CASE Ukraine case-ukraine.kiev.ua

1. The Political-Economic and Institutional Framework for Assessing the Business Environment in Ukraine Vladimir Dubrovskiy CASE Ukraine www.case-ukraine.kiev.ua

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

3. CASE Ukraine Keywords:Discretionary rule Karamsin, 19th century Russian historian Institutional legacy of the former empire: “The severity of the Russian laws is alleviated only by discretion in their enforcement” “… just this disorder makes life in Russia possible” Gertzen, 19th century Russian social thinker Legislation is designed (intentionally?) in such a way that almost EVERYONE must become a lawbreaker “Laws are written for the fools” Discretion is the only resort from such a “total guilt” “Who are the boss, we or the law?” Every business is subject to the authorities’ arbitrary, discretionary power

4. Nachal’niks: not the bureaucrats! Bureaucracy (by Weber) Administrative power in Ukraine Highly-paid professional public servants facilitating rational processes of control. Implements legislation in a strictly formal (impersonal) way Poorly-paid and dependent upon administrative rents (in money or barter) Relies upon discretionary power and vague and arbitrary informal rules Operates under constant public scrutiny and political oversight Controls politicians rather than vice versa. Tries to control mass-media to avoid public scrutiny No decision-making power Clear separation of “powers” from branches of State Possesses the political power to magnify ambiguity and non-transparency in legislation Strictly controlled and separated from business Uncontrolled and mostly affiliated with business

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

6. CASE Ukraine Keywords: Blat networks Forced modernization, especially the Communist regime: Legislation violated the natural law Normal economic activities were considered illegal No contract enforcement was officially available Ledeneva, 1998 Reputation-based informal networks of interpersonal mutual exchange with “favors of access” (blat) Emerge to facilitate the illegal transactions of all kinds Litwak, 1991 (!) “One has to deserve a right to pay a bribe” while Weak rule of law

7. CASE Ukraine Keywords:The Rent Seeking Profit seeking Rent 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 Players can agree on certain mutually-beneficial rules and enforce them Usually requires a coercive force to arrange appropriation and/or prevent overappropriation (“tragedy of the commons”, overfishing) 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.

8. CASE Ukraine Rent as an exhaustible common resource Authoritarian arbiter Restrains the devastating competition by force, based on his discretionary power… A renewable rent source (as a state budget) A renewable rent source (as a state budget) client player player client player player client client … but instead extorts the rent himself

9. CASE Ukraine Effects of an authoritarian rule Rent seeking sector Competitive market sector Monopoly rent client player player client client client player player Increase in the social wealth Decrease in the social wealth Enterprises’ rents depend primarily on the arbiter’s discretion Paternalism towards the enterprises

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

11. CASE Ukraine Evolution: The rent seeking is costly for a society It takes certain cost of an arbiter to coordinate and control the rent seekers 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 contracts With exhausting of the available rents, and complicating of control and coordination

12. Whither “captured state”: a dead end? Administrative power: Provides protection and patronage for business Property rights, rents Business: a “Milk caw” or a “Rent pump” for officials Orange Revolution November, 2004 Sources of rents Perceived totally rent-seeking Perceived manipulated Perceived totally corrupted Blat A tacit social contract: “We” do not bother “them”, “they” do not bother “us” Public PASSIVE PLAYER

13. CASE Ukraine As a result of the revolution: Public is not passive anymore, it became a “principal” of the politicians The oligarchs are not the main players anymore Political market emerges Executive power officials have lesser impact on the legislature Politicians appeal to the broad groups of population while Public consciousness is still immature: does not properly distinguish profits from rents supports redistributive activities (as “re-privatization”) supports “coordination and control” (e.g. price regulation) Threat of populism and paternalism towards large groups of population

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

15. CASE Ukraine Evolution of the informal property rights

16. Depletion of the rent sources Close collaboration of business and officials based on blat «intermediate winners» Sources of Rent 1988 - 1994 Stripping of the fixed assets (“end game”) Dependence on government's re-distributive power Sources of Rent 1995 – 2004??? Market imbalances Financial instability Cheap energy and credit Subsidies and government contracts

17. Thanks for your attention!