CASE UkraineCASE Ukraine
www.case-ukraine.com.ua
Investment environment in UkraineInvestment environment in Ukraine
Vladimir DubrovskiyVladimir Dubrovskiy
Prepared for the congress Investment in Ukraine. Challenges and opportunities
Hotel Polonia Palace, Warsaw, 8th-9th November 2004
CASE Ukraine
Formal and informal impediments to entrepreneurship and investments in Ukraine: the main peculiarities and the ways of coping with them
The political-economic causes for persistence of the "bad institutions" in Ukraine: can we predict the changes, and promote the improvements?
Evolution of the political-economic system: where Ukraine is going?
CASE Ukraine
Peculiarities of investment climate
Blat networks of interpersonal exchange with favors
“Soft” rule of law
The nachal’niks versus bureaucrats
Making things done:
Institutions:
Vague property rights
CASE Ukraine
The “pales of law” can be… The “pales of law” can be…
…tight: so hard to keep within the law!…loose
… and SOFTSOFT: no way to fully keep within the law!
“Soft” rule of law
but“There is only a block of concrete that really means “NO ROAD”.
The rest of prohibitions mean just “TOLL ROAD”
For your competitors tooFor your competitors too
CASE Ukraine
personalpersonal vlast’vlast’ of NACHAL’NIKSof NACHAL’NIKS
““The severity of the Russian laws is alleviated The severity of the Russian laws is alleviated onlyonly by by discretiondiscretion in their in their enforcementenforcement” “… just this ” “… just this disorderdisorder makes life in Russia possible” makes life in Russia possible”
Everybody is a lawbreakerThe law applies to all
“Laws are written for the fools”
“Who are the boss, we or the law?”
Preconditions forPreconditions for extortionextortion
Authoritarian modernization: law contradicts to practices
EXTORTIONEXTORTION underunderenforcement of the lawenforcement of the law
Because they are applied at the discretion of a nachal’nik
Karamsin, 19th century Russian historian
Gertzen, 19th century Russian social thinker
“Soft” rule of law
UnUncontrolled and mostly controlled and mostly affiliatedaffiliated with business with business
Strictly controlled and Strictly controlled and separatedseparated from business from business
Possesses the political power to Possesses the political power to magnify ambiguity and non-magnify ambiguity and non-transparency in legislationtransparency in legislation
No decision-making power No decision-making power Clear separation of “powers” from Clear separation of “powers” from branches of Statebranches of State
Controls politicians rather than vice Controls politicians rather than vice versa. Tries to control mass-media to versa. Tries to control mass-media to avoid public scrutinyavoid public scrutiny
Operates under constant public Operates under constant public scrutiny and political oversightscrutiny and political oversight
Poorly-paid and dependent upon Poorly-paid and dependent upon administrative rents (in money or administrative rents (in money or barter) barter) Relies upon Relies upon discretionarydiscretionary power and power and vague and arbitrary informal rulesvague and arbitrary informal rules
Highly-paid professional public Highly-paid professional public servants facilitating rational processes servants facilitating rational processes of control. of control. Implements legislation in a strictly Implements legislation in a strictly formal (formal (impersonalimpersonal) way) way
Administrative power in Ukraine
Bureaucracy (by Weber)Nachal’niksNachal’niks: not the bureaucrats!
