VoxUkraine: How Ukraine can start thriving as nation
In August, President Petro Poroshenko declared, “144 reforms have been launched… We have to become a democratic, free and, most importantly, successful country.”
Two months earlier, Hugues Mingarelli, the head of the European Union mission in Ukraine, told journalists that the Verkhovna Rada effectively blocks reforms and there is little progress now.
They were talking about the same country!
An average Ukrainian may wonder which side is true.
Should we be happy with how much has been done since the EuroMaidan Revolution that drove President Viktor Yanukovych from power in 2014?
Although elections in 2019 will give a popular assessment, the contours of progress are apparent.
VoxUkraine, a non-profit, non-partisan platform for analysis and policy recommendations, has been monitoring reforms since 2014 and is uniquely positioned to take stock of where the country stands.
Here is a summary of major achievements and failures and what needs to be done to transform Ukraine into a successful nation.
Ownership of reforms
No reform is successful unless people take ownership of how they change a country. In contrast to the 2004 Orange Revolution, which brought Viktor Yushchenko to power, the EuroMaidan Revolution led to a burst of civic activity aimed at making the government more accountable and influencing the course of Ukraine’s future. While the majority of Ukrainians do not have a strong sense of ownership of the reforms, there is a critical mass of engaged citizens to push the agenda. The massive injection of new blood into the government created conditions for some radical changes. Given the war and more than 10,000 lives lost in eastern Ukraine, society has been more mobilized than ever.
However, the shadow of the Soviet past and the oligarchic system made even this powerful force likely insufficient to overcome corruption, incompetence and vested interests.
In terms of governance indicators, Ukraine’s starting point was tremendously weaker than that of Poland in the mid-1990s. In 2013, Ukraine still belonged to 30 percent of countries with the lowest government effectiveness and rule of law indicators, while Poland was twice better back in 1996. Fortunately, the grassroots movements were empowered by financial, technical, and political assistance from the West.
Ukraine’s post-Maidan administration secured political and financial backing from international partners. Over 2014–2016, Ukraine received $22 billion in loans from the International Monetary Fund, other international financial institutions and Western governments, which represents 24 percent of the country’s 2016 gross domestic product.
International financial support helped to stabilize the currency and economy and push through many reforms. In addition to loans and grants, visa-free travel to EU countries was conditional on meeting reform milestones, while the political and trade association agreement with the EU signed in 2014 became a roadmap for reforms.
Improved public ownership and international support enabled Ukraine to make visible progress. The Index for Monitoring Reforms suggests that the regulatory environment was changing in the right direction, though at a relatively slow pace with international partners’ conditionalities providing for 23 percent of the cumulative score over the period.
Top 6 achievements 1. Gas sector reform
Low energy efficiency and dependence on Russian supplies of natural gas were among key challenges. The gas sector reform is one of the main success stories. Before 2013, Russia was the only major supplier (over 99 percent). In 2016, all imported gas was bought on the European market through reverse flows.
The second major step was sharp adjustment in domestic gas prices. The gap between high import prices of gas and low household utilities’ tariffs was so large that Naftogaz’s deficit in 2014 reached 5.4 percent of GDP. The government hiked domestic gas tariffs for households 5.5-fold in the last three years, bringing them closer to import parity and adjusted heating tariffs accordingly. Simultaneously, eligibility criteria for direct utility subsidies for poor households were loosened. The drastic gas tariff hike substantially improved the fiscal position, making Naftogaz a net contributor to the state budget.
The third major change was to appoint a professional management team to run Naftogaz and to create an independent supervisory board. However, these positive changes have stalled. Three independent directors of the supervisory board announced in April that the Cabinet blocked the corporate governance reform and hampered a solution of gas arrears. One director resigned in August, leaving the board incapable to approve any decision.
Despite these achievements, gas sector reform is not over. Major challenges ahead include unbundling Naftogaz in line with the third EU energy package, demonopolization of gas supplies to households, investment in obsolete utilities infrastructure, etc.
