will be incident on the enterprise itself and cannot implicitly be shifted to workers in the form of a lower cash wage. (In a company town, on the other hand, it is possible for the enterprise to 'tax' its workers to pay for public services, see section 7 below.) Whether the costs of these services be transferred to consumers, to the local government or to central government depends ultimately whether the services are private goods, local public goods or have an income redistribution objective. For example, in current conditions in Russia there is probably not much ;ustification in terms either of economic efficiencv or income cistribution for public transport subsidies, while hospitals might reasonably be made a responsibility of local government. The survey evidence, reported in Table 1,
Benefits in Russia 13 shows that none of the firms in the Moscow area are providing such services. This may not, of course, be representative, and may indeed be an indication that only firms that dominate their local labour markets are in a position to provide services of this type.

It is evident that most of the benefits in each of these categories would be provided in market economies by local rather than by central government. But this raises the problem of the adequacy of local government finance, and whether divestiture to local authorities simply recreates the problem at the community rather than the enterprise level. Most obviously it will not help an enterprise to be divested of its non-remunerative services if it then has to pay in taxation to the local government as much as it previously had to pay in direct costs. The cost of the service has to be met, but in a manner which (a) does not distort competition or efficiency and (b) provides a reliable and continuing source of funds irrespective of the fjnancial position of local enterprises. On both these counts, there are strong grounds for shifting at least part of the cost directly onto households, in the form either of direct charges or of personal or household taxes. Insofar as part of the burden continues to fall on firms, it should take a non-distortionary form (ie a tax on payroll or profits, but not a charge related to the demands its workers make on these services).

However, such measures can only improve the efficiency of cost recovery within the locality. In the event of the closure of large enterprises in a locality, there will be widespread financial distress, and no way of sustaining services on the basis of local resources however efficiently the burden is shared. Only central grants to local governments, or revenue sharing arrangements, can assist in the face of local economic collapse. In considering the design of a grant or revenue sharing system, it is again important that enterprises should be in a position to compete on equal terms across oblasts, and not be subject to hugely different tax rates. A general view is that the system of local government finance would need to compensate for two dimensions of differences between localities, namely differences in spending needs and differences ii, resources. A local government supported by resource equalization grants can continue to provide social services irrespective of the financial position of local enterprises. There is, however, at present in Russia no
Benefits in Russia 14 systematic resource equalisation procedure, so that the financial failure of an enterprise leads to a corresponding collapse in local government revenue. Without an appropriate system of local authority grants, the divestiture of services to local authorities provides no relief to areas in financial distress.

There is the associated question of the relationship between management and finance. Clearly the financial burden on enterprises could be alleviated as effectively by a syqtem of subsidies from public funds in support of nonremunerative activities. What are the advantages of transferring the management of such services, as opposed to just the cost, to gov"'rnment? And does the transfer of managerial responsibility necessarily enta4 f physical relocation of the facilities themselves in the case, -say, of cj --s cr kindergartens? While some managers in Russia regard running soci. ;riices a distraction from their main commercial tasks, others seem happy to teacr esponsibility for these aspects of their workers' lives. Since practice iv' thesce macters differs a lot in market economies, it would appear inappropriate to be too prescriptive. If t:,rkets are competitive and these benefits remain the responsibility of firms, there would need to be a system of financial transfers to firms, rather than to local authorities, to prevent the distortions described above.

With regard to the management of the services themselves, in principle there might seem to be gains of greater professional expertise and the like from having the service run by a specialist agency rather than by enterprises. In a town with a number of small enterprises each providing on a small scale health or pre-school education services, there may also be considerable efficiency gains from rationalisation of the service into a smaller number of larger units, though in the short run, it would obviously be wasteful to build new facilities and close down what already exists.