CASE Ukraine Blat networks
Reputation-based informal networks of interpersonal mutual Reputation-based informal networks of interpersonal mutual exchange with “favors of access” (exchange with “favors of access” (blatblat))
Emerge to facilitate the illegal transactions of all kindsEmerge to facilitate the illegal transactions of all kinds
““One has to One has to deserve a deserve a rightright to pay a bribe” to pay a bribe”
No contract enforcement was officially availableNo contract enforcement was officially available
Normal economic activities were considered illegal Normal economic activities were considered illegal
Authoritarian modernization,Authoritarian modernization,
especially under Communists especially under Communists : : law contradicts to practiceslaw contradicts to practices
Ledeneva, 1998
Weak rule of lawWeak rule of law
Litwak, 1991 (!) while
CASE Ukraine
Right to use the object WITHIN THE LAWVague property rights
Under a “soft” rule of law
Vague Vague property rightsproperty rights
Real value of an asset depends on the position of its Real value of an asset depends on the position of its owner within the informal networks of owner within the informal networks of blat blat
CASE UkrainePolitical economy
The “vicious triangle” of legislation-corruption-discretion
Rent seeking, overappropriation, and “arbiter-client” relations
“State capture” by corrupt networks
“Zero-sum perception” and the problem of legitimacy of entrepreneurship
The Orange revolution and its immediate consequences
Evolution of the rent-seeking society of Ukraine
FACILITATEFACILITATE
CASE Ukraine
Legislation Legislation (flawed, (flawed,
ambiguous, ambiguous, impracticable)impracticable)
Corruption Corruption
DiscretionDiscretionENHANCESENHANCES
INTERESTINTEREST INTERESTINTEREST
Decreasing the demand for improvementsDecreasing the demand for improvements
ALLEVIATESALLEVIATESALLEVIATESALLEVIATES
In many cases players fail to establish the efficient institutions.
CASE UkraineRent seeking vs. profit seekingProfit seekingCreation of the value voluntary apprised by competitive market
Appropriation of already existing value, e.g. created by others
A positive-sum game (“cooking a pie”) increases the public wealth
A zero- or negative-sum game (“cutting a pie”) usually decreases the public wealth
Rent seeking
Players can establish certain efficient institutions, primarily, the property rights by a voluntary agreement
A coercive force is required to arrange appropriation while preventing the overappropriation
Rent seeking requires FORCED coordination and Rent seeking requires FORCED coordination and control that can only be arranged by control that can only be arranged by
AUTHORITARIAN POWERAUTHORITARIAN POWER
Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and
Savvateev (2002):
playerclient Rent source
CASE Ukraine
player
playerplayer
The “arbiter-clients” model
Authoritarian arbiterDistributes the quotas for rent appropriation arbitrarily,arbitrarily, and enforces
them in order to restrain the devastating competition
client
clientclient
… … but instead extorts the rent himself, or trades it for loyaltybut instead extorts the rent himself, or trades it for loyalty
Rent sourceLobbyist
“Oligarch”Nachal’nik
...
State budgetNatural
resourcesPublic property
...Weak property rights
“the tragedy of the commons”
CASE UkraineAn arbiter: CASE Ukraine
Has an incentive to extract the rent (share the players’ rents)
Looks as “captured” with vested interests
Asymmetry: The players can motivate their arbiter with a “carrot”, but not threaten to him irresponsibility
players are clients of their arbiter
In effect, “owns” a source of rent
Interested in using his discretionary power for further weakening the clients’ residual rights of control
Arbiters and clients form a hierarchy
Crowds out and suppresses any other ways of preventing the overappropriation
Rent-maximizing Power-maximizing totalitarian
authoritarian, plutocraticArbiters: Arbiters: ≡
≡
AnyAny kind of market exchange is being perceived as a sort of kind of market exchange is being perceived as a sort of ««zero-sum gamezero-sum game»»
Business incomes are not being distinguished by their originBusiness incomes are not being distinguished by their origin
Business and wealth ofBusiness and wealth of ANYANY kind is kind is illegitimateillegitimate
Weak property rightsWeak property rights ““fairness” of business fairness” of business is unrewardedis unrewarded
The rent seeking DOES dominateThe rent seeking DOES dominate!!
A “zero-sum” perceptionInherited to a traditional society
CASE Ukraine
Why do the people hate entrepreneurs?