2. Banking transformation
While the National Bank of Ukraine made several breakthrough reforms, we focus on two key ones.
First, the central bank adopted a new policy framework: inflation targeting. This will bring macroeconomic stability as well as low and stable inflation and, therefore, will stimulate economic growth. The central bank enhanced its communication to create a predictable business environment. The flexible exchange rate will absorb external shocks, thus reducing macroeconomic risks and making the economy more robust.
Second, the NBU started to exercise more oversight over banks and other financial institutions. Indeed, the banking sector in Ukraine was infamous for related-party lending, which made the country vulnerable to crises and panics. The banking system in 2015 was undercapitalized and many banks were de facto bankrupt — some were nothing more than Ponzi schemes — but continued operations. To address these enormous problems, the NBU curbed related party lending, raised capital requirements and removed “zombie” banks. More than half of the 180 banks in operation were liquidated.
3. Public Procurement
The system of public purchases was considered one of the major sources of corruption and waste in the pre-EuroMaidan Ukraine. A new e-procurement system for all public purchases (ProZorro) was launched. A comprehensive set of reforms had five objectives, most of which were achieved. First, the new system reduced opportunities for corruption. Second, businesses obtained better access to public tenders: the number of suppliers for large tenders grew 74 percent. Third, reform provided tools for civil society and businesses to keep public contracting authorities accountable. ProZorro was supplemented with the business intelligence module which provides access to the data and visualizes major procurement metrics. Fourth, the legislation harmonized public procurement with the EU and World Trade Organization, giving Ukrainian producers access to public procurement abroad. Finally, the new system cut red tape and waste. By some estimates, the new auction system generated approximately 3.5 percent savings. Reform in this area gained plaudits internationally and was approved by the European Bank for Reconstruction and Development as a model for other countries.
Ukraine’s decision-making in public policy was highly centralized. Important changes to the budget code and a number of other laws
have been adopted since the beginning of 2015 which give more powers, responsibilities and resources to local governments, although decentralization reform still requires amendments to the Constitution to clearly define the responsibilities of central and local governments.
The reform provides financial incentives for communities to unite to achieve economies of scale. At the end of 2016, there were 414 united communities in Ukraine and they held their first elections.
5. Business environment
Just before the 2014 EuroMaidan Revolution, Ukraine ranked 112th out of 189 countries in the World Bank Doing Business survey. Since then Ukraine’s rank rose to 80th in 2017.
Several reforms were instrumental for improving business environment. There was a reduction in regulations and licenses. The government assisted business registration and other procedures through the “single window” approach. As of July, 701 operating centers issuing licenses and permissions were open. Now it takes only one day to register a new business. In 2016, the social security tax rate was cut from above 40 percent to 22 percent, which brought the overall level of taxation in line with the average in Central and Eastern European countries. Finally, in April the government introduced an electronic system for value-added tax refunds, previously a source of corruption and a tool for selective pressure on businesses.
6. Patrol Police
In July 2015, new patrol police took to the streets of Kyiv, replacing the disliked and corrupt traffic police. Though confidence in the new police declined over the past year, the reform offers an example of how a new strong institution can be successfully built from scratch.
Laggard reforms 1. Prosecuting corruption
Fighting endemic corruption along with moving towards the EU was one of the key demands of the EuroMaidan Revolution. However, corruption still remains a major obstacle for foreign investment, according to a recent survey.
Ukraine has made noticeable progress in reducing corruption opportunities with the online public procurement system, business deregulation, banking system clean-up and open public access to detailed electronic asset declarations for state officials.
