CASE UkraineCASE Ukraine

www.case-ukraine.com.ua

Investment environment in UkraineInvestment environment in Ukraine

Vladimir DubrovskiyVladimir Dubrovskiy

Prepared for the congress Investment in Ukraine. Challenges and opportunities

Hotel Polonia Palace, Warsaw, 8th-9th November 2004

CASE Ukraine

Formal and informal impediments to entrepreneurship and investments in Ukraine: the main peculiarities and the ways of coping with them

The political-economic causes for persistence of the "bad institutions" in Ukraine: can we predict the changes, and promote the improvements?

Evolution of the political-economic system: where Ukraine is going?

CASE Ukraine

Peculiarities of investment climate

Blat networks of interpersonal exchange with favors

“Soft” rule of law

The nachal’niks versus bureaucrats

Making things done:

Institutions:

Vague property rights

CASE Ukraine

The “pales of law” can be… The “pales of law” can be…

…tight: so hard to keep within the law!…loose

… and SOFTSOFT: no way to fully keep within the law!

“Soft” rule of law

but“There is only a block of concrete that really means “NO ROAD”.

The rest of prohibitions mean just “TOLL ROAD”

For your competitors tooFor your competitors too

CASE Ukraine

personalpersonal vlast’vlast’ of NACHAL’NIKSof NACHAL’NIKS

““The severity of the Russian laws is alleviated The severity of the Russian laws is alleviated onlyonly by by discretiondiscretion in their in their enforcementenforcement” “… just this ” “… just this disorderdisorder makes life in Russia possible” makes life in Russia possible”

Everybody is a lawbreakerThe law applies to all

“Laws are written for the fools”

“Who are the boss, we or the law?”

Preconditions forPreconditions for extortionextortion

Authoritarian modernization: law contradicts to practices

EXTORTIONEXTORTION underunderenforcement of the lawenforcement of the law

Because they are applied at the discretion of a nachal’nik

Karamsin, 19th century Russian historian

Gertzen, 19th century Russian social thinker

“Soft” rule of law

UnUncontrolled and mostly controlled and mostly affiliatedaffiliated with business with business

Strictly controlled and Strictly controlled and separatedseparated from business from business

Possesses the political power to Possesses the political power to magnify ambiguity and non-magnify ambiguity and non-transparency in legislationtransparency in legislation

No decision-making power No decision-making power Clear separation of “powers” from Clear separation of “powers” from branches of Statebranches of State

Controls politicians rather than vice Controls politicians rather than vice versa. Tries to control mass-media to versa. Tries to control mass-media to avoid public scrutinyavoid public scrutiny

Operates under constant public Operates under constant public scrutiny and political oversightscrutiny and political oversight

Poorly-paid and dependent upon Poorly-paid and dependent upon administrative rents (in money or administrative rents (in money or barter) barter) Relies upon Relies upon discretionarydiscretionary power and power and vague and arbitrary informal rulesvague and arbitrary informal rules

Highly-paid professional public Highly-paid professional public servants facilitating rational processes servants facilitating rational processes of control. of control. Implements legislation in a strictly Implements legislation in a strictly formal (formal (impersonalimpersonal) way) way

Administrative power in Ukraine

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

CASE Ukraine Blat networks

Reputation-based informal networks of interpersonal mutual Reputation-based informal networks of interpersonal mutual exchange with “favors of access” (exchange with “favors of access” (blatblat))

Emerge to facilitate the illegal transactions of all kindsEmerge to facilitate the illegal transactions of all kinds

““One has to One has to deserve a deserve a rightright to pay a bribe” to pay a bribe”

No contract enforcement was officially availableNo contract enforcement was officially available

Normal economic activities were considered illegal Normal economic activities were considered illegal

Authoritarian modernization,Authoritarian modernization,

especially under Communists especially under Communists : : law contradicts to practiceslaw contradicts to practices

Ledeneva, 1998

Weak rule of lawWeak rule of law

Litwak, 1991 (!) while

CASE Ukraine

Right to use the object WITHIN THE LAWVague property rights

Under a “soft” rule of law

Vague Vague property rightsproperty rights

Real value of an asset depends on the position of its Real value of an asset depends on the position of its owner within the informal networks of owner within the informal networks of blat blat

CASE UkrainePolitical economy

The “vicious triangle” of legislation-corruption-discretion

Rent seeking, overappropriation, and “arbiter-client” relations

“State capture” by corrupt networks

“Zero-sum perception” and the problem of legitimacy of entrepreneurship

The Orange revolution and its immediate consequences

Evolution of the rent-seeking society of Ukraine

FACILITATEFACILITATE

CASE Ukraine

Legislation Legislation (flawed, (flawed,

ambiguous, ambiguous, impracticable)impracticable)

Corruption Corruption

DiscretionDiscretionENHANCESENHANCES

INTERESTINTEREST INTERESTINTEREST

Decreasing the demand for improvementsDecreasing the demand for improvements

ALLEVIATESALLEVIATESALLEVIATESALLEVIATES

In many cases players fail to establish the efficient institutions.

