Poverty in Ukraine

Macroeconomic Decline and Poverty in Ukraine

Ukraine faced serious economic difficulties in the early 1990s: an energy price shock, evaporating military demand and dissolving trade relationships. The initial policy responses made things worse. Fiscal and monetary indiscipline led to 10,000 percent inflation in 1993. Limited price and trade liberalization and anemic privatization could not prevent output from declining precipitously, an estimated 47 percent between 1990 and 1995. Aggregate consumption fell an estimated 32 percent from 1991 to 1994. Economic policies subsequently improved, especially starting in the second half of 1994. By then, however, the damage to the Ukrainian economy was too great to reverse easily.

The macroeconomic collapse, together with the halting progress of economic reforms, adversely affected households in three ways. Weak labor demand resulted in a dramatic drop in the real wage, an estimated 63 percent between 1990 and 1993. Household financial savings were wiped out by hyperinflation. Social benefits declined in real terms, and in any case were badly targeted to help the truly needy. Rapid growth in the informal sector has only been able to cushion the impact of macroeconomic collapse on Ukrainian households to a limited extent.

Poverty Patterns

It is difficult to analyze poverty in Ukraine using official data. This study relies on studies that were carried out specifically for this poverty assessment, a household survey of income and expenditure, a labor sector study, and an anthropological study of poverty. Much more attention should be given to measuring and monitoring poverty in Ukraine. The poverty assessment recommends implementation of a Poverty Monitoring System.

In order to measure poverty over time and among groups, it is convenient to define a poverty line in terms of per capita household consumption. The poverty line used in this report, krb 3.675 million (about $24) per person per month in June 1995, is based on the food component of Ukraine's Minimum Consumption Basket together with a non-food component based on household survey data. This poverty line is a convenient analytical tool, but it is not intended as an eligibility threshold for social assistance programs. Using a poverty line of krb 3.675 million, 29.5 percent of Ukrainian households were living in poverty in June 1995. Poverty is not quite as serious in Ukraine as in Russia, but it is much more serious than in Poland. Many Ukrainian housholds are close to the poverty line. A proportionate 20 percent increase in per capita consumption would result in a 34 percent decline in the number of households below the poverty line.

The most important factor explaining the incidence of poverty in Ukraine is family composition. Poor households tend to have more children (under age 15), and more elderly (over age 64), than households that are not poor. Households with no adults aged 15-64 account for nearly one-quarter of all poor households, and nearly 40 percent of such households are poor.

Age is an important factor in understanding poverty. In Ukraine, beyond age 60, the frequency of poverty increases with each successive age bracket. This contrasts with most other countries where information is available. The usual pattern is that the frequency of poverty decreases with increasing age. Note that the key variable is age, not status as an old-age pensioner. Many old-age pensioners are not elderly (2 out of 5 old-age pensioners are under 65 years of age), and only a subset of old-age pensioners (35 percent) are poor. Attempts to help poor people by raising all old-age pensions are likely to be both ineffective and inefficient.

As measured by the household survey, rural poverty is lower than urban poverty, probably because of easier access to land and food. However, the anthropological study reveals very important qualitative differences in poverty between rural and urban areas. These qualitative differences are so important that one might conclude that rural poverty is more severe than urban poverty. There is also an important regional dimension to poverty, with the frequency of poverty highest in the east (35 percent) and lowest in the south (26 percent). The regional dimension of poverty is likely to become more important over time. This argues for federal, not local, funding for social benefits.

Explicit unemployment is not yet an important determinate of poverty in Ukraine -- the main labor force variable explaining differences in household economic well-being is the real wage. Many poor households do have working members, but they earn wages too low to keep the number of people in the household above the poverty line. Many other poor households have no members who participate in the work force.

The Labor Market and Poverty in Ukraine

A decline in real wages has been the primary labor market link between macroeconomic decline and poverty. The drop in real wages has been estimated at over 60 percent between 1990 and 1993. Taxes on labor totalling 52 percent of the wage bill mean that enterprises must pay much more for labor than the workers themselves receive. This discourages employment and pushes down wages, and it discourages informal, unregistered businesses from joining the formal sector.