To combat high-level corruption, Ukraine’s authorities created new independent institutions, such as the National Anti-Corruption Bureau of Ukraine Specialized Anti-Corruption Prosecutor’s Office. These organizations shortly became operational and opened hundreds of criminal cases, including against the head of the State Fiscal Service. However, their effectiveness in prosecuting corrupt officials charged by NABU has been limited: in 2016 through June 2017, only 3 cases (out of 171 high-ranking officials charged) resulted in jail sentences. This poor performance was largely due to the dysfunctional, corrupt and politically dependent court system. This state of affairs prompted calls for the creation of a specialized anti-corruption court. While such a court has been envisaged in the recently adopted judicial reform legislation, there has been no visible progress for its creation.
2. Land market reform
With 41 million hectares of agricultural land covering 70 percent of the country, Ukraine accounts for a third of the global black soil area. At the same time, Ukraine along with Belarus remain the only two European countries where land cannot be bought and sold. A ban on the sale of farmland was introduced in 2001 and remains in place today. The moratorium severely hurts farmers’ capacity to borrow capital and consequently the sector’s productivity because land cannot be used as collateral. In addition, agricultural land in state and communal ownership — a quarter of total agricultural land — is poorly managed and misused, generating fiscal losses.
Lifting the moratorium remains heavily politicized and unpopular. This is unfortunate. Successful land market reform will improve property rights of landowners, enhance the public benefit from using state and communal land and encourage investment in rural areas.
3. Civil service reform
A modern country requires an efficient and competent bureaucracy to formulate economic policies, allocate government resources, design reforms and ensure their speedy implementation. Unfortunately, the effectiveness of civil service in Ukraine is the second lowest in Europe after Moldova, according to the World Bank Governance Indicators.
Successful civil service reform should include three key elements: (1) bring new, competent people to the civil service, (2) minimize the political impact on appointments and (3) redesign processes inside the government to make it efficient and transparent.
The first attempt to launch civil service reform was made at the end of 2015 with approval of the new Law On Civil Service. The law envisaged that all top appointments should be made with a special selection committee, created new positions of state secretaries in the ministries, chosen through a new competitive process, and changed the salary structure of civil servants. Senior level officials were banned from having membership in any political party. Despite high expectations, the law did not lead to major improvements. To correct some of these mistakes, the government intends to hire 1,000 new civil servants (vs. 202,000 total) to newly created directorates in selected ministries, offering them higher salaries. Directorates will be responsible for strategic policymaking and restructuring of ministries.
Ukraine has more than 3,300 stateowned enterprises. Their oversight is so poor that different agencies provide different numbers, ranging from 3,350 (Ministry of Economy) to 4,500 (State Property Fund). For the last three years, the goal for privatization revenues in the state budget was set to Hr 17 billion, but this plan has not been fulfilled. Privatization revenue in 2016 was only Hr 0.2 billion. This means that SOE losses (near 3 percent of GDP in 2016), stemming from incompetence and corruption schemes continue to be covered by taxpayers.
Perhaps the largest success is the reform of Naftogaz, which holds 48.5 percent of all assets in the top 100 SOE list. Indeed, Naftogaz has new independent management, has conducted audits and published results and improved its financial results. At the other side of the spectrum is Ukrspirt. Estimates suggest that up to 40 percent of all vodka and other alcoholic beverages’ production uses “gray” (i. e. unaccounted) spirits from Ukrspirt.
The government recently drafted legislation streamlining privatization procedures and identified SOEs to be privatized, liquidated or left in state hands, but corporate governance reform in strategic SOEs stalled.
5. Judicial, law enforcement
Ukrainians distrust the judicial system, which is deeply damaging the economy and society. Not surprisingly, one of the first major laws approved after the 2014 EuroMaidan Revolution was “On renewal of trust to judicial system,” which essentially prescribed lustration of judges. In a sign of entrenchment, 75 percent of court chairmen fired by this law were re-elected by their peers. Subsequent reforms focused on gradual upgrades to achieve greater trust and independence in the judicial system. For example, new legislation granted an imperative power to Supreme Court decisions, introduced open competition for all positions, considerably raised salaries of judges and set up the Higher Council of Justice (a self-governing body for the judicial branch) to make all decisions regarding hiring, promotion and punishment of judges. At the same time, judges were obliged to submit e-declarations, which are now available online, to minimize corruption. So far, the Higher Council of Justice has been reluctant to reject judges shown to be corrupt or dishonest by the integrity commission comprised of civil activists.
