Transcript lec9old Pivnenk

Lecture 9
TRANSITION FROM PLANNING:
THE CASE OF UKRAINE
Sergiy Pivnenko, M.A. Economics, SFU
Introduction to Theory of Transition
Definition of “Transition”:
“The process from socialism to capitalism in former socialist
economies” - Gerard Roland
• A move from central planning to market economy
• Large-scale institutional change
• A complex economic and social change which affects
- laws, rules and norms according to which agents interact
contract law, bankruptcy law, property law, competition law, securities
law, and intellectual property law
- organizations: economic, political, etc.
- change from communist party regime to representative
democracy (is democracy a necessary condition for market
reforms?)
Central planning: economy as a big firm
• fixed prices, quantity and quality (absence of markets)
• production and exchange governed by central
administration (ministries)
• centralized distribution of resources
• setting output targets
Distortions:
• oversized heavy industry and small service sector
• coordination failure  shortages or excess supply
• poor incentives  low quality products, no cost
minimization (soft budget constraints)
Transition Reforms
Basic steps:
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Stabilization – to create macroeconomic environment for markets functioning
- fiscal: balanced budget (cut subsidies, sell and restructure bankrupt enterprises)
- monetary: low inflation and stable currency create conditions for the price system to provide
correct signals to consumers and producers
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Liberalization – to end the excess demand and create working price system
- deregulation, end of price controls
- demonopolization, ease of entry for new firms and businesses
- creating a convertible currency followed by opening of domestic
economy to foreign trade
Mass privatization – to correct incentives
- a transfer of ownership of state assets to the private sector
Creation of social safety net – to alleviate the negative effects of enterprise
restructuring
• introduction of unemployment compensation system
• effective utilization of government expenditures for social needs — on pensions, family assistance,
and health
The debate over gradualism vs. “shock therapy”
Examples:
Shock therapy: Poland, Czech Republic
Gradualism: Russia and Ukraine (“shock without therapy”), China
Argument against shock therapy:
Institutional transformation is rather evolutionary process:
- cannot privatize overnight
- cannot build financial system overnight
However, fast stabilization makes possible efficient structural reforms
High social cost of shock therapy (would it be lower under gradualism?)
Political argument for shock therapy:
Jeffrey Sachs: ”Fragile governments facing a deep economic crisis are
best able to carry out strong measures at the beginning of their tenure”
Economic Transformation: the case of Ukraine
Population: 47,732,079 (July 2004
est.)
Territory: 603,700 sq km (slightly
larger than France)
Location: Eastern Europe
Life expectancy at birth: male: 61.35
years, female: 72.27 years (2004 est.)
GDP per capita: at purchasing power
parity - $5,400 (2003 est.)
Ukraine remains the only country in the world that voluntarily got rid of its
entire nuclear arsenal.
Between 1994 and 1996 all nuclear warheads and their carriers were partly
destroyed, partly transferred to Russia in exchange for the nuclear plants fuel.
A Lost Decade
Ukraine's transition in the 1990s: half-hearted reforms=no reform
• Total decline of about 53 percent of GDP from 1989 to
1998 (negative value added, disorganization)
• The underground economy amounted to 49 percent of
GDP in 1995 (tax evasion)
• Privatization of land has been persistently blocked by the
left wing of the parliament
• Rudimentary stock market, shareholders’ rights not
protected
• Pervasive corruption (Ukraine ranked 69th out of 85
countries in 1998 Corruption Perception Index)
• Lack of liberalization (Ukraine ranked 122nd out of 123
countries in 1995 Index of Economic Freedom)
• Disorganized financial system (amount of barter
transactions was estimated about 50% of GDP in 1996)
Partial success
• After a period of hyperinflation in 1991-94
macroeconomic stability was achieved
(government stopped uncontrolled monetary
emission, balanced budget)
• In 1996 a new Ukrainian currency (hryvna) with
fixed exchange rate was introduced.
• Independence of Central Bank (!). Despite the
pressure from the Government Central Bank,
maintained stability of Ukrainian currency
• Privatization (though slow and inefficient) was on
the way: sale to insiders/outsiders, IPOs, small
scale privatization
Why gradualism?
