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

2. In many cases players fail to establish the efficient institutions. CASE Ukraine Rent seeking vs. profit seeking Profit 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 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 control that can only be arranged by AUTHORITARIAN POWER Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and Savvateev (2002):

3. player client Rent source CASE Ukraine player player Arbiter-clients model: how it works Authoritaria n arbiter D i s t r i b u t e s t h e q u o t a s f o r r e n t a p p r o p r i a t i o n a aa a r b i t r a r i l y, a n d e n f o r c e s t h e m i n o r d e r t o r e s t r a i n 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 client … but instead extorts the rent himself, or trades it for loyalty Rent source

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

5. 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-maximizingtotalitarian authoritarian, plutocratic Arbiters: ≡ ≡

6. 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

7. “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 “Soft” rule of law

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

9. 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 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

10. 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 ” Informal networks of interpersonal exchange (Blat) captured state Whither “captured 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 Perceived manipulated

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

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

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. A tacit social contract: “We” do not bother “them”, “they” do not bother “us” Informal networks of interpersonal exchange (Blat) captured state Whither “captured 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 Perceived manipulated

17. 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)

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

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 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

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) “CONTRABANDA-STOP” Increase in prices Improved since 2004 (122 out of 145, score 2.2) but G i v i n g t o t h e s y s t e m i c r o l e t h a t c o r r u p t i o n p l a y s, p u n i t i v e s t r a t e g i e s s o l e l y c a n n o t e l i m i n a t e i t, a n d e v e n t h e i r m o d e s t s u c c e s s m a y b e h a r m f u l ! bankruptcies while Increasing demand for improvement of the formal (legislative!) rules

24. 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 WASTED WASTED

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

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

27. CASE Ukraine Threats and risks ratings of both leaders of the Orange team have decreased four times possible defeat at the Parliamentary elections of 2006 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 “revelation of the entrepreneurial potential of Ukrainian nation” new and more capable elite may be needed that would 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 dependence on cheap Russian energy Relatively high human capital is a real competitive advantage Relatively high innovation rate r e m a i n s u n r e v e a l e d d u e t o t h e p o o r b u s i n e s s c l i m a t e L o w d o m e s t i c d e m a n d f o r i n n o v a t i o n s L o w c a p a c i t y t o a d o p t t h e m Will hardly sustain unless supported in some way

29. Thanks for your attention!