Economic Reform in Ukraine: The Unfinished Agenda

On November 3rd, 2000 Carnegie Endowment's Russian & Eurasian Program hosted a lunch meeting to introduce a new book, co-edited by Senior Associate Anders Åslund and Georges de Ménil. Economic Reform in Ukraine: The Unfinished Agenda is a comprehensive and policy-oriented study, with contributions from leading reformers in the Ukrainian government and their foreign economic advisors. The book launch began with a presentation by Anders Åslund on the evolution of Ukrainian economic reform, its obstacles, achievements and prospects. His remarks were followed by discussion.

Ukraine's Poor Record

Calling Ukraine "the last post-Communist country to return to growth," Anders Åslund first evaluated Ukraine's attempts at economic reform. He suggested that the country's "poor record" could not be explained by corruption alone. Rather, it was the "inefficiency of corruption" that has wreaked havoc. By "inefficiency" he meant massive administrative disorganization, as well as the lack of rules and institutions established in other post-Communist countries. This, in turn, led to businesses spending disproportionate amounts of management time (over one-third) with state officials. This disorganization persisted because it benefited certain people.

Identifying these dominant interests, Åslund recalled a statement by one of the major oligarchs, Ihor Bakai: "All really rich people in Ukraine have become rich through gas trade." About half a dozen of the so-called Ukrainian "gas barons" make together approximately $1-2 billion a year (6-7% of GDP), using three different tricks. The first strategy is theft of natural gas from the pipeline running from Russia to Europe through Ukraine. An official Ukrainian statement assessed that $1.4 billion worth of gas was stolen in this fashion in 1999. The second method involves importation of gas from Russia and its sale to consumers, while passing on the costs to the Ukrainian state. Each year, no less than $500 million of gas debt to Russia is passed on to the Ukrainian government. The third trick is more complicated - it allows escape from payments and taxes through complex barter deals. A chapter of the new book by Christian von Hirschhausen and Volkhart Vincentz analyzes Ukrainian energy policy.

Obstacles to Reform and Strategies for Overcoming Them

Åslund delved into other obstacles to reform, elaborated upon in the introduction of the new book. After the collapse of the Soviet Union there was an "excessive but perhaps necessary focus on nation-building and national security rather than economic reform." The weakness of Ukrainian élites and lack of well-trained economists contributed to the slow start of reforms. The gradual nature of the Ukrainian reforms led to an "unfortunate path dependence," that gave rise to a powerful class of rent seekers.

So, the question before Ukraine was: "What can we do when we have started on the wrong track, reinforcing the enemies of reform?" This question and the politically feasible strategies of economic reform are examined by Roman Shpek in his chapter. Åslund identified three types of reforms, distinguished by the oligarchs' attitude towards them. Some reforms "can be undertaken because they suit the rent seekers." These include macroeconomic stabilization, discussed in the book by Georges de Ménil, Viktor M. Pynzenyk and Viktor A. Yushchenko, and privatization, analyzed by Yuri I. Yekhanurov. Other reforms are feasible because rent seekers find them irrelevant, for instance, the introduction of lump-sum taxes for small entrepreneurs. Reforms are much more difficult to undertake, if rent seekers benefit from the status quo. Thus, Ukraine's "absurd" tax system has remained dysfunctional. This problem is considered in chapters by Marek Dabrowski, et al. and Serhyi Teriokhin. The "complete arbitrariness" in handling budget revenues and expenditures in mid-1990s undermined both education and healthcare systems, but recipients of plentiful ad hoc subsidies had a direct interest in maintaining the disorder. The most difficult reform, due to rent seekers' interests, was "deregulation of major rent opportunities in energy and agriculture." Finally, the social welfare system in Ukraine, examined in Helena Góralska's chapter, needs major improvement, as "social expenditures go to the rich rather than the poor."

Underlying Problems and Recent Changes

Accordingly, Åslund reckoned Ukraine's fundamental problem lies in the "political power of the rent seekers." Their influence is reflected in excessive and poorly controlled public expenditures as well as a detrimental regulatory framework that allows for monopoly rents. Besides, the Ukrainian legislative body, the Rada, is swarming with businessmen, who promote their own interests instead of their constituents' concerns, blurring the line between state and business. Racketeering has been taken over by the Ministry of Interior and the Ministry of Security. In Ukraine "business is socialized while politics is privatized."

However, during the last year Ukraine has picked up speed in its economic restructuring. Ukraine's GDP grew by 5.3 percent in the first half of 2000, due to both political and qualitative economic changes.

According to Åslund, four political developments had helped Ukraine to overcome some of the obstacles to economic reform. The first was the introduction of proportional representation for half of the 450 seats in the Rada during March 1998 parliamentary elections. It "endowed Ukraine with party politics, restraining decision makers with public opinion." The presidential elections of 1999 brought about the second political shift. The run-off victory of incumbent Leonid Kuchma over Communist Petro Symenenko put an end to the communist threat in Ukraine and made the president fully responsible. The third positive change was President Kuchma's appointment of Viktor Yushchenko as Prime Minister. Åslund emphasized that Yushchenko was "the most highly-respected economic reformer in Ukraine." The most recent significant political development occurred in January 2000, when Kuchma mobilized the anti-Communist majority in the parliament to unseat the leftwing speaker, thus opening the door to promulgation of new reform laws.

