Labour markets of the former command economies of Central and Eastern Europe have gone through profound transformation since the start of political, economic and social reforms. Until 1990, enterprises had been largely protected against the impact of the world markets through centrally organised production and distribution and the dominance of producers in the home market. In addition, labour markets were also strongly regulated so that workers enjoyed very high employment security and job stability. The opening up of the national economies of transition countries to global competition has forced domestic enterprises to adjust their inputs (including labour), production technology and outputs to market demand.

At the macro-level, flexibility refers to the speed of adjustment to external shocks or changing labour market conditions. Therefore, labour market flexibility means the degree to which employment and/or working time (labour input adjustment) or wages (labour costs adjustment) adjust to economic changes. There are indeed different definitions of labour market flexibility: external versus internal flexibility, the former referring to job changes involving new employment with a different employer and relating to labour turnover and geographic mobility, while the latter refers to job changes within the same enterprise. There is also numerical versus functional flexibility, the former relating to changes in the number of workers, while the latter means occupational changes and mobility within the enterprise. This article focuses on external numerical flexibility, from both a macro- and microeconomic perspective, with a particular emphasis on labour market regulations and institutions. The reason for this choice is, first, because we believe these are among the most relevant aspects of labour market flexibility; and second, because of the current unavailability of data on functional flexibility.

By flexible forms we understand here labour contracts with limited duration (fixed-term and short-term contracts), agency work (work for a fixed short-time period arranged by a manpower agency), part-time employment, multiple-job holding and work agreements between two parties for a certain task/activity (so-called civil contracts, regulated by the Civil Code). In particular, the last two forms are closely interrelated with informal employment. Also self-employment is often considered as another flexible form of work. The reason for the expansion of flexible forms of work is the need on the side of employers to relatively smoothly adjust their production profile and costs to the market conditions as termination of employment relations is easier, faster and less costly.

The transition process exposed firms to new economic conditions and forced them also to adjust their labour input. The level of labour mobility and intensity of labour reallocation can be measured by labour turnover as a sum of recruitments and separations from enterprises divided by employment. For calculating recruitments and separations we used two sources of employment flow data: those based on establishment surveys and those originating in labour force surveys, which both have their advantages and shortcomings [3].

Labour turnover is of course significantly affected by economic fluctuations. In industrialised countries, it typically accelerates in periods of economic growth: enterprise start-ups and expansions create new jobs, attracting newcomers to the labour market and increasing hires of unemployed job seekers. At the same time, as dismissals for economic reasons abate, the growing number of job opportunities encourages more people to change their jobs voluntarily. In contrast, in economic downturns, enterprises seek to cut costs by reducing new hires and by resorting to redundancies, yet the consequent sharp reduction of voluntary quits more than counterbalances the increase in dismissals. Largely for supply-side reasons, labour turnover thus tends to behave pro-cyclically (Boeri, 1995; International Labour Office (ILO), 1996).

Job tenure– the length of time currently employed individuals have spent with their present employer– is a variable commonly used in studies that focus on labour market stability. Average job tenure and the distribution of employment by class of job tenure are used as indicators of job stability and can indicate differences across countries. Table 4 presents these indicators for six Central European countries in 1999. Average job tenure in these countries was 9.3 years in 1999, slightly below the average of 10.5 years of the “triad” (the European Union, the United States and Japan). This finding is not surprising, considering the high labour turnover that characterises the majority of labour markets in transition economies. The two Baltic States have the lowest job tenures of 6.9 years for Estonia and 7.6 years for Lithuania (close to the US level of 6.6 years), followed by the Czech Republic and Hungary with tenures below 10 years (levels similar to Denmark, the Netherlands and the United Kingdom). The longest average tenures are found in Poland and Slovenia.

The introduction of economic and social reforms initiated long-delayed structural adjustment of the former centrally planned economies to world markets. This was facilitated by significant changes in labour legislation and labour market institutions as well. The weaknesses of newly established or refurbished institutions further enhanced adjustment flexibility for firms, which used not only direct staff cuts and real-wage reduction but also shortening of working time, delayed wage payment or informal work, as documented by our findings. The latter four practices actually helped enterprises to merely cut the labour costs, while often contributing towards delays in the necessary restructuring of poorly performing enterprises. The protection of workers at enterprise level was considerably reduced and was to be compensated by institutional assistance, labour market policy and social protection. As a result of these reforms and the underdeveloped enforcement mechanisms, insecurity of employment and income has sharply increased in transition economies, compared with the past.

