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31 August, 2012  ▪  Volodymyr Lanovyi

A Cure to Fend off Poverty

First things first – the healing of Ukraine’s economy must go hand in hand with structural reform and technological upgrading of assets.

The way to accomplish this is to have free market distribution of investments. This in turn is possible only with regard to private investments as they are the only kind that targets maximum profits and can rapidly react to growth in new sectors. The macroeconomic model of financial redistribution and monetary and price stability must also foster this process. Macroeconomic leverage is inefficient in conditions of monopoly and centralisation as it requires a free, competitive and self-regulating market system.

For capital to flow to new economic sectors, freedom of entrepreneurship needs to be secured and the state must stop supporting outdated production facilities. For innovative projects and enterprises to emerge it is especially important to expand the sector of small and medium business, which is the most flexible sector in terms of market supply and the most financially disciplined regarding its commitments. Another key factor is citizens having direct access to stock markets and incentives to own shares of stock and other corporate rights. Protection of rights, freedoms and operational opportunities of small-scale stockholders ought to be among the top items on the government's agenda.

Converting degraded fixed assets into financial resources serving the needs of society is another aspect of overhauling the structure of capital. This conversion will take place if chronically unprofitable enterprises are shut down, hopelessly indebted ones run through bankruptcy proceedings and administrative price fixing in state-run corporations is removed. The process will be facilitated if high amortisation rates for fixed assets and a property tax on large commercial objects are introduced, while government holdings and companies are demonopolised.

An influx of private investments will be significant if citizens become the main investors, because their total income accounts for the largest share of GDP. Investment incentives – to make bank deposits, savings on individual pension accounts and investments in stock and housing construction – arise when there is financial stability and the population's real income is growing.

The stability of finances and prices is achieved when market economic mechanisms are self-regulating and all economic subjects – from an individual to the entire state – have equal rights. Any lawless action by the government that skews naturally-established distribution, exchange or consumption of goods will disrupt the balance and lead to the inefficient use of national resources. In this context, the government and the NBU need to limit their interference in bank liquidity, interest rates, crediting policy and the commitments and material liability of financial institutions, including sorting out the debacles caused by defaults on loans.

Household incomes will rise as a result of structural economic reform (one that favours highly profitable industries), higher labour efficiency, more jobs and a higher employment level. Another contributing factor would be market distribution of investments, largely through a free stock market, and bank credits to finance business project issued on the criteria of profitability. Market investments may also be a result of cutting budget spending on government purchases and subsidising selected enterprises, as well as downsized government borrowing and lower corporate and household income taxes. A priority measure would be to scrap VAT and discontinue the NBU’s practice of refinancing state banks and debt securities of unprofitable state corporations.

Motivation to work and do business will only be possible if the government clamps down on criminal and corrupt methods of enrichment, embezzlement of budget money, illegal ways used by certain individuals to secure political and property rent, illegal activities to secure monopolistic super-high profits, behind-the-scenes deals to appropriate government property, and so on.

More jobs and a higher level of employment could be facilitated through lower deductions companies must pay to the pension and social funds and exempting small businesses from these payments. Real tax reform is needed, reform that would cut red tape, put a ban on lawless dispossession of taxpayers of their property, stop the curtailment of their civil rights, introduce a defined-contribution pension system, annul the turnover tax on small businesses, etc. This reform would have to be the starting point for a dynamic expansion of small business.

An improved investment climate and financial stability are certain to attract foreign capital to Ukraine. Direct foreign investments will facilitate technological upgrades of production facilities and increase their competitiveness. Then the surplus of the country’s foreign trade and current payment balance will be real.

We need to understand that Ukraine’s success depends also on how useful the budget policy is. National finances should be used to meet the needs of society’s social and humanitarian development, as well as certain important national needs, such as security, large production infrastructure, utilities and social infrastructure. Budget financing of these needs must be at least doubled or tripled.

Social and humanitarian development has to do with science, education, spiritual and physical culture, healthcare, environment, housing and utilities, computerisation, as well as providing social aid to the underprivileged and socially vulnerable citizens. It makes sense to not only increase spending in this area but also fundamentally to change the financing formulas –  money should be allocated not proportionally to the size of staff, but in light of the volume of services needed by employees. The system of social benefits also needs to be cardinally reformed: benefits should go to the poorest, the disabled, the sick, etc., rather than being awarded for “merits before the state” in continuation of the Soviet totalitarian tradition. The bulk of social and humanitarian payments should be disbursed from local budgets.

The special area of countryside infrastructure and agricultural production also needs enhanced financial support. There is no doubt that a different method to distribute and allocate finances from the state budget is needed: through bank accounts directly to farms, bypassing regional and local budgets and thus the greedy hands of local bosses.