# 4: **Housing Benefits** - **Incidence and Costs**

Housing programmes provide the single largest component of benefits programmes. Though by no means universally provided, we found that a significant proportion of firms -- over 50% of the sample -- had some form of direct housing programme. There seems to be a clear positive association with firm size but, save among the smallest firms, housing programmes were offered by a majority of enterprises. In all, over 28% of the total labour force was housed in firm
Fig 4 15

# Real Vclue of Housing Expenditures

<!-- Start of picture text --> Constr & Maintenonce (dec 90 pnces)<br>1.9<br>1.7<br>1.6<br>1.3<br>i.2<br>0.5_\<br>0.<br>0.8<br>0.6<br>0.3-<br>0.2 -<br>0. 1<br>q gi q291 q391 q49 I q 192 q292 q392 q492<br>9 Empoy Sim! Class I + 5C 2 SC 3 SC 4 X SC 5<br>Fig 5<br>Real Value of Housing Expenditures<br>Mdinitendnce (dec 90 prices)<br>1.2<br>1.1<br>0. 9<br>0.8<br>0.7<br>0<br>0.5<br>0.4<br>0.3<br>0.2<br>O ElmaIoy Siz C q 9~~1 main q2grcnq gsss I ' q49 5C 2 1 mnain ° SCmain 3 2g2Smain 5CraSq3T q 492rman<br>C3 Ernplay SizeClassI -'4 SOC2 '0 SC 3 A. SC4 X SOCS<br><!-- End of picture text -->
Benefits in Russia 16 property and this share rose to over 75% in the case of the second largest firm size class (see Table 2).

While housing has normally been financed through the Social Fund, the survey indicates some recent departures from this practice. Firms with large housing programmes hare tended to shift to financing directly from profits or by borrowing. This is likely to reflect in part some of the risk sharing that firms are creating for new construction projects.

Figure 4 is instructive for showing a signifi:ant decline in the real value of construction by firms across most firm size classes when comparing 1991.1-4 with the same period of 1992; the decline is in excess of 60%. We also observe a fall in maintenance charges which, considering the limited scale of the intervening privatisation of housing -- barely 2% of tenants had privatized their apartments by November 1992 -- largely relates to the same housing stock. Over the same reference period, the decline is less than 30% and is not uniformly distributed over size classes. Putting the two expenditure items together, the result is more than halving of housing expenditures by firms comparing 1992 with 1991. The fall is considerably steeper among the firm size classes with higher frequencies for housing programmes. Relating housing outlays to total benefits expenditures captured by the firms' Social Fund, we again see a reasonably significant reduction in the share. For all firms housing expenditures declined from around 45% in 1991.1 to under 20% in 1992.3. A similar decline in the share of gross profits -- from 9% to 5% -- can also be observed.

The motivation behind the fall in housing expenditure is not difficult to fathom; indeed one might perhaps have expected a sharper decline. Rents remain regulated and yield derisory current incomes. Moreover, whiile housing programmes were commonly built up in the Soviet period to reduce labour mobility, this is certainly not an objective they attain at the present. We can see, in fact, that nearly 40% of current tenants in the housing stock of the survey were not current firm employees. This share was moreover rather stable across all firm size classes with significant housing stock.

It is interesting to estimate t.e likelv effect of reduci-;? rent contro s. Recent figures suggest large negative shocks to current -ncome given the extremely low base from which adjustments will be made. For-una-ely, :ne survey
Benefits in Russia 17 allows a rough estimate of the likely impact of rent adjustments in terms of wage income. As a base, we assume that the objective of the firm is simply to close the financing gap generated by maintenance expenditures. Bearing in mind that such outlays were 50% lower in 1992.3 than in 1991.3, we can calculate that it would require an additional rental payment by each current tenant of around 320 roubles per month in order to cover maintenance costs for 1992.3. The figure doubles if we assume that 1991.3 expenditures were a more appropriate target level. This implies that between 15-30% of average monetary wages would reed to be directed at housing rents simply to cover mointenance.

We can also extract some conclusions regareing the preferer.ces of firms and workers with respect to housing benefits and some idea of the likely direction of change for housing variables. In this regard, two factors should be emphasized. First, housing benefits were the last benefit that workers were prepared to lose, but inversely a benefit that some firms were ready to shed first. The picture on the firm side is ambiguous because new housing construction programmes potent;.ally offer high rates of return and current revenue streams -- either by direct sales of new housing stock or increased commercial lettings '. This ambiguity further shows up in the responses to questions about future plans for housing. Roughly 50% of responses indicated that housing programmes would be sustained at comparable levels to the current. Seven firms had curtailed or reduced their housing obligations by end 1992 with 2 more intending to reduce in 1993. Finally, in just over 50% of cases housing stock had already been or was in the process of being transferred to local authorities. The decision appears unrelated to current firm profitability but is clearly associated at the level of the firm with the decision over new programmes. Those firms with continuing or new housing programmes tended to retain previous housing stock, possibly cross-subsidising it through new starts.