Unemployment, even broadly defined, has been a less important link to household economic well-being than the real wage decline. The poverty assessment estimates broadly defined unemployment in Ukraine in mid-1995 at 5.3 percent, including 3.8 percent unemployment using the broad definition plus 1.5 percent unpaid leave and involuntary part time work. This is a large multiple of officially measured unemployment, which is still below 0.5 percent, but it is nevertheless low by comparison with other European countries. Official estimates of hidden unemployment exaggerate its magnitude because they are based on reports from enterprises. People who are on forced leave or involuntary part-time work cannot afford to remain idle, so they often engage in informal sector activities.

The rapid decline in the real wage, and to a lesser extent the decline in employment, resulted in a decline in wages as a fraction of household income from 71 percent in 1990 to only 49 percent in 1993. Subsequently, as other forms of household income also fell, this fraction began to increase and it increased further in 1995 as some increase in real wages occured. By mid-1995, wages accounted for about 60 percent of household income.

This average disguises considerable variation in the importance of wages among households. Specifically, wages as a fraction of income tend to be lowest for households at the bottom of the income distribution. This pattern means that even a large increase in real wages in isolation would leave many households in poverty. Stabilization, price and trade liberalization, and privatization policies that lead to economic growth and a resurgence in labor demand will be extremely important in alleviating poverty both directly via the real wage and indirectly via growth in non-wage income. The impact of growth must be complemented by reform of the social protection system.

Social Protection and Poverty in Ukraine

Because of the magnitude and depth of poverty in Ukraine, and because eventual resurgence in the labor market alone will not "cure" poverty, social protection reform cannot be delayed until the economic climate improves. A medium-term vision of social protection in Ukraine would include three main elements: a means-tested income subsidy that could evolve from the present targeted housing subsidy program; social insurance with the insurance function restored, financed by beneficiaries via a wage tax; and a social justice scheme for Chernobyl victims, financed by general revenues, with increased benefits for those still suffering the most more than a decade after the tragedy.

The present situation provides a starting place toward this future vision. The means-tested housing and communal services subsidy is an improvement over the old, universal housing subsidy, yet improvements in administration and a strengthening of the means test is desirable. A strengthened, means-tested child allowance and new means-tested benefits for the elderly could help population groups where the incidence of poverty is greatest. Social service programs are well intentioned, but they are being overwhelmed by the needs created by the general economic decline and they are dependent on weak local finances. The old-age pension system is a failure as social insurance because the contributions-benefits link has been lost to benefit compression, and it is a failure as social assistance because it is untargeted. Unemployment insurance has not yet demonstrated its value. Chernobyl benefits were designed to be financed by the entire Soviet Union, so Ukraine's efforts to finance them may not be sustainable. The Chernobyl Fund is financed by a 12 percent tax on labor that increases the cost of labor and pushes down wages. It is unclear whether Chernobyl benefits are achieving the goal of social justice for Chernobyl victims, since studies of beneficiaries have not yet been undertaken.

The first next step is to reach consensus among the populace generally, labor, business, the government and Parliament on a medium-term vision of social protection in Ukraine. After careful analysis of budgetary concequences, the means-tested child allowance should be strengthened and a means-tested social assistance benefit for the elderly should be introduced, both with federal funding. Improving administration of the targeted housing and communal services subsidy and strengthening the means test should have high priority. Locally controlled social services are the best hope of the truly destitute. Consideration should be given to strengthening these programs and financing them federally. In the medium-term, the goal for social assistance could be to convert the targeted housing and communal services subsidy into a means-tested income subsidy.

There is an urgent need for a periodic actuarial analysis of the pension system. Based on this kind of analysis, measures should be designed to increase the ratio of contributors to beneficiaries over time (for example, by gradually raising the pension age) and to decrease the ratio of the average pension to the average wage (for example, by paying reduced pensions to those who claim them before age 65). As these measures take hold, it will become possible to decompress the benefit structure and restore a strong contributions-benefits link. The Employment Service should focus on paying benefits (its insurance function) rather than on training and job creation programs that have not been cost effective in other countries. The modernization of the health sector should take precedence over so- called "health insurance" that is not, in fact, social insurance at all. Wage tax financing of the health sector should be avoided.

Beneficiary studies are needed to make sure that Chernobyl victims are receiving the help they need. In the short-term, Chernobyl benefits and programs should be appropriated annually as part of the normal budget process, and the 12 percent wage tax should be added to general revenues. Over time, as economic growth permits, wage tax financing of the Chernobyl Fund should be replaced by general revenues.