CASE Ukraine case-ukraine.kiev.ua

1. Prepared for the East Jour Fixe Ukraine: Shifting Economic Horizons and Interlinkages OENB, Vienna, January 20, 2006 Ukraine One Year After the Orange Revolution: Economic Policy Challenges and Goals Vladimir Dubrovskiy CASE Ukraine www.case-ukraine.kiev.ua

2. CASE Ukraine Rent seeking vs. profit seeking Profit seeking Rent seeking Creation 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 Players can establish certain efficient institutions, primarily, the property rights by a voluntary agreement In many cases players fail to establish the efficient institutions. Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and Savvateev (2002): A coercive force is required to arrange appropriation while preventing the overappropriation Rent seeking requires FORCED coordination and control that can only be arranged by AUTHORITARIAN POWER

3. CASE Ukraine Arbiter-clients model: how it works Authoritarian arbiter Distributes the quotas for rent appropriation arbitrarily, and enforces them in order to restrain the devastating competition Rent source Rent source client player player client player player client client … but instead extorts the rent himself, or trades it for loyalty

4. CASE Ukraine Effects of authoritarian rule Rent seeking sector Profit seeking (competitive) sector Monopoly rent client player player client client client player player Increase in the social wealth Decrease in the social wealth Firms earn their incomes mostly as rents depending primarily on the arbiter’s discretion Paternalism (clietnelism) and corruption

5. CASE Ukraine An arbiter: CASE Ukraine Has an incentive to extract the rent (share the players’ rents) In effect, “owns” a source of rent Looks as “captured” with vested interests Crowds out and suppresses any other ways of preventing the overappropriation Asymmetry: The players can motivate their arbiter with a “carrot”, but not threaten to him irresponsibility players are clientsof their arbiter Interested in using his discretionary power for further weakening the clients’ residual rights of control Rent-maximizing ≡ authoritarian, plutocratic Arbiters: Power-maximizing ≡ totalitarian Arbiters and clients form ahierarchy

6. Officials: not a bureaucracy Bureaucracy (Weber) Administrative power in Ukraine Highly-paid professional public servants facilitating rational processes of control. Implements legislation in a strictly formal (impersonal) way Poorly-paid and dependent upon administrative rents (in money or barter) Relies upon discretionary power and vague and arbitrary informal rules Operates under constant public scrutiny and political oversight Controls politicians rather than vice versa. Tries to control mass-media to avoid public scrutiny No decision-making power Clear separation of “powers” from branches of State Possesses the political power to magnify ambiguity and non-transparency in legislation Strictly controlled and separated from business Uncontrolled and mostly affiliated with business

7. CASE Ukraine “Soft” rule of law Karamsin, 19th century Russian historian Institutional legacy of the former empire: “The severity of the Russian laws is alleviated only by discretion in their enforcement” “… just this disorder makes life in Russia possible” Gertzen, 19th century Russian social thinker Legislation is designed (intentionally?) in such a way that almost EVERYONE must become a lawbreaker “Laws are written for the fools” Discretion is the only resort from such a “total guilt” “Who are the boss, we or the law?” Every business is subject to the authorities’ arbitrary, discretionary power

8. CASE Ukraine INTEREST INTEREST ALLEVIATES ALLEVIATES FACILITATES ENHANCES Decreasing the demand for improvements Corruption Legislation (flawed, ambiguous, impracticable) Discretion

9. CASE Ukraine Blat networks Forced modernization, especially the Communist regime: Legislation violated the natural law Normal economic activities were considered illegal No contract enforcement was officially available Ledeneva, 1998 Reputation-based informal networks of interpersonal mutual exchange with “favors of access” (blat) Emerge to facilitate the illegal transactions of all kinds Litwak, 1991 (!) “One has to deserve a right to pay a bribe” while Weak rule of law

10. Whither “captured state”: a dead end? Administrative power: Provides protection and patronage for business Property rights, rents Business: a “Milk cow” or a “Rent pump” for officials Sources of rents Perceived totally rent-seeking Perceived manipulated Perceived totally corrupted A tacit social contract: “We” do not bother “them”, “they” do not bother “us” Informal networks of interpersonal exchange (Blat) Public PASSIVE PLAYER

11. CASE Ukraine Transition from a rent-seeking society: Evolution and REvolution? Rent-seeking sector Profit-seeking sector Politically responsible government REVOLUTION? Profit-seeking sector Rent-seeking sector Technology SOCIETAL NORMS “Standard” approach applies