In short, the survey results indicate a scaling back of housing construction and maintenance. There is a clear and sharp fall in the share of housing in total Social Fund outlays. But the picture is by no means uniform. Housing starts remain reasonabiv high as sales and more commerc_a: letti-ngs offer

> - See the case of TsAGI (Box 2) reported in Commander, Liberman and Yemtsov (1993a).
18 Benefits in Russia the prospect of reasonable current income streams 9. There is also some evidence that firms are using new programmes to subsidize the substantial outgoings on existing programmes arising primarily via rent controls. Such programmes tend to be primarily financed outside the Social Fund, commonly through retained profits and in some cases, through borrowing ".

Housing benefits, as we have seen, generally constitute the largest nonmonetary component in labour income and firm couts. From the viewpoint of the firm the possible benefits associated with providing housing could possibly be (a) increased effort by workers through any positive motivational effects linked to access to a desired resource, (b) positive benefits through labour attachment with presu7ed returns to 'resident skills' and retention of plant-specific human capital. On the cost side, the recent period has been dominated by the asymmetric evolution of maintenance charges and rent receipts, resulting in large financing gaps. This imbalance comprises one part of the claims of the firm sector on government; whether through the budget or the banking system. And while it is desirable to have such claims consolidated and openly recorded in the budget, it is also desirable to reduce the size of the claims. Unfortunately, we have no way of ae4quately specifying the level and share of housing and other firm benefit costs in total claims of the firm sector.

Tne provision of housing is strongly and positively correlated with firm size. Over time, the strict association of benefits to current employment -- in part the attachment of workers to firms that benefits were presumed to secure more satisfactorily -- has been dissociated from current employment. Rent controls, moreover, have been binding and in the most recent period rents have had very slight nominal adjustments despite high inflation. This, in effect, has increasingly left firms covering significant maintenance charges with little if any offsetting revenue from the extant housing stock. In many cases, this has led to a reduction or suspension of maintenance, reducing the quality of the 3 Note taxation of commercial rental income is fairly punitive but widely evaded.

; Note tha~- the number of firms undertaking construction projects in 4Q92 was half the level of 1991.1-4Q with over 75% of current construction costs covered by retained earnings.
Benefits in Russia 19 housing stock. Recent decrees and other measures aimed at facilitating the privatisation of housing and creating a framework for forming condominiums have had limited effect, partly because of continuing confusion over their status and legal validity. Ambiguities over title and rights, have commonly resulted in the worst of al. worlds -- both firms and tenants abjuring responsibility. The longer this persists, the more rapid will be the deterioration in the housing stock.

Despite rent controls, however, where internal financing or bank borrowing has been feasible, firms have actively pursued construction programmes, seeking once-off returns from 'key' money; rolling over these revenues into new construction projects. There are some indications that de facto firm-worker partnerships have arisen with rights to new housing contingent on up-front contributions in kind (labour) or cash. Given the substantial excess demand in the housing and office rental markets and the current thinness of those markets, returns to investment in buildings remain relatively high; but obviously are likely to decline over time. Further, there is little evidence for supposing that returns to building investment has been comparable in the more backward regions or areas dominated by single firms/industries and where the low level of economtic activity constrains structural change.

- 5: Housing **Some Possible Responses**

In considering how to tackle the current set of housing problems in Russia, three main factors need to be borne in mind. First, nearly all housing units, particularly in urban areas, consist of large blocks of flats, the maintenance and supply of communal services to which is the responsibility either of the firm or of the local government. Second, rental incomes fall far below the costs of provision of communal services, let alone making any contribution to the costs of maincena-ice, thus creating a substantial financial burden. Third, tenants can, for free, "privatise" their dwellings if they so wish, acquiring ownership rights without at present any obligation to contribute at an economic rate to the costs of communal services or maintenance. Within this context, three possible approaches can be easily identified. Each has its own set of problems and they are discussed below.

