What factors have caused reform in Ukraine to go astray?

 

Declan Fearnley

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Introduction – some basic information on the Ukraine

Ukraine gained independence after the collapse of the Soviet Union in 1991. It has a population of about 49 million and a significant minority of that population are Russians. While Ukrainian is the official language, a large minority of the population uses Russian as their first language. Ukraine includes the autonomous Republic of Crimea that transferred from Russia in 1954. Christianity is the major religion and Ukraine is lucky to have been largely free of the ethnic conflicts that have affected some other former Soviet republics. Ukraine mainly exports military equipment, metals, pipes, machinery, petroleum products, textiles, and agricultural products. The average annual income of a Ukraine citizen is about US $700. [1]  Two things that Ukraine is famous for around the world are, 1.The Chernobyl nuclear disaster. Millions continue to suffer as a result of the 1986 nuclear accident at Chernobyl, during which about 8% of the country was contaminated.  2. The Antonov 124 and 225, the biggest jetliners in the world. The Antonov aeronautics company was part of the brief Soviet space shuttle company. The Soviet space shuttle piggybacked on the back of the enormous Antonov 225. After the collapse of the Soviet Union, the 225 project was mothballed. Only in the last few years has it been re-commissioned, after the Antonov company was privatized and joined with a London company. This merger has seen the Antonov aeronautics company become the world leader in very heavy haulage by air. 

The country is a presidential democratic republic. The Verkhovna Rada/Verkhovny Sovet (Supreme Council) has 450 members, elected for a four-year term, 225 members by proportional representation and 225 in single-seat constituencies.[2] Leonid Makarovych Kravchuk (b. 1934), a former Communist Party official, was elected the country’s first president ruling from 5 Dec 1991 to 19 Jul 1994. He favoured greater independence from Russia. However, during his tenure, he presided over three and a half years of economic decline and runaway inflation. Factors such as Kravchuk’s own indecisiveness and a parliament dominated by former Communist deputies did not help matters.[3] In the 1994 presidential election Leonid Danylovych Kuchma narrowly defeated Kravchuk proming a new era for[4] the Ukraine while in contrast to his predecessor, advocating closer ties with Russia. What followed was a series of squabbles and stand-offs between Kuchma and parliament. Delay in implementing reforms, corruption and difficulty in securing investment have been the main economic features for Ukraine until recently. In the very recent past however, the country is experiencing rising industrial output, improving exports and falling inflation.

Ukrainian foreign policy on the other hand has been far more dynamic and proactive. It has declared EU membership to be a strategic objective. In July 2002 NATO Secretary-General George Robertson while on a visit to Kiev, welcomed Ukraine’s recent declaration of a desire to join NATO, but commented further that more political, economic and military reforms were needed before Ukraine could join NATO. Ukraine has been in accession talks with the WTO since its accession working party was established on 17 December 1994. The last meeting of the accession working party took place on 25 February 2003.

 

Two Presidents, one country, same problems

Leonid Makarovych Kravchuk

 

Despite Kravchuk’s repeated declarations of commitment to reform, his tenure was dogged by economic decline. He had his work cut out. According to Andreas Wittkowsky,

 

“Simulations could be observed within the Ministry of Economics, which continued to draw up illusionary production plans, and the Ministry of Finance, whose budget figures were not binding and left ample space for political bargaining. In the end, actual spending decisions were dependent on the ability to exert political influence.”[5]

 

One of the most blatant examples of corruption among the elite at this time was provided by the actions of the acting prime minister from 1993-1994, Yefim Zvyagilsky, the director of a local Donbass coalmine “Zasyadko”, who stood accused of having defrauded the state of $25 million.[6] Another ongoing problem was that as if being a net energy importer wasn’t bad enough (energy accounting for nearly 50% of all imports), it was impossible to obtain agreement on how best to harness the country’s own limited natural resources. Economic actors were engaging in rent-seeking and using their influence to avoid reform. At the end of 1992, hyperinflation was running at 10,000%, production was plummeting, and there was a growing current account deficit.

