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7 January, 2020  ▪  Lyubomyr Shavalyuk

A little less conversation, a little more reforms

How economic transformations drive GDP growth

In early October, the IMF published its World Economic Outlook that looks fairly pessimistic. The global economy is slowing down as a result of trade and geopolitical problems. Industrial production and international trade are stagnating. Central banks apply quantitative easing but its capacity is very limited given low interest rates, so it will not resolve a relatively serious crisis. Making the situation look more dramatic is the proposal to apply coordinated international fiscal support if the global economy continues to slow further. In fact, this is a call to create something like a supranational budget. 

The World Economic Outlook inspires little optimism, but some elements look hopeful. One is the study of the impact of economic reforms published in a separate section. It has some interesting conclusions that trigger reflections on transformations in Ukraine. 

The study covers 1973-2014 and 90 countries, including 48 developing or formerly developing ones, and 20 low-income countries. The IMF has compiled an extensive database of reforms with six categories: international trade, foreign and domestic funding, markets for goods and services (based on power and telecommunications industries), labor market and public governance. Modeling the link between GDP growth and changes in these spheres, the IMF shows how reforms work in reality via quantitative measurement of their efficiency. Some conclusions may seem obvious. But research like this helps fine-tune information filters in an era overwhelmed by the noise around transformations in Ukraine. 

The main takeaway is that, for an average country, a package of reforms in all six categories allows them to increase GDP by over 7% during six years and halve the time needed to catch up with living standards in developed countries. In the long run, economic growth multiplies as the effect of transformations accumulates and spills over to adjacent sectors. This is all it takes. If we want to live better, we need to do reforms regardless of who initiates, enforces, controls them and speaks about them. Things will not get better if we remain inactive.  

 

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Still, there are nuances. Firstly, reforms are better when implemented in comprehensive packages, not individually. The study says that most developing economies have many market imperfections, so removing one of them will not necessarily help unless others are fixed too. At the same time, changes in some categories create synergy with other transformations reinforcing their positive impact. The study points to two vectors: strengthening public governance and expanding access to funding.  

Efficiency of reforms is perfectly captured in the Liebig law of the minimum: unless you eliminate the most critical factor that keeps you behind, the system will not get better. This means that reforming of one segment that is not necessarily the worst one may well go unnoticed, while even small changes in the sectors that lag behind most of all can have positive impact on the entire economy. The Liebig law explains why some transformations have dubious results while others trigger a chain reaction of positive effects.

When projected to Ukraine, its economic development could get on a whole new level nobody dreams of now the moment it ensures the rule of law. Without progress in this most flawed segment, the efficiency of other reforms will most likely be poor and cause many disputes in society. 

Secondly, reforms are better when implemented in a good time when the economy grows. This boosts the effect of some of them severalfold. The study shows that the effect of financial liberalization at the stage where the economy grows is threefold the effect at the stage of a crisis. In the latter case, the reform can actually aggravate economic downfall. Liberalization of the labor market generates a visible positive result in a good economic environment and leads to a growth of unemployment during a crisis. 

Projection of these results to Ukraine leads to this conclusion. When looked at without the media hype, the post-EuroMaidan reforms have done much, but the results were far from perfect or expected. One of the reasons is that the reform process started at the peak of a sharp economic crisis and some of the changes aggravated rather than smoothed it. But it is because they did not have a full-fledged effect then, they can have it now. Because there were then implemented in a crisis environment while now the economy is in a good shape. Now is the perfect moment to launch the reforms that were not implemented before. And it needs to be used. 

Thirdly, the study tackles political consequences of reform implementation. This aspect raises a number of interesting conclusions. First and foremost, the results of transformations are often too dispersed to create clear links between the changes implemented and the improvement of life in the eyes of the population. In fact, there is nobody to assess the reforms and to praise and recognize the reformers. Also, it takes time – three years on average – until reforms deliver visible results. Unless reformers embark on changes right after elections, the fruits of their efforts will most likely be reaped by their successors – and those will hardly miss a chance to present the positive accomplishments as their own.

But when transformations lead to economic losses, especially for the influential groups and individuals with the means to spread negativity in the media, the population develops a clear link between these losses and the actions of the reforms, destroying their election rates. To be fair, the population hardly holds on to bad blood for too long. The study shows that serious losses in elections were caused by the reforms conducted during the election year while all changes implemented before that were forgotten and had virtually zero effect on election rates. 

A projection of these on Ukrainian realm leads to similar conclusions. If the new team in power plans to get re-elected, it should launch most of the planned transformations in the first year of its term in office. That is the only case in which the improvement of life as a result of these reforms will become visible by the end of their term in office and could be used as part of the agitation for the next elections. In addition to that, the entire period between the implemented reforms and the moment when life gets visibly better as a result – nearly three years – requires proper communications policy. For now, the results are not yet here and political opponents are active. The last three years offer a good illustration: some work has been done on reforms, but there has been no sharp growth of the GDP. This created a foundation for a tsunami of criticism and political negativity that determined the election outcome. 

Finally, a number of other factors beyond the spheres under reform reinforces the impact of transformations on economic growth. Quantitatively, the countries with strong public governance have double the pace of GDP growth as a result of reforms compared to the countries with poor governance. This is why it is extremely important to develop effective public institutions regardless of the phase of the political cycle and the stage of transformation. This is one of the reasons why the outcome of Ukraine’s transformations has been so flimsy so far. 

The second factor is the share of the grey economy. The greater the effect of reforms, the more companies switch to transparency thus contributing to the improvement of the GDP statistics. Fun fact: grey economy in Ukraine is seen as an evil that has to be eliminated, and this struggle merits efforts of the state apparatus. For qualified economists, grey economy is just a symptom and a product of inefficiency. The IMF’s study mentions that as well. Those working in the shadow economy do not do this out of ill intent; they do so because they are unable to make ends meet if they pay all taxes. The recommendation is simple: implement changes that will decrease the cost of labor for the employer and the losses incurred as a result of corruption fees – and entrepreneurs will start moving out of the shadow. The thing is that transparent work creates a lot of advantages, including access to funds and foreign markets, top quality professionals who prefer to work for serious companies, a change to improve productivity thanks to higher capital absorption capacity and more. Many would probably like to leave the shadow economy but they lack a small incentive. The state has every opportunity to help these actors. This is a partnership approach to the problem, but those who fill the treasury in Ukraine do not share it unfortunately.  

 

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The IMF’s study proves that there is space for transformations in developed countries. Ukraine has even more of that. When the global economic growth slows down and many speak of a looming global crisis, well-thought reforms allow governments to control over the situation and not fear an economic downturn. The attempt to launch changes after the Revolution of Dignity was not entirely successful, but Ukraine has gained experience and a network of proactive people ready to deliver change. All these accomplishments of the past five years have not vanished. Smartly applied in the current favorable moment of economic growth, it can bring far better results than it did before. The main thing is to go beyond the information war, guarantee economic security – including from oligarchs and other influential groups, and draft and implement a comprehensive package of reforms aimed at the most backward points as soon as possible, avoiding distractions with secondary things. It will not be easy, but this is worth the effort. As the IMF’s study shows, the result will not take too long to arrive. 

 

 

 

Translated by Anna Korbut 

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