The first is to facilitate an adjustment of rents through an abrogation of
Benefits in Russia 20 rent controls or the introduction of service charges. This could be done gradually with a preannounced rate of permitted rent, or service charge, increase. With greater cost recovery, the presumption is that firms and local governments would better maintaix. their housing stock. While rental market conditions will vary widely, we may presume that, absenting the right to buy, the jump from controlled to market determined rents would be large almost everywhere and will not simply be a function of the cutrent low level of rents. Though excess demand is indeed large at present, both from households and from the business sector, this may in part reflect the near zero price rather than severe shortage. Lags in construction will restrain any rapid change in the housing stock.

The second approach is to transfer control of enterprise housing to local authorities or agencies dissociated from employment. One justification would be that the multi-functions of firms should be pared down leaving them to concentrat3 on essentials -- efficiency in production. Local authorities would be responsible for rent collection and maintenance with non-recovered costs absorbed by explicit budgetary allocations. The element of cost recovery would similarly be determined by the overall government stance on the level of rents and the frequency of their adjustment.

The third approach is to divest (compulsorily) housing to incumbents translating bccupancy into de jure transferable ownership rights. The objeztive would be to provilde workers with assets and stimulate (with appropriate changes to the legal environLment) the development of a housing market at low initial levels of capitalisation. The obvious merits of such ail approach include the provision of instruments for housing swaps as well as more conventional trades wittout, aZ the outset, being constrained by an absence of housing finance. As such, large scale privatisation cuts the cord from firms to housing; represents an explicit asset transfer to households (but one that is unlikeCv to have short run inflationary consequences via a wealth effect) and may help to reduce shortages in the housing market. The eliminiation or severe reduction in rent conltrols, as a subordinate feature of the divestiture, would be desirable as a
**21**

**Benefits in Russia**

means for provoking a **functioning rental market '1** Clearly, each approach has components that are not mutually exclusive and all have quite significant drawbacks. i: is useful to consider the nature of these drawbacks. The obvious problem with the first approach is that the gap between current rents and current maintenance remains very high. Rent decontrol would transfer this cost from the enterprise to households and this would call for significant adjustments to cash wages to compensate. This may lead to difficult problems of equity as between workers living in accommodation belonging to local authorities or to other enterprises, not to mention those who have privatised their homes, and likewise with tenants working in other sectors, or retired or unemployed, but little improvement_ to the maintenance of housing stock or the generation of a renta1 market, given current controls. It may also be politically disturbing if not impossible; giver. the implicit 'anchoring' of household incomes by rent controls.

Second, continuing to vest control with firms may run against the underlying trend. Firms provided housing in the old system to tie workers to employment, to reduce turnover and to validate the low level of monetary payments. But labour attachment is increasingly a function of relative wages and governed by local labour market conditions. Further, many firms will have to lay-off o7orkers. With excess employment, the decision rule on lay-offs is critical. Severance decisions will depend on the ratio of rents from job retention to outside opportunities, including, possibly, layoff with compensation (severance packages). For the worker, the rent from staying in employment equals the current wage (monetary + non-cash components) minus unemployment benefits by the probability of being separated from the firm. If the housing part of the non-cash component is in practice delinked from employment at the firm, then there is no direct effect on rents from staying in employment. But if, say, for mobility or other reasons, this does not hold, housing raises significantly the rents from staying in empluyment and may act as an impediment to restructuring, particularly given the shadow ratio of cash tc non-cash wages.

This decision is obviously very political, but a pre-announced declining scale of rent cqntrols could be introduced as companion to the transfer of assets.
Benafits in Russia 22 Finally, if loss of employment was synonymous with loss of access to benefits then in principle, firms could use extant housing stocks to attract and attach the workers to whom they give priority. We may presume that in a context of continuing shortages, this would be an attractive component of income. But rhese conditions do not and are not likely to hold.

The problems with t"e second approach are equally serious. In the first place, local authorities or newly created housing agencies will have no prior information on the housing stock (or tenants) of wh'.ch they are given control. Incomplete information regarding the characteristics of the divested stock will have costs and in principle allow space for gaining information rents. Most of such information has been vested to date in the firms as has a history of managing housing programmes. Equally, however, in most localities the local authority has a significant housing stock of its own, and no doubt nuch of the experience and expertise derived from managing its properties will be of value for managing any property taken over from enterprises. Nonetheless, experience in other countries with publically administered housing and limited sanctions against defaulters is that cost recovery remains low, requiring significant budgetary support.

