Ukraine’s chance for modernization

Ukraine is to enter a new stage of globalization, which is leading to radical changes in the economic structure of the world’s leading states. The 2008 financial crisis forced the real economic titans (the US and European countries) to update their economic “arsenal,” which is bound to lead in the near future to another redistribution of global sales markets. World Bank experts, who presented a new Country Economic Memorandum (CEM) entitled “Strategic Choices to Accelerate and Sustain Growth in Ukraine,” decided to advise the Ukrainian government on how to derive a benefit from this. This 120-page document lists recommendations about how to create an economic miracle in this country as fast and as painlessly as possible. The Day asked Martin RAISER, World Bank Country Director for Ukraine, Belarus, and Moldova, to comment on the possibility of building a new-era economy in Ukraine.

In the abstract to the memorandum on economic development, the Word Bank rather highly appraises the future role and place of Ukraine in Europe. What economic factors allow you to make this forecast?

“Looking back on the two decades of transition to a market economy, I have the impression that Ukraine has not yet fully used its potential. Take agriculture for example. Today, the yield of agricultural crops in Ukraine is only a third of that of the crops grown on a similar soils in Europe. Or take the aerospace and mechanical engineering sectors. Ukraine traditionally has a strong potential for engineers and specialists in these sectors to work successfully. Yet they still do not have wide access to international markets. The same goes for other sectors. Therefore, the full use of all sectoral capacities will allow for 7-8-percent annual GDP growth. In our view, Ukraine stands a good chance to become the motor of economic growth in Eastern Europe. In other words, you have major economic opportunities ahead. But, to seize them, you should effectively take advantage of your geographic position, rich natural resources, and well-educated workforce.

“This means you must urgently carry out radical structural reforms. In 2000-2008 the country registered an average GDP growth of about seven percent. This helped essentially lower the level of poverty among the population: from 47 percent in 2002 to 16 percent in 2009. At the same time, nobody cared about serious economic reforms because the state was rife with bitter power-struggles from 2005 to 2009. The current financial crisis, which caused Ukraine’s economy to contract by 15 percent in 2009, and a slow pace of world economic recovery, prove that the previous model of economic development can no longer ensure Ukraine’s progress. The main factors of the pre-crisis growth — rapid improvement of terms of trade and a considerable inflow of foreign capital, especially after 2005 — will no longer play the leading role in the country’s economic stabilization.

“The memorandum comprises the World Bank’s advice on the measures that the Ukrainian government should take to build a new, more effective and stronger economy. The recommendations are aimed at solving three main problems: overcoming the fiscal crisis, improving the investment climate, and reforming the public sector, the judicial and the administrative systems. The overall scenario of the country’s further progress will depend on what decisions Ukraine’s political leaders will be making today and in the next three years. This may either be a set of chaotic steps leading to low growth rates, or rapid economic modernization, which will turn Ukraine into a prime mover in Eastern Europe.”

How did the Ukrainian economy change during these two years of crisis?

“It is too early to sum up because the crisis is still going on to some extent. But we can already say that companies are working in a more balanced and thought through manner. Before the crisis, everybody tried to buy as many assets as possible and increase the overall turnover of companies and holdings. Whether these assets fetch a profit was a secondary question. Now the situation has changed. Companies began to attach greater importance to profitability. Investments in the use of new production technologies are also on the rise, which will in due time make Ukrainian businesses more competitive on world markets. To consolidate these positive effects of the crisis, the government should drop the practice of carrying out economic reforms according to the principle ‘one step forward and two steps back.’”

The new memorandum’s basic message is to build a new-era economy. What do you mean by this?

“The motor of the Ukrainian economy should be labor productivity growth and the implementation of innovations in all spheres of life. It is impossible to achieve this without active competition among businesses on the market. In my opinion, a modern Ukrainian economy will enable everybody to be successful using their own knowledge rather than personal connections.”

How soon can it be built?

“If the economy grows at an annual rate of 7-8 percent for ten years, Ukraine will catch up with the level of income in the new EU member states. Keeping up these growth rates for another 10 years will bring you to the level of Central European states. In other words, it is possible to achieve decent European living standards within a generation. At the same time, there are many spheres where you should not wait: reforms may be carried out in three to five years (public services, education, research, health care, and public utilities).”

Your forecasts for Ukraine’s economy are very optimistic. But even they do not match the president’s goal of making Ukraine one of the world’s 20 most developed countries by 2020.

“I look at this a bit differently. It is very good when the leadership sets ambitious goals. By so doing, they show that they are no longer thinking just about the next elections, but have a clear vision of the country’s development over the next 10 to 20 years. In my personal opinion, it does not matter whether Ukraine will meet the president’s deadline. The most important thing is that there should be strong political will, a powerful executive team, and reliable parliamentary support in order to achieve clear and ambitious goals. This has been proved by the experience of some ex-Soviet countries, which have set themselves rather ambitious goals and, as a result, have made considerable progress. Look at Georgia: the country has drastically slashed the level of corruption in the public sector in just five years. Another example is Belarus. In the World Bank’s Doing Business ranking, Belarus has risen from the 148th to the 58th place. Ukraine can also achieve this kind of success.”

But will the reforms in Ukraine be successful if they are to be carried out by a bureaucracy whose powers are supposed to be reduced in the end? Maybe, we should seek some other ways to carry out reforms?

“There are different approaches. But I can say in no uncertain terms that Ukraine should, first of all, introduce a ‘regulatory guillotine.’ Georgia is a perfect example — it simply abolished all regulatory institutions. They no longer exist, and nobody misses them. On the other hand, Ukraine is a European country and it should, of course, adopt international standards. In other words, the government should abolish ineffective regulatory bodies, which often duplicate one another, study European regulatory law, and gradually adopt its norms.”

And what ineffective, in your opinion, bodies do you think Ukraine should get rid of?

“It is the government that should draw up this list after a detailed study of the functions and activities of all state-run regulatory institutions. I will say, for example, that Ukraine has some elements of food industry regulation that have nothing do with public health and food safety. These provisions do not exist in most European states, and their Ukrainian equivalents should vanish. The state should only regulate the observance of food safety norms, and this control can be organized when primary products are being produced. All the remaining norms should be abolished.”

But, in addition to being supported “from above,” reforms should also be backed “from below.” To what extent is it likely that the government-sponsored reforms will produce an opposite effect?

“The World Bank always emphasizes that all reforms are only to be carried out if some explanation is given to the populace. Naturally, it is hard for ordinary people to accept reforms, for they do not know and do not understand how the changes will improve conditions for opening and doing business, increase the protection of families and business, and enhance the quality of medical, educational, and public-utility services. It is also important to convince people that reforms will affect everybody, first of all bureaucrats and the rich. The government’s job is to make sure that it is so. Besides, the government should care about the protection of the low-income strata of the population. If you really introduce target-oriented social security, it may benefit 15 or 20 percent of population, but never 80.”

To improve the investment climate, Ukraine’s government suggests giving taxation preferences to certain economic sectors. How effective is this approach?

“In my view, a sector-oriented policy is wrong. It is no good. We said at the beginning of this interview that there is considerable economic potential in almost all sectors. So why not improve the investment climate for all? But when it comes to a specific contract in a specific sector, then some special measures may be taken. In my opinion, there will be no improvement of the investment climate if all reforms only boil down to stopping tax gaps, exempting from certain taxes, and granting privileges or subsidies. The government should care about protecting the rights of the investor and establishing the same market-based rules for all, and invest in the infrastructure that will help develop all kinds of businesses.”