The pay-as-you-go pension system dominates in Ukraine, and finances are transferred from the state budget to the deficient State Pension Fund. But deploying a defined-contribution system would quickly fund that deficit and enable faster growth of payments made to low-income pensioners.

Budget spending in other areas needs to be cut and gradually cancelled. We need to leave the practice of providing various government assistance packages and recapitalisation for bankrupt companies and banks in the past.

The budget system needs to become less centralised. The local budgets of villages, towns and cities need to be filled autonomously with reliance on a local tax base and without subsidies from the national budget. Only certain regions that are recognised as depressed should be subsidised.

An efficient macroeconomic model calls for an adequate macroeconomic management system. This system differs from the existing one in three aspects: the government structure, functions performed by government agencies and the quality of top officials in these agencies. There is no need to keep so many deputy prime ministers and ministers, who largely busy themselves with their own affairs while in office. Reformed ministries and agencies need to include those that run the national economy in general and perform the special function of administration at the same time rather than managing certain groups of enterprises (industries, sectors, etc.). Such linear-type ministries do not have the right to exist, with a possible exception of the ministries of energy and agriculture.

The structure of the Cabinet of Ministers does not need to duplicate that of the ministries. It should be minimised, leaving only units that draft government decisions. Government agencies that provide services to citizens should be disbanded. (These services are to be provided by the private sector.) We also need to do away with all directorates, agencies and state committees subordinated to ministries that perform largely the same functions as the latter but on a smaller scale or represent central government bodies in the regions.

Government administration bodies need to be stripped of administrative-structural functions regarding sectors, markets, groups of foods, etc. They should not be used as transit stations in the money flow from the treasury to end recipients, i.e., they should not have the status of central financial distributors. Instead, their main functions should be to develop and implement financial-economic regulations that stimulate the development of the country.

Certain markets recognised as natural monopolies should be regulated by special national commissions, but they should be appointed by the parliament and not be subordinated to the government. As well, they should not regulate prices (as they do now) but control over monopolies, including prevention of abuse.

As far as the quality of top officials is concerned, it would be most sensible to appoint renowned specialists capable of thinking in national, country-wide terms rather than big capitalists.

A separate issue is the quality of interaction between the economy and society and the external world, from international exchanges to merging national markets. Today Ukraine gives the impression of being an island isolated from international processes rather than part of a large modern continent. Ukraine is still hiding behind a high wall as if it provided extra security and the country remains a marginal, provincial European state. One reason for this is that our prosecutors and judges are resistant to all universal human values, Roman law and international courts and tribunals. This situation is welcomed only by the ruling class, which can leverage it to impose its thoughts and priorities on people and present its activities as perfect and unsurpassed in performance. Limited international exchange and high barriers to cooperation and transactions constrain the best macroeconomic factors and models. In any case, their application in Ukrainian reality produces a much more modest effect than in open national systems that are integrated into the world community.

Therefore, internal financial-economic improvements must be accompanied by external convergence of our institutes, structures, legal norms, knowledge, languages, values, standards, rules, relationships and procedures.

In general, with this value system in place, conceptual changes in macroeconomic regulation should secure a dynamic development of the country and a steadily increasing standard of living. Tentative estimates show that the above-mentioned transformations could yield the following results:

The total losses of enterprises will shrink to one-fourth or one-third of their current level in 4-5 years, which will bring an additional UAH 100 billion per year to the country. The profits of profit-making companies will rise by 15-20 per cent, which is another UAH 30-40 billion.

Indirect taxes (around UAH 190 billion at present) will go down by 20-25 per cent and pure government loans (UAH 117 billion as of 2010) by 75-80 per cent.

The inflation rate will not exceed 3-4 per cent per year; the budget will have a surplus of 1-1.5 per cent of the GDP, while the hryvnia exchange rate will not drop by more than 1-2 per cent per year.

Bank loans to enterprises may increase by 400-500 per cent, reaching UAH 200-250 billion, with the interest rates of about 6-7 per cent.

Investments into capital assets will double at the very least, rising to UAH 300-350 billion, while portfolio investment may grow by 6-8 times (to UAH 100-120 billion).

The national economy may employ approximately 2-2.5 million more people, and at least 2.5 million Ukrainians can be expected to return from emigration.

The ratio between social and pension payments and salaries will change due to higher levels of employment, and the deficit of the Pension Fund filled under the pay-as-you-go system will be history.

End consumption will reach a totally different level. The real income of the population may grow by 45-50 per cent, while hryvnia savings will double at a minimum.

Ukraine may post Chinese-like GDP growth figures, while international exchanges boost the country's gold and currency reserves and guarantee the security of household net worth.

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