Photocopy Table 11.1 pge 250.

 

Near the end of 1994, Ukraine’s foreign debt was over US$7bn with two-thirds of this made up of payment arrears for energy imports. Capital flight was estimated at between US$1.2 and 4.5bn per year. Crimea and the mining heartland of Donbass were experiencing displaying worrying signs of separatism. Things were so bad that at one stage, the CIA genuinely believed the Ukraine would split up.

 

Leonid Danylovych Kuchma

 

 

A former director of the largest Soviet missile producer Iuzhmash, Leonid Kuchma was first elected on 19 Jul 1994. Market reforms and stronger ties with Russia were part of his manifesto. His vote was based in three main categories; Russophone East, industry, and communists. A reform team was created consisting of First Deputy Prime Minister Viktor Pynzenyk, Deputy Prime Minister Igor Mityukov, and Minister of Privatization Yuri Yekhanurov. The reform leader was the incumbent Minister of Economy Roman Shpek, together with Viktor Yushchenko, the chairman of the NBU. “On the Road of Radical Economic Reforms”, was presented to parliament on October 11, 1994. The program listed the following main aims: a swift transition to a full-fledged market economy, including liberalization of all prices apart from natural monopolies, deregulation of domestic trade, liberalization of foreign trade, radical tax reform with sharp tax reductions, mass privatization, and private ownership of land. On October 19, the Ukrainian parliament voted (231 for, 52 against) in favour of the reform program.[7] One new constitution and one new currency later however and the momentum of reform had slowed. Short-term goals had been achieved and political expediency again began to cloud over the possibility of further, more long-term reform. Also, the 1999 presidential elections were not far off, so all political pro-reform coalitions were off. So the economy drifted towards 1999 on whatever impulse power might have been left from the initial burst of reform. As Andreas Wittowsky reflects,

 

“The institutions of competitive markets were hardly developed and excessive regulations impede market entry for domestic and foreign firms. Bankruptcies were not enforced and enterprises continued to count on the state as their saviour. The government had aspirations to plan out the structural change in detail. These plans too turned out to be simulations as they were barely implemented.”[8]

The interests of the major strategic groups were still determining reform. Kuchma wanted to see the arms industry get a fillip, while other groups would still only stand by reforms that created new rent-seeking opportunities. Privatisation of state monopolies would be protected by regulations engineered by the branch ministries that still had interests in those enterprises.

Elites and the regions – tit for tat

The elites from Kuchma’s own home oblast were more successful in gaining influence on key decisions particularly on regulation. Kuchma’s team was primarily made up of people from the Dnipropetrovsk region whose main interest was the region’s armament and space sector. Former Prime Minister Pavlo Lazarenko’s Dnipropetrovsk-based company IESU quickly became one the Ukraine’s biggest companies. The Donbass region tried to get in on the game. Vladimir Shcerban became chairman of the budget commission. The regional administration intervened in Donbass market privatisation procedures, but counter-decisions were made at national level by the Dnipropetrovsk competition. Regulation and ownership could not be dealt with at the regional level. Lazarenko got Shcerban fired by accusing him of misappropriating Donbass miners’ payments.

 

The oligarchs 

Ukraine, along with other transition countries has seen the rise of the oligarchs whose economic empires encompass everything from the media to energy. They have in the past blocked reforms to protect ongoing rent-seeking schemes, but also have sought individual reforms in order to create new rent-seeking schemes.

The OECD Investment Policy Review – Progress in Investment Reform

Looking ahead.

A fragile center-right parliamentary majority emerged, composed of free-market liberals, conservative nationalists, and parties with ties to oligarchic clans and big business. This coalition successfully pushed for major economic reforms, including the stepped-up privatization of state-owned industries. President Kuchma drew praise from the West for dismantling Ukraine's Soviet-era nuclear arsenal, for preventing strife between the country's ethnic Ukrainian majority and its Russian minority, and for appointing as his prime minister a highly regarded reformer, former Central Bank Director Viktor Yushchenko.

