Structural Adjustment Without Mass Unemployment

1Structural Adjustment without Mass Unemployment? Lessons from Russia

Simon Clarke,
Centre for Comparative Labour Studies
University of Warwick

The Russian economy has seen GDP fall by over forty per cent and industrial production more than halved in the five years of radical reform and yet registered unemployment still stands at only 3%, with the labour force survey reporting a relatively modest 8.6% unemployment on the ILO/OECD definition at the end of March 1996.[1]

Is this low rate of unemployment an indicator of the failure of structural adjustment as state and former state enterprises continue to hoard labour, shielded by their soft budget constraints (Commander et al.)? Or is it an indicator of an extremely flexible labour market which is allowing extensive structural adjustment to take place without the intervening stage of mass unemployment (Layard and Richter)? Or is reported unemployment only the tip of an iceberg, with a large proportion of the economically active population in a state of limbo: some with occasional casual work, some formally employed but laid-off without pay, some working but being paid wages far below the subsistence minimum or not being paid at all (Standing)?

These three very different interpretations of the Russian experience have very different policy implications, not only for Russia but for all those countries that have been advised to pursue flexible labour market policies as part of a structural adjustment programme. However, to date there has been very little engagement between the three positions nor any attempt to confront them systematically with the available empirical evidence. In this paper I would like to review the evidence for and against these three interpretations before drawing some
provisional conclusions.

Structural adjustment and unemployment in transition

The dominant model applied in the early years of the transition was that which had been developed for the structural adjustment of market economies suffering chronic fiscal and payments imbalances. The structural adjustment model was based in the first instance on an evaluation of the experience of the structural adjustment of the developed market economies to the 1974 oil shock. The received wisdom was that those countries which had opened their economies to the world market and which had dismantled the barriers to the free play of the domestic market had been the most successful in making the major structural changes required to adjust to the new global economic environment and so to resume sustained growth through the 1980s. The generalisation of this model developed from the laudable desire to spread the benefits of the dynamism of the world economy in the 1980s to those relatively stagnant regions which had not participated in the world boom and which remained weighed down by the debts incurred in the 1970s. Structural adjustment would allow these
countries to initiate or resume a process of economic growth and to restore fiscal and payments balances by reorienting their economies from protected and stagnant domestic markets to booming world markets. Macroeconomic stabilisation, privatisation and price liberalisation came to be seen as the sine qua non of structural adjustment programmes, both for their immediate impact on financial imbalances and as conditions for the effective operation of the market. In an ideal world a structural adjustment programme which stabilised the price level and allowed relative prices to adjust freely to market conditions would simultaneously encourage investment in the expansion of profitable branches of activity and free the human, material and financial resources for such expansion by accelerating the decline of unviable branches.

The appropriateness of the structural adjustment model appeared to be confirmed by the contrast between the fate of what became known as the ‘newly industrialising countries’, particularly the ‘Asian tigers’, and those economies which sought to protect themselves from the ravages of the world market. While the former rode the first punch before moving onto the offensive, the latter merely experienced economic stagnation as the cost of protection increasingly weighed on them in the form of a growing burden of domestic and international public debt and corresponding fiscal and financial instability. The short-term cost of adjustment could be high, as reductions in insupportable state expenditure and the impact of the market lead to the liquidation of unviable economic activity and rising unemployment, but fiscal and financial stabilisation and the freeing of resources tied up in stagnant sectors would supposedly provide the means and the incentive for new investment in those sectors which enjoy a comparative advantage in the global market and so for the creation of new and viable jobs which alone can promise a rising standard of living.

The fact that many countries persisted with irrational protectionist policies and regulation of the domestic economy was explained in terms of a simple political economy of adjustment first proposed by Adam Smith in The Wealth of Nations, his critique of the mercantilist system in the eighteenth century. Those who benefited the most, at least in the short-run, from the protectionist system were those who were the most conscious of their own interests and the best placed to defend them because they were those who were the most deeply embedded in the protectionist bureaucratic-political system. They secured a political base for themselves by ensuring that the employees of the state and of state-supported industry enjoyed security of employment, relatively high wages and superior working and living conditions. The principal victims of protectionism, the rural and urban poor involved in subsistence production and casual employment in the informal economy, were the least aware of their situation and the worst placed to do anything to remedy it. The beneficent hand of the market was therefore impeded in its liberating mission by the barriers of privilege, ignorance and narrow self-interest. Just as Adam Smith contrasted the virtues of enlightened despotism with the demagoguery of democracy, so the ideologues of structural adjustment presented themselves as the anointed representatives of the world’s poor and dispossessed against the ‘populism’ of political regimes which masked the self-interest of a privileged minority (World Bank, 1995).