In a rare reform of prosecution, amendments to the Constitution removed prosecution’s universal oversight function, a Soviet remnant. Unfortunately, prosecution remains opaque and repressive.
Although the new patrol police was a success, the rest of the police (namely, the investigative police) remains unreformed.
6. Health Care
Ukrainians have dismal access to quality health care services. The government covers only half of health costs and many households have difficulty paying their medical bills. Attempts to reform have been constantly halted by political and economic vested interests, including sizable cash flows in the industry.
One important step was the temporary (until 2019) outsourcing of centralized procurement of medicines to international organizations and simplification of medicines’ registration. This helped to the eliminate a large source of corruption at the Ministry of Health.
The government drafted broader reform, proposing to change financing by allowing citizens to freely choose doctors, clinics and hospitals. The proposed changes are intended to raise competition, improve the quality of services, increase efficiency in spending and reduce corruption. However, the respective draft laws are stuck in parliament. The stalemate deprives the nation of a chance to increase the productivity of the labor force and lengthen life expectancy, which remains far below the EU average (72 years in Ukraine vs. 81 years in the EU).
By formal metrics, Ukraine has one of the most educated countries in the world: the literacy rate is almost 100 percent and enrollments are high. While these statistics are impressive, the system shows troubling signs of inefficiency and waste. For example, according to the World University Ranking, the best Ukrainian university is ranked between 800th and 1,000th place, while four more come after 1,000, which is basically just a recognition that they have applied. The education-job mismatches are high and persistent. Since human capital is a cornerstone of a modern economy, the inability of the system to produce high-productivity workers is a limiting factor.
While the government took some steps in enhancing quality, they are not enough. Also, the system of funding of public universities and scientific research remains inadequate, keeping Ukraine on the sidelines of international science.
The political and economic landscape in Ukraine has changed dramatically since early 2014.
Poroshenko won early presidential elections in May 2014, while two thirds of parliament were renewed during parliamentary elections in October 2014. Russia’s war against Ukraine and the lingering effects of corruption under Yanukovych are among factors that hurt consumer and investor confidence. As a result, Ukraine’s economy shrank by 6.6 percent in 2014 and almost 10 percent in 2015, while the local currency lost 62 percent of its value before stabilizing in mid-2015. Finally, the pre-EuroMaidan Ukraine was living in the shadow of post-Soviet legacy with pervasive corruption, inflated but incapable civil service and repressive law enforcement agencies.
However, Ukraine should be proud of its accomplishments.
It was inconceivable in 2013 that Ukraine can stop importing gas from Russia, banks can be more than toys in oligarchs’ hands, public procurement is not a major source of corruption, local governments are in charge of providing many public goods, the police and business environment can be friendly and Ukrainians can travel to the EU visa-free.
Obviously, modernization is not complete. It will likely take many years before Ukraine is on par with its more developed neighbors. There is abundant space for improvement in law enforcement, health care, education, civil service and other areas. However, some of the building blocks for democratic, robust and prosperous society are in place and we remain optimistic that Ukraine will finish the rest of its reform agenda to become a successful country.
Employees work at a drilling rig of gas company Ukrgazvydobuvannya in Poltava Oblast on May 3. (Kostyantyn Chernichkin)
Key obstacles to foreign investors (10= the biggest obstacle) Widespread corruption and distrust in the judiciary rank as the top two obstacles to foreign investment, major reasons why less than $50 billion has come since 1991.
Ukraine’s gas imports (bcm) Ukraine has switched from dependency on Russia for natural gas imports to reliance on European Union nations.
A farmer works his fields on May 31 in Kyiv Oblast. (Volodymyr Petrov)