CASE Ukraine case-ukraine.kiev.ua

CASE UkraineCASE Ukraine

www.case-ukraine.kiev.ua

Ukraine One Year After the Orange Revolution: Ukraine One Year After the Orange Revolution: Economic Policy Challenges and GoalsEconomic Policy Challenges and Goals

Vladimir DubrovskiyVladimir Dubrovskiy

Prepared for the East Jour Fixe

Ukraine: Shifting Economic Horizons and InterlinkagesOENB, Vienna, January 20, 2006

In many cases players fail to establish the efficient institutions.

CASE Ukraine

Rent seeking vs. profit seeking

Profit seekingCreation of the value voluntary apprised by competitive market

Appropriation of already existing value, e.g. created by others

A positive-sum game (“cooking a pie”) increases the public wealth

A zero- or negative-sum game (“cutting a pie”) usually decreases the public wealth

Rent seeking

Players can establish certain efficient institutions, primarily, the property rights by a voluntary agreement

A coercive force is required to arrange appropriation while preventing the overappropriation

Rent seeking requires FORCED coordination and Rent seeking requires FORCED coordination and control that can only be arranged by control that can only be arranged by

AUTHORITARIAN POWERAUTHORITARIAN POWER

Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and

Savvateev (2002):

playerclient Rent source

CASE Ukraine

player

playerplayer

Arbiter-clients model: how it works

Authoritarian arbiter

Distributes the quotas for rent appropriation arbitrarily,arbitrarily, and enforces

them in order to restrain the devastating competition

client

clientclient

… … but instead extorts the rent himself, or trades it for loyaltybut instead extorts the rent himself, or trades it for loyalty

Rent source

Profit seeking (competitive) sector

Rent seeking sector

Monopoly rent

CASE Ukraine

player player

playerplayer

InIncrease in the social wealth

DeDecrease in the social wealth

Effects of authoritarian rule

Paternalism (clietnelism) and corruptionPaternalism (clietnelism) and corruption

Firms earn their incomes mostly as rents depending primarily on the arbiter’s discretion

client

client client

client

CASE Ukraine

An arbiter:CASE Ukraine

Has an incentive to extract the rent (share the players’ rents)

Looks as “captured” with vested interests

Asymmetry: The players can motivate their arbiter with a “carrot”, but not threaten to him irresponsibility

players are clients of their arbiter

In effect, “owns” a source of rent

Interested in using his discretionary power for further weakening the clients’ residual rights of control

Arbiters and clients form a hierarchy

Crowds out and suppresses any other ways of preventing the overappropriation

Rent-maximizing

Power-maximizing totalitarian

authoritarian, plutocraticArbiters: Arbiters:

≡≡

Uncontrolled and mostly affiliated with business

Strictly controlled and separated from business

Possesses the political power to magnify ambiguity and non-transparency in legislation

No decision-making power

Clear separation of “powers” from branches of State

Controls politicians rather than vice versa. Tries to control mass-media to avoid public scrutiny

Operates under constant public scrutiny and political oversight

Poorly-paid and dependent upon administrative rents (in money or barter)

Relies upon discretionary power and vague and arbitrary informal rules

Highly-paid professional public servants facilitating rational processes of control.

Implements legislation in a strictly formal (impersonal) way

Administrative power in Ukraine

Bureaucracy (Weber)

Officials: not a bureaucracy

“The severity of the Russian laws is alleviated only by discretion in their enforcement” “… just this disorder makes life in Russia

possible”

Institutional legacy of the former empire: Institutional legacy of the former empire:

Legislation is designed (intentionally?) in such a way that almost EVERYONE must become a lawbreaker

Discretion is the only resort from such a “total guilt”

Every business is subject to the authorities’ Every business is subject to the authorities’ arbitrary, arbitrary, discretionarydiscretionary power power

CASE Ukraine

“Who are the boss, we or the law?”

