Lecture 4 TRANSITION FROM PLANNING: THE CASE OF UKRAINE Sergiy Pivnenko, M.A. Economics, SFU

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Lecture 4 TRANSITION FROM PLANNING THE CASE
OF UKRAINESergiy Pivnenko, M.A. Economics, SFU
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Introduction to Theory of Transition

• Definition of Transition
• The process from socialism to capitalism in
  former socialist economies - Gerard Roland
• A move from central planning to market
  economy
• Large-scale institutional change
• A complex economic and social change which
  affects
• - laws, rules and norms according to
  which agents interact
• contract law, bankruptcy law, property
  law, competition law, securities
• law, and intellectual property law
• - organizations economic, political,
  etc.
• - change from communist party regime to
  representative democracy (is democracy a
  necessary condition for market reforms?)

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Central planning economy as a big firm

• fixed prices, quantity and quality (absence of
  markets)
• production and exchange governed by central
  administration (ministries)
• centralized distribution of resources
• setting output targets
• Distortions
• oversized heavy industry and small service sector
• coordination failure ? shortages or excess supply
• poor incentives ? low quality products, no cost
  minimization (soft budget constraints)

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Transition Reforms

• Basic steps
• Stabilization to create macroeconomic
  environment for markets functioning
• - fiscal balanced budget (cut
  subsidies, sell and restructure bankrupt
  enterprises)
• - monetary low inflation and
  stable currency create conditions for the price
  system to provide
• correct signals to
  consumers and producers
• Liberalization to end the excess demand and
  create working price system
• - deregulation, end of price
  controls
• - demonopolization, ease of
  entry for new firms and businesses
• - creating a convertible
  currency followed by opening of domestic
• economy to foreign trade
• Mass privatization to correct incentives
• - a transfer of ownership of
  state assets to the private sector
• Creation of social safety net to alleviate the
  negative effects of enterprise restructuring
• introduction of unemployment compensation system
• effective utilization of government expenditures
  for social needs on pensions, family
  assistance, and health

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The debate over gradualism vs. shock therapy

• Examples
• Shock therapy Poland, Czech Republic
• Gradualism Russia and Ukraine (shock without
  therapy), China
• Argument against shock therapy
• Institutional transformation is rather
  evolutionary process
• - cannot privatize overnight
• - cannot build financial system overnight
• However, fast stabilization makes possible
  efficient structural reforms
• High social cost of shock therapy (would it be
  lower under gradualism?)
• Political argument for shock therapy
• Jeffrey Sachs Fragile governments facing a deep
  economic crisis are best able to carry out strong
  measures at the beginning of their tenure

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Economic Transformation the case of Ukraine

• Population 47,732,079 (July 2004 est.)
• Territory 603,700 sq km (slightly larger than
  France)
• Location Eastern Europe
• Life expectancy at birth male 61.35 years,
  female 72.27 years (2004 est.)
• GDP per capita at purchasing power parity -
  5,400 (2003 est.)

Ukraine remains the only country in the world
that voluntarily got rid of its entire nuclear
arsenal. Between 1994 and 1996 all nuclear
warheads and their carriers were partly
destroyed, partly transferred to Russia in
exchange for the nuclear plants fuel.
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A Lost DecadeUkraine's transition in the 1990s
half-hearted reformsno reform

• Total decline of about 53 percent of GDP from
  1989 to 1998 (negative value added,
  disorganization)
• The underground economy amounted to 49 percent
  of GDP in 1995 (tax evasion)
• Privatization of land has been persistently
  blocked by the left wing of the parliament
• Rudimentary stock market, shareholders rights
  not protected
• Pervasive corruption (Ukraine ranked 69th out of
  85 countries in 1998 Corruption Perception Index)
• Lack of liberalization (Ukraine ranked 122nd out
  of 123 countries in 1995 Index of Economic
  Freedom)
• Disorganized financial system (amount of barter
  transactions was estimated about 50 of GDP in
  1996)

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Partial success

• After a period of hyperinflation in 1991-94
  macroeconomic stability was achieved (government
  stopped uncontrolled monetary emission, balanced
  budget)
• In 1996 a new Ukrainian currency (hryvna) with
  fixed exchange rate was introduced.
• Independence of Central Bank (!). Despite the
  pressure from the Government Central Bank,
  maintained stability of Ukrainian currency
• Privatization (though slow and inefficient) was
  on the way sale to insiders/outsiders, IPOs,
  small scale privatization

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Why gradualism?

