Few businesspeople believe that a government headed by former chief tax inspector Mykola Azarov could possibly be reformist, and hence the disbelief when they hear my answer: “expect radical reforms.” Disbelief becomes somewhat less pronounced when I explain what is meant by “radical” and what the current government seems to understand by the term “reforms.”
The term “radical” refers to a stark change of course from that taken by the previous government of Yulia Tymoshenko, which itself shifted “radically” from its Kuchma-era predecessors.
Kuchma’s selective capitalism
Under President Leonid Kuchma, in power from 1994-2005, the Ukrainian economic model was clearly producer-based: overt and covert subsidies were provided to industries and companies deemed “strategic,” taxes were collected on a selective basis, privatization was open only to the loyal and privileged few.
The result: Ukraine became an export-oriented economy, and since foreign direct investment (FDI) was not encouraged, the country became one of the few in Eastern Europe (not counting Russia) with a significant domestic big business sector.
Orange consumer boom
Then came the 2004 Orange Revolution, which overturned a rigged election in favor of Viktor Yanukovych, and the subsequent coming to power in 2005 of President Viktor Yushchenko and Prime Minister Yulia Tymoshenko.
During the Yushchenko-Tymoshenko era, the economic model shifted from one focused on supporting export-oriented financial-industrial groups to one focused on stimulating gross domestic product growth through mass consumption. To paraphrase President George W. Bush after 9/11: in the post-Orange Revolution period, the most patriotic thing you could do was to go shopping.
During 2005-2008, Ukraine attracted more FDI than in the previous 15 years combined. Much of that money went to finance cheap loans to consumers, and to offset the trade deficit created by import-hungry Ukrainians. Indeed, if it hadn’t been for the global financial crisis, the consumer-oriented gross domestic product-growth model implemented by Yushchenko and Tymoshenko likely would have continued.
After all, if one discounts 2009, the average Ukrainian’s living standards improved dramatically during the post-Orange Revolution era: over 12 percent of the country’s families bought a new car during this period (even more bought used cars, washing machines and TV sets – not to mention real estate), pensions more than doubled, real wages increased by almost 50 percent.
However, regardless of previous achievements, sudden economic downturns have a tendency to lead to changes in governments. In 2010, Ukrainians obtained a “new” government – full of Kuchma-era politicians with very few new faces. Not surprisingly, the term “reform” for this new-old team denotes a process of shifting the economy back to a producer-based model.
What’s coming?
Expect a return to tax exemptions for “strategic” exporters. Expect a return to the rhetoric of “Donbas– the region that feeds the nation” (Donetsk and Luhansk, in fact, are net receivers of central government financing if one includes coal and energy subsidies); expect Ukraine’s financial-industrial groups to strengthen both economic and political positions.
Miners end a work shift in a coal mine in the small city of Bulavinskoye, not far from the industrial city of Donetsk on Oct. 30, 2008. For weary miners in this remote village in the barren hills of eastern Ukraine, the country‘s financial crisis has hit all too close to home. (AFP)
In his election campaign, Yanukovych promised to bring Ukraine into the club of the 20 most economically developed countries in the world within 10 years. Reading between the lines, one can expect that the development indicator the president’s team will use will be nominal gross domestic product per capita (Ukraine is currently 45th in the world, according to the International Monetary Fund). If we use gross domestic product per capita with the purchasing power parity index – a more accurate gauge of spending power – a jump to the top 20 will be too difficult. On the measure of gross domestic product per capita on the purchasing power parity scale, Ukraine was 98th in the world in 2009.
For the reader who is not overly technical in economic terminology, here’s the simple explanation: the economy will grow. But the rich will get richer and the poor will stay poor. Russia has gone down this path. Indeed, its nominal gross domestic product per capita is double that of Ukraine’s, but the economic disparities of our northeastern neighbor are also significantly more pronounced than ours.
