New Ukrainian State
© Oleksandr Paskhaver, 2001
There has been built a very ineffective form of bureaucratic capitalism in Ukraine.
This is explained first by objective reasons, and only then by the errors made by the reformers. To mend the situation, it is necessary that the state machine ceases to cater to the benefits of the bureaucracy, thus becoming a means of achieving goals that are beneficial to the society. Further delay threatens the existence of the Ukrainian state.
The steps and the dynamics of the changes
Of all the post-Socialist states, the transformation of the planning type of economy into an economy of the market type is executed in the most complicated way which requires maximum expenditures in the productive and social spheres. The indices of economic decline are the worst among the member-states of the CIS states, including those that have endured armed conflicts. In the CIS countries, from 1991 to 1999 the average decrease of officially declared yearly gross product per capita amounted to 37 per cent, while in Ukraine it was 53 per cent. Almost all CIS countries renewed their economic growth by 1997, but in Ukraine the very first signs of growth appeared only at the end of 1999. The share of Ukraine in the total CIS bulk production was reduced from 14.5 per cent in 1991 to 10.1 per cent in 1998.
The drop of industrial and agrarian production as well as of the volume of transport services has exceeded 50 per cent. The living standards of the population have drastically declined. At the beginning of the nineties, most foreign experts considered Ukraine to be quite ready for implementation of a market type economy. It is obvious that the poor results cited above could be explained only by the particular economic policy of the past decade.
In 1991-1992, being de facto within the common economic area with Russia, Ukraine had to duplicate the steps of the Ye. Gaidar government. From the end of 1992 to the end of 1994, there was a period of ‘reformers’ eclecticism’: along with the continuation of slow reorganization in the field of property and creation of market infrastructures. There were attempts to recreate the policy of rigid state control over the economics. The role of the traditional structures based on ministries and departments was reinforced, a strict system of state regulation of prices and of the currency market was implemented along with some elements of centralized planning and distribution such as issuing state orders, state contracts, etc.
The most characteristic feature of that period was the implementation of the ‘inflation gradualism’ policy, according to which the state budget deficit was compensated with money emissions effected by the National bank. That was done to preserve the productive potential of Ukraine, even at the expense of an endless pumping of ‘empty money’ into national economy. As a result, the highest level of inflation in the world transpired. The financial system was ruined, it was impossible to save and invest, and a precipitous drop of productivity occurred.
Finally, in the first half of 1994 the government of Ukraine began to restrict the budget deficit and the level of state expenditures and to renew control over the money supply. In October 1994, the principles of new economic policy were proclaimed (in The Report on the Economics made by the President of Ukraine). They envisaged the introduction of traditional monetary and financial means of stabilization, as well as implementation of a series of measures aimed at liberalization of the economy as a whole. Beginning in 1995, the policy of ‘non-inflation gradualism was carried out. It envisages financing the state budget deficit (which is gradually decreasing) on the basis of non-inflation sources - loans made on the domestic and foreign markets. The implementation of the policy made it possible to gradually restore the National Bank’s control over the monetary sphere, to reduce inflation to a manageable level, and then to achieve economic growth. Nevertheless, in 1998 in Ukraine (as well as in Russia that implemented the same policy) severe negative consequences of the policy of ‘non-inflation gradualism’ appeared. Firstly, the state debt has reached a level which necessitated frequent external and internal loans and the state was unable to fulfil its obligations. Secondly, the appropriation of investment resources for maintaining the budget deficit reached a critical level, and it became impossible to stimulate the development of the real economic sector.
These two hazards become real only when state debt increased excessively, and the majority of states employing the ‘non-inflation gradualism’ successfully avoided them (Hungary, Slovenia, etc.) In these cases the market economy grew successfully. This makes it possible to effectively maintain state debt and neutralize the budget deficit. But due to the retardation of the basic reforms, for the two last years Ukraine balanced at the edge of default.
The need for institutional-structural reform in our country was more urgent than in any other post-Socialist European country, especially in the industrial sector. That is because the centralization and concentration of industrial production in Ukraine was much higher compared to both developed countries as well as to the republics of the former USSR, including Russia. But reform has been carried out very inconsistently, very slowly, and very unsystematically.
The most important sectors in the economic structure of Ukraine were primary processing of raw materials, the fuel-energy complex, and enterprises producing military equipment and the so-called ‘production of the means of production of the means of production’. The portion of economic sectors directed immediately at consumers and their needs was too low. Therefore, it was necessary to carry out basic structural reforms at both the micro and macro levels. Moreover, the state continued supporting the traditional ‘base’ sectors (which in many developed countries lost status long ago).
