panelists from Identifying and Removing Barriers to Investment in Ukraine
Three years after Ukraine’s Revolution of Dignity, a centralized, oligarchic power structure has once again taken hold. This has made it challenging to keep the business environment in Ukraine friendly to western investment, as the new power structure allows for increased influence from oligarchs and leads to increased corruption. Further, ongoing hostility with Russia and corruption act as a serious deterrent for western investors, which bring with them demands for higher standards in compliance, governance, and accountability from government institutions.
Because public funding alone cannot solve the country’s infrastructure problems, foreign investment into Ukrainian infrastructure is essential to the country’s ability to increase exports and gross domestic product. Despite this paradox in expectations and reality, an increase in investment in Ukraine has already begun, as Ukraine has consciously turned its efforts towards recruiting western businesses. CIPE and the U.S.-Ukraine Business Council co-hosted a panel discussion in June to discuss the investment climate in Ukraine, featuring Volodymr Omelyan, Minister of Infrastructure in Ukraine; former Ambassador John E. Herbst, current Director of the Dinu Patriciu Eurasia Center at the Atlantic Council; and Matt London, Deputy Managing Director at Amsted Rail Russia-CIS at Amsted Rail Inc.
18th Annual Assembly of Business Circles
Seven years ago a blog with this title would seem ridiculous. In the aftermath of the 2010 elections, President Lukashenko had several opposition members imprisoned, had others harassed, and cracked down hard on demonstrators. Five years earlier, Secretary of State Rice named Belarus the “last dictatorship of Europe.” However, in March, I observed how far Belarus has come to opening up to civil society. Sitting in a meeting with a leading minister, a dozen business associations were discussing the merits and potential modifications to a forthcoming presidential decree. The minister asked the association representatives thoughtful questions and addressed their concerns with straight-forward answers and promises to follow-up where answers were not readily available.
On May 1, 2016, the law, On Introduction of Amendments to Certain Legislative Acts of Ukraine Regarding Protection of Investors’ Rights (No. 289-VIII), came into effect. It introduced a number of new aspects to Ukrainian corporate law including the right to shareholder derivative actions, direct payment of dividends to shareholders, and –perhaps the most relevant to reducing corruption and privatizing state owned enterprises– the establishment of independent directors.
Francis Fukuyama giving a lecture about case study methodology at the Leadership Academy for Development in Ukraine.
Ukraine is a resource rich country, an entrepreneurial country, a country filled with talented individuals who work hard for their families, but why do so many Ukrainian people live in poverty? The answer, perhaps, is public governance, or more precisely, a lack thereof.
To be clear, allow us first to define the words “public governance,” as we understand them. Simply put, public governance is the relationship of power among the government, civil society, and the market. Given the strong skepticism concerning democracy in nations near Ukraine, without improvement in the standard of living of Ukrainians, the Ukrainian people may soon lose their excitement about their own bustling and fledgling democracy. In short, Ukraine’s democracy must begin to deliver tangible benefits to its citizens.
In Ukraine, thousands of companies are still owned and operated by the government — a legacy of Soviet central planning that bleeds money from the already strained state budget. With the country in economic crisis, there have been renewed calls for Ukraine to speed up its privatization process and sell these firms to private owners who can restructure them and run them more efficiently.
Ukraine’s former Minister of Economic Development and Trade, Aivara Abromavicius, recently made a well-reasoned argument for faster privatization on the Atlantic Council’s blog. Similarly, the IMF has also urged Ukraine to speed up the pace of privatization.
However, focusing on the pace rather than the quality of privatization will likely result in a botched privatization process — which will undermine the little bit of faith Ukrainians have left in the free market and state institutions, potentially leading to the growth of populist movements and destabilizing the current government.
