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. Last Updated: 07/27/2016

Jobless Lightning Fails to Strike

A recurring nightmare for economic reformers in Russia for the past three years has been that a growth in mass unemployment would trigger a social explosion.

The fear has been that as factories are confronted by the free market, they will start sacking millions of useless workers, provoking unrest, strikes and providing legions of angry supporters for people like Vladimir Zhirinovsky.

But despite all the pitfalls of reform in Russia, at least this scenario has so far been avoided. The official level of unemployment is only about 2 percent, up only marginally from 1 percent in 1992 at the start of reform.

Richard Layard and Andrea Richter, two economists from the Center for Economic Performance at the London School of Economics, in a recent unpublished paper, try to explain how Russia has avoided mass unemployment and what the costs of this major achievement have been.

The basic reason they offer for the low drop in employment and the corresponding slow growth in unemployment is that, in one respect, Russia is a neo-classical economists' dream.

Wages in Russia since the start of reforms have been highly flexible. If the demand for labor has dropped, the level of wages has fallen just as fast.

While production has fallen by about one third in the past two and a half years, the real wages of workers fell by a similar proportion in 1992 and have barely recovered since then.

In societies with less flexible wage structures -- that is where workers refuse to accept such wage cuts -- a fall in the demand for labor would result in much higher unemployment.

But in Russia, employers have been able to cut wages rather than cutting the number of people they employ. As a result, only 1.5 percent of the workforce was affected by lay-offs in 1993 and a similar proportion this year.Not only are wages flexible but the Russian worker has in fact accepted other forms of wage reduction that cut the cost of labor.

According to Layard and Richter, the Russian labor market has invented a form of job sharing that provides a useful cushion against long-term joblessness.

At any given time, about 2 percent of workers are on involuntary leave and about 4.5 percent are on reduced hours (although not part-time).

Russian workers are also willing to help their managers deal with cash-flow problems: at any one time over a fifth of workers have not received their last month's pay.

Why have Russian workers been willing to accept such a massive erosion in their living standards while workers in other Eastern European countries have struck or forced their company into a financial crisis?

The reason appears to be that Russian workers, who have a long tradition of identifying with the interests of their factory, have relatively little choice. Unemployment benefits are low and leaving a job often means losing company health care and housing.

Richter and Layard point out that wage flexibility has allowed for a relatively peaceful adjustment to the economic slump.

In industries facing a big drop in demand, workers have accepted much lower wages. This may involve a drop in living standards but it also avoids the socially destructive phenomenon of unemployment.

Eventually, workers who have taken a cut will try to find a new job with better pay in an industry where the demand for labor is growing.

One particularly positive note is that the transfer of labor from old industries to new ones appears to be happening. While employment in manufacturing fell by 8.7 percent and in science and scientific services by 13 percent, employment in finance and insurance grew 7.3 percent last year.

The downside of the Russian system of labor market adjustment is that in many cases workers are sitting around at factories doing absolutely nothing. This is in many respects just as destructive as unemployment for morale and does nothing to speed the process of restructuring.

For the moment, bosses are willing to keep these people on the payroll. Not only is this in the Soviet tradition, it is also encouraged by current labor and tax laws.

Compulsory severance pay for workers is high and a tax on excess wages means that managers have an incentive to employ lots of people on low wages rather than a few people on high wages.

The other problem with restructuring Russian style is that in many single-industry towns, there are simply no new jobs for people to go to. Ultimately, the population has to move and this can only happen over time, usually when the young leave home.

In these cases, Richter and Layard suggest, "Provided the young people do move, it may not be so bad to keep adults within the shell of the enterprises until new work develops."

Geoff Winestock is a Moscow-based correspondent for the Journal of Commerce. John Lloyd, who usually contributes The Big Picture, is on vacation.