The consequence of these processes was that recently the demands of our economy for materials and energy grew by 40 - 50 per cent. However, the ‘drug like dependence’ on the import of fuels has increased.
In addition, state support of big non-restructured enterprises in the traditional sectors of the economy has drastically narrowed the prospects of development of small and medium-size business. Ukraine is the only post-Socialist country in which small business not only periodically slowed its development, but even regressed. Nowadays it produces 8 per cent of the gross income while in the developed countries its portion reached the level of 40 - 50 per cent. For example, the number of small enterprises in Ukraine per 1.000 inhabitants is 10 times less than in Poland.
In the second half of 1998 it has become obvious that relative monetary and financial stability at the expense of reforms is practically impossible. Though outside influence (the crisis at the Asian financial markets as well as the August default in Russia) has ultimately aggravated the situation, it was not the immediate reason. The total crisis of state finances, retaining stability of the national currency at the expense of unprecedented growth of inner and especially external debts, - all pointed toward a cardinal turn in economic policy. At the end of 1998 and throughout 1999 something was done to mend the situation (cutting the budget expenses, decreasing the deficit, accelerating the privatization processes, liberalizing the currency market, etc.) As for cardinal changes in the attitudes toward economic policies, that is the task of the Cabinet headed by Victor Yuschenko. In the most general form, the assignment he has to perform was formulated by a French economy expert Jerair Duchaine during the seminar for the deputies of the Supreme Rada of Ukraine in June 1998: “Ukraine has to make an historical choice: to continue to support the traditional sectors of heavy industry (as well as the bureaucracy related to it) which in most cases are obsolete and unprofitable, or to admit that if these sectors of the economy are unable to get out of the crisis on their own they will gradually degenerate. Along that, it is necessary to allow the development of private enterprise and not to hinder the process.” The key point of these theses is that the role of the Ukrainian bureaucracy since independence has been fundamental to the crisis facing the country as a whole as well as to any prospect of its resolution.
The role of the bureaucracy in economic reforms
Over the last decade, the status of the bureaucracy in Ukraine has ballooned: having been a means of power, it has become a subject of power. In the Soviet times, the Communist Party performed these functions. Its total power provided for stability and dictated the algorithm of the behaviour of the bureaucrats, including the forms and the boundaries of permitted corruption.
Ukraine failed to create a democratic alternative to the Communist Party as the highest goal-creating and controlling the state machine. The newly created state machine preserved the old cadres, value orientations, and the technology of rule. The weak mechanism of social and political control not only allowed the bureaucracy to take over economic power, but also encouraged the adjustment of the reforming processes to their advantage.
The reformers underestimated the possible self-development of the state machine for achieving strictly inner bureaucratic goals. As a result, approximately from 1993-1995 the economic development in Ukraine has been diverted in favour of the bureaucracy and the associated social groups. These twists are easily seen within the organizational structure of the state machine, in the technology of administering, in the structure of private capital, and in the development of the reforms.
The structure of the state machine
A hypertrophied development of the state machine functions, procedures, and organization structures connected with the regulation (registering, permitting, licensing, certification, etc.) and control over the activities of the citizens and enterprises takes place. The bureaucracy has proved to be extremely inventive in creating new possibilities for bribery. This process takes place against the background of declarations by the highest power about the need to promote liberal ideology of deregulation. State functions that do not provide the possibilities for bribery are atrophied or left undeveloped.
The technology of the state rule
During the transition period, the most profitable nation-wide and regional markets have been monopolized. Very often artificial monopolies are assigned with functions of state regulation; therefore, the functions of state rule are factually privatized.
The structure of private capital
In these circumstances only capital which has become associated with the state bureaucracy is able to survive. It survives due to privileges and due to not being punished for shadow activities. Bureaucracy counteracts the creation of big private capital markets which would be independent from the state, and ‘pushes away’ solid foreign investors. The bureaucratic way of regulation retards the development of small enterprise, making it impossible to convert them to medium-size or big sized ones.
The macro-economic reforms
The bureaucracy is interested in retarding economic reforms and in freezing the transition from totalitarianism and the free market. Such a process -- the freezing of development at an intermediate stage -- is the best environment for carrying out unlawful operations. In this environment, reforms necessary for providing the climate in the sphere of micro-economics which would be agreeable to enterprise and investments, for reforming the sphere of deregulation, implementation the legal procedures of bankruptcy, and liberalizing the taxation system are blocked or stymied.
