The simple truths of spatial economics

“Eastern Ukraine keeps Western Ukraine afloat.” In his exclusive interview with The Day, Pavlo DEMCHUK, a young expert who won a Ph.D. degree in economics at Rice University in Houston, Texas, USA, explains that this opinion is wrong from the economic viewpoint. The expert once researched, together with his scholarly supervisor, the productivity of Ukrainian regions. Although the researchers had to overcome a number of “specific” obstacles, which national science is still tripping over, they came to some interesting and sometimes paradoxical conclusions. Even though the period of their research ends in 2002, the questions they raise are still highly topical. Moreover, if the economists’ conclusions are anything to go by, the steps that the Ukrainian government announced the other day are criminally erroneous. Here is the transcript of the interview.

You studied the productivity of Ukrainian regions in 1996-2002 and concluded that they were overcapitalized, i.e., had excessive and unnecessary human and obsolescent technological resources. Has the situation changed today?

“It is difficult for me to answer this question. Unfortunately, continuing the research you are speaking about is so far just a part of my plans. I do not even know if I will manage to find the relevant data. Access to information is, incidentally, an extremely critical problem for Ukrainian academics. When I was doing research, I found it extremely difficult to find the information I needed. There was no electronic information – it was only published in the yearbooks kept at the Statistical Department’s library. I had to just sit and copy materials over there. Then it occurred to me to photograph the information. But I still had to put down statistics by hand.”

You try to prove some unexpected things in your research: you say there is no essential difference in the productivity of Ukraine’s eastern and western agrarian and industrial regions. You claim that productivity inversely varies with the inflow of direct foreign investment. What consequences are these results supposed to have for Ukraine’s economic policy?

“Firstly, the policy of attracting direct foreign investments needs to be corrected. For, in my opinion, instead of having several special free economic areas (FEA), we should establish one common, so to speak, free economic area. This means there should be certain conditions for investors all over Ukraine, not only in the government-picked regions. At the same time, this would minimize corruption.

“What is critically needed is a transparent law that would offer equal opportunities to big and small investors which could compete using their brains, not brawn. Free economic areas existed when Valentyn Zelenik and I were writing a study on Ukrainian regions – it was a very interesting thing at the time. Those areas did not help improve productivity and effectiveness.”

What do you mean?

“In some FEAs companies took advantage of ‘holes’ in the law: for example, they managed to produce a batch of finished products in a month’s time and take it outside Ukraine as raw materials, without declaring any added value. Most of the FEA businesses were entitled to tax exemptions. The rest of the FEAs existed on paper only. So nothing in fact worked even when there were investments. Naturally, we did not take into account the gray economic sector, which reflected on the productivity index in a FEA region.

“As for comparing the agrarian and industrial regions, we mist recall that Ukraine reached the 1990 production level as late as in 2002-03. This means that, when we were doing research, the new equipment was not used (and, naturally, it became obsolete in the course of time) but remained on the enterprises’ books. The number of laid-off people was very high, although they were full-time employees. Such things were not isolated – they were typical of all the regions, so our research produced quite an expected result.

“I must admit that the acquisition and usage of fixed assets and labor force at an enterprise is a more lasting and painful problem than investments. The outdated and unnecessary equipment can be disposed of rather quickly, but it is far more difficult to dismiss or retrain employees.”

In other words, you mean that, according to your study, labor productivity is equally low in both western and eastern Ukraine in spite of the popular stereotype that the east “feeds” the west?

“When it comes to comparing the agrarian and the industrial regions, very many issues are too much politicized. When we compared the east and the west, we saw that both regions were applying obsolete technologies, there were no innovations and, hence, development.

“One of our goals was to show that the voluble political rhetoric about the regions was totally groundless in terms of economics. One can claim anything, but one must use facts, models, and research results.

“We practically tried to show a true situation on the basis of normal economic methods. Comparing the industrial and the agrarian regions, we saw that they were approximately at the same level. There are no grounds to claim that Chernivtsi oblast is inferior to that of Luhansk or that Donetsk oblast ‘feeds’ that of Ivano-Frankivsk. It is totally different in terms of effectiveness and productivity.

“Naturally, the size and the population of regions should be taken into account. We also did so in our research. We first assessed the effectiveness of every oblast and then generalized the results group-wise: western-eastern regions and agrarian-industrial regions. On the individual level, Kyiv proved to be the most effective and far outstripped the other regions. Generalizing the results and comparing the effectiveness of the groups of oblasts, we came to the conclusion that they did not differ statistically. In our opinion, a slight difference between the agrarian and the industrial regions results from the fact that they are similar not only because they have obsolete assets and redundant employees, but also because the difference between the notions ‘agrarian’ and ‘industrial’ is somewhat blurred, for any oblast has both sectors with the same problems.”

Is regional differentiation as a research subject applicable only to Ukraine, as it develops under the influence of certain historical factors, or is it a universal thing?

“There is regional differentiation in any country. Studying the productivity of Ukrainian regions, we read a similar research paper from Belgium, which compared the Flemish and the Walloon regions. In Spain, too, they researched the region-wise effectiveness of school education. It was very interesting. We wanted to somewhat play down the political polemic about the east-west relationship. Valentyn Zeleniuk, the supervisor of my master’s degree thesis and a coauthor of that article, comes from Donetsk, while I come from Lviv. So we even decided to show, with a touch of humor, that east and west are together. Nobody feeds anybody: we all work as much as we can under the current conditions and do certain things in the right or the wrong way.”

Experts talk so much about a gap between the economic results of the regions and those of Kyiv. You also write about this. To what extent is this thing typical of Europe and the US, or is it a purely post-Russian syndrome?

“Our companies get registered in the capital because they are closer here to ministries, agencies and other organizations, where they can settle some problems. The capital is a certain business center. It is a place where all problems can be addressed.

“For this reason, the situation looks a little warped – just because a large number of firms are registered in the capital. But we can also take a deeper look into this. If a firm is registered in Kyiv but conducts business in, say, Transcarpathian oblast, we can assess information relative to Transcarpathian oblast, not to Kyiv.

“Incidentally, there is an economic research field known as spatial economics which considers these matters from the angle of interregional links. I think this field is in for a bright future, especially as far as integration of Ukrainian regions is concerned.”

What do you think about the current Ukrainian government’s ability to apply the achievements of economic science?

“These achievements are being taken into account, but I do not know exactly which ones and to what extent. I have personally mingled with Finance Ministry analysts – they are really doing some research, but they sometimes apply outdated models which are no longer taught in academic institutions and have already been pronounced ineffective. Some achievements of science are being applied, but I cannot say for sure to what extent they are up to date. It depends on top official whether or not ministerial research centers will adopt scientific innovations. I have seen the list of academics employed at the National Academy of Science’s economic section – none of the names ring bells to me, I’ve never come across them in the literature I read. There may be certain scientific concepts in ministerial research centers, but I cannot judge about their quality and freshness.”

As is known, the government is again bent on establishing free economic areas. Vice-Premier Serhii Tihipko is moving three bills to this effect. What is your attitude to this?

“As for the government’s recent initiatives, I will focus on the economic side, although it is also important to clearly word the provisions that will produce a direct economic effect. I must note, above all, that there is just no such thing as a list of top-priority sectors in Ukraine. Nor do we know the experts who will be choosing investment projects. Who are they? Representatives of the government, of enterprises, or of some collective body? Unfounded criteria and unclear requirements will be conducive to corruption and tax abuses when projects are being decided upon and carried out.

“I do not approve of exemptions because they always create a non-competitive situation. A target-oriented assistance is far more effective.”