Privatization seemed to be gaining momentum as Ukraine's economy took off. In January 2001, GDP was up by more than 9.1 percent from the year before and industrial production had increased 19.5 percent. At the same time, the government projected an inflation rate of just 13.5 percent for the year, far lower than the hyperinflation rates that had devastated the country only a few years earlier. And wage and pension arrears were eliminated for most Ukrainian workers and retirees. All this was achieved even as the country, which imports most of its energy, was coping with skyrocketing oil and gas prices.

Now, however, Ukraine's dramatic success has come to a crashing halt, and the country is in the throes of a major political and institutional crisis. Trouble began with the September 16, 2000, disappearance of Gongadze -- an investigative journalist who lacked a major print or television outlet but used the Internet to report on the financial machinations of the country's corrupt oligarchs. Tapes…[9]

The OECD Investment Policy Review of 2002 had some interesting points as to how it sees Ukraine moving forward. In acknowledging that Ukraine has achieved much, it also makes the point that it still has a longer list of things to do. It lists the following areas that are holding up real reform that will Ukraine a chance to really harness its potential.

Financial sector needs cleaning up. 30% of the 150 banks are in bad shape. The OECD advocates the stimulation of local lending for SME’s that it sees as the real engine of sustained growth of the economy. However, this lending must be protected by legislation.

Privatisation. Some 4000 companies were still on the list as of 2002. And many of the privatised companies had not had their privatisation managed correctly.

The OECD sees the transition to a market economy in the Ukraine as not being fully implemented, but rather a copying and adopting of EU legislation.

Level playing field for local and foreign investors. FDI is still a problem in Ukraine thanks to corruption between the elites.

Bureacrazy. This ties in with the last point. Over-regulation and over-bureaucratisation is stifling the realisation of the full potential of FDI.

Simplification of the tax system. Huge disparity between payers and non-payers makes the costing of products and services much too high. 22 central taxes and 16 local taxes. 6 of the 32 generate 80% of state revenue.

New impetus should be given to Ukraine’s WTO accession status and desire to join the EU.[10]

Since his re-election in 1999 for a second five-year term, the economy has shown signs of recovery. However, questions remain over Kuchma's leadership style and commitment to economic reform and he has survived mounting calls for his resignation.

As those calls reached a new crescendo in the early spring of 2003, Kuchma tabled constitutional reform proposals. He said they were intended to reduce his powers and increase those of parliament. Opposition representatives reacted with scepticism and some accused him of seeking to achieve the opposite.

The president has denied allegations of involvement in the killing in 2000 of journalist Georgiy Gongadze, who had been critical of his administration, and has also flatly rejected reports of involvement in arms supplies to Iraq. The dispute over the latter led the USA to suspend millions of dollars in aid. 

Most of the media are privately owned. This does not prevent the government and presidential administration, as well as local authorities, from trying to control media content.

While the authorities attempt to keep the media in line, Ukraine still has a significant - albeit struggling - opposition media. The Kuchma government hhas seen the closure of several opposition papers.

Burdened by financial problems, the regional press fails to maintain high editorial standards. The Russian press is very strong, especially in the east of the country.

In June 2001 the Ukrainian parliament adopted a resolution recognising the "unsatisfactory situation in the field of regulating mass media activities, freedom of speech and the public's right to free access to information".

Several journalists investigating high-profile crimes have died in mysterious circumstances. Journalist Georgiy Gongadze disappeared in September 2000, his body was found and eventually identified a year later.

The Ukrainian authorities have been uncooperative in investigating the Gongadze case, a parliamentary committee said in 2001.

In July 2001, the director of a radio station in Slovyansk, Donetsk Region, died after having been attacked in his office by unknown assailants using baseball bats.