Kazakhstan: Living Standards During the Transition

This report examines the impact of the transition on living standards in Kazakhstan, assesses the scope for burgeoning growth to reduce poverty, and makes recommendations on how to strengthen the social safety net. There are three principal findings:

1. Over a third of the population lived below a 'subsistence minimum' living standard in 1996. This is significantly lower than estimates of poverty based on Family Budget Survey (FBS) income distribution data, and is due to problems with the measurement of income in the FBS.
2. Given the proportion of the population that can be considered poor, it should be clear that the problem of poverty cannot be eliminated by public transfer programs. Indeed, the social safety net has shrunk substantially since independence under the combined impact of falling revenues and the need to maintain fiscal discipline. Strong and sustained growth will therefore be key to poverty reduction in Kazakhstan.
3. Given that it is unrealistic to expect a significant expansion of social protection expenditures in the near future, assisting the poor will hinge on making existing social programs more effective. This should include maintaining an adequate income floor for pensioners, increasing the coverage of unemployment benefit, and reducing the leakage of child allowances and other social assistance to the non-poor.

Developments in the macroeconomy and the labor markets

Although poverty was not unknown in Soviet times, Kazakhstan was one of the least poor central Asian republics. However, the sharp contraction in output since independence has contributed significantly to an increase in poverty. In cumulative terms, the decline in output in Kazakhstan since 1991 has been of the order of 40 percent. Although employment has fallen, the burden of adjustment has fallen on the price of labor. Wages have fallen by over 50 percent in real terms, with serious implications for household income and consumption. Open unemployment remains low relative to the scale of output decline. Unemployment (ILO definitions) stood at around 4.5 percent at the end of 1994, rising to around 6 percent in 1996. Workers who are the most severely affected by unemployment appear to be new labor force entrants, those with low education or vocational and technical skills and, to a lesser extent, women.

At independence, Kazakhstan inherited an economy deeply dependent on Soviet supply and trade networks. The demise of central planning, the loss of established patterns of supply and trade, and the loss of transfers from Moscow following independence all contributed to large falls in output. The need to bring inflation under control squeezed the economy further. Stabilization efforts were however successful in reducing inflation which fell from over 1800 percent in 1994 to 29 percent in 1996 and 11 percent in 1997. The aftermath of separation from the Soviet Union appeared to have been finally thrown off in 1996 when, after declining continuously for five years, the economy began to grow again although at a modest pace. Economic growth during 1997 is estimated at 2 percent.

Another feature of macroeconomic decline has been a fall in the government's ability to mobilize tax revenues. As a result, tax revenue as a share of GDP fell from 39 percent in 1992 to 24 percent in 1996. Poor revenue performance has contributed to disproportionate declines in the social safety net, in public investment, and the funding of public services. In an effort to keep the budget deficit under control, the government has accumulated large wage and cash benefit arrears. At the end of 1996, arrears in wages stood at 6 percent and arrears in pensions at 2 percent of GDP. Pension arrears were fully cleared in 1997 at the cost of considerable belt-tightening in other areas.

The profile of the poor in Kazakhstan

This report makes use of the Kazakhstan Living Standards Survey (KLSS), a representative household survey conducted in July 1996, to examine the extent and main correlates of poverty in Kazakhstan. Households whose per capita consumption is less that the Government's 'subsistence minimum' (prozhitochnyi minimum) are considered to be poor⁽¹⁾ . Nearly 35 percent of the population was found to be living in poverty in July 1996. While by no means low, the estimate is significantly lower than poverty estimates based on income distributions generated by the Family Budget Survey (64 percent in 1995 and over 80 percent in 1996), largely due to problems with the measurement of income. Income data are often subject to a under-reporting, particularly in the case of income from own business and informal activity. While there are differences in rural and urban poverty rates, the more striking difference in Kazakhstan is by region. The poverty rate in the south of the country (69 percent) is nearly twice the national average, while that in the north (9 percent) is many times lower⁽²⁾ . In terms of number of poor, nearly two out of three poor people live in the south or east of the country. This has the strong implication that reducing poverty in Kazakhstan is largely a question of improving the opportunities for people in these two regions.

The poverty profile highlights correlates of poverty that are similar to that observed in other parts of the former Soviet Union (FSU). Large households with many children or many dependents (whether young or old) tend to be poorer, as do households with unemployed members. There is also a distinct correlation between low levels of education, and technical and vocational training, and poverty. Pensioners are also found to be at risk of poverty, although they are relatively well-protected from extreme (bottom quintile) poverty.

The analysis of household expenditures points to the emergence of own-production as a very important source of food consumption in Kazakhstan. Over a third of all food consumed on average in July 1996 was derived from home-production. In addition to growing their own food, individuals engage in other informal activity, including working in second jobs and running their own businesses. There are large, private inter-household transfers in Kazakhstan-mostly from family and other relatives-which are another important source of income. The growth of informal incomes does not come as a surprise given the sharp fall in main wages and formal social support. But equally, informal incomes significantly compromise the ability of the government to effectively means-test available social assistance.

