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Economic freedom for Ukraine

Ukraine needs economic growth, as it provides the resources for defence, social peace and reforms. The state’s interference in the economy has been too strong and the increase of social obligations given the bad business climate has constrained business activity.

December 18, 2017 - Valerii Pekar - Blogs and podcasts

WORLD ECONOMIC FORUM/swiss-image.ch/Photo Jolanda Flubacher

Ukraine: The European frontier – a blog curated by Valerii Pekar.

There are many reasons to suggest that the next year, in spite of the return of street protests, will be politically moderate for Ukraine. At the same time, the economy will be under pressure.

In general, Ukraine is doing well. In the areas of military, diplomacy and domestic politics it has had some undeniable successes. The Russian aggression has been stopped, the army is being modernised, and the world supports Ukraine in its struggle. Over the past four years, Ukraine managed to avoid major social shocks, it accommodated 1.8 million internally displaced persons, and began to reform most of the state institutions, although with varying success.

However, these achievements have not been accompanied by economic growth.

In 2014, the Ukrainian economy received a heavy blow: the war, the occupation of Donbas, the annexation of Crimea, and the loss of the traditional Russian market all contributed to the ongoing crisis. And ever since, the fragile Ukrainian economy has not recovered.

Economic growth is necessary, because it provides the resources for defence, social peace and reforms. Poverty is the main cause of people’s discontent.

Unfortunately, Ukraine has had little economic success. Sluggish economic growth of about 2.5 per cent after such a blow means that it will take a whole generation to restore the wealth lost since 2013. But Ukraine has a more serious problem: prices are rapidly increasing and the inflation is above expectations. The low economic growth, high price increase and high unemployment is the most deadly combination, as it leads to stagflation. That is why the National Bank of Ukraine has recently raised the discount rate twice, sending a signal to the government, parliament and society that the country has a serious problem. The diagnosis is clear: the interference of the state in the economy has been too strong and the increase of social obligations given the bad business climate has constrained business activity.

My trips around the country and meetings with hundreds of local businessmen in various cities allow me to draw several conclusions.

The most important problem is business security. There are numerous law enforcement institutions which use their power to penetrate businesses, threaten to interrupt their operations and, in fact, collect bribes. Recently, the government pushed through the parliament a law that essentially limits the rights of state institutions to destroy businesses. While this is clearly a positive development, it is not enough. Business people know that the most brutal so-called “tax militia” was eliminated a year ago, but it still actively collects money from private businesses. It is about time to finally dissolve the numerous “economic divisions” of law enforcement institutions and create a long-awaited single Financial Investigation Service to deal with the biggest tax avoiders, instead of fighting small local stores, cafes and workshops.

Let us come back to the need for fast economic growth. There are a lot of countries which went through a rapid economic breakthrough in just a 15-year interval: the “Asian tigers” in the 1970s, Israel in the 1980s, Eastern European countries in the 1990s. But to generate such growth, we need to improve the business climate and attract huge investments.

Ukraine ranks 166th in the Economic Freedom Index of the Heritage Foundation and 76th in the Doing Business rank. The big leap planned after the EuroMaidan was not achieved.

Ukrainian economists say that several solutions would allow us to generate a rapid growth and make Ukraine an attractive economy.

First, we should accelerate transparent privatisation: most of the 3,500 state-own enterprises are not strategic and have to be immediately sold through online auctions. This will contribute to decreasing political corruption and lowering the number of bureaucrats engaged in state property management.

Second, we should implement the land reform: the temporary moratorium to sell agricultural land, which was adopted many years ago for a short term of six months, is constantly extended to please the local “barons”, and meanwhile the black land market flourishes. A transparent land market would attract investments and stimulates the banking system.

Third, capital exit tax instead of the inefficient corporate profit tax would dramatically increase local investment resources (15-20 billion US dollars in five years, according to the Ukrainian Institute for the Future), and at the same time will have an impact on decreasing shadow economy and corruption. It is because the current corporate profit tax allows for a high level of tax inspectors’ discretion and the use of offshores.

Fourth, we need to implement a decisive deregulation. According to the Better Regulation Delivery Office, 95 per cent of regulatory acts are not clear when it comes to what and why they regulate.

Finally, the reform of taxation of labour is another necessity. The post-Soviet taxation system is convenient for old-fashioned industries with huge assets and low salaries, but at the same time it constrains the development of new economy, where highly paid creative work is the main cost.

Other important steps will include the launch of accumulative pension system, public-private partnership programmes in infrastructure development, housing leasing, energy independence, among other solutions. Respective research for major sectors of economy are currently being conducted by Ukrainian think tanks.

Ukrainian political elite has already begun to prepare for the next elections and has chosen a strategy of high social obligations. Higher salaries for public sector employees, higher pensions and active reforms in the social sphere are meant to prove to the voters that the authorities take care of them.

In the case of low economic growth and high inflation this strategy is doomed to fail. The rapid rise of prices will quickly balance all the salary and pensions rises and drive the poor into even greater poverty. People may then become easy prey for populists, who will help to turn many thousands hungry people against the authorities as the enemy.

Taking into account huge payments on external debts in the coming years, we undoubtedly see that only the accelerated economic growth is a way forward. Ukraine can grow between six, seven and eight per cent per year, if not more. And the change has to begin now.

Valerii Pekar is a co-founder of the Nova Kraina Civic Platform, a lecturer at the Kyiv-Mohyla Business School and a former member of the National Reform Council. He curates a blog titled Ukraine: The European frontier.

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