“Laws are written for the fools”

Karamsin, 19th century Russian historian

Gertzen, 19th century Russian social thinker

“Soft” rule of law

FACILITATES

CASE Ukraine

Legislation (flawed,

ambiguous, impracticable)

Corruption

Discretion

ENHANCES

INTEREST INTEREST

Decreasing the demand for improvements

ALLEVIATESALLEVIATES

CASE Ukraine

Blat networks

Reputation-based informal networks of interpersonal mutual exchange with “favors of access” (blat)

Emerge to facilitate the illegal transactions of all kinds

““One has to One has to deservedeserve a a rightright to pay a bribe” to pay a bribe”

No contract enforcement was officially available

Normal economic activities were considered illegal

Forced modernization, especially the Communist regime:

Legislation violated the natural law

Ledeneva, 1998

Weak rule of law

Litwak, 1991 (!) while

A tacit social contract:

“We” do not bother

“them”, “they” do not

bother “us”

Informal Informal networks of networks of

interpersonal interpersonal exchange (exchange (BlatBlat))

Whither “captured statecaptured state”: a dead end?

Business:

a “Milk cow” or

a “Rent pump” for officials

Administrative power:

Provides protection and patronage for

business

Property rights, rents

Public

Sources of rents

Perceived totally corrupted

Perceived totally rent-

seeking

PASSIVE PLAYER

PASSIVE PLAYER

Perceived Perceived manipulatedmanipulated

Profit-seeking sectorRent-seeking sector

Technology Technology

SOCIETAL NORMSSOCIETAL NORMS

CASE Ukraine

REVOLUTION?REVOLUTION?

Rent-seeking sector

Profit-seeking sector

“Standard” approach applies

Transition from a rent-seeking society: Evolution and REvolution?

Politically responsible government

Depletion of the rent sources

Market imbalances

Financial instability

Cheap energy and credit

«intermediate winners»«intermediate winners»

Sources of Sources of RentRent

1988 - 19941988 - 1994

Overappropriation of state budget and enterprises’ fixed assets

“Overappropriation” of creditors’ trust

Sources of RentSources of Rent1995 – 1995 – 20020000??????

Subsidies and government contracts

Close collaboration of business and officials based on blatblat

CASE Ukraine

-80

-70

-60

-50

-40

-30

-20

-10

0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

0.5

1

1.5

2

2.5

3

self-reliance

satisfaction with socialstatus

SATISFACTION with own SOCIAL STATUS (score

of maximum 5, right axis), and SELF-RELIANCE (percentage of respondents agreed that their life success depends on themselves, net of the percentage of respondents agreed that it is determined mostly by the external conditions – left axis).

source: National Academy’s Institute of Sociology’s survey (Panina, 2005)

CASE Ukraine

0%

10%

20%

30%

40%

50%

60%

70%

80%

2000 2001 2002 2003

Intolerance to corruption in the state-business relationships grew up before the Orange Revolution

Percentage of entrepreneurs reported corruption as substantial impediment source: IFC annual business surveys

CASE Ukraine

50.38

43.4

31

0

10

20

30

40

50

60

200420032002

… as well as corruption as such

Percentage of respondents reported they had to pay bribes during the last year source: Partnership for a Transparent Society household survey

A tacit social contract:

“We” do not bother

“them”, “they” do not

bother “us”

Informal Informal networks of networks of

interpersonal interpersonal exchange (exchange (BlatBlat))

Whither “captured statecaptured state”: a dead end?

Business:

a “Milk cow” or

a “Rent pump” for officials

Administrative power:

Provides protection and patronage for

business

Property rights, rents

Public

Sources of rents

Perceived totally corrupted

Perceived totally rent-

seeking

PASSIVE PLAYER

PASSIVE PLAYER

Perceived Perceived manipulatedmanipulated

Threat of populism and paternalism Threat of populism and paternalism towards large groups of population towards large groups of population

CASE Ukraine

Public is not passive anymore, it became a “principal” of the politicians

The oligarchs are not the main players anymore

Executive power officials have lesser impact on the legislature

As a result of the revolution:

Political market emerges

Politicians appeal to the broad groups of population

Public consciousness is still immature:

while

does not properly distinguish profits from rentssupports redistributive activities (as “re-privatization”)supports “coordination and control” (e.g. price regulation)

CASE Ukraine

0 1 2 3 4 5 6

1998

1999

2000

2001

2002

2003

2004

2005

2005

Ku

chm

aY

ush

che

nko

The peoples’ evaluation of two presidents

(for Yushchenko – on Apr. 2005)

source: National Academy’s Institute of Sociology’s survey (Panina, 2005)

CASE Ukraine

Upsurge in the social protection

30%

Partly due to fair but Partly due to fair but awkwardly made awkwardly made elimination of elimination of privileges privileges

pension expenditures

69%social budget expenditures

>60%tax revenues

Has overgrown the Has overgrown the “national economy” by “national economy” by >7% - for the first time>7% - for the first time!!

