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Main reason for economical weakness of Ukraine

Author : Oleksiy Kushch

Ukraine has got into the so-called "institutional trap". This is when every economic agent tries to win at the individual level, but in the end everyone loses
20:47, 6 November 2018

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If now a certain “Charles Darwin” tries to create a theory of evolution in the economy, then the direction of reforms in Ukraine will be called a “dead end”. Today we have actually cleared a place for our competitors in the food chain of the global economy. Look: with the proper pace of reforms, Ukraine could now be in Polish economic orbit with a GDP of more than $ 500 billion and at least twice as much if we estimate it at the purchasing power parity level. But instead of us, Poles, Czechs, and Chinese sell goods with a high added value. For them, our raw material economy is, in fact, a double victory. On the one hand, Ukraine is an almost limitless source of cheap raw materials (ore, grains) and semi-finished products (metal, sunflower oil), of which the same Turks produce much more expensive products of metallurgy and food industry. And on the other - we voluntarily gave up our place under the sun, giving a direct competitor not only a head start in our market segment and a potential share in the volume of global investments, but also gave them the most expensive thing a person and country can have – the time . Twenty five years. And it is worth a lot. Lost generations are generally costly to any country, causing social frustration and massive labor migration.

The key reason is that the structural reforms of the economy in Ukraine are being started in the absence of the necessary institutional changes. It sounds complicated but has a rather simple meaning. The state is trying to apply all sorts of incentives in the form of deregulation and preferential taxation regimes with a complete vacuum of the institutional environment and the absence of even a minimal set of public and market institutions designed to streamline this chaotic energy into a positive effect. Using the famous theory of the scientist Ilya Prigozhin, chaos in the form of entropy can create a positive effect in the presence of certain equilibrium conditions of the system.

The increase in economic entropy leads to the emergence of permanent externalities, that is, the impact of a market transaction on third parties, not mediated by the market. For example, the increase in gas tariffs for the population. It is obvious that the existing prices are not market prices, since they are not balanced by supply and demand. Yes, gas is more expensive in some countries. But in some it is cheaper. In addition, in Europe, bread is also more expensive, but this does not mean that the price of a loaf in Vinnytsia should be equated to the cost of the loaf in Paris. In addition to world prices, there is also the specificity of the cost of domestic factors of production: raw materials, labor. That is why the price of bread, fuel and taxi services in different countries is radically different. Attempts of the manufacturer to raise monopoly prices immediately run into market depreciation mechanisms. If someone in the EU decided to increase prices by 23% for a while, then tomorrow they would be bankrupt. We have no such mechanisms, and instead of market transactions, the very externalities that feed the rental model of the economy appear.

Ukraine has got into the so-called "institutional trap". This is when every economic agent tries to win at the individual level, but everyone loses. Let’s take for example a reduction in taxes and fees. A good example is the reduction of the single social contribution to 22% under the pretext of de-taxing wages, although the real reason is much more prosaic: the main payers of SSC were not small and medium businesses, but large companies, with hundreds of thousands of full-time employees, and the SSC value billions, and the large enterprises pay mostly in transparent way. It is not difficult to calculate that the reduction in the SSC allowed the owners of the largest holdings of the country to save billions of hryvnias, which were unlikely to increase the payroll fund.

As we see, the tranches to the Pension Fund were approximately at the same level during 2013-2015. The same can be said about state subsidies for the payment of pensions in the range of 61-64 billion UAH (2 billion USD). The situation changed dramatically in 2016, when the Pension Fund "lost" almost UAH 63 billion of SSC, while state subsidies increased by UAH 81 billion (3 billion USD) to a fantastic figure of UAH 142 billion (5 billion USD)! In 2018, the situation with SSCs will partially improve, but the increase in fees is dictated by the growth of the minimum wage, especially in the public sector. And the state subsidies are at about the same level as in 2016 - UAH 140 billion. Big business simply shifted the burden of maintaining the Pension Fund on the shoulders of the state budget. Formally, the amount of SSC paid by business increased from UAH 168 billion (6 billion USD) to UAH 214 billion (7.5 million), but this was due to inflation, which in recent years has exceeded 100%, and hryvnia devaluation, which affected the growth of hryvnia exporters' income.

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When would the business allocate 70-80 billion UAH saved by for wage growth? Only if there is an effective dialogue between employers and employees. Dialogue leading to a consensus in understanding the level of remuneration. But for this you need an institution such as trade unions, and the correct policy in determining the minimum hourly wage. And this is exactly what we don’t have. As a result, the ratio of the wage fund in Ukraine compared to the size of GDP is below 30%, while in other countries it is from 50% and above. That is, the absence of such an institution as trade unions leads to the fact that every Ukrainian on average loses about 30% of his wages.

Or let’s speak on a favorite topic of our reformers - deregulation. What does it lead to? Paradoxically, to the monopolization of the economy.

Only 42% of the (in terms of output) is formed in a competitive environment. Almost 17% is distributed in the system of collective dominance (oligopoly), where the proportion of the three largest participants exceeds 50% of the market. Markets with sole dominance (the share of one participant is one third of the total) accounting for 31%. Another 10% are classic monopolies, where the share of one participant exceeds 90%.

Thus, the oligarchic concentration of the modern Ukrainian economy exceeds even that of militarist Japan. And this happens because we lack such an important institution as the anti-monopoly committee. More precisely, it exists, but only Gazprom, which received huge fines from it, knows of its existence. But the operators of the fuel market and retail chains almost did not hear about it. Although in Western countries, businessmen are more afraid of the antimonopoly committee inspections than tax officials. The absence of this institution costs each of us in overpaying the cost of goods and services. In total, we lose about 20-30% of our total costs per year. This is exactly how much inefficient antitrust policy costs Ukrainians.

Taking into account wage losses, we are talking about 40% (minimum) of household resources. Considering that last year's population expenditures amounted to UAH 2.5 trillion, the population pays about UAH 1 trillion per year, or $ 36 billion, to stay in the institutional trap. In this numbers we can assess the capital intensity of the rental model of the economy, our anti-efficiency.

Now it is clear why tens of billions of foreign loans only worsened our position.

In this regard, I would like to quote Victor Polterovich, a well-known economist: “Imagine that you live in a system where everyone is involved in corruption. You cannot get out of this system, in any case, this will be a very serious trouble for you: outside the community, you cannot interact with your colleagues, they look at you as someone else’s, and you also lose materially. Corruption is an institutional trap, a system in which it’s pretty hard for everyone to change the norms of behavior. At the same time, society understands that the whole system is vicious, inefficient. In a certain sense, a corruption trap also arose in the 1990s, and we are still trying to get out of this corruption trap ... We constantly observe the emergence of new institutional traps, and each time we face the task of how to get out of them. For example, we have introduced a flat income tax. According to many economists, such a tax is ineffective because it greatly increases inequality. Inequality is to some extent useful and necessary, but excessive inequality is harmful, y because it leads to mass discontent, to social explosions. Now public opinion is inclined to the fact that the flat tax should be gradually replaced by a progressive one. But how can we achieve that? The decision on the reform of taxation of individuals should be made by the parliament. But parliamentarians are not the poorest people. And even with the introduction of a moderate progressive tax, they will lose their profits. "

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