Explaining the Increase in Inequality During the Transition

The paper tries to explain the increase in inequality that occured in all transition economies by constructing a simple model of change in composition of employment during the transition. The change consists in the "hollowing-out" of the state-sector middle class as it moves either into the "rich" private sector or the "poor" unemployed. The predictions of the model are contrasted with the empirical evidence from annual household income surveys from six transition economies (Bulgaria, Hungary, Latvia, Poland, Russia and Slovenia) over the period 1987-95. We find that the most important factor driving overall inequality up was increased inequality of wage distribution. Non-wage private sector contributed strongly to inequality only in Latvia and Russia. Pensions, paradoxically, also pushed inequality up in Central Europe, while non-pension social transfers were everywhere too small and too unfocused to make much of a difference