- Lost momentum!
Immediately after collapse of communist rule (1991)
the leadership of newly independent Ukraine was
preoccupied with nation building which was widely
perceived as separate from market economic reform.
The devastating financial crisis (10,155% inflation in
1993) ruined social consensus thus making “shock
therapy” politically impossible.
What went wrong?
A rent-seeking model of Ukrainian economy (Anders Aslund):
Four sectors:
1. The government: opposes any deregulation that would reduce its
monopoly power and thus its revenues from bribes.
2. Rent-seeking businessmen: focus on elementary monopoly rents,
lobbying for regulations that guarantee them. They favor all kinds of
regulations which apply to others but not to themselves.
3. The parliament: largely lives for bribes, in particular the center that
represents the party of power, which essentially supports the
government. Thus, the parliament is largely interested in as messy a
legislation as possible.
4. The Ukrainian households suffer from corruption and a dysfunctional
economy. They have to work in the underground economy in order to
sustain minimal living standards. Many blame reform, as Ukraine has
officially been pursuing reform for years.
A rent-seeking model (cont’d)
Anders Aslund:
“Thus, we have found an iron triangle of government,
businessmen and parliament who all favor a maximum
of regulation and state interference to maximize rentseeking and corruption, while the population is of
little consequence and partly co-opted and
compromised. The problem is that this model of selfreinforcing rent-seeking looks far too stable and it is
close to an equilibrium.”
A rent-seeking model (concluded)
A Vicious Circle: “Piecemeal reforms have bred extraordinary
corruption and rent-seeking. A small group of very rich
people has arisen, and they have bought political power
with their wealth. They are using their fortunes to maintain
their fortunes by bribing politicians, bureaucrats and
parliamentarians to introduce new regulations that generate
more rents.”
“… Ukraine appeared stuck in a severe under-reform trap.”
(Anders Aslund, 1999)
Ukraine’s return to growth in 2000
Fastest growing industries:
food processing and packaging, energy generation and transit,
telecommunication and information technology, construction
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6% growth in 2000 (13% growth in industrial output, 9% - in agriculture)
9 % GDP growth in 2001 (18% - in industrial output, 27% - in agriculture)
4.1% GDP growth in 2002
6% GDP growth in 2003
In 2004 GDP is set to expand by an amazing 10% to 12% (mainly exportdriven growth, due to high metals prices on world markets)
Reform leaders:
•
prime-minister Victor Yuschenko (former governor of Central Bank)
•
vice-prime-minister Yulia Tymoshenko (formerly one of the biggest gas
traders)
What has worked well:
• substantial progress in establishing fiscal discipline
– refusal of the central and local governments to settle tax obligations in
anything other than cash
– the increase in cash payments for gas and electricity by final consumers
from levels around 10 % of payments due in 1999 to levels around 70 % in
2001
• sources of energy rents (these rents amounted to 13% of GDP - import at
subsidized prices and re-export at world prices) were removed in
- gas imports
- electricity-generating industry
- oil imports
• large scale privatization intensified competition for rents
• lower and simplified taxes pulled entrepreneurs out of the shadow
economy
• foreign trade liberalization created a competitive pressure that forced
large enterprises to restructure
Ukraine’s transition reform today
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February 2001: president Kuchma dismissed Tymoshenko and in April 2001
the pro-president parties and communists voted Yuschenko out of power.
2001-2004: reforms slowed down. Despite of the growing GDP living
standards have not improved (30% of the population remain below poverty
line). Pervasive corruption and lack of economic restructuring threaten the
sustainability of growth.
January 2005: Victor Yuschenko inaugurated as a new President of Ukraine.
February 2005: Yulia Timoshenko appointed by the President and unanimously
approved by the Parliament as the Prime Minister of Ukraine; announced the
Government's Action Program:
– dismantling of “corruption vertical”, create new judicial system;
– creation of reliable and transparent business environment;
– modernization of the power industry, reliance on renewable energy sources and
energy-saving technologies;
– reducing government intervention, fostering small and midsized privately-run
businesses;
– “taxes must be comprehensible, stable and low”
– core principle: “the State serves the people, not the other way around.”