The daily life of cartels

5 December 2016, 18:23

The market is not omnipotent. This conclusion is evident to both market economy theorists and practitioners, who are faced with its shortcomings on a daily basis. Nevertheless, humankind has not yet invented anything better. Moreover, 70 years of communist experiments prove that even when we get a better idea in theory, it will not be a replacement for the market, but rather its continuation, a sort of superstructure based on the same unshakable market principles.

Competition always exists alongside the market. It occurs where there is more than one seller (buyer), which forces manufacturers to be more active in order to make the most profit possible per time unit. Competition envisages an unprecedented strain on entrepreneurs' efforts, but ultimately rewards society with decreased production costs (saving public resources), increased product quality, lowered prices to cost level (the production cost of the least efficient manufacturer that remains on the market) and the elimination of inefficient producers. Entrepreneurs are always kept on their toes, progressing and evolving, while consumers enjoy a quality product for a low price. This positive social effect forces market economy theorists to passionately defend competition and government officials to keep tabs on it and step in at the first signs of market distortion. The economies of developed countries function in this way, more or less. Ukrainian circumstances differ significantly.

The law is an ass

Today, three laws form the basis of Ukrainian competition legislation: On the Antimonopoly Committee of Ukraine (AMC), On Protection of Economic Competition and On Protection from Unfair Competition.

The first regulates the activity of the AMC, which is the government agency responsible for antimonopoly policy. The law was adopted back in 1993, a year after the committee began work. It existed in its original form without amendments until 2000. This means that during the first ten years either everyone was satisfied with how the committee worked, or those who were not happy with it did not have sufficient influence in the state. The second option is more likely. To be precise, the oligarchs who established themselves on the country's economic and political scene at the turn of the century later began to use their power to change laws they disagreed with for their own benefit and the benefit of their businesses.

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The AMC has two key functions. The first is to protect competition, expose and stop any violations of it, and ensure the priority of consumer rights. The second is to control the concentration of companies, so that it does not lead to the formation of monopolistic monsters. According to experts, both functions of the committee, as well as its operation principles – as prescribed by the law and implemented in reality – are fully in line with international practices. At least they were at first, before the oligarchs started to interfere.

Protecting competition

The second law is fundamental to conducting antitrust policy. It was passed in early 2001 to replace the law On Monopoly Restrictions and Preventing Unfair Competition in Business. It was an attempt to rethink the principles of competition under the new conditions when the economy began to grow.

Two items that deserve special attention appear in the list of anti-competitive actions spelled out in the law, namely actions that lead to a limitation of technical and technological development and measures to remove other businesses from the market or limit their access to it. Violations of these two points, as will be shown later, are a common feature of all the monopolies that can be found in Ukraine and consistently hold back the country's development.

The law qualifies a monopoly position as one where one business entity has a market share exceeding 35%, the largest three market participants have a total share of over 50%, or the largest five have more than 70%. Based on this categorisation, the AMC divides markets into monopolies (with characteristics of individual dominance), oligopolies (with signs of collective dominance) and competitive ones. According to the committee (see Fighting for position), pure monopolies do not occur in Ukraine too often. Besides, their formal existence does not necessarily mean that a monopolist takes advantage of their position. However, many people are aware of how monopolies actually operate and how much effort businessmen, especially oligarchs, exert to have a monopoly on a certain market. If the juice were not worth the squeeze, then no one would fight in this way for a monopoly position.

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Most cases of competition violation looked at by the AMC conclude with recommendations from the committee. According to the law, the guilty party is completely vindicated if it implements them. In fact, until recently, the committee specialised in issuing recommendations. Nevertheless, the law provides for fines of 1%, 5% or 10% of an offender's annual income, but this happens extremely rarely. The figures speak for themselves: according to the AMC annual report, last year the committee imposed 339 million hryvnias (~$13m) in penalties, which is 3.4 times higher than the 2014 figure (evidently, the amount prior to this was even smaller). We should add that it was recently decided to fine seven oil traders 204 million hryvnias ($8m). These are all of the committee's successes so far.

The fine issued to Gazprom for abuse of its monopoly position in natural gas transit through Ukraine, which amounts to 172 billion hryvnias ($6.75bn) including penalty fees, could be the AMC's first considerable step in the financial struggle to preserve competition. A struggle that is accompanied by loud scandals every year in Europe and because of which companies like Google have to pay billions of euros into the budgets of European countries. For success in this area, the committee will have to do some good work in the courts, and judges, as well as AMC employees, will have to resist the bribes that the Russian side will doubtlessly offer them repeatedly to put everything on the back burner. Therefore, the Gazprom case will be the litmus test for changes in the committee and government institutions in general.