The role of the social safety net in Kazakhstan

Kazakhstan's social safety net has undergone major transformation since 1991. The need to maintain fiscal discipline in the context of a sharp contraction in revenues meant that spending on the social safety net as a share of GDP fell by over a third from 11.2 percent in 1992 to 6.6 percent in 1996. Although new forms of social protection have been introduced-such as unemployment assistance-there has been a general decline in program beneficiaries assisted by a tightening of eligibility criteria. Real benefit levels have declined substantially, with the exception of means-tested child allowances. Although they have increased in real terms in the last two years, pensions remain at less than 50 percent of 1993 levels.

Pensions dominate social protection expenditures (over 75 percent), while child allowances come a distant second. The housing allowance scheme, which is currently quite small, is expected to expand in the coming years. Despite the general contraction of the system, there remain a multiplicity of small benefits which are complex to administer.

The 'thinning' of the social safety net is evident from the fact that over 60 percent of poor households in Kazakhstan receive no public transfers at all. This is partly related to pure 'gaps' in the social safety net, and partly due to non-payment of benefits to eligible households due to resource limitations. In the lowest quintile, pensions and other transfers contribute to about 20 percent of consumption on average.

Among existing social assistance programs, targeting of benefits towards the lowest quintiles is generally poor. In the case of the means-tested child allowance scheme, over 50 percent of the program expenditure leaks to the non-poor (defined as the top 60 percent). Better targeting outcomes have been achieved in other countries such as Uzbekistan, Albania and Chile. Social assistance which is targeted using categorical criteria generally does far worse in terms of leakage than the means-tested child allowance program as the categories in use are inherited from Soviet times and do not appear to correspond to the present realities.

Reducing poverty in Kazakhstan: growth and the social safety net

Given the scale of output decline, and the rise in poverty, it should be clear that broad-based growth that both raises wages and creates employment will be key to reducing poverty in Kazakhstan. Growth is critical not just for raising incomes but also for providing the resources for a fiscally sustainable safety net to help those who might be temporarily or chronically disadvantaged.

In general, the prospects for a sustained increase in output over the medium term in Kazakhstan are good, both because it is one of the stronger reformers among the FSU countries, and because it is well-endowed with natural resources(3) . The World Bank estimates that the economy will grow modestly in the short-run (2-3 percent), picking up speed (4-6 percent) early in the next century. However, there are several critical areas that need attention if growth in Kazakhstan is to be sustained:

• further development of the legal and regulatory framework for private sector development,
• stronger regulation and oversight of the financial sector,
• deepening of capital markets in conjunction with the careful management of pension reform,
• sound management of the process of enterprise restructuring to encourage output and productivity growth,
• improved management of public resources, including an expansion in the level and the quality of the public investment program, and judicious handling of likely future natural resource revenues,
• further restructuring and improvement in the quality of health and education services, and
• improved governance through the development of a professional, well-remunerated civil service.

While growth is a necessary condition for the reduction of poverty in Kazakhstan, it is not sufficient. Whether poverty is reduced by growth is a function of how income growth is distributed in society, and the opportunities offered by growth to the poor to improve their income earning opportunities. The restructuring that has yet to take place (notably in agriculture, but also mining, transportation, utilities, and public administration) is likely at least in the short run to swell the ranks of the unemployed. The evidence from the KLSS on the returns to education suggests that those with low education or mismatched skills may find it difficult to find work. The social safety net will be critical for these and other groups who are not well-positioned to benefit from growth.

Poverty Reduction Strategy

While important for maintaining the living standards of the poor, severe constraints have been imposed on the social safety net by poor revenue performance and the need to keep the budget deficit under control. Moreover, the transition from a public pay-as-you-go pension system to a private fully funded system starting in 1998 will add a significant burden to the budget for many years to come due to the reduction in payroll taxes contributed to the public system(4) . A national poverty reduction strategy should therefore aim to make social programs more effective within existing fiscal constraints. This report makes five main recommendations in this respect:

Ensure the adequacy of pensions under the pension reform. From a poverty perspective, the strength of the existing pension system in Kazakhstan is that pensioners do not face increased risks of extreme (bottom quintile) poverty. The 1998 reform provides for a minimum pension of 2,400 Tenge which is about 70 percent of the 'subsistence minimum' and in keeping with World Bank recommendations. However, a key concern is whether the minimum pension will be maintained in real terms. A second issue is whether state pensions will be paid on time. It will be important for the Government to maintain the minimum pension in real terms to protect the living standards of poor pensioners, and to keep to its commitment to prevent the emergence of new pension arrears. A medium-term issue under the reformed system is pension adequacy for low-income workers, those with short work histories, and women, all of whom typically receive lower pensions from systems which rely on personal saving. There are a number of options here for improving outcomes, including: higher contribution rates, contributions from other social insurance funds to cover periods of temporary inability to work (owing to sickness, maternity or unemployment), joint treatment of contributions, equalization of retirement age for men and women, and the use of standard life tables when issuing annuities. The Government should develop the capacity to analyze likely pensions for workers with non-standard work-history and other characteristics and develop options to ensure adequate replacement rates.