• - Lost momentum!
• Immediately after collapse of communist rule
  (1991) the leadership of newly independent
  Ukraine was preoccupied with nation building
  which was widely perceived as separate from
  market economic reform. The devastating financial
  crisis (10,155 inflation in 1993) ruined social
  consensus thus making shock therapy politically
  impossible.

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What went wrong? A rent-seeking model of
Ukrainian economy (Anders Aslund)

• Four sectors
• 1. The government opposes any deregulation that
  would reduce its monopoly power and thus its
  revenues from bribes.
• 2. Rent-seeking businessmen focus on elementary
  monopoly rents, lobbying for regulations that
  guarantee them. They favor all kinds of
  regulations which apply to others but not to
  themselves.
• 3. The parliament largely lives for bribes, in
  particular the center that represents the party
  of power, which essentially supports the
  government. Thus, the parliament is largely
  interested in as messy a legislation as possible.
• 4. The Ukrainian households suffer from
  corruption and a dysfunctional economy. They have
  to work in the underground economy in order to
  sustain minimal living standards. Many blame
  reform, as Ukraine has officially been pursuing
  reform for years.

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A rent-seeking model (contd)

• Anders Aslund
• Thus, we have found an iron triangle of
  government, businessmen and parliament who all
  favor a maximum of regulation and state
  interference to maximize rent-seeking and
  corruption, while the population is of little
  consequence and partly co-opted and compromised.
  The problem is that this model of
  self-reinforcing rent-seeking looks far too
  stable and it is close to an equilibrium.

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A rent-seeking model (concluded)

• A Vicious Circle Piecemeal reforms have bred
  extraordinary corruption and rent-seeking. A
  small group of very rich people has arisen, and
  they have bought political power with their
  wealth. They are using their fortunes to maintain
  their fortunes by bribing politicians,
  bureaucrats and parliamentarians to introduce new
  regulations that generate more rents.
• Ukraine appeared stuck in a severe
  under-reform trap.
• (Anders Aslund, 1999)

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Ukraines return to growth in 2000

• Fastest growing industries
• food processing and packaging, energy
  generation and transit, telecommunication and
  information technology, construction
• 6 growth in 2000 (13 growth in industrial
  output, 9 - in agriculture)
• 9 GDP growth in 2001 (18 - in industrial
  output, 27 - in agriculture)
• 4.1 GDP growth in 2002
• 6 GDP growth in 2003
• In 2004 GDP is set to expand by an amazing 10 to
  12 (mainly export-driven growth, due to high
  metals prices on world markets)
• Reform leaders
• prime-minister Victor Yuschenko (former governor
  of Central Bank)
• vice-prime-minister Yulia Tymoshenko (formerly
  one of the biggest gas traders)

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What has worked well

• substantial progress in establishing fiscal
  discipline
• refusal of the central and local governments to
  settle tax obligations in anything other than
  cash
• the increase in cash payments for gas and
  electricity by final consumers from levels around
  10 of payments due in 1999 to levels around 70
  in 2001
• sources of energy rents (these rents amounted to
  13 of GDP - import at subsidized prices and
  re-export at world prices) were removed in
• - gas imports
• - electricity-generating industry
• - oil imports
• large scale privatization intensified competition
  for rents
• lower and simplified taxes pulled entrepreneurs
  out of the shadow economy
• foreign trade liberalization created a
  competitive pressure that forced large
  enterprises to restructure

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Ukraines transition reform today

• February 2001 president Kuchma dismissed
  Tymoshenko and in April 2001 the pro-president
  parties and communists voted Yuschenko out of
  power.
• 2001-2004 reforms slowed down. Despite of the
  growing GDP living standards have not improved
  (30 of the population remain below poverty
  line). Pervasive corruption and lack of economic
  restructuring threaten the sustainability of
  growth.
• January 2005 Victor Yuschenko inaugurated as a
  new President of Ukraine.
• February 2005 Yulia Timoshenko appointed by the
  President and unanimously approved by the
  Parliament as the Prime Minister of Ukraine
  announced the Government's Action Program
• dismantling of corruption vertical, create new
  judicial system
• creation of reliable and transparent business
  environment
• modernization of the power industry, reliance on
  renewable energy sources and energy-saving
  technologies
• reducing government intervention, fostering small
  and midsized privately-run businesses
• taxes must be comprehensible, stable and low
• core principle the State serves the people, not
  the other way around.