In Ukraine bureaucratic capitalism has flourished in which the rate, proportions, and quality of creation and re-creation of private capital are controlled by the bureaucracy. The unprecedented deepness and scale of the crisis that has stricken the Ukrainian economy gave birth to the phenomenon designated by foreign scientists as ‘the virtual economy.’ This is largely a feature of bureaucratic capitalism.
Generally, an economy in which the majority of industrial enterprises and nearly all agricultural enterprises are unprofitable cannot exist. Therefore, there are many reasons to designate the existing phenomenon as ‘the Ukrainian miracle’. But this miracle has deep rooted causes.
The disintegration of the USSR considerably diminished the scale and changed the structure of the previous principal consumer - the state -- and evoked a shocking jump in fuel prices, causing the collapse of traditional markets and making the Ukrainian economy unattainable for foreign investors. The majority of enterprises in Ukraine (except for the extractive industries) have proved to be ineffective.
In a market economy, a normal reaction to such circumstances would be a reallocation of capital and labour resources between and within the branches of the economy, creating mass bankruptcies, the restructuring of production, and implementation of extensive innovation and innovation strategies. But Ukrainian enterprises, both state owned and corporate, have created principally a new type of economy. It includes barter operations, concealment of income, avoidance of payments to suppliers, to employees, and to the budget. With these manoeuvres, production expenditures are reduced while the employees’ consent to be paid with material goods. All that means totally unprofitable enterprises.
Over several years, the crisis has stabilized. The unprofitable economy is being steadily revived. Influential social strata appeared for which such economy is profitable and which creates, supports and revives its organizational and legal conditions. First of all, it supports the employees of the state machine who have privatized the state functions of regulating and controlling enterprises (taxes, legal documentation, land ownership, sanitary inspection, price regulation, state guarantees, etc.) These functions (the “assets” of the bureaucracy) control the activities of enterprises. But the income gained from the realization of these functions does not convert into the market price of the “assets”.
The impossibility to capitalize the bureaucrat’s “assets” along with the high risk imposed by the possession of such “assets” greatly determine the attitude of the bureaucracy toward production and capital circulation:
- it has become obvious that the bureaucracy is not interested in the growth of the market value of production because that does not influence the growth of their own well-being, but impedes allocation of illegal property;
- accordingly, the bureaucrats counteract the growth of the legal profitability of capital because that is the main factor of the growth of their value. The legalization of profits impedes its illegal re-allotment;
- the greatest hindrance to the bureaucracy’s goals is presented by legal consolidation of capital in the hands of big business independent from it. That is why their obstacles are being created to the growth of share liquidity and to the development of the stock market in its civilized forms.
Most of the highly ranked managers of state owned and privatized enterprises are among the most active advocates and even the originators of the virtual economics. Expenditure of capital is even supported by some of the legitimate capital owners. The reason is that in the situation when production risks are very high, it is more reasonable to consume and compile non-productive riches rather than increase productive capital.
It is the economics of ‘capital eating’ which is the reason for the unprecedented decrease of capital investments (6 to 7 times in the last decade) which has laid the foundation for an economic decay unprecedented in peace time. Its social and political consequences would be much more dramatic for the citizens if it were not for the so-called ‘shadow economy.’
The ‘shadow economy’: positive and negative features
The reaction of enterprises and the citizens of Ukraine to the collapse of the state economy in 1991 - 1993 with the subsequent creation of bureaucratic capitalism and the system of catering to the demands of the bureaucracy was the creation of the shadow economy whose extent is astonishing.
The ‘shadow economy’ includes:
- concealment of the production of goods and services, that is, the hiding from the state the scope of legal activities of officially registered enterprises;
- informal, unofficial activities, unregistered enterprises, the work at households for the provision of income;
- illegal economic behaviour: bribes, cheating, rackets, smuggling, prostitution, narcotics trafficking, and other activities connected with forced re-allotment of the income, production and distribution of goods and services banned by the law.
According to most experts, the shadow sector dominates the economy of Ukraine. Up to 50 - 60 per cent of the gross income is produced within the shadow economy (therefore, the economic decline fixed by the official statistics was indeed smaller.) The results of random surveys suggest that more than half of the employees obtain income beyond their official job.