The third approach has the evident drawback, that with heterogeneity in the housing stock, simple across-the-board transfer to incumbents will have powerful distributional effects. Those fortunate enough to occupy good quality housing will have windfall gains, while others may indeed be saddled w-th negative net worth with housing in poor repair and/or in declining regions. Further, given the current ratio of rents to maintenance costs, ownership transfer implies a large cost transfer from firms to households. With absent financing and problems arising from the nature of divested housing stock -- the predominance of small flats in large housing blocks -- this may actually compound existing maintenance .roblems and dissipate any of the positive effects of property rights transfer. While in a properly functioning market we could imagine that so long as the present discounted value of any investment was positinE, the obvious way to surmount the mismatch between asset and capital holding w(uld be for new owners to contract long term with agents prepared to invest in the improvement and subsequent management of the building. But aside from difficulties in writing
23 Benefits in Russia long term contracts in a context of erratic and high inflation and uncertainty, it is by no means clear, in the absence of a functioning capital market, that there are currently individuals/firms with sufficient resources to invest in this sphere r that the returns to such investment, appropriately discounted for risk, are sufficiently high to attract investment.

The inherent coordination problem arising from a decentralizing divestiture obviously gives rise to standard problems that can, in a crude sense, be interpreted in both 'stock' and 'flow' terms. The stock problem is to deal with excessively large differences across endowments given by the divestiture. In ?articular, we can consider some simple, necessary minimum conditions for a divestiture, such as that the divested housing have positive net worth. This would aim to minimize any moral hazard for firms to dump deteriorated housing on households and/or local public agencies. Even so, we can expect to find large dispersion in the values of divested assets. Clearly, it is not feasible to correct for spatial or other differences, but one desirable objective would be to correct for the most eggrpgious differences in housing stock quality at the outset of the divestiture; bringing all divested housing stock, in effect, up to a certain minimum level. The flow problem arises in creating a framework in which decentralized agents will be compelled to move as close to a coordinated result as could be obtained by a principal.

Given the non-trivial problems associated with each option, are there combinations that are likely to be more efficient ? At this stage, the discussion is limited to relatively competitive local labour markets with no single firm dominance. As already noted, we are assuming that the housing stock is composed of large numbers of individual rental ur ts within large blocks of flats. This potentially gives rise to easily recognisable problems -- particularly free riding -- once the prior coordination .if a principal has been removed. And any process of divestiture that gives significantly greater control rights to current tenants will tend to imply loss of coordination in decisions. Thus, the task is to ensure that any large scale divestiture is as egalitarian as possible, given spatial and other constraints; that compensating payments or means be made available to new owners of housing stock below a minimum standard and that the process of divdstiture be explicitly associated to an institutional
**24**

**Russia**

form consistent -,th encouraging cooperative behaviour. This has evident legal as well as econom%c implications.

We start wii:h the problem of the initial dispersion in the quality of the divested asset ar.d a possible mechanism for ensuring a minimum level. At this stage, we make no assumptions about the distributic . of housing around that minimum level. We specify some minimum condition using standard building specifications centred on age, square metreage and other characteristics. From this we derive the cost of bringing housing stock below that minimum specification up to the minimum; the cost, in other words, of closing t'gap ". Ideally, the solution would be to provide in lump-sum form the amount equivalent to closing that gap. This payment would be made at the time of the privatisation and would provide a rough-and-ready compensation to those holding housing assets in sub-minimum condition. It has the further advantage that the layment could be lump sum, involving no future commitments. How best to allocate that amount is discussed below and is contingent on the legal arrangement. However, it makes little sense to allocate grants to individual recipients of the divestiture when the very reason for making the grant relates to the characteristics of the building as a whole. Further, any grant so provided could be used to motivate behaviour by the new asset owners that was consistent with managizag a shared resource.

