Explaining the increase in inequality during transition

This paper attempts to explain the increase in inequality that has been obs erved in all transition economies by constructing a simple model of change in composition of employment during the transition. The change consists of the 'hollowing-out' of the state-sector middle class as it moves into eithe r the 'rich' private sector or the 'poor' unemployed sector. The prediction s of the model are contrasted with the empirical evidence from annual house hold income surveys from six transition economies (Bulgaria, Hungary, Latvi a, Poland, Russia and Slovenia) over the period 1987-95. We find that the m ost important factor driving overall inequality upwards was increased inequ ality of wage distribution. The non-wage private sector contributed strongl y to inequality only in Latvia and Russia. Pensions, paradoxically, also pu shed inequality up in Central Europe, while non-pension social transfers we re too small everywhere and too poorly focussed to make much difference.