Lessons from the Ukrainian Transition:Lessons from the Ukrainian Transition:

Reform Driving Forces in a Captured Reform Driving Forces in a Captured StateState

CASE-UkraineCenter for Social and Economic Research

Delhi, January 2004

Reforms in Ukraine (1991-2001) : A process, not an action

Reactive, not proactive

Occurred in the historically “captured” state

Never openly supported by the majority of population

Very painful

Slow, inconsistent, incomplete

But nevertheless resulted in the impressive growth and relative macroeconomic stability

A success story ????A success story ????

CASE Ukraine

Economic policies defined within the elites

“Public choice”: the “mandated” reforms, based on the political support of a resulting political force

In Ukraine: The major reforms were undertaken irrelevant to the position

of a broad publicNo program of reforms has ever got a public mandate

The only positive example we may provide is the simplified taxation for small and micro business

A majority of broad public was always against privatization of the large enterprises

The monetary stabilization was started without any mandate and continued despite the political defeat of its initiators.

The paternalism towards the enterprises was contracted despite the growing public sentiment in its support

CASE Ukraine

CASE Ukraine

The reforms in Ukraine: rarely proactive

“Passive” “Reactive”

Just accepting the new rules of the game that have already become

dominant in the grassroots

Rarely took place Price liberalization

Imposed by an authoritarian government

“Proactive”

maximize the political gains

minimize the political loses

Privatization and reduction of paternalism

Mandated

In Ukraine:

Public alienated from the state

CASE Ukraine

Why the inefficient institutions persist?

Nobody knows how to make the things better

Vested interests of the rent seekers

The efficient institutions already exists in other

countries

the rent seeking is to some extent primary to other

impediments because it provides an incentive for

market players to support, create or magnify the

market distortions and imperfectness

CASE Ukraine

a dead end?a dead end?

Sonin: Who needs the bad [formal] institutions ?

Efficient allocation of resources

Market imperfections

Rent seeking

opportunities

creates

supports

CASE Ukraine

A rent sourceA rent source

player player

playerplayer

The reforms under rent seeking

Tornell: The rent is an exhaustible common resource

Competition destroys it because of the

problem of commons

CASE Ukraine

monopoly rents at the product

and factor markets

player player

playerplayer

Different sources of rents

Distorting and inhibiting the factor allocation

Competition should be protected and encouraged

CASE Ukraine

State budgetState budget

Natural Natural endowmentendowment

player player

playerplayer

Different sources of rents

The “good” ones, vitally needed for a society

Competition should be restricted

It is safer to even prohibit it at all if there is no way to discriminate between sources of rents

CASE Ukraine

Rent sourceRent sourceplayer player

playerplayer

Back to the rent maximization – 1:

CASE Ukraine

The rational and transparent formal institutions

provides with the opportunity of distinguishing between the rent sources if such distinction may be rationally justified

May still serve to prohibit the market competition

Requires the corresponding informal institutions

Limit the property rights but do not affect their clearness, symmetry and distribution

Can be a basis for an efficient market economy

CASE Ukraine

Rent sourceRent sourceplayer player

playerplayer

Back to the rent maximization – 2:

Authoritarian arbiter

An arbiter:CASE Ukraine

Has an incentive to extract the rent (share the players’ rents)

If he does so, he becomes “captured” with the vested interests

Asymmetry: The players may motivate their arbiter with a “carrot”, but not threaten to him irresponsibility

players are clients of an arbiter

But still preserves some freedom of choice (in a sense of Grossman-Helpman-Dixit model)

He is interested in using his discretionary power for weakening the players’ residual property rights of control

Being endowed with authority to resolve the problem of commons in the vital sectors is interested to use it for enforcing any kind of cartel, therefore restricting the economic freedom

CASE Ukraine

He is constrained with the threat of PUBLIC UNREST that may occur if a vital rent source would get exhausted

is not interested in the market reforms as long as they reduce the sources of rents and enhance the economic freedom