These political changes have been followed by substantial economic reforms. First, Yushchenko introduced regularity into decision-making process of the cabinet. Second, Minister of Finance Ihor Mitiukov had put state finances in order by balancing the budget, cutting public expenditures, reducing government arrears, improving the budgeting process as well as "reducing offsets and other non-monetary payments of taxes." Ukraine accomplished all this without IMF funds. The third area of qualitative economic reform has involved the energy sector under the leadership of oligarch-turned-Deputy Prime Minister of Energy Yulia Timoshenko. Acting decisively against offsets, barter and other tricks of the gas barons, Timoshenko had raised cash collection for electricity from one-tenth to 70 percent of all payments from January to September. "The so-called virtual economy is dwindling before our eyes" thanks to her management of the energy sector. A final qualitative change was land reform, instigated by presidential decree last December. Although it was "opaque," Åslund argued that it has increased pluralism and private ownership of land.

Prospects for Ukrainian Economic Reform

In conclusion, Åslund summed up the positive and negative tendencies in Ukraine and their future potential. Most positive was the strong growth in food processing and light industry. A significant liberalization, especially in foreign trade, had taken place. Much of the new growth could be attributed to Russia, Ukraine's major export market, taking off, and a substantial devaluation. A good legislative package was also on the way with a tax code, civil code and land code, which were likely to be adopted within the next few months." Åslund noted that "a strong sense of private property" is taking hold in the country.

Yet Åslund also saw several areas of concern. Especially, he found Ukrainian media extremely poor, reflecting the interests of their oligarchic owners and their dislike of Yushchenko and Timoshenko. Although Yushchenko is not likely to be ousted while Kuchma stands behind him, he could easily be stalemated by oligarchic parties in the Rada or by controversy surrounding Timoshenko. The "presidential administration is not part of coordination of government decision-making," and it had passed "one decision after another going against IMF and World Bank conditionality," blocking Ukraine from IMF funding. Åslund concluded that hopefully "Ukraine has passed through the critical stage and we are now seeing the country moving from politics of redistribution to politics of growth."

The Discussion Period

· Ukrainian mood and civil society. When asked about the attitude of the Ukrainians towards the changes, Åslund commented that during his last visit in early October he had noticed that "the mood was very pessimistic," but Ukrainians are "never easily impressed by small improvements." "Ukraine does have a civil society, but one that is excessively patient, with people not prepared to stand up and protest."
· Banking and financial sector. Responding to a question about the status of the banking and financial market sectors, Åslund said that the banks in Ukraine had been so severely hurt by hyperinflation that they never became very important, and "the oligarchs have remained essentially commodity traders." The stock market primarily traded in utilities, while the bond market was destroyed by Ukraine repeatedly not paying on bonds either domestically and externally." On the positive side, Ukraine has a small foreign debt, as few can be persuaded to lend to this country.

· Changes in the legislature. Åslund was asked to expand on changes in the Ukrainian legislature. He labeled 120 deputies as "pro-Yushchenko," while 150 deputies stand behind President Kuchma. He saw the three strong oligarchic parties as "the weakest pillar in Yushchenko's coalition." The main question, for how long the oligarchic parties will support Yushchenko, remains unanswered.

· Russian involvement in Ukraine. On Russia's involvement in Ukrainian economy, Åslund observed that "right now, big decent Russian businessmen are expanding fast in Ukraine." This was partly due to improved business conditions in Ukraine, and partly to Russian business leaders' experience in turning "big Soviet enterprises around" in similar circumstances. The Ukrainians, were not much worried about the Russian expansion because they feel in control of foreign investment. Åslund predicted that "the Russian wave of investment is a harbinger of broader investment rather than something dangerous."

· Ukraine and the IMF. Asked about his pessimistic outlook on Ukrainian prospects of IMF funding, Åslund emphasized that the new presidential decrees tended to hurt Ukraine's relationship with the IFIs. "The IMF also complains about too little privatization in Ukraine and too much budgeted privatization revenues, and it wants Ukraine to close down some bad banks." On Yushchenko's credibility if he did not receive IMF funding, Åslund argued that "given that their relationship with the West is worse, they need Yushchenko more, and if they get the money, they could sack him because he is no longer needed." Of course, Yushchenko would be more popular if he were able to convince IMF to give money to Ukraine.

· President Kuchma. On Kuchma's personal policy preferences, Åslund recalled that Kuchma was supportive of reform in 1994 until June 1995, and now he is back to his reformist positions. However, Kuchma is "totally inscrutable and very shrewd," playing oligarchs and politicians against each other. Åslund compared President Kuchma to former Russian president Yeltsin, as Kuchma is also "very focused on power, has some ideas on how to improve things," while remaining very enigmatic.

· Regional differences. With regard to regional differences in economic development, "for a long time, it was striking how small the differences were." However, he also noted that eastern Ukraine has a more criminalized economy than the western part of the country due to extensive commodity trading. Although many expected western Ukraine and Crimea to take off, "this did not happen at all." Instead, Odessa, a port city, was the pioneer in development, and now Kyiv is doing better in comparison with other parts of the country. On the whole, Åslund praised the Ukrainian government for skillfully containing regional differences.

Summary by Victoria Levin, Junior Fellow with the Russian and Eurasian Program.