Under the centrally planned economic system, workers enjoyed a fairly high degree of employment protection in their jobs. In general, the Labour Code did not allow enterprises to lay off workers for economic reasons. In (rather rare) cases of enterprise restructuring or relocation connected with the abolition of certain jobs, the enterprise was obliged to offer another job internally (combined with internal retraining if necessary) to the workers concerned. This was usually to be agreed with the worker and the trade union organisation, and supplemented by compensation for hardship caused by the job transfer. Where internal redeployment was not possible, labour departments of local authorities had to find for these workers other jobs of similar quality, skill requirements and level of remuneration, as under the policy of full employment it was the State’s responsibility to provide employment to all able-bodied persons of working age.

Measuring employment protection is a difficult task, so different indicators of EPL strictness have been developed and applied according to ad hoc specific research needs. Quantitative aspects can be easily computed, such as the number of months’ notice required for individual dismissal and severance pay. But other aspects, such as the interpretation of the definition of “just cause” for termination, are more difficult to measure precisely. However, these problems have been partly overcome by the positive correlation of the different indicators to each other to produce unambiguous cross-country rankings of EPL. The OECD has produced EPL indicators (for both regular and fixed-term contract workers) to study the relationship between EPL and labour market outcomes for its member countries: these indicators consider a whole set of regulations that are weighted according to their importance. This methodology has been updated and enlarged to consider regulation concerning collective dismissals (OECD, 1999), and this is the version used here for the transition countries [6].

The “Eurosclerosis” debate (the European labour market has been said to be “sclerotic”, because of the full range of labour protection schemes) has renewed relevance with the forthcoming enlargement of the EU to CEE countries, in particular in a context of poor employment performance and persistently high unemployment in the transition countries of Eastern Europe [7] (see table 6). As the candidate countries are required to harmonise their laws and regulations with those of the EU (“acquis communautaire”), it is interesting to examine where the CEE countries stand in terms of labour market flexibility/rigidities. The two key issues here are therefore: first, to assess the extent to which these accession countries– and the transition countries in general– have adopted the same set of labour market institutions and policies as the EU; and second, to assess the impact, if any, of these institutions on labour market performance. The “institutional package” considered here refers to the following provisions: the legislation protecting employment (discussed in previous section); various features of the unemployment insurance schemes and active LMP; indicators of trade union strength; and the tax burden (payroll taxes).

The transition economies have introduced a wide range of labour market programmes, both active and passive. The aim of these policies has been to relieve tensions in the labour market and provide income support. Passive policies include unemployment insurance schemes and early retirement, while active policies encompass job mediation, labour market training, public works, job creation, subsidised employment or mobility measures, as presented in more detail below. Over the decade, unemployment insurance systems have increasingly become less generous. This tendency can be demonstrated by the reduction of the level of benefit payments in real terms and in their duration, as well as the tightening of eligibility conditions. Table 7 presents the main features of the unemployment insurance systems in nine selected transition countries in the late 1990s: replacement rates (the share of income that is replaced by the unemployment benefit); the length of the benefit payment; and the share of benefit recipients in total registered unemployment. Again, diversity prevails. Table 7 shows that initial benefit replacement rates (the ratio of initial – and therefore highest – benefits to previous earnings) in the selected countries ranged from 40 to 75 per cent in 1998, with the exception of the two extremes: Estonia (7 per cent) and Ukraine (100 per cent). An alternative way to compare the benefit level across countries is to express the average benefit as a percentage of the average wage. Countries also differ in terms of benefit duration, ranging from six months in the Czech Republic or Estonia to 24 months in Slovenia or the Russian Federation, in line with those of the EU and the Western OECD countries (some EU countries even offer benefits of unlimited duration). Another interesting feature of unemployment insurance refers to the coverage rates of the system, that is, the percentage of registered unemployed persons receiving unemployment benefits. These rates also vary widely across countries, from 25 to 90 per cent. Moreover, the development of the rates over the decade– not shown here– was different. While they remained fairly stable in the Czech Republic, Estonia and Hungary, the coverage rates have fallen continuously in Poland and Slovakia (and to a lesser extent in Slovenia).

