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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

“I can see a potential for self-sufficient development of Ukraine”

Some advice to the government and the president from Grzegorz KOLODKO who drew up Poland’s EU membership budget
5 June, 2014 - 11:54

Last Friday, MIM-Kyiv successfully hosted an international forum, “Ukraine: Facing the Future,” which attracted a lot of economic policy experts and businesspeople. Among the forum’s key speakers was Grzegorz KOLODKO, a well-known intellectual and politician, one of the Poland’s most cited economists, director of Leon Kozminski University’s Transformation, Integration and Globalization Economic Research (TIGER) center in Warsaw. He is known as chief architect of economic reforms in Poland. Kolodko is admittedly the one who led his country to OSCE when he first held the office of deputy prime minister and finance minister in 1994-97. During a second tenure of the same offices in 2002-03 he played an important role in Poland’s integration into the European Union.

Mr. Kolodko contributed to Den three times in 1999. One of his best-known publications was on “therapy without shock” for Ukraine. In this material, the professor offers Ukraine a nine-point reform. Our conversation with Mr. Kolodko at MIM-Kyiv in fact began with his advice to Ukraine’s mister of finance about how to prepare this country for EU membership.

“When we were going to join the European Union, we tackled the problems of inflation, unemployment, and competitiveness of Polish business, but, first of all, we cared about the quality of societal institutions.

“I would say reduced unemployment and inflation in fact resulted from the serious structural institutional reforms that we had carried out. This laid the groundwork for an improved economic situation and competitive Polish business, for the European Union wanted to have members that were capable of economic survival.”

There is only one of the factors you mentioned on the European Union’s agenda – the ability to compete as equal with other EU members.

“I came here to learn, not to give advice. Every time I am asked for advice I just share my point of view. I will do the same this time. If I were Ukraine’s minister of finance, I would make more efforts to increase budget revenues rather than cut expenditures. The goal of a finance minister is to make the fiscal system more effective. One should make a greater effort to integrate the black economy. Ukraine should seriously fight tax evasion. I understand, naturally, that it is easier said than done, but, in the long term, I would retain a budget deficit.

“Of course, I do not know all the details of the Ukrainian situation, but my impression is that your state loses too much money due to smuggling and illegal supplies from Turkey, Russia, China, etc. So, in my opinion, reforming the customs service should be one of the main objectives. We in Poland also had a similar situation at the beginning of transformations. Most of the vodka drunk and cigarettes smoked were contraband. Now the situation has radically changed. Clearly, there is no 100-percent absence of illegal import, but still it is many times lower.”

What did you do?

“First of all, it was political will. Obviously, we needed resources and money to raise customs officers’ salaries, as well as software – and we discussed all this. But these expenditures are investments because they will fetch a profit very soon.”

Do you think, out of your own experience, that Ukraine needs to introduce tax exemptions as a safety cushion for certain industries after it has joined the EU free trade area?

“Moving forward, you should be guided not by whether or not you will be an EU member but by whether or not you need the fiscal system that works in Europe. This system is based on three types of taxes. The first is a relatively low corporate tax (for example, this tax was 40 percent during my first term in the government and 19 percent when I was finishing my second term in 2003). The second, VAT, is relatively high in Poland – 24 percent. And the third is a personal tax on individual profits, which is calculated on a progressive scale. There are no general rules about the number of steps to be taken to reach a certain level. It is only clear that this complicated system must guarantee receipt of the amount necessary to cover public spending.

“As a rule, all disputes about taxes begin at a wrong place. First of all, one must answer the question: what should the government spending be? What is the state supposed to finance? I think everybody, even neo-liberals, will agree that the state must finance diplomacy, the army, and central government bodies. And culture? The National Opera in Kyiv perhaps deserves to be funded from the state budget. And all the other operas? And what about public health? What is to be ensured by the state and what by individuals themselves? And education? These are very difficult questions.

“In theory, you can assess what specifically must be funded and how much money this needs – say, 35 percent of GDP. Crowd-pleasers may throw a fit of hysterics: ‘35 percent? But we need 50 percent!’ Neo-liberals will say 25 percent. There is no exact scientific answer about the optimal figure. It is a question of political compromises. And it is not the job of a finance minister.

“Clearly, if the minister of finance really asks President Poroshenko, Premier Yatseniuk, or the Verkhovna Rada how much money they want, they will say not less than 45 percent of GDP. This will cause a real financial headache – where to take the money, how to collect these taxes, etc.? If you see that you lack 5 percent of GDP, this raises the question: what is to be raised – taxes on business and on individual incomes, VAT, or taxes on real estate?

“In the long term, I would advise Ukraine to reformat the fiscal system on the EU lines, when VAT is of a relatively great importance and everything rests on progressive taxation.”

There is a proposal to replace VAT with a turnover tax – as it is in the US. What is your attitude to this idea? If we choose this option, will it create problems with integration into the EU?