In any case, the size of fines for anticompetitive behaviour is increasing. That may signal that the committee is on the right track. But there are two sides to this coin too. To have high-quality antitrust policy, including fines, we need an effective law enforcement system and flawless operation of the committee. However, as soon as these conditions materialise, an army of politicians and oligarchs will immediately want to use the AMC as a tool to suppress competition. Then, in the Ukrainian context, the committee may become a body that punishes competition rather than restoring it. How can we achieve a balance? The issue is complex, and there cannot be a solution to it without the institutional independence of the AMC and the financial independence of its employees.

A grey area of resourcefulness

The third law is "On Protection from Unfair Competition". It is surprising how inventive businessmen can be in gaining the upper hand. In the name of profit, wheeler-dealers label their products with competitors' trademarks, create brands similar to well-known ones (e.g., Adibas), copy the appearance of products from famous brands, discredit rivals with negative information, bribe competitors' suppliers or clients to act to the detriment of concluded agreements, acquire rivals' trade secrets from their workers (this is universal in Ukraine) and so on. The list of unfair competition tools is extremely wide. We can only guess where Ukrainian business would be if all this "creativity" was redirected in a constructive fashion.

The law also provides for penalties of up to 5% of annual income for violations. If there is no income, the amount can be up to 10,000 times the tax-free allowance.

Unfair competition, although it is a negative phenomenon that shows the level of business culture in a country, does not have the same devastating impact on a system as monopolisation and the artificial, deliberate distortion of competition. It is necessary to pay attention to this, but the focus should be on de-monopolisation.

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It is interesting that this and previous laws contain a provision that entitles people affected by distorted or unfair competition to compensation for the damage caused by offenders, which the victims have to prove in court. But do we know of even isolated cases when a consumer has been compensated as much as a few thousand hryvnias for false information on a label, or when a small businessman won millions in damages from a big monopoly? This is a rhetorical question. An affirmative answer to it will not be possible until the law enforcement system starts to function correctly.

The state factor

The developing economy stands for an economy in which the institutions are far from ideal. Ukraine has a typical developing economy, as many authorities promote monopolisation rather than competition. Most government agencies and the people who work in them have not only become accustomed since the days of the Soviet Union to constantly interfering in the affairs of businesses, but partly consider it their main function.

Last year, the AMC sent a questionnaire to 830 business entities, the replies to which are given in the 2015 Report of the Ukrainian Antimonopoly Committee. Most respondents had come across actions that distort competition. Indeed, 30% implicated the local authorities in this, 22% – central authorities, 20% – legislators (parliament) and 16% – the judicial system. Against this background, the 30% of respondents who see the actions of other entities – their competitors – as the cause of unfair competition seem like a negligible part of the problem.

The exact forms of restrictive practices are also very interesting (see State Monopoly). The biggest problem, mentioned by 21% of respondents, is tax relief, when the state -– ostensibly with good intentions – wishes to support certain companies and industries. The road to hell is paved with good intentions. These initiatives have only negative consequences: complications for efficient producers and the conservation of inefficient ones, as well as the use of tax incentives by oligarchs in order to fill their own pockets at taxpayers' expense. That is to say nothing about the social spending that this money could have gone towards. The worst thing is that there is still a whole host of supporters of such measures in Ukraine, even among academics.

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The same applies to other factors that arise from government actions. Subsidies to enterprises, personal assignment of public contracts (relevant before the introduction of ProZorro), differing energy prices, the use of taxes and duties to pressure one company while being lenient towards others – all these anticompetitive actions are well known to anyone who has at least a bit of experience in Ukrainian business. Not to mentionabsolutely illegal activities, especially on the part of security forces (the police, Security Service, Prosecutor's Office), which often demand money from some while providing cover for others in return for an appropriate fee.