Ukrainian state-owned enterprises (SOEs) remain a drag on the national budget. They serve as incubators for corruption and gray market deals and in some cases serve as piggy banks for Ukrainian politicians. While I agree with Abromavicius that “simplicity, clarity, and transparency,” must be maintained in order to successfully privatize Ukrainian state owned enterprises, his concept of creating a simplified privatization procedure (without advisers) through an online auction of over 1,000 smaller SOEs will likely lead to public anger over a process that would surely enrich insiders.
Without independent advisors overseeing the due diligence process and hiring independent auditors, bidders will not have transparent access to information about the companies listed. This would, in effect, be like buying from an unrated seller on eBay with only a vague description of what is for sale – something that would not inspire confidence in potential buyers.
A lack of independent advisors–and the transparency and investor assurances they would bring to an auction—can lead to lower realized prices for the Ukrainian government, attracting only those bidders with inside knowledge of the true status of the enterprises for sale.
It is clear that if we do not start taking action today, including by carrying out structural reforms, we could end up going into a lengthy period of economic stagnation tomorrow. Our economy is still based primarily on natural resources rather than on manufacturing. Our economic system has changed little in essence. Where does most of our money come from? From oil, gas, metals and other raw materials.
– Vladimir Putin, Annual Address to the Federal Assembly, April 3, 2001
Fifteen years later, the Russian economy envisioned by that progressive speech by Putin in April 2001 seems to be a distant memory. Russia’s economy, and budget, are still largely dependent upon the sale of oil and the majority of Russian industry is still based on extractive industries. The modern vision of Russia in that speech, one deeply embedded into the international system, where property rights are protected by the undiscriminating rule of law, has been replaced by a cynical “managed” system of crony capitalism where profits are skimmed off by insiders while Russia has isolated itself by its actions on the international stage.
Since 2001, record-setting commodity prices have supported increased social benefits, military spending, and infrastructure investments, each of which has supported corruption schemes where insiders profit off of the state’s largess (see the cost of the Sochi Olympics as Exhibit A). High commodity prices also allowed the Russian government to slowly smother individual rights and free speech at home and, largely through key investments in media, buy the country a larger voice in affairs abroad.
Rather than pulling away from a resource-based economy, Russia’s entire economy appears to now be moving in near perfect correlation with energy prices (see chart below).
Storied aviation company Antonov, makers of the world’s largest cargo plane, is in no position to be privatized.
The stakes for reforming Ukraine’s state-owned companies are high: these companies are the lifeblood of a corrupt, sclerotic crony capitalist system that scares away potential investors, drives off international donors, and robs the Ukrainian government of legitimacy. But privatizing them as quickly as possible is not the solution.
Even after mass privatization in Ukraine in the 1990s, the government still owns a large portfolio of companies in a variety of sectors – from heavy industry to banking — that employ over 900,000 employees, far more than any private firm. Reforming these state-owned enterprises (SOEs) has been a slow process and remains incomplete due to weak corporate governance, unmotivated management, and a near-total lack of transparency. None of these problems will be solved by simply speeding up the process.
The demand for rapid privatization is a familiar tune. Western “expert” advice in the early 1990s led to a huge transfer of wealth from the former Soviet Union to a handful of connected insiders, particularly in Russia: first through voucher privatization and later through the disastrously corrupt loans-for-shares schemes in the run-up to Russia’s 1996 election.
To get an idea of the scale involved, a 1993 paper by several Western economists who worked directly on the voucher privatization program estimated that most of the Russian Federation’s civilian industrial base – nearly every plant, factory, and mine in the country – was effectively sold off to insiders for between $5 and $10 billion, less than it would have cost to buy a single mid-sized Fortune 500 company (and roughly equal to the market capitalization of Whole Foods today). Still, at the time they regarded this program as a great success.
Unfortunately, the corrupt and predatory “oligarch” elite, created practically overnight, proved to be more interested in asset-stripping than in transforming their new firms into firms that could compete on world markets. What followed was the largest peacetime economic collapse of any country in recorded history. The sheer volume of banditry surrounding state assets during the 1990s led many average citizens in post-Soviet countries to believe that lower standards of living and a complete lack of justice were a natural part of living under democracy.