In most countries, trade unions play a major role in the collective bargaining process and are therefore likely to influence wage formation and labour costs (wage flexibility) in response to economic shocks. Depending on certain characteristics and factors, trade unions may influence the wage negotiation process through the setting of the minimum wage, bargaining over wage increases and the shaping of the wage structure. Even in countries where the number of unionised workers is low, as in France and Spain, collective agreements can in fact cover a large share of workers. Co-ordination amongst unions is another particularly important aspect of ensuring consensus in bargaining on macroeconomic objectives: wage increase negotiations may, for example, take precedence over negotiations on other issues, creating upward wage pressure and higher equilibrium unemployment (see, for example, Bertola, 1990). However, unions may also set employment goals and accept wage restraint, trading wage moderation against additional employment creation (see Hartog, 1999, for example, on the importance of the social partners in the Dutch labour market success story). Another relevant aspect to consider regarding unions is the extent to which they manage to co-ordinate their wage-setting activities together with employers’ organisations. The government involvement in the negotiation process is another relevant aspect, as is the case in France. Table 9 summarises the key features of the trade unions in our sample of transition countries: namely, the union density, collective agreement coverage, and levels of co-ordination. Co-ordination may be distinguished from centralisation, which refers to the level of bargaining (plant, firm, industry, region or country). Highly co-ordinated bargaining is not necessarily centralised, as in Germany or Denmark, for example. While empirical research has generated datasets on unions and employers’ organisations for OECD countries (see Calmfors and Drifill, 1988; Layard et al., 1991; ILO, 1997; and Traxler and Kittel, 1997), few data are available for transition countries.

The impact of taxation on labour market outcomes operates via the wedge between the real labour cost for the employer and the real consumption wage received by the worker. As it is extremely difficult to construct a tax wedge based on reliable and consistent information on value-added taxes (VAT) and income taxes for all the selected transition countries [12], only payroll taxes data– defined as the sum of employers’ and employees’ social security contributions– are presented here. Moreover, it could be argued that not only workers but also unemployed and inactive persons pay income and consumption taxes. Figure 3 shows that payroll taxes in transition countries are high, even by EU standards. Rates range from 33 per cent in Estonia to as high as 50 per cent in Slovakia. While these rates vary enormously across the OECD, they do not exceed 40 per cent: payroll taxes stretch from almost zero in Denmark to 38.8 per cent and 40.2 per cent in France and Italy respectively in the mid-1990s. In transition countries, deteriorating labour market outcomes push governments to increase the levels of public expenditures on unemployment insurance systems and active LMP. The ageing population, declining employment rates and elevated poverty levels place additional constraints on the funding of public pension schemes, health care and social welfare. At the same time, fiscal revenues fall considerably, particularly in periods of economic contraction, generating very strong pressure to maintain high payroll taxes. With respect to the negative effects of high taxation on employment and business development, some countries started to lower their payroll taxes and saw amendments and fiscal reforms taking place, though at a slow and gradual pace over the decade. Recently in Hungary, for example, employers’ social contributions were cut by 2 percentage points to 31 per cent at the beginning of 2001.

Based on theoretical and empirical evidence for Western OECD countries– referring to the expected effects on job search behaviour, bargaining power, turnover, and so forth– an econometric analysis was conducted to assess the potential effects of labour market institutional settings on labour market outcomes and test the assumption of similar responses in the transition countries (see Cazes & Nesporova, 2003). Simple cross-country regressions have been conducted to address various aspects of unemployment (total unemployment, long-term and youth unemployment rates) [13] and aggregate labour input (employment rate and labour force participation rate), based on the information presented in the previous section. As it was impossible to conduct an econometric analysis on the sole group of transition countries, the hypothesis tested statistically was that the labour markets of the OECD countries and the OECD plus transition countries have similar behaviour vis-à-vis labour market environments using a Chow test [14].

Labour markets of CEE countries have undergone profound changes since the beginning of their transition to a market system. While the intention was to direct labour market developments in these countries towards the situation common in the industrialised world by modelling the transformation of national labour market institutions and policies on similar, mostly Western European, institutions and policies, the outcomes have been to a large extent different from the expectations.