CASE UkraineRent seeking vs. profit seekingProfit seekingCreation 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 Rent seeking requires FORCED coordination and control that can only be arranged by control that can only be arranged by

AUTHORITARIAN POWERAUTHORITARIAN POWER

Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and

Savvateev (2002):

playerclient Rent source

CASE Ukraine

player

playerplayer

The “arbiter-clients” model

Authoritarian arbiterDistributes the quotas for rent appropriation arbitrarily,arbitrarily, and enforces

them in order to restrain the devastating competition

client

clientclient

… … but instead extorts the rent himself, or trades it for loyaltybut instead extorts the rent himself, or trades it for loyalty

Rent sourceLobbyist

“Oligarch”Nachal’nik

...

State budgetNatural

resourcesPublic property

...Weak property rights

“the tragedy of the commons”

CASE UkraineAn 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-maximizing totalitarian

authoritarian, plutocraticArbiters: Arbiters: ≡

≡

AnyAny kind of market exchange is being perceived as a sort of kind of market exchange is being perceived as a sort of ««zero-sum gamezero-sum game»»

Business incomes are not being distinguished by their originBusiness incomes are not being distinguished by their origin

Business and wealth ofBusiness and wealth of ANYANY kind is kind is illegitimateillegitimate

Weak property rightsWeak property rights ““fairness” of business fairness” of business is unrewardedis unrewarded

The rent seeking DOES dominateThe rent seeking DOES dominate!!

A “zero-sum” perceptionInherited to a traditional society

CASE Ukraine

Why do the people hate entrepreneurs?

Profit seeking (competitive) sector

Rent seeking sector

Monopoly rent

CASE Ukraine

player player

playerplayer

InIncrease in the social wealth

DeDecrease in the social wealth

Effects of authoritarian rule

Paternalism (clietnelism) and corruptionPaternalism (clietnelism) and corruption

Firms earn their incomes mostly as rents depending primarily on the arbiter’s discretion

client

client client

client

“A “zero-sum” perception

CASE Ukraine

Size of the rent-seeking sector is determined by the

balance between amount of rents available for an

arbiter and his costs of control and coordination of

the rent seekers

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:

Profit-seeking sectorRent-seeking sector

Technology Technology

SOCIETAL NORMSSOCIETAL NORMS

CASE Ukraine

REVOLUTION?REVOLUTION?

Rent-seeking sector

Profit-seeking sector

“Standard” approach applies

Transition from a rent-seeking society: Evolution and REvolution?

Politically responsible government

Depletion of the rent sourcesMarket

imbalancesFinancial instability

Cheap energy and credit

«intermediate winners»«intermediate winners»

Sources of Sources of RentRent

1988 - 19941988 - 1994

Overappropriation of state budget and enterprises’ fixed assets

“Overappropriation” of creditors’ trust

Sources of RentSources of Rent1995 – 1995 – 20020000??????

Subsidies and government contracts

Close collaboration of business and officials based on blatblat

A tacit social contract:

“We” do not bother

“them”, “they” do not

bother “us”

Business-Business-administrative administrative groups (BAG)groups (BAG)

Whither “captured statecaptured 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 PLAYERPASSIVE PLAYER

Perceived Perceived manipulatedmanipulated

Threat of populism and paternalism Threat of populism and paternalism towards large groups of population towards large groups of population

CASE Ukraine

Public is not passive anymore, it became a “principal” of the politiciansBAGs and their arbiters are not the only 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 rentssupports redistributive activities (as “re-privatization”)supports “coordination and control” (e.g. price regulation)

The “captured” state starts working for the competitors

Business-administrative

groups

Financial-industrial groups

An “arbiter” for the An “arbiter” for the large groupslarge groups

Revolution of the politiciansPolitical capitalPolitical capital

POPULISMPOPULISMPolitical parties

Destruction of the rent-seeking opportunities

A “zero-sum” perception

Demand for the Demand for the UNIVERSALUNIVERSAL rules of rules of

the gamethe game

State budget

Tax base

a group

a group

a group

a group

The tragedy of the commons

CASE Ukraine

0

10

20

30

40

50

60

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

rather negative

rather positive

People's attitude to the privatization of large-scale enterprises

source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)

CASE Ukraine

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Balance of attitudes to land privatization

source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)

CASE Ukraine

-80

-70

-60

-50

-40

-30

-20

-10

01994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

0.5

1

1.5

2

2.5

3

self-reliance

satisfaction with socialstatus

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)

Thanks for Thanks for your attention!your attention!