dramatic decrease in the current dramatic decrease in the current account surplus, and two-digit inflationaccount surplus, and two-digit inflation

Share of transfers in Share of transfers in household incomes household incomes overgrew the share of overgrew the share of wages for 9 monthwages for 9 month

CASE Ukraine

0

10

20

30

40

50

60

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

rather negative

rather positive

People's attitude to the privatization of large-scale enterprises

source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)

CASE Ukraine

Re-privatization

quarrel between members of Orange team in September, 2005

“every district’s leader will have his own Krivorizhstal’” (Paskhaver)

Yushchenko: “Krivorizhstal’ was stolen!”

Finally re-privatized and sold for good price

but

Price six times lower than was paid later at the transparent and open auction

Revenues actually spent for bribing the voters for Yanukovich

Decrease in investments

Populist attitudes proliferated

CASE Ukraine

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Balance of attitudes to land privatization

source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)

CASE Ukraine

Combating the corruption

Rated 107 (out of 158) by the Transparency International in 2005 with a score of 2.6 (out of 10)

“CONTRABANDA-STOP” Increase in prices

Improved since 2004 (122 out of 145, score 2.2)

butGiving to the systemic role that corruption plays,

punitive strategies solely cannot eliminate it, and

even their modest success may be harmful !

bankruptcies while

Increasing demand for improvement of the Increasing demand for improvement of the formal (legislative!) rules formal (legislative!) rules

CASE Ukraine

Attempts of administrative price regulations (meat, gasoline, sugar…)

Sudden shift in the exchange rate

Obvious mistakes

Attempt of partial abolishment of simplified taxation for SME

Procrastination of major systemic reforms (tax system, courts, public administration, health care and education, etc.)

“the period of extraordinary politics” (Balczerovich)

374 parliamentary votes out of 450 supporting the Cabinet

WASTEDWASTED

CASE Ukraine

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1 2 3 4 5 6 7 8 9 10 11 12

2004

2005

Real GDP growth (cumulatively, yoy)

CASE Ukraine

drop in investments by 2% due to political instability and further weakening of the property rights FDI increased twofoldFDI increased twofold

economic growth of just 2.4%, the lowest since 2000

Slowdown of growth started due Slowdown of growth started due to other factors before the to other factors before the revolution revolution

two-digit inflation

household real incomes went up household real incomes went up by 20%,by 20%,

are the positive developments really are the positive developments really sustainable, and the negative ones just sustainable, and the negative ones just

transitorytransitory ??

dramatic decrease in trade balance

balance was unsustainably high balance was unsustainably high and partly fake and partly fake still lower than it was still lower than it was in 2004in 2004

Macroeconomic results of 2005: mixed outcomes and excuses

CASE Ukraine

Threats and risksratings of both leaders of the Orange team have decreased four times

possible defeat at the Parliamentary elections of 2006

Yushchenko’sYushchenko’s current rating is current rating is lowerlower than it used to be for the than it used to be for the few years before the Orange few years before the Orange Revolution; “Revolution; “Our UkraineOur Ukraine” is ” is even less popular; but for even less popular; but for TimoshenkoTimoshenko it is still it is still higherhigher

Timoshenko can Timoshenko can possibly become an possibly become an “arbiter” of a new kind “arbiter” of a new kind – the populist dictator – the populist dictator

Increasing tensions between Increasing tensions between East and West aggravated by East and West aggravated by the Russian political the Russian political technologiststechnologists

Too Too DANGEROUSDANGEROUS to assessto assess

CASE Ukraine

““revelation of the revelation of the entrepreneurial potential entrepreneurial potential

of Ukrainian nation”of Ukrainian nation”

new and more capable elite may be needed that new and more capable elite may be needed that would be able to respond to these challengeswould be able to respond to these challenges

Current economic structure: reveals mostly the Russian competitive advantages of cheap energy

The strategic challenges

getting rid of getting rid of dependence on cheap dependence on cheap

Russian energyRussian energy

Relatively high human capital is a real competitive advantage

Relatively high innovation rate Relatively high innovation rate

remains unrevealed due to the

poor business climate

Low domestic demand for innovations Low capacity to adopt them

Will hardly sustain unless supported in some wayWill hardly sustain unless supported in some way

Thanks for Thanks for your attention!your attention!