The record of structural adjustment programmes has been a very mixed one. In particular, many economies which have submitted to the initial shock have found themselves with high and persistent rates of unemployment without necessarily enjoying any of the benefits of recovery, while others have enjoyed the fruits of recovery without having to undergo the initial pain of shock therapy. Cynics might argue that such contrary experiences undermine the universality of the model, indicating that policy has a rather limited impact on the fortunes of a national economy in the global market, or even that the direction of causality is reversed: the successful can afford liberalisation, while continued regulation is the least-worst option for the unsuccessful. Those who are well-placed to respond to the challenge of globalisation, by virtue of location or of human or natural resource endowments or of the legacy (or absence of a legacy) of the past, enjoy a virtuous circle of export-led growth supporting rising domestic employment and living standards, drawing in young labour from the countryside, from backward industries or from abroad, without the need to destroy existing production facilities or social institutions and with bulging state coffers providing resources for growing public investment. Those who are burdened by a legacy of debt, an outdated industrial structure, unfavourable location, an absence of easily mobilisable reserves of labour or exploitable natural resources find themselves locked in to a vicious circle of decline as ‘stabilisation’ leads to rising unemployment, falling incomes, a deteriorating social fabric, rising inequality, a shrinking domestic market and an explosion of crime with few prospects for domestic investment, which is further discouraged by the need to retain high interest rates to stem capital flight. While the former can embrace the rhetoric, and even much of the reality, of liberalisation (though often retaining high levels of state intervention and state investment), it is hardly surprising that the latter take steps to try to arrest decline.

The structural adjustment model has remained impervious to all such criticism, despite the growing record of failure and the few examples of success. But no amount of empirical counter-examples can dent the model, or the self-confidence of its proponents, because the model is not presented as an empirical generalisation but as a statement of fundamental economic principles. Adam Smith’s critique of the mercantilist system was based not any rigorous theoretical or substantive analysis but on the application of a few abstract ideological principles, the truth of which he insisted was self-evident. It is these same abstract ideological principles, whose truth is still regarded as self-evident, which have guided the ideologues of structural adjustment: the liberal economic model is an abstract model which rests on the supposedly self-evident foundations of human rationality. If the medicine of stabilisation and liberalisation does not achieve the miracle cure, it is because vested interest and timid politicians have prevented it from having its full effect. The limited success of structural adjustment programmes only feeds the radicalism of the ideologues and whets their appetite for more and deeper liberalisation.

The structural adjustment model is a three-stage model of transition from a regulated to a market economy. In the first stage, fiscal and financial ‘stabilisation’ force the reduction in the level of state activity, including the levels of social and welfare provision, and the closure of unprofitable state and private enterprises, leading to rising unemployment. In the second stage, the reduction in public borrowing leads to falling inflation and interest rates and the stabilisation of the exchange rate, while an increase in unemployment lubricates the labour market and allows wages to fall to levels which in the third, recovery, stage make new investment in new sectors profitable for domestic and foreign investors. The longer drawn out is the first stage, the more effectively are the benighted defenders of the old order able to mobilise support in opposition to reform, appealing particularly to its immediate victims, the state bureaucrats and urban industrial workers whose privileges have been eroded. At the same time, the longer
reform is drawn out the longer it takes for stabilisation to create the environment for recovery. Thus, both political and economic arguments are in favour of a short sharp shock, a stabilisation package which works its wonders as rapidly as possible.

