Larissa Paschyn Homework 1 Student ID: 2010280348

The State, Market, and Society in Ukraine and Needed Institutional Changes

According to the UN’s Human Development Indicators, Ukraine ranks 6th out of the ‘10 Lowest HDIs for Europe’, and Ukraine ranks 69th out of the total169 countries. Life expectancy is around 68 years of age, and most Ukrainians typically have only 11 years of schooling. In terms of sustainability, the adjusted net savings is 8.5% of GNI, and the population percentage living below $1.25 PPP per day is <2. The HDI of Europe and Central Asia as a region increased from 0.534 in 1980 to 0.717 today, placing Ukraine below the regional average. Though Ukraine is below the regional average it has increased its ranking since 2000 when it was at a .649. In 2005 it was a .69 and has incrementally risen to .717. It is interesting to note, that in 1990 it was also .696, but Ukraine dipped in the rankings dramatically from 1990 to 2000 due to a deep recession.

Regionally, Ukraine has been considered the key buffer of the Russian Federation from the former Soviet Satellites, and countries such as Hungary and Poland have pushed for Ukraine to integrate into NATO and the EU. Ukraine is geopolitically important because it is the largest country in Europe, excluding Russia, and is a major transit route for European energy. It is also strategically located on the Black Sea coast which is home to Russia's Black Sea fleet. Russia sees Ukraine as often time’s a compliant and culturally-similar neighbor which Russia wants to use to anchor its sphere of influence over the former Soviet countries. However, the West wants Ukraine to be Europe's final outpost in the East, to weaken Russian influence in the region, and to continue extending the borders of NATO and the EU (Encyclopædia Britannica). Thus, Ukraine is in a precarious position, and being the mediator between two economic and political territories can be seen in its HDI rankings, especially when compared to its neighbors. Poland, Ukraine’s EU and NATO integrated neighbor, has outperformed Ukraine in all aspects, steadily rising in HDI from 1990 and reaching a .795 today. Poland is also above the regional average, and has a 9.8 GNI per capita, and has an average age expectancy of 76, and net savings of 9.2%. Poland also ranks 41st for the index. Russia however matches Ukraine’s rankings, showing the influence the Soviet Union had, and also had the same initial dramatic dip from 1990 to 2005, and then a steadily increasing HDI reaching .717 today. Ranking 69 th, Russia’s average level of schooling is only 8 years; adjusted net savings is only 1.6%. Life expectancy is similar to Ukraine at 67.2 years of age (http://hdr.undp.org/en/). A data basis for Russia, Poland, and Ukraine is included in the attached appendix for reference.

The indicators show Ukraine’s governance has improved overall since 1990, and that Ukraine is an emerging free market. It can be considered a Bureaucratic Capitalist political economy. The focus is on agrarian and industrial exports, and there has been a growing middle class and civil society development. However, there is also active industrial policy and FDI market control. Ukraine is also well known for its extensive bureaucratic control and limited RoL which often leads to corruption problems. Ukraine though has been continuously growing in socioeconomic modernization. In Soviet times, the economy of Ukraine was the second largest in the Soviet Union, but with the collapse of the Soviet system, the country moved from a planned economy to a market economy (Encyclopædia Britannica) and the World Bank classifies Ukraine as a middle-income state. This is a result of the deep recession Ukraine experienced in the 1990s, which included hyperinflation and a fall in economic output. This affected future growth and while Ukraine registered positive economic growth beginning in 2000, the standard of living for

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Larissa Paschyn Homework 1 Student ID: 2010280348

most citizens has declined more than 50% since the early 1990s, leading to a high poverty rate. Yet, Ukraine’s economy has continued to grow thanks to exports since 2000. This has been at uneven speeds and was highly affected (circa -15% GDP growth) by the late-2000s recession and the 2008–2009 Ukrainian financial crises (State Statistics Committee of Ukraine). In general though, growth has been supported by strong domestic demand, low inflation, and solid consumer and investor confidence. There is also a robust GDP and income growth, and falling levels of government debt (Foundation for Effective Governance, pg. 3). Growing sectors of the Ukrainian economy include the information technology (IT) market, which topped all other Central and Eastern European countries in 2007, growing some 40 percent (Economic Ministry).