An arbiter:

and particularly those, strengthening the residual property rights of the players

BUT:

His ability to control the players is limited by the same factors, primarily non-transparency, that facilitate rent seeking

Even a hierarchical structure with the players and arbiter at each level cannot secure the rents from exhaustingThe reforms are get imposed on the players mostly

when a crisis comes

CASE Ukraine

Vague and asymmetric property rights

Paternalism

Clientelism

Soft budget constrains

(SBC)

“Party rule”: never

formally legitimized

Elitism

The post-Soviet institutional legacy

Discretion Formal institutions

Selective implementation

CASE Ukraine

State propertyState property

BudgetBudgetdirector director

bureaucratbureaucrat

USSR: Under the command economy

Communist Party

CASE Ukraine

State propertyState property

BudgetBudgetdirector director

bureaucratbureaucrat

Soon after

Unconstrained paternalism towards enterprises (not the population!)

The first-wave “intermediate winners”

CASE Ukraine

rents for the directors at the expense of the population and deadweight loses

Paternalism is dangerous

Credit emission

The government commits to “support a domestic producer”

“support of the

effective demand”

Tolerating arrears

Protectionism Direct subsidies

monetary emission

Soft crediting

monopolism Forced crediting

Fiscal deficit

Tolerating barter

Price growth out of control

CASE Ukraine

0%

20%

40%

60%

80%

100%Other

National defence

Public administration

Social assistance

Social institutions andactivities financingNational economysupport

Consolidated budget’s expenditure structure

Source: Ministry of finance, own estimates

CASE Ukraine

Remedy suggested: privatization

Oligarchs: wanted title property rights to secure their rent

The first program was developed already in 1992

The government decision-making was controlled by

directors and bureaucrats already “captured” the

rights of control and not interested in gaining of the

title property rights

BUT:

“Under Kuchma your factory will stay in business!”

The director supported by communists became the

President in 1994:

Kuchma became an “arbiter” of the oligarchs and conducted the mass privatization (1995-98)

CASE Ukraine

“captured” by the directors and bureaucrats

Still controlled by the directors and bureaucrats by the means of

SBC

Property rights

Time

The title property rights

The residual rights of control

Privatization: just a half-way

CASE Ukraine

.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.001

.01.

1995

01.0

7.19

95

01.0

1.19

96

01.0

7.19

96

01.0

1.19

97

01.0

7.19

97

01.0

1.19

98

01.0

7.19

98

01.0

1.19

99

01.0

7.19

99

01.0

1.20

00

01.0

7.20

00

01.0

1.20

01

01.0

7.20

01

01.0

1.20

02

Tax arrears (UAH billions)

Source: the World Bank, 2003

CASE Ukraine

0

10

20

30

40

50

60

70

80

1997 1998 1999 2000 2001 2002

%

Tax privileges (% of budget revenues)

Source: Ministry of finance, own estimates

CASE Ukraine

Oligarchs: interested in the title property rights as a means of control the rents brought by paternalism

The next step: reducing paternalism

“virtual economy” + irresponsible borrowing

Crisis of 1998 and expected default in 2000

Series of reforms subversive for oligarchs and directors but VERY POPULAR

CASE Ukraine

Evolution of the informal property rights

0

20

40

60

80

100

120

1994 1995 1996 1997 1998 1999 2000 2001 2002

0

5

10

15

20

25

30

% of entities privatized by the moment in the total number of privatized entities

ACTUAL percentage of the total labor force working at the private sector

PERCEIVED working in the private sector (IS NAS survey)

CASE Ukraine

00.10.20.30.40.50.60.70.80.9

119

90

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

*)

Per capita GDP (1990=1)

The “unpopular reforms” appeared to begot the most popular Ukrainian politician

CASE Ukraine

The clientism is alive

Business Environment In Ukraine, International Finance Corporation, 2003

About 40% of enterprises respond that the personal changes in some government authorities could significantly affect their business (IER, 2002)

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