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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

Unequal Competition Caused by Our “Economy” and “Politics”

16 November, 1999 - 00:00

In the election hoopla many interesting economic events have escaped attention. All thought that by casting their ballots they could start life over afterwards. This is an illusion, of course, because tomorrow will see problems that appeared the day before. For example, renew relationships with IMF, and we think that these relationships will not reflect Ukraine’s cautious choice: let everything remain the way it has been. Instead, they will become another test of strength, not so much for the old and new regime as for the other residents of this country.

In late September a Ukrainian delegation left to attend the annual meeting of the IMF and World Bank member countries. Eyewitness accounts show that attitudes toward Ukraine had obviously changed. And this considering that there was still a month left until the people would make their own “cautious choice.” Changed how? Simply no one asked the visiting Ukrainians any questions. In other words, instead of the heated debates characteristic of such sojourns last year, their reports on attainments and failures, and even the usual calls for investment in the Ukrainian economy all met with polite silence. But was it because the Western colleagues had nothing to say? On the contrary. Their response was ready last year and now it was being placed in a diplomatic package, so as to make Ukrainian officialdom face the hard reality in early December when Kyiv will host numerous IMF and WB partners. What reality? After five years of trying, rather ineffectively, to help Ukraine, Western economists realized that their recommendations had been somehow mistaken. Now they will offer something else.

Futile attempts to induce economic growth in Russia and Ukraine with the aid of monetary stabilization, by analogy with Central and Eastern European countries, has forced the international economic community to take a closer look at the “specifics” of both these states. Readers interested in economics will recall the effect of the studies that introduced the notion of the virtual economy. True, many of the intriguing discoveries made by those researchers quite recently and universally acknowledged only after the financial collapse of Russia had long been evident to the natives. Too bad they were not promptly formulated in generally accepted Western academic jargon.

After finally making out the essence of the Ukrainian-type economy, the Western creditors sounded the alarm, yet theoretical revelations such as virtual economy were apparently not strong enough for them to make radical decisions. A year later the world public would start to discuss (and prosecutors in various countries would investigate) ways money was being laundered. The scandal mainly concerned Russia. Ukraine, however, is not likely to offer convincing arguments denying the leak of capital and leaking (tax evasion) schemes using offshore zones to transfer bucks to Western banks. There was no coincidence about the Bank of New York closing the accounts of banks located in whole CIS regions. Incidentally, the clearing bank of the Ukrainian Interbank Currency Exchange also had an account with BONY, although this author does not know what has become of it.

Another campaign, aimed at Russia but significantly affecting Ukraine, was launched several weeks ago when McKinsey consultants published their review of Russia’s economic situation, trying to answer a question haunting many: What makes this dying economy ignore all attempts to revive and develop it? What makes this study so interesting? Primarily the fact that it uses a language understandable to all Western donors to explain that there is no use keeping countries with the post-Soviet type of economy on the Western financial needle, because the obstacles in the way of their economic growth have nothing to do with investment, meaning that they do not need Western money, not at this stage anyway.

According to the review, production efficiency (i.e., unit of labor per unit of output or labor productivity) in Russian industries is a mere 19% that of the United States. In Ukraine (having a similar economic structure, except that it is even worse), these indices are not likely to be more encouraging. One of the reasons (or so McKinsey experts believe) is that most idle enterprises and those operating off and on do not formally dismiss their workers, although often pay them nothing. This is understandable, since Ukraine’s economy — were one to believe official statistics — has dwindled three times (in terms of GDP) over the past less than ten years, with the unemployment rate reaching only 5%. The Great Depression reduced the American GDP by a “mere” 30%, making 25% of the able-bodied residents jobless.

Yet at the most productive and fully staffed modern factories production efficiency does not rise above 30% compared to the US (as it did during Soviet times). This paradox is explained by the same reason as are staggering production costs; in business one often comes across economic criteria other than prime cost, quality, and price. Among such other reasons are political connections. Western economists point to this factor, maintaining that by pulling strings here one can get tax concessions, buy a plot cheap, or avoid the red tape.

The McKinsey review dwells at length on the “unequal” terms of competition resulting from the specificity of economic policy, stressing that they are slowing down adjustments and investment. A Ukrainian citizen interested in economics would be surprised to learn that such self-evident things as different rules of the same game for outwardly similar enterprises need special justification. Yet the review proves (and this proof is praised by Western media as a theoretical discovery) that “different” rules of the game play into the hands of inefficient enterprises dating from the Soviet period, in that they spare them the need to compete with new firms and the risk of being absorbed by other companies.

Perhaps we are underestimating this report. Indeed, after companies in the donor countries draw their governments’ attention to the fact that international organizations (that generally act in their interests) are supporting the wrong kind of reforms, Ukraine will find it hard to by-step fundamental adjustments in these reforms. And the need to make such adjustments can hardly be overestimated.

Trying to explain what makes efficient companies unprofitable and inefficient ones thrive, McKinsey people point out that the crux of the matter is unequal competition. Unequal rates and taxation procedures applied to enterprises belonging to the same industry, unequal terms of land allocation and placement of state contracts, different actual electricity costs for different companies operating in the same sector, unequal requirements to the management of different companies, unequal application of the law — for example, concerning import duties; unequal terms of access to the government-controlled export infrastructure — all this prevents economic growth.

Unequal terms of competition are also the basic reasons for chronic budget deficits. The state continues to subsidize ineffective enterprises in stagnating industries (like heavy industry) on the sly thereby causing budget expenses to grow. In new industries tax returns from unproductive firms remain low because of their “special” relationships with the regime. As for other reasons for low productivity, the authors of the review do not consider them totally insurmountable obstacles, as previously believed. Be it problems with corporate management, manpower mobility restrictions, or shortcomings in the judicial and banking systems. The review says a dozen industries have been investigated and the findings show that all these problems will have no critical effect on such enterprises.

And so, having analyzed the “microeconomy” of ten industries, McKinsey experts arrived at a conclusion most unpleasant for the Ukrainian bureaucracy: the problem of the lack of investment is explained not by the absence of capital but by the inability to keep the money in this country because of unequal competition. Also, the reader will note that this conclusion well supplements the “macroeconomic” analysis of that virtual economy, political analysis of the bureaucratic interest in keeping the situation unchanged (considering how much the bureaucrats make on the side, pulling rank for a fee), and the international investigations into money-laundering schemes.

Apparently, such “attainments” of the world public will be more or less generalized and taken into account by the IMF as “basic” considerations in upholding credit relationships with Ukraine. Despite the fact that IMF cannot get politically involved under its statute, there is little doubt that such theoretical studies will be used for precisely such involvement (after all, what are these “unequal” rules of the game? None other than politics!). Thus Ukraine should brace itself for being told a polite no in response to requests for continued currency injections — or maybe it will find itself forced to change its policy, even if under the pretext of introducing equal competition. Incidentally, McKinsey experts estimate that equal competition, along with other institutional measures, could produce at least a 45% rise in labor efficiency productivity. Only after such changes (and increment) will foreign investment be useful in this country.

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