However there are a growing number of concerns that revolve around reforming the relations between the State, Market, and Society. Significant issues include underdeveloped infrastructure and transportation, corruption and bureaucracy. Further, the pension budget deficit has become chronic, and labor productivity remains at a level that is five times lower than that of the most developed countries (Foundation for Effective Governance, pg. 5). As a result, rising costs of production factors such as energy and wages, a worsening demographic situation and obsolete capital assets can seriously undermine Ukraine’s competitiveness globally. In order to maintain Ukraine’s competitive strength in the globalized economy, and its current economic pace, overall productivity must be increased. Further, investment in infrastructure improvement is insufficient, and an excessive share of state-owned enterprises is depressing productivity, slowing denationalization, and encouraging corruption (Foundation for Effective Governance, pg. 5). Heavy taxation, outdated business legislation and a weak judicial system also scare away foreign investors and impede the development of domestic enterprises. Society and demographic issues have also affected productivity and competitiveness within several years. A shrinking working population and continuing emigration of the labor force have produced a deficit of high-skilled personnel in some sectors (McKinsey & Co., pg. 3).

Decentralization is needed to promote human development, as well as citizen participation. Through their participation in local self-government, an impact will be made on the choice of methods effective for a given region. For example, there are serious problems in all areas of education, from primary to higher education systems. Decentralization can improve the education system by providing more local authority in making decisions on the delivery of education services. This could stimulate additional financing at the local level and create a more stimulating environment for recruiting teachers and other professionals needed in the education field. At the central government level there needs to be further clarification of the legal, financial, and territorial divisions for local governments. This includes domestic changes to policy, and the development of the laws on local government finance, taxes and community property. One of the key areas for additional action by the central government is improvements to the Budget Code to stabilize the transfer formulas and allocations to the local governments (Foundation for Effective Governance, pg. 18).

In addition, Ukraine needs to establish the fundamental prerequisites for economic growth including a functioning market economy via an effective foreign liberalized trade policy. With this must coincide, macro-economic stability, effective factor markets, a developed infrastructure, and efficient use of natural resources. Currently, obsolete transport and energy infrastructure are sources of significant risk, and Ukraine needs to enable a level of infrastructure

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Larissa Paschyn Homework 1 Student ID: 2010280348

investment sufficient for rapid economic expansion (McKinsey & Co., pg. 5). The state should provide facilities for retraining, quality education, and mobility. Not only will it alleviate economic problems, but also give people opportunity to adapt more quickly to changes on the labor market and therefore create faster a self-assured and independent middle class. These are the basic requirements that will define the scale and sustainability of Ukrainian economic success.

Within the context of globalization and a globalized economy, the business environment in Ukraine must improve while also ensuring fair competition. A favorable environment will enable capital and best practice inflows, thus increasing economic efficiency, and fair competition will create the necessary productivity pressure. There are two major elements in Ukraine’s competition protection system: the Law on Protection of Economic Competition and Anti-Monopoly Committee of Ukraine (AMCU). The main problems of Ukraine’s competition policy are the excessively wide coverage by the anti-monopoly system in regulating market concentration, and the complex process of approval of mergers and acquisitions (Foundation for Effective Governance, pg. 9). Excessively wide coverage of market concentration regulations in the Law on Protection of Economic Competition (the threshold for merger approval in Ukraine is 20 times lower than in the EU) requires approval by the AMCU of a vast number of transactions that have no impact on the competitive landscape. This puts unnecessary stress on AMCU and diverts its resources. Further, the complex process of document submission, along with the sheer volume of required documentation exceeds similar requirements in the EU. This creates corruption, increases risks and unpredictability for businesses, and increases costs and time requirements for transactions. In order to improve Ukraine’s global economic position, modifying the market concentration provisions and regulating the process of submission and review of applications should occur. This would simplify the approval process. In addition, creating a more favorable business environment will require improved tax policy and business legislation, better protection of investors’ rights, an improved judicial system and lower administrative barriers. Fair competition will also require improved regulation of monopolies, lowering the tax burden and improving tax administration (which will also reduce the shadow economy), and the strengthening of the legal and institutional tools for competition protection (McKinsey & Co., pg. 14-15). This must coincide with the development of sectors that are structurally important and capable of becoming the engines of growth. For example, a robust retail sector and construction sector would improve overall economic development, as both sectors fuel growth in the related industries (McKinsey & Co. pg. 9).