Improve the targeting of social assistance. Targeting of the main programs of social assistance in Kazakhstan (e.g. child allowances) has largely relied on formal income-testing. But given the structure of incomes in Kazakhstan, alternative approaches clearly need to be developed. One way to improve targeting at low cost would be to use additional household characteristics that are well-correlated with poverty, such as the presence of young children or unemployed members. More sophisticated proxy means-testing could also be considered, with attention both to administrative capacity and costs. Attention should also be paid to features of the housing allowance scheme that tend to exclude rural households (who are equally needy) and to replacing directed subsidies in utilities with targeted cash transfers to those who are in genuine need.

Rationalize social assistance programs. In addition to main programs which are means-tested, there a number of small programs (e.g. other child allowances, local social assistance programs) which are categorically targeted at pre-identified -vulnerable- groups. Data from the KLSS show that these programs largely benefit the middle income groups. These resources should be redirected towards those who are truly in need. A simple way to do this would be to continue the existing trend of merging existing programs with means-tested ones. Where this is not feasible, it would be worth considering making benefits subject to an income test, which although it has its limitations, would be an improvement over present criteria.

Strengthen the system of unemployment compensation. Although not directed at the poor, unemployment benefit in Kazakhstan is relatively well-targeted. Attention should be paid to increasing coverage, including through better provision of information to the unemployed and, possibly, through raising compensation levels. At the same time, rules governing receipt-especially with respect to job refusals-should be tightened so as not to escalate costs.

Consider assisting the unemployed through regionally targeted temporary employment schemes. Given the administrative costs and complexity of improving the targeting of individual programs, the scope for exploiting the self-targeting potential of public works programs deserves closer attention.

Monitoring progress with poverty reduction

Whatever improvements are introduced, it will be essential to monitor changes in poverty and targeting effectiveness. This report recommends developing the Family Budget Survey into an appropriate instrument for such a monitoring exercise. Improvements to the FBS being initiated under the World Bank's Technical Assistance Loan should be sustained. The Government should maintain a commitment to tracking the impact of growth and policy changes on living standards and developing the capacity to undertake analyses of alternative reform options.
Future agenda

Finally, this report does not address three types of policies that will need to complement the strengthening of the social safety net to improve living standards in Kazakhstan:

• Labor market policies designed to facilitate labor market restructuring, encourage mobility, and equip workers for changed economic conditions;
• Policies aimed at reducing regional imbalances;
• Health and education sector policies to maximize the poverty reduction impact of reduced expenditures.

The first of these is to be the subject of a subsequent study to be initiated during 1998. A start has been made on the second, through the World Bank's study of the Kzyl-Orda oblast which is affected by the Aral Sea crisis. Further work, particularly pertaining to the role of the republican government in reducing imbalances, and role of regional development policies, is clearly warranted. Restructuring the health and education systems so as to maximize quality and efficiency from reduced resources will be an ongoing challenge over the medium term. A Bank-sponsored health reform program, which is expected to be approved by March 1999, should be followed closely for lessons for the reform of the medical care system throughout the country.
                                                                                                                                        

Footnotes:

1. The subsistence minimum is based on a consumption basket, 70 percent of which is food and 30 percent non-food goods. The food basket is derived from official nutritional norms. In dollar terms, it is equivalent to around US$70 per capita per month at purchasing power parity (and around US$40 at the market rate of exchange). Although more generous than many poverty lines, the subsistence minimum does have the advantage of being recognizable.
2. The regions are defined as: North - Kostanai, Kokshetau, Pavlodar, and North Kazakhstan oblasts; Center - Zhezkazgan, Karaganda, Akmola and Torgai oblasts; West - Manghystau, Atyrau, Aktyubinsk, West Kazakhstan; East - Semi Palatinsk, East Kazakhstan, Taldykorgan and Almaty oblasts and Almaty city; South - Kzyl-Orda, South Kazakhstan and Zhambyl oblasts. In April 1997, the number of oblasts was reduced from nineteen to fourteen.
3. Natural resources can be a mixed blessing. The competitiveness of non-oil sectors of the economy has been found to be a problem in almost every country that has experienced a rapid expansion in foreign exchange earnings from petroleum exports. In a recent study covering growth in ninety-seven developing countries during the period 1970-89, Sachs and Warner (NBER Working Paper, 1995) found that countries with high export earnings based on natural resource wealth grew more slowly than those without such natural resources.
4. In the first year of the reform, the payroll tax funding the public system would fall from 25 percent to 15 percent.