Only the existence of the shadow economics prevents the total impoverishment of Ukraine. Moreover, in 1998 the average dwelling space in Ukraine amounted to 20.2 sq. meters per capita against 17.8 sq. meters in 1990. It should be noted that in 1998, 59 per cent of the house building expenses were covered by the citizens while a decade ago their share constituted 24.2 per cent. The number of cars in the citizens’ possession increased by one third, from 63 to 98 per 1.000 inhabitants.
In a situation where the obsolete state machine was collapsing, the shadow economics (its non-criminal sector) has played the role of a kind of a ‘stabilizer’ of production and of living standards. Its development stimulated a structural reconstruction of the state economy by orienting it to market demand. Nevertheless, in the long run the massive shadow activities lead to the technical and technological degradation of economy. Due to the peculiarities of relations between state and society, the shadow economy inevitably becomes criminal, and criminal types of relations gradually becomes a necessary attribute of any economic operation. Finally, the massive shadow economics is connected with the loss by the state of control over most real financial operations that prevent it from performing its basic functions, including social ones. The most vulnerable groups of inhabitants who do not get income from the shadow activities do not get proper social support from the state.
Chronologically, the acceleration of the shadow economy took place in 1994-1997. It is confirmed by the growth of the monetary mass beyond the range of bank operations: 24.7, 38.3, 43.1, and 48.9 per cent in 1994, 1995, 1996, and 1997 correspondingly. Some experts, including Prime Minister Victor Yuschenko and Secretary of the Cabinet of Ministers Victor Lysytskyj, attribute this to the sudden increase in state consumption.
In addition, the expenditures of the administrative power grew at a strikingly high rate, and that took place against the background of a decline of the gross income which is the main source of production expansion (in 1997, the part of the gross income constituted only 30 per cent of the bulk production while in 1993 that index was equal to 54 per cent). These indices depict an economy of ‘eating the capital’ and of re-allotting public resources to the bureaucracy.
Since 1993, a persistent increase tax increase has become the means of this reallotment. Most of the bureaucrats assert that the level of the taxation in Ukraine is much less than European rates. They explain the continuing drop of state budget income and tax revenues with the reduction of taxation levels.
But it is incorrect to compare Ukrainian fiscal policy and realities with corresponding policies of most developed countries. The fiscal possibilities of every country depend on the level of its economic development. Therefore it is necessary to compare the levels of taxation with those countries with comparable gross production per capita. In countries where the gross national product per capita is between $2.000 and $6.000 (Ukraine belongs to this group even if the shadow national product is taken into consideration), the average level of total fiscal revenues is almost two times less than Ukraine. That means that the level of average tax burden in Ukraine is much higher than in other countries with comparable economies.
The reduction of the tax share in the gross national product cannot be assessed as the reduction of the taxation burden. The level of the latter is best characterized by the index of the true taxes (the volume of the taxes less subsidies) in the gross national product. In 1993 it has increased three times.
From a technical point of view, it would not be difficult to make the economy shadowless. It is simply necessary to reduce the volume of state expenditures to a realistic level, to radically reduce the tax burden and thus to eliminate such key elements of the ‘virtual economy’ as barter-type operations, avoiding of payments, abolishing debts, privileges, etc. Indeed, it’s the excessive tax burden that legalizes these traits. In circumstances when the state reallocates nearly the entire volume of income and profits produced by legal economics, it is practically impossible to meet all tax demands.
The prospects are not that hopeless
Could Ukraine use the experience of more successful Eastern European countries?
Their economies were less militarized, were better oriented toward the demands of the population, and their service sector is much better developed than that in the USSR. Besides, some countries of Eastern Europe began the implementation of market oriented reforms much earlier (Hungary - in 1968, Poland - in 1971). That made possible the creation of a basic market infrastructure well before the nineties which acquired definitive significance in achieving better results compared to, say, Ukraine, Romania or Bulgaria.
Ukraine was unable to set starting conditions for reform. As other CIS countries, Russia endures the same problems with the ‘virtual economy’ and ‘shadowing’ as does Ukraine. More decent indices of economic decay and higher gross national product per capita are explained first of all by the inflow of the oil and gas dollars, as well as to some extent by a more rational financial policy at the beginning of the reforms which allowed Russia avoid the highest world rates of inflation.
As a consequence of economic, historical, mental, and geopolitical circumstances, as well as their greater political maturity, the Baltic and Eastern European countries promptly created a more or less effective means of social control over the bureaucracy, and of designing a state machine for the benefit of the entire society. These means are similar to those employed in the process of forming Western civilization. That has not been the case in Ukraine. At the very early stages of economic transformation, the bureaucracy as a sovereign subject of economic power did not encounter any competition. As a result, there emerged such features as a ‘virtual economy’, ‘eating the capital’, mass ‘shadowing’ of economic relations which lead to the appearance of a stable ‘rotten’ semi-criminal market economy and a political system serving it.
