Why is Unemployment Low in the Former Soviet Union? Enterprise Restructuring and the Structure of Compensation

June 1996 The authors explain why in the Former Soviet Union (FSU) - especially Russia - unemployment has remained low and employment in state and privatized firms has remained high, while at the same time the informal or unofficial economy has grown swiftly. They trace this development to a combination of factors, including the control regime of state and privatized firms, the nature of worker compensation, and privatized firms, and the nature of subsidies or financial supports that firms continue to receive. Firms have remained the primary site for social protection. Subsidies for social benefits have effectively been a subsidy to employment and have promoted the workers' continuing attachment to these firms. Partly because the subsidies still flow and partly because of the firms' internal control structure, firms have held back on shedding labor. Firms typically work at low capacity. Instead of laying workers off, they significantly cut hours and wages, sometimes through wage arrears. The share of worker compensation that is nonmonetary had grown during the transition, and is significant. So workers search for additional sources of income, either moonlight or get involved in the informal economy. Why has this happened? Privatization has so far failed to keep firms from behaving as if they have important social responsibilities. Managers may have more discretion in decisionmaking, but seem to be reluctant to fire workers. This reluctance reflects various pressures, including insider coalitions and pressure from local and federal governments to limit the flow to unemployment. One factor may be the need to keep workers cooperative and possibly repel outsider interest. And in the FSU, many firms continue to operate under soft budget constraints, so they are under less pressure to reduce employment levels than firms in Eastern and Central Europe. The authors show that under certain conditions if the subsidy to insider-dominated firms disappears, those firms will scale down employment and the provision of benefits. In a firm with two divisions - one that produces and one that provides benefits - the dominant (producing ) division will tend to close down the benefits-providing division if the firm assumes a simple majority decision rule.