“I would advise Ukraine to stick to the European pattern of fiscal policy. There are many reasons for doing so. Let me name the key one. You in Ukraine are saying: ‘We’d like to join the EU.’ To be convincing in this pursuit, you should take European schemes as a model, rather than something absolutely different. Naturally, you are free to choose. We in Poland were tied up with commitments and decisions to enter the EU. By contrast, you can introduce a system that has nothing in common with the EU, but you must remember: when the question of closer contacts with the EU arises again, this problem will resurface.

“In my view, your question is different: in what way can your state make available 35, 45 or any other percent of GDP? Technically, you should only improve the system of accounting, monitoring, administering, and controlling.

“But there is a factor in Ukraine, which may complicate things. Are you going to be a federation or a unitary state? If you plan to be federation, the fiscal system should meet this goal. In a federation, people make payments that first go to the local and only then to the federal budget. In Poland, the system is as follows: most of the local expenses are formed by the money that first goes to the central budget and then is sent down.”

How did you in Poland make up for drop-out budget revenues? For it is no secret that there were enterprises and even sectors that failed to endure competition with EU producers and died – accordingly, the budget was short of revenues. This seems to be awaiting Ukraine. How can expenditures be offset?

“There are three ways. In a transitional period, if you believe in your long-term strategy, raise the fiscal deficit and increase the public debt.

“The second option – the outside world will help. The World Bank and the IMF will lend money to support you, to help you take the necessary steps. But this can only happen if you comply with very strict demands. Experts in the international financial institutions know what they are doing, they know what to see to assess the reality of your approaches.

“For example, we in Poland received certain support in the shape of a loan. The World Bank can give money provided you have a good program. And, of course, the political factor is also playing. If you come to terms with the White House, the German chancellor, and the British, the ‘big guys’ will give you money, but if they conclude that you asking for money just to squander it, you will get nothing.

“The third, most difficult, way is to cut budget expenditures, freeze the salaries of doctors, teachers, and the military… People will pay for a likely improvement of the situation some day with the sagging living standards.

“You will be able to carry out reforms if you move towards EU membership, but even if you are not going to become an EU member, you still have to carry them out. There is a very good example for you, perhaps even a better one than Poland – it is Turkey, your southern neighbor. They have been negotiating with the EU for many years. I have a feeling that they do not want to be an EU member and use negotiations as a lever to carry out structural reforms and improve legislation. Their economy is already more competitive than it was 10 or 15 years ago. They are saying they want to the EU and use this argument in favor of domestic reforms.”

What is your vision of Ukraine now? Do you believe in the new government and the new president? Are you prepared to help with personal consultations?

“I would not like to appraise any concrete personalities and say whether or not I believe in or like somebody. As a researcher, I am trying to understand what is going on, what may happen here in the future, and what amounts to a utopia.

“Firstly, I do not share the viewpoint that Ukraine has squandered the past 20 years. There are a lot of fields where you have made great progress. But it is also true that you might have been progressing better.

“Secondly, you can solve very many problems. But, again, you are running the considerable risk of blowing a lot of chances and losing time due to populism.

“Thirdly, Ukraine should place more trust in young people. They are more open-minded, have new habits, and are not afraid to take risks.

“You are asking about the new government, but I don’t know any new government. We will only see one after a democratic parliamentary election. You should first settle a few political issues, calm eastern Ukraine, and find a suitable format of relations with Russia. If you fail to establish good relations with Russia, you will not be able to achieve success. The other political factor is what political system – presidential or parliamentary-presidential – you need. Your economy needs a very strong leader who will take it through all the difficult reforms. Another still open political question is: a federation or a unitary state? And so on.

“You have resources, a very fertile soil, and the ever-improving human capital. You need a strategy to enable you to turn the situation to your advantage. The question is how to make use of your geopolitical position between the West, which begins with Poland, Turkey, and the EU, and the East – Russia, Belarus, and China. What was your problem until today should become your advantage. If you do not let Ukraine be a card for Russia and the West to play, you will be able to reap a tremendous benefit from your geopolitical position and will perhaps say 20 years later: what a treat it is to be between Russia and the EU!

“I can see a potential for a long-term self-sufficient economic development of Ukraine, owing to which it will stand among the world’s most developed states. You do have these possibilities. During my short visits to Ukraine (I was in Kharkiv and Dnipropetrovsk last week and in Kyiv this week), I met people from the Cabinet, the Presidential Administration, businesspeople, and academics. This convinced me that there are people who know how to do this. But this is not enough. Politics is not a debate club – one must do, not speak, more. But before you bring something to fruition, you should know how to do this.

“I must say after all that I am not sure that Ukraine knows what it wants.”

Have you been invited yet to become President Petro Poroshenko’s advisor?

“If I am asked, I answer. I try to do this as best as I can, albeit informally. I know from my experience that it is superb when you have a good advisor, but… It is a normal practice when people seek advice from the best and experienced experts in something, but please do not confuse a seminar with the serious work of an advisor.”

But would you agree?

“When Poroshenko asks me about this, I will answer him.”

P.S. The Day expresses gratitude to the International Institute of Management (MIM-Kyiv) for assistance in organizing this interview.

By Alla DUBROVYK, The Day