This leads us naturally enough to the second consideration; the institutional-cum-legal framework for the identification of rights and obligations. The rights, we assume, can be assigned strictly to current incumbents. The obligations are more difficult. In a multi-occupancy building, certain charges are common; maintenance being the most significant. A standard way to deal with this is to have a legal arrangement supporting articles of association along the lines of a cooperative or condominium. Crudely stated, each owner has rights contingent on satisfaction of obligations to the cooperative as a whole. These obligations could be specified in terms of minimum maintenance charges, either levied equally on all owners of flats or else prorated in terms of size of flat. Owrership would carry an obligatior, to fulfil This refers only to the collective dimensions of maintenance; hence only to external and common features of any given building.
Benefits in Russia 25 payments to the cooperative, with membership of the cooperative vested in each owner. There would have to be quite strong penalties, reinforced by the legal system, to default on payments. There are numerous examples from OECD economies of contractual arrangments that might be adapted. In the case of groups of owners receiving compensation maintenance payments, receipt would be contingent on formulating a standard articles of association and forming a managing board for the cooperative or condominium. The latter would be required to provide certified financial accounts at specified intervals. For those groups of owners not receiving compensation grants, receipt of title would be contingent on adoption of similar articles of association by all owners in **a** building; the same accounting and other rules would obviously apply.

# **6: Types of Firms and their Settings**

Any discussion of benefits has to distinguish not only over the type of benefit but also with respect to the type of firm as given by its place in the labour market. This is important given the immense diversity of firms in addition to the problem of concentration in employment.

At first approximation, we can characterise the Russian economy in terms of numbers of semi-closed economies within which labour is largely immobile. In addition, we can try and characterize in terms of degree of concentration over regions and within regions. Russian industrial structure has generally been characterized by high concentration. At one pole, we have the large company town; but also structures still dominated by relatively few firms. Pzown et al (1993), using a large firm dataset for 1989, qualify these assumptions in several significant ways !. First, they argue that at national level, there -s little robust evidence of concentration; further, Russian industry is not generally characterized by very large firms and those very large firms that do exist are not generally in heavily concentrated industries. In addition, most very large firms are not in company towns, but are located in areas with reasonably diversified industrial bases.

Nevertheless, 90% of Russian cities have 10 firms or lecs and empocyment The dataset excludes firms in the military-industrial complex and hence may iikely understate concentration.
_26_ Benefits in Russia concentration is quite significant. Further, given labour immobility across regions -- exacerbated by the housing constraint -- local concentration in employment is the more appropriate indicator for our purposes. Excluding the Central Region, which incorporates Moscow, between 25-70% of industrial employment in each region was concentrated in industries which had four or fewer firms in that region in 1989, as indicated in Table 4.

Further, even where a number of firms exist in a locality, in some cases they may all operate within the same industrial sector, so that the local economy is wholly dependent on the fortunes of one particular industry. Local government in Russia, at both oblast and raion levels, is financed wholly from taxes levied on local enterprises: a collapse in local industry therefore translates directly into a collapse in local authority revenues. There is at present no indication that the Russian government is prepared to contemplate the introduction of equalisation grants for local authorities, along Western European lines and as recommended by the World Bank ", so that there is at present no revenue provision for social benefits in the event of widespread enterprise bankruptcy in a locality. (For an example of a single industry town, see Box 2.) Concentration in employment is likely to be closely correlated with concentration in the provision by enterprises of services and benefits. This implies that shocks to employment likely translate into shocks to services. In the most extreme case when services are provided entirely within the firm this means cessation of benefits. This is less likely to be a problem in multi-firm settings with services provided largely outside the firm. This has both practical and analytical aspects and motivates distinguishing over such settings.

As a consequence, we modify our assumptions regarding the labour market setting. So far we have implicitly worked with what we call a Type . setting with many firms and industries in the local labour market. It has been assumed that there is some local labour market mobility, outside opportunities for workers and diversity in the provision of services; loss of employment may have marginal implications with respect to access to basic services. With reasonable local labour market mobility firms face an exogenouslv determirned supply price 14 See Wallich et al (1993)
Benefits in Russia 27 of labour; the package of wage and non-monetary benefits they offer has to be at least equivalent to what the worker could earn elsewhere. In such settings, one would normally presume greater municipal provision of services, since it is unlikely to be sensible for each firm to provide its own. Further, with a diversified industrial base sustaining local authority revenues, the bankruptcy of an individual enterprise can take place within a context wherein local government can take over the services the enterprise prerviously provided.