As noted above, structural adjustment programmes, in the broadest sense, have a mixed record. Even amongst those market economies which have taken a lead in adopting the package of stabilisation and liberalisation, which have experienced structural adjustment and which have even tapped new sources of economic growth, some have experienced persistently high rates of unemployment, the most obvious contrast being between Western Europe, where unemployment rates have still not recovered from the sharp increases of the 1970s and 1980s, and the United States, which has seen unemployment rates below the historic average. According to the liberal model, such persistent unemployment can only derive from barriers to market adjustment. Once domestic and international product and financial markets have been liberalised, the only remaining culprit is the labour market.[2] During the 1980s the view became dominant that ‘labour market rigidities’ were one of the prime barriers to structural adjustment because they impeded labour mobility in response to the changes in relative prices that are induced by price liberalisation, a view which received the official support of the OECD and World Bank. The breaking down of ‘barriers’ to labour mobility therefore came to be seen as a prime task of the first stage of structural adjustment. These barriers are all those institutional and normative factors which prevent labour power from functioning as a commodity like any other: people’s attachment to time and place, to their homes and their jobs, to forms of work, ways of living, and even to standards of living, that make them reluctant to uproot themselves and move to a new home, a new profession and a new way of life and induce them to look to government, trade unions and other social and political organisations for protection. The greater are these attachments, the more money people need to be paid to induce them to move and so the more difficult it is for new economic activities to attract people to work at wages sufficiently low to make the new jobs viable. Breaking the barriers involves breaking those attachments by destroying jobs that are no longer viable in market conditions. Once these ties have been broken, people will be willing to seek new jobs in new spheres at wages that make the jobs sustainable. This is claimed not to be the heartlessness of the banker, but the benevolence of the realist who appreciates that these jobs can no longer be sustained (and supposedly they have only been sustained at the expense of other, less fortunate or more enterprising, members of the population), so that it is necessary to be cruel to be kind. Only by destroying existing jobs can people be induced to seek new jobs in new spheres at wages which make the jobs sustainable. A relatively high level of transitional unemployment is therefore accepted as an essential feature of structural adjustment.

Providing that labour markets are flexible, this unemployment will only be transitional as investors take advantage of the abundance of low-wage labour to invest in the new opportunities opened by the market. The reform of labour market institutions through both passive and active labour market policies therefore came to be seen as an increasingly important component of structural adjustment packages. The purpose of such reforms was to increase wage flexibility, so that people would ‘price themselves into jobs’; to increase the provision of training and retraining, so that people would have the skills required by the labour market; and to improve the functioning of employment services, to match the unemployed to available vacancies. The major barriers to wage flexibility were centralised collective bargaining, state regulation of wages and liberal unemployment benefit regimes, all of which set a floor to wages at a level above that sustainable by the market. The liberalisation of labour market institutions, therefore, implied decentralised wage bargaining, an end to state wage regulation and a stringent unemployment benefit regime. Those who could not find work at a tolerable wage as a result of specific disadvantages would be protected from the impact of liberalisation by the creation of a systematically targeted ‘social safety net’ providing income support for those unable to support themselves.

Although there were plenty of critics of this model in the West, and even within the multilateral organisations that promoted it, the model appealed to the elites in the so-called ‘transition countries’ in its most liberal form: the challenge of reform was to restructure an economy which had been distorted by the military and political demands of the Party-state and the rigidities of the administrative-command system, with an overdeveloped heavy industry and underdeveloped consumer goods and service sectors. The Party-state had tried in vain to reform the system over thirty years, and was now in a state of collapse. What could be more attractive than a programme of ‘market Bolshevism’ which promised an instant cure while absolving the state of all responsibility? Moreover, the promises of structural adjustment coincided precisely with the aspirations of a large part of the population of the transition economies: the opening of frontiers, access to world markets, participation in global society, the attainment of Western living standards were all goals worth suffering for, particularly if other people were to do the suffering.

The application of the structural adjustment model to the transition economies focused on a restructuring of the economy based on the decline of large state industrial enterprises which would free the resources to permit the growth of a new private sector, with little expectation that overdeveloped state enterprises, burdened with an excessively large labour force, outdated capital stock, poor product quality, inappropriate location and conservative management had much potential for internal restructuring. A tight stabilisation policy would subject the state sector to a ‘hard budget constraint’ leading to widespread lay-offs and large-scale bankruptcy. The resultant increase in unemployment would lead to falling wages, with labour market slack being absorbed by the new private sector, particularly in the underdeveloped branches of the economy (services, consumer goods production and extractive and processing industries oriented to the world market).[3] However, the extent of the structural maladjustment of the transition economies combined with a highly educated labour force, a generally favourable location with basic infrastructure in place and a strong resource base should have meant that, once freed from the straightjacket of state control, transition would be a rapid process.