Compensation, Incentives and Risk: Economic Theory and Russian Practise

Mr. Pechersky set out to examine a specific feature of the employer-employee relationship in Russian business organisations. He wanted to study to what extent the so-called "moral hazard" is being solved (if it is being solved at all), whether there is a relationship between pay and performance, and whether there is a correlation between economic theory and Russian reality. Finally, he set out to construct a model of the Russian economy that better reflects the way it actually functions than do certain other well-known models (for example models of incentive compensation, the Shapiro-Stiglitz model etc.). His report was presented to the RSS in the form of a series of manuscripts in English and Russian, and on disc, with many tables and graphs. He begins by pointing out the different examples of randomness that exist in the relationship between employee and employer. Firstly, results are frequently affected by circumstances outside the employee's control that have nothing to do with how intelligently, honestly, and diligently the employee has worked. When rewards are based on results, uncontrollable randomness in the employee's output induces randomness in their incomes. A second source of randomness involves the outside events that are beyond the control of the employee that may affect his or her ability to perform as contracted. A third source of randomness arises when the performance itself (rather than the result) is measured, and the performance evaluation procedures include random or subjective elements. Mr. Pechersky's study shows that in Russia the third source of randomness plays an important role. Moreover, he points out that employer-employee relationships in Russia are sometimes opposite to those in the West. Drawing on game theory, he characterises the Western system as follows. The two players are the principal and the agent, who are usually representative individuals. The principal hires an agent to perform a task, and the agent acquires an information advantage concerning his actions or the outside world at some point in the game, i.e. it is assumed that the employee is better informed. In Russia, on the other hand, incentive contracts are typically negotiated in situations in which the employer has the information advantage concerning outcome. Mr. Pechersky schematises it thus. Compensation (the wage) is W and consists of a base amount, plus a portion that varies with the outcome, x. So W = a + bx, where b is used to measure the intensity of the incentives provided to the employee. This means that one contract will be said to provide stronger incentives than another if it specifies a higher value for b. This is the incentive contract as it operates in the West. The key feature distinguishing the Russian example is that x is observed by the employer but is not observed by the employee. So the employer promises to pay in accordance with an incentive scheme, but since the outcome is not observable by the employee the contract cannot be enforced, and the question arises: is there any incentive for the employer to fulfil his or her promises? Mr. Pechersky considers two simple models of employer-employee relationships displaying the above type of information symmetry. In a static framework the obtained result is somewhat surprising: at the Nash equilibrium the employer pays nothing, even though his objective function contains a quadratic term reflecting negative consequences for the employer if the actual level of compensation deviates from the expectations of the employee. This can lead, for example, to labour turnover, or the expenses resulting from a bad reputation. In a dynamic framework, the conclusion can be formulated as follows: the higher the discount factor, the higher the incentive for the employer to be honest in his/her relationships with the employee. If the discount factor is taken to be a parameter reflecting the degree of (un)certainty (the higher the degree of uncertainty is, the lower is the discount factor), we can conclude that the answer to the formulated question depends on the stability of the political, social and economic situation in a country. Mr. Pechersky believes that the strength of a market system with private property lies not just in its providing the information needed to compute an efficient allocation of resources in an efficient manner. At least equally important is the manner in which it accepts individually self-interested behaviour, but then channels this behaviour in desired directions. People do not have to be cajoled, artificially induced, or forced to do their parts in a well-functioning market system. Instead, they are simply left to pursue their own objectives as they see fit. Under the right circumstances, people are led by Adam Smith's "invisible hand" of impersonal market forces to take the actions needed to achieve an efficient, co-ordinated pattern of choices. The problem is that, as Mr. Pechersky sees it, there is no reason to believe that the circumstances in Russia are right, and the invisible hand is doing its work properly. Political instability, social tension and other circumstances prevent it from doing so. Mr. Pechersky believes that the discount factor plays a crucial role in employer-employee relationships. Such relationships can be considered satisfactory from a normative point of view, only in those cases where the discount factor is sufficiently large. Unfortunately, in modern Russia the evidence points to the typical discount factor being relatively small. This fact can be explained as a manifestation of aversion to risk of economic agents. Mr. Pechersky hopes that when political stabilisation occurs, the discount factors of economic agents will increase, and the agent's behaviour will be explicable in terms of more traditional models.