At the other extreme are what we call Type 2 settings, where one industry, or even a single company dominates employment in the locality: we refer to this as a 'company town'. Access to services and employment are strongly correlated. Value added in (or credits to) the enterprise-provides the only resource base for the finance of local social services. If there is no alternative source of employment, it is feasible for enterprises to tax workers in the form of a lower cash wage in order to pay for the services. Using this crude distinction over settings, we try and think through the implications for service provision in Section 7 below.

# 7: **Company Towns**

So far the treatment has largely concentrated on the divestiture problem in Type I settings. At the opposite extreme, the company town consists of a single manufacturing enterprise wnich is the dominant employer and upon whom all economic activity in the town depends. There is, in the extreme case, an identity of interest between the enterprise and the local community and this has continued after the breakdown of monolithic authority by an equivalence of interest between an erterprise concerned with the well-being of the workforce and a democratic local government, because the population and the workforce are essentially the same constituency. It follows (for a proof, see Appendix 1) that the level of provision of social benefits will be the same whether they are provided directly by the enterprise (financed by reduced wages) or by local government (financed by taxation).

However, this equivalence no longer holds if the enterprise cuts back employment as is likely with restructuring. For this creates a divergence of interests between the 'insiders' employed in the firm and the 'outsiders' who are not. Typically this may mean that if social benefits are left in the hands of
Benefits in **Russia** 28 the enterprise it will cut back, insofar as the insiders prefer higher wages for themselves to better services for the community as a whole (see appendix). The conflicting interests of different groups in the society are most appropriately resolved through the political process rather than relying on the benevolence of the enterprise workers.

Though **interesting,** the **extreme** case of the company town is, as noted above, something of a rarity. More common is the single industry town, such as the textile **town, Ivanovo,** which **is described** in **Box** 2. In a single industry town there may be many enterprises and factories with none particularly dominant in terms of employment, and a mix of social benefit provision be..ween the local authorities and the larger enterprises. However, everyone depends on the same source of **finance, the earnings** of (or credits obtained by) enterprises all of which are **concentrated** in **the same** industry. If the industry fails there is no way that a rejuggling of services between sectors can help.

The **dependence** of **local** public services on the profitability of local industry may appear to be a serious structural defect in the Russian system of local government finance, though it is to some extent mitigated by the fact that almost all taxes are initially collected at the local level, with a share, in principle, predetermined but, in practice, subject to bargaining passed up to the federal government. While enterprises can still borrow to pay their taxes the system can function. But, with the present system of local government finance, the imposition of hard budget constraints would have devastating effects on social service provision in industrially depressed lo.alities.

# **8: Conclusion**

Russian firms continue to provide workers with significant non-monetary components of income. The constituent elements vary substantially across firms but commonly are dominated by housing and acess to pre-school and health care facilities. Quantitatively, however, the housing problem dominates. Following the government decree of 10 February 1993, some accelerated steps toward privatisation have occurred but these have been piecemeal. The underlying constraint remains the management and financing cf the common provertv element. Indeed, in the current context the general problem of free riding and the lack of an appropriate institutional setting is only i kely to exacerbate the current
29 Benefits in Russia situation with respect to common maintenance and other charges. The paper consequently argues that a more systematic and generalized programme of divestiture is essential and that this needs to be explicitly associated with a new institutional arrangement addressing the management problem. Given wide dispersion in the initial qualitv of Lhe housing stock, we further suggest a scheme, and possible financing, for dampening the distributional effects of a large-scale privatisation and for ensuring a minimum level of quality for the divested housing stock.

The paper further discusses the divestiture problem and associated financing questions in a number of settings, focussing in particular on company towns or contexts where lack of diversity -in production results in serially correlated shocks which likely amplify the size of any fiscal or financial shock. Given such shocks, the resulting separation of workers from the firm/firms generates a potential problem of coverage of benefits over retained and separated workers. This likely requires that decisions over benefits be divorced from the decisions of the firm and suggests a greater role for local government. In addition, it raises quite explicitly the difficult financing problem. Negative financial shocks to a company town or single industry town imply a need for compensating financial supports, which under the existing budgetary arrangements are either absent or difficult to pinpoint. These issues stray directly into the overall question of fiscal relations between the centre and the regions. While obviously important, we do not deal with these questions in greater detail in the paper.