CASE Ukraine The Political-Economic and Institutional Framework for Assessing the Business Environment in Ukraine Vladimir Dubrovskiy

CASE Ukraine Keywords for the framework Blat networks of interpersonal exchange with favors Discretionary rule; selective law implementation (enforcement) The nachal’niks as opposite to bureaucrats The “vicious triangle” of legislation-corruption-discretion Rent seeking, overappropriation, and “arbiter-client” relations Paternalism and its consequences “State capture” by corrupt networks Societal structures: Institutions: Political economy Some notions concerning the institutional changes Some examples In place of conclusions

“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: 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’ arbitrary, discretionary power CASE Ukraine “ W h o a r e t h e b o s s, w e o r t h e l a w ? ” “ L a w s a r e w r i t t e n f o r t h e f o o l s ” Karamsin, 19th century Russian historian Gertzen, 19th century Russian social thinker Discretionary rule Keywords: Discretionary rule

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 (by Weber) Nachal’niks Nachal’niks: not the bureaucrats!

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

CASE Ukraine Blat networks Keywords: 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 deserve a right 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

Usually requires a coercive force to arrange appropriation and/or prevent overappropriation (“tragedy of the commons”, overfishing) CASE Ukraine The Rent Seeking Keywords: The Rent Seeking Profit seeking Creation of the value apprised by a competitive market Appropriation of a value created by others or already existed 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 agree on certain mutually-beneficial rules and enforce them Manufacturing, trading, financial operations, etc. – if conducted under the fair competition and an even “playing field” Robbing, fraud, racketeering, and ANY economic activities, to the extent they involve privileges, abuses of competition (like protectionism), etc.

A renewable rent source (as a state budget) A renewable rent source (as a state budget) CASE Ukraine player player Rent as an exhaustible common resource Authoritaria n arbiter R e s t r a i n s t h e d e v a s t a t i n g c o m p e t i t i o n b y f o r c e, b a s e d o n h i s d i s c r e t i o n a r y p o w e r … … b u t i n s t e a d e x t o r t s t h e r e n t h i m s e l f client

Monopoly rent CASE Ukraine player In Increase in the social wealth De Decrease in the social wealth Competitive market sector Rent seeking sector Effects of an authoritarian rule Paternalism towards the enterprises Enterprises’ rents depend primarily on the arbiter’s discretion clien t

CASE Ukraine Rents Rents for the nachal’niks and oligarchs at the expense of the population; deadweight loses Credit emission The government commits to “support a domestic producer” “support of the effective demand” Tolerating arrears ProtectionismDirect subsidies monetary emission Soft crediting monopolismForced crediting Fiscal deficit Tolerating barter Price growth out of control Paternalism Paternalism results in crises

CASE Ukraine S i z e o f t h e r e n t - s e e k i n g s e c t o r i s d e t e r m i n e d b y t h e b a l a n c e b e t w e e n a m o u n t o f r e n t s a v a i l a b l e f o r a n a r b i t e r a n d h i s c o s t s o f c o n t r o l a n d c o o r d i n a t i o n o f t h e r e n t s e e k e r s The rent seeking is costly for a society It takes certain cost of an arbiter to coordinate and control the rent seekers The rent seeking contracts With exhausting of the available rents, and complicating of control and coordination Evolution:

A t a c i t s o c i a l c o n t r a c t : “ W e ” d o n o t b o t h e r “ t h e m ”, “ t h e y ” d o n o t b o t h e r “ u s ” Blat captured state Whither “captured state”: a dead end? Business: a “Milk caw” 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 Perceived manipulated

Threat of populism and paternalism 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 rents supports redistributive activities (as “re-privatization”) supports “coordination and control” (e.g. price regulation)

CASE Ukraine “captured” by the directors and bureaucrats Still controlled by the directors and bureaucrats by the means of paternalism Property rights Time The title property rights The residual rights of control Formal and actual institutional changes

CASE Ukraine Evolution of the informal property rights

Depletion of the rent sources Market imbalances Financial instability Cheap energy and credit «intermediate winners» Sources of Rent Dependence on government's re- distributive power Stripping of the fixed assets (“end game”) Sources of Rent 1995 – 2004??? Subsidies and government contracts blat Close collaboration of business and officials based on blat

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