12. Depletion of the rent sources Close collaboration of business and officials based on blat «intermediate winners» Sources of Rent 1988 - 1994 “Overappropriation” of creditors’ trust Overappropriation of state budget and enterprises’ fixed assets Sources of Rent 1995 – 2000??? Market imbalances Financial instability Cheap energy and credit Subsidies and government contracts

13. CASE Ukraine 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)

14. CASE Ukraine 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

15. CASE Ukraine … 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

16. Whither “captured state”: a dead end? Administrative power: Provides protection and patronage for business Property rights, rents Business: a “Milk cow” or a “Rent pump” for officials Orange Revolution November, 2004 Sources of rents Perceived totally rent-seeking Perceived manipulated Perceived totally corrupted A tacit social contract: “We” do not bother “them”, “they” do not bother “us” Informal networks of interpersonal exchange (Blat) Public PASSIVE PLAYER

17. CASE Ukraine As a result of the revolution: Public is not passive anymore, it became a “principal” of the politicians The oligarchs are not the main players anymore Political market emerges Executive power officials have lesser impact on the legislature Politicians appeal to the broad groups of population while Public consciousness is still immature: does not properly distinguish profits from rents supports redistributive activities (as “re-privatization”) supports “coordination and control” (e.g. price regulation) Threat of populism and paternalism towards large groups of population

18. CASE Ukraine The peoples’ evaluation of two presidents (for Yushchenko – on Apr. 2005) source: National Academy’s Institute of Sociology’s survey (Panina, 2005)

19. CASE Ukraine Upsurge in the social protection 30% Share of transfers in household incomes overgrew the share of wages for 9 month pension expenditures social budget expenditures Has overgrown the “national economy” by >7% - for the first time! 69% Partly due to fair but awkwardly made elimination of privileges >60% tax revenues dramatic decrease in the current account surplus, and two-digit inflation

20. CASE Ukraine People's attitude to the privatization of large-scale enterprises source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)

21. CASE Ukraine Re-privatization Yushchenko: “Krivorizhstal’ was stolen!” Price six times lower than was paid later at the transparent and open auction Revenues actually spent for bribing the voters for Yanukovich Finally re-privatized and sold for good price but “every district’s leader will have his own Krivorizhstal’” (Paskhaver) quarrel between members of Orange team in September, 2005 Decrease in investments Populist attitudes proliferated

22. CASE Ukraine Balance of attitudes to land privatization source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)

23. 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) Improved since 2004 (122 out of 145, score 2.2) but Giving to the systemic role that corruption plays, punitive strategies solely cannot eliminate it, and even their modest success may be harmful ! Increase in prices “CONTRABANDA-STOP” while bankruptcies Increasing demand for improvement of the formal (legislative!) rules

24. CASE Ukraine Obvious mistakes Attempts of administrative price regulations(meat, gasoline, sugar…) Sudden shift in the exchange rate Attempt of partial abolishment of simplified taxation for SME Procrastination of major systemic reforms (tax system, courts, public administration, health care and education, etc.) 374 parliamentary votes out of 450supporting the Cabinet WASTED “the period of extraordinary politics” (Balczerovich)

25. CASE Ukraine Real GDP growth (cumulatively, yoy)

26. CASE Ukraine Macroeconomic results of 2005: mixed outcomes and excuses drop in investments by 2% due to political instability and further weakening of the property rights household real incomes went up by 20%, FDI increased twofold Slowdown of growth started due to other factors before the revolution economic growth of just 2.4%, the lowest since 2000 dramatic decrease in trade balance balance was unsustainably high and partly fake still lower than it was in 2004 two-digit inflation are the positive developments really sustainable, and the negative ones just transitory?

27. CASE Ukraine Threats and risks possible defeat at the Parliamentary elections of 2006 ratings of both leaders of the Orange team have decreased four times Yushchenko’s current rating is lower than it used to be for the few years before the Orange Revolution; “Our Ukraine” is even less popular; but for Timoshenko it is still higher Timoshenko can possibly become an “arbiter” of a new kind – the populist dictator Increasing tensions between East and West aggravated by the Russian political technologists Too DANGEROUS to assess

28. CASE Ukraine The strategic challenges Current economic structure: reveals mostly the Russian competitive advantages of cheap energy Relatively high human capital is a real competitive advantage remains unrevealed due to the poor business climate getting rid of dependence on cheap Russian energy “revelation of the entrepreneurial potential of Ukrainian nation” Relatively high innovation rate Low domestic demand for innovations Low capacity to adopt them Will hardly sustain unless supported in some way new and more capable elite may be needed that would be able to respond to these challenges

29. Thanks for your attention!