Social Insurance in the Transition to a Market Economy: Theoretical Issues with Application to Moldova

April 1996 What is the proper mix of social insurance and social assistance in the transition economies of Eastern Europe and the former Soviet Union? Social security systems in Eastern Europe and the former Soviet Union devote most of their resources to earnings-related pensions and neglect targeted interventions to aid losers from the transition to a market economy. As social insurance systems, they have the characteristic weaknesses of the insurance model, paying benefits on the basis of past contributions or work history rather than need. Yet contributions and benefits are not closely enough related to enable the system to operate as social insurance in a market economy. More attention must be paid to the potential impact of high payroll taxes on employment in a market economy. Some analysts have argued that contributors to the system (future pensioners) should perceive their contributions as savings, in addition to which unemployment benefits and a new social assistance system could be developed. Such a two-tier system would distinguish between social insurance and social assistance. Mabbett discusses an alternative prescription --- a unified system, in which the earnings-related system would be curtailed, making it as flat as possible, thereby establishing a universal categorical age benefit. Other benefits, including unemployment benefits and family allowances, could also form part of the system. In principle, benefits in a unified system could be means-tested, but means-testing is not integral to the system, whereas it is the defining feature of social assistance in the two-tier model. Some analysts have argued for a unified system in the short term (because of fiscal constraints), moving to a two-tier system later in the transition. Both types of system exist in capitalist economies. Indeed, systems in many countries are an untidy mix of insurance and assistance. Mabbett examines some of the issues that arise from the relationship between insurance and assistance in the transition and beyond. She derives three criteria for determining whether the two-tier model is viable, then applies the criteria to the small republic of Moldova. She concludes that Moldova probably does not fulfill the three criteria because it has experienced a severe economic shock and adjustment has been a long drawn-out process. The two-tier prescription may be more problematic for countries of the former Soviet Union than for the Eastern European states. This paper --- a product of the Country Operations Division 2, Europe and Central Asia, Country Department IV --- is part of a larger effort in the region to assist in reorienting social expenditure to help the poor.