Social Policy Facing the Problems of Youth Employment

Rumiana Stoilova (Bulgaria). Social Policy Facing the Problems of Youth Employment. Ms. Stoilova is a researcher in the Institute of Sociology in Sofia and worked on this project from October 1996 to September 1998. This project involved collecting both statistical and empirical data on the state of youth employment in Bulgaria, which was then compared with similar data from other European countries. One significant aspect was the parallel investigation of employment and unemployment, which took as a premise the continuity of professional experience where unemployment is just a temporary condition caused by external and internal factors. These need to be studied and changed on a systematic basis so as to create a more favourable market situation and to improve individuals' resources for improving their market opportunities. A second important aspect of the project was an analysis of the various entities active on the labour market, including government and private institutions, associations of unemployed persons, of employers or of trade unions, all with their specific legal powers and interests, and of the problems in communication between these. The major trends in youth unemployment during the period studied include a high proportion of the registered unemployed who are not eligible for social assistance, a lengthening of the average period of unemployment, an increase in the percentage of people who are unemployed for the first time and an increasing percentage of these who are not eligible for assistance, particularly among newly registered young people. At the same time the percentage of those for who work has been found is rising and during the last three years an increasing number of the unemployed have started some independent economic activity. Regional differences are also considerable and in the case of the Haskovo region represent a danger of losing the youngest generation, with resulting negative demographic effects. One major weakness of the existing institutional structure is the large scale of the black labour market, with clear negative implications for the young people drawn into it. The role of non-governmental organisations in providing support and information for the unemployed is growing and the government has recently introduced special preferences for organisations offering jobs to unemployed persons. Social policy in the labour market has however been largely restricted to passive measures, mostly because of the risk that poverty poses to people continuously excluded from the labour market. Among the active measures taken, well over half are concerned with providing jobs for the unemployed and there are very limited programmes for providing or improving qualifications. The nature of youth employment in Bulgaria can be seen in the influence of sustained structures (generation) and institutions (family and school). Ms. Stoilova studied the situation of the modern generation through a series of profiles, mostly those of continuously unemployed and self-employed persons, but also distinguishing between students and the unemployed, and between high school and university students. The different categories of young people were studied in separate mini-studies and the survey was carried out in five town in order to gather objective and subjective information on the state of the labour market in the different regions. She conducted interviews with several hundred young people covering questions of family background, career plans, attitudes to the labour situation and government measures to deal with it, and such questions as independence, mobility, attitude to work, etc. The interviews with young people unemployed for a long period of time show the risk involved in starting work and its link with dynamics of economic development. Their approval of structural reforms, of the financial restrictions connected with the introduction of a currency board and the inevitability of unemployment was largely declarative. The findings indicate that the continuously unemployed need practical knowledge and skills to "translate" the macroeconomic realities in concrete alternatives of individual work and initiative. The unemployed experience their exclusion from the labour market not only as a professional problem but also as an existential threat, of poverty, forced mobility and dependence on their parents' generation. The exclusion from the market of goods and services means more than just exercising restraint in their consumption, as it places restrictions on their personal development. Ms. Stoilova suggests that more efficient ways of providing financial aid and mobilisation are needed to counteract the social disintegration and marginalisation of the continuously unemployed. In measuring the speed of reform, university students took both employment opportunities and the implementation of the meritocratic principle in employment into account. When offered a hypothetical choice between a well-paid job and work in one's own profession, 62% would prefer opt for the well-paid job and for working for a company that offered career opportunities rather than employment in a family or own company. While most see the information gained during their studies as useful and interesting, relatively few see their education as competitive on a wider level and many were pessimistic about employment opportunities based on their qualifications. Very similar attitudes were found among high school students, with differences being due rather to family and personal situations. The unemployed, on the other hand, placed greater emphasis on possibilities of gaining or improving qualifications on a job and for the opportunities it would offer for personal contacts. High school students tend to attribute more significance to opportunities for personal accomplishment. A significant difference that five times fewer high school students were willing to work for state-owned companies, and many fewer expected to find permanent employment or to find a job in the area where they lived, Within the family situation, actual support for children seems to be higher than the feelings of confidence expressed in interviews. The attitudes of the families towards past experience seems to be linked with their ability to cope with the difficulties of the present, with those families which show an optimistic and active attitude towards the future having a greater respect for parents experience and tolerance in communication between parents and children.