The presence of these signs in Ukraine is obvious although hardly stable. The ‘economy of eating the capital’ has nearly exhausted its own feeding reserves which is attested by the country’s balancing at the edge of national default. We can only pray the bureaucracy has some ‘instinct of self-preservation’. It worked once in 1994 when the hyperinflation lead the country close to financial collapse. It is hardly a coincidence that V. Yuschenko has headed the government at the end of 1999. The Prime Minister declared his adherence to liberal values while the corner stones of his program are the measures aimed at eradicating the ‘virtualism’ and ‘shadowness’ of the economy. Further delay with their implementation threatens the existence of the Ukrainian state.
Neither is it a coincidence that active measures have been directed at the creation of a party-based political system and a responsible parliamentary majority which would cooperate with the Cabinet (though it is doubtful if the existing system will prove effective without immediate forming of the government by the parliamentary majority and the adoption of the government’s program as a coalition treaty between the parties comprising the parliamentary majority).
These features as well as the administrative reform provide a basis for a process of creating a system which would advocate the priority of social goals over the private interests of the bureaucracy. Only tough persistence in the chain: society -- the parties - the representative organs (the parliament, the president) - political government - bureaucracy`-- will provide the subordination of the bureaucracy to the interests of society.
Optimism also comes from nature of economic development in 1999 - 2000. However, economic growth per se does not always mean a stronger and more vibrant economy.
For example, the 1998 (prior to the beginning the August crisis) economic growth was negatively interpreted by a number of experts. Specialists at the Ukrainian-European Consultative Center on Legal Issues consider that the indices of economic growth achieved in 1998 were “... not the signs of halting the crisis. The reasons are as follows:
1) the growth takes place predominantly in the basic sectors. Therefore, it will preserve the branch structure which is disadvantageous for competition on foreign markets and which negatively influences the well being of the country as a whole;
2) growth took place at the non-restructured plants; it is not accompanied by the creation of newly flexible units in the production and service sectors.
Therefore, the economic growth has a very limited material base. It depends on financial support from the state”.
Some foreign and Ukrainian leading experts (for example, a former vice-Prime Minister Victor Pynzenyk) also doubt the existence of a sound base for economic growth in the second half of 1999 and in 2000. But the nature of this last economic growth differs from that of the beginning of 1998. At the session of the Supreme Rada on 5 April 2000, Premier Victor Yuschenko declared: “... The highest growth rates have been registered in the branches oriented to the ultimate consumer (practically, the production index in these branches exceeded by three times that of the correspondent period of the previous year). Factually, we are witnessing the first positive financial results of the hard work in the area of the transformation of property relations in Ukraine. The branches in which the growth exceeds by three times the average in the country are the denationalized ones: they are either private or operate on corporate principles”.
In spite of all difficulties, endless bureaucratic distortions, deformations, etc., the process of Ukrainian ‘sleepy’ privatization has lead to some positive consequences. Non-state enterprises more often demonstrate the signs of rational market behaviour.
Experts at the Harvard Institute of International Development and the Center of Market Reforms have analyzed the dynamics of the changes of balance indices in 1999 at 9 thousand privatized and state owned enterprises. Through all sections of the balances the average indices of the privatized enterprises are better than those of the state owned ones:
- the growth of the long time investments volume (per 1 hryvnia of sold production) is 15 times higher than the corresponding index of state owned enterprises;
- unlike state-owned enterprises, the non-state ones are more accurate in choosing their business partners. As per 1 hryvnia of sold production, their overdue debtor’s debts are 7 times less;
- in their accounts with the budget, the indices of privatized enterprises are incomparably better. The credit debts against the tax invoices are 200 times lower than those at the state owned enterprises;
- non-state enterprises make production for not to be stored in repositories but for the consumers. The ready products stock (per 1 hryvnia of the sold production) there is 15 times less than that at state owned enterprises.
Therefore, the dynamics of economic growth in 2000 presents grounds for optimism though it is too early to speak of solid economic growth and of overcoming the ‘economy of capital eating’. But it is important that in spite of all pains on the way of reforms, the first results have been achieved. The Ukrainian economy still possesses the prospects of normal development on the basis that have been successfully employed in the countries of Eastern and Central Europe.