Profit seeking (competitive) sector
Rent seeking sector
Monopoly rent
CASE Ukraine
player player
playerplayer
InIncrease in the social wealth
DeDecrease in the social wealth
Effects of authoritarian rule
Paternalism (clietnelism) and corruptionPaternalism (clietnelism) and corruption
Firms earn their incomes mostly as rents depending primarily on the arbiter’s discretion
client
client client
client
“A “zero-sum” perception
CASE Ukraine
Size of the rent-seeking sector is determined by the
balance between amount of rents available for an
arbiter and his costs of control and coordination of
the rent seekers
The rent seeking is costly for a society
It takes certain cost of an arbiter to coordinate and control the rent seekers
The rent seeking contracts
With exhausting of the available rents, and
complicating of control and coordination
Evolution:
Profit-seeking sectorRent-seeking sector
Technology Technology
SOCIETAL NORMSSOCIETAL NORMS
CASE Ukraine
REVOLUTION?REVOLUTION?
Rent-seeking sector
Profit-seeking sector
“Standard” approach applies
Transition from a rent-seeking society: Evolution and REvolution?
Politically responsible government
Depletion of the rent sourcesMarket
imbalancesFinancial instability
Cheap energy and credit
«intermediate winners»«intermediate winners»
Sources of Sources of RentRent
1988 - 19941988 - 1994
Overappropriation of state budget and enterprises’ fixed assets
“Overappropriation” of creditors’ trust
Sources of RentSources of Rent1995 – 1995 – 20020000??????
Subsidies and government contracts
Close collaboration of business and officials based on blatblat
A tacit social contract:
“We” do not bother
“them”, “they” do not
bother “us”
Business-Business-administrative administrative groups (BAG)groups (BAG)
Whither “captured statecaptured state”: a dead end?
Business:
a “Milk caw” or
a “Rent pump” for officials
Administrative power:
Provides protection and patronage for
business
Property rights, rents
Public
Sources of rents
Perceived totally corrupted
Perceived totally rent-
seeking
PASSIVE PLAYERPASSIVE PLAYER
Perceived Perceived manipulatedmanipulated
Threat of populism and paternalism Threat of populism and paternalism towards large groups of population towards large groups of population
CASE Ukraine
Public is not passive anymore, it became a “principal” of the politiciansBAGs and their arbiters are not the only players anymore
Executive power officials have lesser impact on the legislature
As a result of the revolution:
Political market emerges
Politicians appeal to the broad groups of population
Public consciousness is still immature:
while
does not properly distinguish profits from rentssupports redistributive activities (as “re-privatization”)supports “coordination and control” (e.g. price regulation)
The “captured” state starts working for the competitors
Business-administrative
groups
Financial-industrial groups
An “arbiter” for the An “arbiter” for the large groupslarge groups
Revolution of the politiciansPolitical capitalPolitical capital
POPULISMPOPULISMPolitical parties
Destruction of the rent-seeking opportunities
A “zero-sum” perception
Demand for the Demand for the UNIVERSALUNIVERSAL rules of rules of
the gamethe game
State budget
Tax base
a group
a group
a group
a group
The tragedy of the commons
CASE Ukraine
0
10
20
30
40
50
60
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
rather negative
rather positive
People's attitude to the privatization of large-scale enterprises
source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)
CASE Ukraine
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Balance of attitudes to land privatization
source: National Academy’s Institute of Sociology’s surveys (Panina, 2005)
CASE Ukraine
-80
-70
-60
-50
-40
-30
-20
-10
01994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
0
0.5
1
1.5
2
2.5
3
self-reliance
satisfaction with socialstatus
SATISFACTION with own SOCIAL STATUS (score
of maximum 5, right axis), and SELF-RELIANCE (percentage of respondents agreed that their life success depends on themselves, net of the percentage of respondents agreed that it is determined mostly by the external conditions – left axis).
source: National Academy’s Institute of Sociology’s survey (Panina, 2005)
Thanks for Thanks for your attention!your attention!