Greater trade liberalization is also crucial, and there must be institutional adaptation to globalisation and integration within international organizations. In 2007 Ukraine had trade relations with 199 countries. The country's foreign trade turnover was about 97% of the GDP. Further integration into international foreign trade practices requires lowering tariff and non-tariff limitations, and simplifying customs procedures (Foundation for Effective Governance, pg. 9). According to the World Bank's report entitled ‘Doing business 2008’, the number of documents required to import goods to Ukraine is twice as big, while the time that the import procedure generally takes is four times longer than the average time in OECD states. Ukrainian foreign trade policy still needs to develop commercial relations with the EU and CIS within not only the WTO but also at the regional level. This will diversify the risks of cyclical recession in demand for Ukrainian exports. Ukraine also needs to create a free trade area with the EU. A free

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Larissa Paschyn Homework 1 Student ID: 2010280348

trade area will primarily lower non-tariff limitations in the movement of goods, services, capital and human resources. However Ukraine’s reliance on State-owned enterprises (State share in Ukrainian GDP is now 37%) and the high share of state owned property combined with the indefinite nature of the privatization process, has encouraged corrupt practices and a lack of competition. Competition is one of the key factors that stimulates productivity gains and ensures sustainable economic growth. The government should protect the markets from unfair competition, including collusion between competitors and excessive market concentration.

Finally to find the optimal balance for State and Market relations within a globalized playing field, there must be a balance between entrepreneurial autonomy and state control. As of now, the energy and telecommunications sectors have yet to be privatized. The government has also passed a foreign investment law, but bureaucratic hurdles, poor corporate governance, corruption, and the weak enforcement of contract law by courts all hamper investment. Thus, for Ukraine, the Negotiations - Based Approach is the most efficient solution (Burakovsky, pg. 5). This is where the enterprise in question negotiates the allocation of profit with the respective branch ministry. It requires the mandatory audit of state enterprises; assists in calculation of normative rates, and takes into account specifics of environment where the enterprises are operating. Also, with agreement on profit distribution, the enterprise gets clear perspective for planning commercial activities while the state gets information for budget-financed investments. Further, it limits state support to enterprises, avoids misallocation of budget resources, and allows enterprises to implement medium and long-run investment projects (Burakovsky, pg. 6). It also improves management by introducing public-private partnership schemes. To be efficient however, Ukraine must abandon the current practice of granting certain enterprises waiver of liabilities to the state, as it undermines the very basis of the state as property owner. Lastly, in Ukraine only an enterprise’s own profit and depreciation can be the source of investments (external funding – budget funding, bank credits, etc. is practically unavailable). Attempts to extort the whole amount of profit will intensify the process of “eating away” fixed capital (Burakovsky, pg. 7).

Sources:

"Average Wage Income in 2008 by Region". State Statistics Committee of Ukraine. Retrieved 2008-07-05.

"Bohdan Danylyshyn at the Economic ministry". Economic Ministry. Retrieved 2008-02-01.

Burakovsky, Vachenko, 2003. State-owned Enterprises on Ukraine, Institute for Economic Research and Policy Consulting, 2003.

FOUNDATION FOR EFFECTIVE GOVERNANCE, 2008, Ukraine's Economic Development Agenda for 2008-2015, Preliminary version for discussion April 9, 2008.

"Independent Ukraine". Encyclopædia Britannica (fee required). Retrieved 2007-09-12.

McKinsey & Company, 2009, Reviving Ukraine’s Economic Growth, New Media Australia, October 2009.

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