Trailing the tigers
Notwithstanding the likely fiddling of some numbers, the Azarov government, to their credit, is taking very seriously the president’s pre-election promise to stimulate GDP growth substantially and quickly. How are they going to accomplish this goal? The simple answer is: by emulating the example of the four “Asian tigers” of the 1980s and 90s.
Incidentally, those tigers – South Korea, Hong Kong, Singapore or Taiwan – were noted for their respect for democratic values (including freedoms of speech, press, assembly, etc.) during the periods when their gross domestic product was growing most rapidly. However, they were noted for building economies where business and government learned to “cooperate” for the sake of their countries’ developmental goals.
Another interpretation might be that business and politics in these countries became so intertwined that the line between corruption and common business practices was effectively erased. Whichever interpretation one prefers, the policy implications are the same: subsidies, tax preferences and privileged access to contracts for the chosen few (particularly exporters); a harsh environment for those who choose not to tow the government’s line.
In South Korea (the largest of the four Asian tiger economies), the collaborative economic model led to the development of large “chaebol” financial-industrial groups whose brands are known throughout the world today: Samsung, LG, Hyundai.
In Singapore (the country that Azarov has identified on the record as his personal developmental model for Ukraine), similar large businesses developed in close cooperation with family members of the island state’s long-time leader Lee Kwan Yu.
Due to its status as a temporary colony of Britain, Hong Kong was a special case, and Taiwan seems to have developed differently – creating its own “oligarchic” businesses in close cooperation with the ruling KuoMindan Party, but also allowing the island’s independent, and highly competitive small business sector to thrive without “support” from the state.
Whether the Azarov government chooses to emulate the laissez-faire example of Taiwan or rather the intensely collaborative model of South Korea (Kuchma was a fan of the Korean model) remains to be seen. Within the current cabinet, Vice Premier Sergiy Tigipko seems to be a lonely voice favoring liberalization of the country’s business climate in addition to “reform.”
The cost of growth
But if the recently proposed draft tax code is any indication, Tigipko seems to be losing. According to this document (already adopted in first reading by parliament), local authorities will have the right to decide which businesses in their jurisdiction will be required to pay income taxes, and which will be exempt. One can only gasp in amazement. At least Kuchma made these decisions centrally!
Decentralization, Yanukovych-style, will dramatically increase corruption at the local level by stimulating businesses to “cooperate” with local officials. Those which choose not to enter into a synergistic relationship with their local “chynovnyk” will be subject to frequent visits by police, fire, tax, health inspections (anecdotal reports from colleagues in various regions seem to indicate that these are already on the rise), and will carry a steadily increasing fiscal burden in the form of both direct taxation, and indirect licensing fees, permits, levies, fines, etc. After all, someone is going to have to pay for those special few who will be deemed too “strategic” to carry the full social burden.
The climate for small and particularly for medium-sized businesses in Ukraine is set to deteriorate rapidly and drastically. On the other hand, “stability” Azarov-style is likely to be welcomed by Ukraine’s large conglomerates – particularly those focused on export markets (i.e. metals and chemicals sectors).
Indeed, these businesses have already obtained what they most wanted from a Yanukovych presidency – cheap gas. (The fact that gas prices were bartered in exchange for 20 more years of a Russian Black Sea Fleet presence in Crimea does not seem to bother Ukraine’s eastern-based big businesses).
Businesses focused on domestic customers should note: stability for Azarov means stable wages for workers, limited loan availability, and in some cases price controls. In other words, businesses that provide goods and services to a domestic clientele can expect competition to increase (particularly from competitors with connections) while consumer spending remains relatively flat.
So what is an independent business owner to do? Simple: find a “roof,” someone in authority to shield you, or find an exit strategy. Unfortunately, the viability of alternative strategies seems to be increasingly doubtful. That’s the Asian way, and now it’s also the Ukrainian way…Good luck to us all!
Mychailo Wynnyckyj is director of the doctoral school at Kyiv-Mohyla Academy and chairs the presidents’ masters in business administration program at Kyiv-Mohyla Academy’s business school. He can be reached at [email protected].