Indeed, the state, represented by various authorities, regularly distorts the competitive environment. This problem has many not only forms, but also inherent causes. First, as already noted, this is a direct consequence of the Soviet period, when an entrepreneur who had not even done anything wrong yet was seen as a potential criminal, just because they went into business. So they regularly had to prove that "two plus two does not make five". Such practices are still common, although reforms are intended to transform the situation. Second, another element of the Soviet legacy is the size of the public sector. It is so large that companies cannot avoid regularly coming into contact with the state and suffering from its unwieldiness, which at best does not have malicious intent, but still causes harm. To overcome this, the state's role, its influence, and the size and functions of the state machine should be reduced. No matter how noble the social motives used by opponents of this to justify their beliefs, a smaller public sector will provide great impetus to businesses and deliver considerable benefits, including for social services. Third, imperfect legislation and the right of the authorities, such as the tax office or customs, to interpret it at their own discretion. As a developing economy, we still have a long way to go in cleansing our legislation of Soviet relics and other superfluous elements. And until we go down it, our laws will resemble a swamp that sucks the energy out of any markets and competitive environments. Finally, it is clear that behind the scenes of these processes there are often oligarchs and "minigarchs" using the weaknesses of the state in their favour. Then it becomes merely a tool for light-fingered individuals to achieve their dubious goals. There is no solution that does not involve figuratively chopping off these fingers or minimising the influence of any one person on the decisions of public bodies. De-monopolisation (in the broad sense) and de-oligarchisation are intended to do precisely this.

The entrenchment of state factors that distort competition suggests a broader conclusion. In developed, European-type economies, businesses succeed through internal transformations (designs, inventions, know-how, cost reduction, active marketing). The market and competition are a platform for them to put themselves to the test and compare themselves with others in order to continuously improve. In Asian-type economies, most of which are still developing, success is achieved through external factors: connections, especially nepotism, the creation of conglomerates and contacts with the state. For such a company, the market and competition reveal its weaknesses, which businessmen want to hide, not understand. Unfortunately, there is still too much "Asia" in Ukrainian business, as nepotism and contacts with the authorities are one of the most important factors of production here. Under these conditions, economic development will never occur, so it is necessary to leave behind these traditions, which, by the way, are not inherent in the Ukrainian mentality. This transformation is impossible without releasing the energy of small businesses, which are now tunnelled on "the realities of doing business". This potential can only be truly realised in a normal competitive environment, which should be cherished as the apple of our eye.

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Ukrainian-style competition

The distortion of competition and monopolisation of markets in Ukraine have many more manifestations than those described in legislation and which the AMC has the mandate to fight. These shortcomings are deeply rooted not only in the economy, but also in the minds of businessmen. Here are just a few examples.

Let's start with the banking sector. Many people are aware that a large number of financial institutions until recently operated like oligarchs' pockets, providing loans to their owners' companies at a low, preferential rate and to other borrowers at a high, market one. This is an incredible distortion of competition, as oligarchs' inefficient business received cheap financing, which was a factor that conserved their inefficiency and "limited technical and technological development", as the legislation mentions. Alongside this, genuine entrepreneurs were forced to pay high interest rates to oligarchs' banks, because they had no alternative sources of funding. In fact, for many of them this was a factor in their "removal from the market", which the law also refers to. Was there at least one AMC investigation in this field? Probably not. It is good that the National Bank has finally got down to business and has started to clean up these personal banks, simultaneously forcing financial institutions to minimise their lending portfolio to associated persons.

Yet another, very recent example from the banking sector. PrivatBank, which has a de facto monopoly position (about a quarter of the banking system's assets), takes advantage of this in order to not meet the requirements of the National Bank, which are identical for all. Why should PrivatBank be special?

We often cite the example of Apple, which was founded in a garage. If it had been based in Ukraine, then after the first signs of success it would be regularly visited by tax officials, security forces, firefighters, hygiene inspectors and common bandits; letters would start to arrive from the courts and there would be offers from competitors or oligarchs to buy the business. That is pure and simple "removal from the market", although not directly. How many thousands of these start-upshave been destroyed and who will be punished for this?

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Another such sector is agriculture. Many now speak of it as the driving force of the economy. Today, we export almost 2/3 of all grain grown (in the future 4/5). According to data for the 2014/15 financial year, the 10 largest exporters accounted for 46.4% of the wheat, 38.6% of the corn and 68.8% of the barley sold abroad. Three years ago, these figures exceeded 50% for all mentioned crops. This is because the largest exporters are the only ones who own or control the infrastructure needed to transport and store grain. Given the fact that in each region the number of large companies is limited, this is a real monopoly. Does anyone really think that monopolies do not take advantage of their position by lowering the purchase prices for grain that they offer to small and medium farmers? This is a monopoly in principle, while we sit here saying that small agribusiness has no money or development opportunities. Of course not. And it never will, just like any small or medium-sized business that has to compete at a disadvantage with monopolies just for resources, not to mention the price of the finished product.

It is possible to go on about oligarchs' monopolies for a long time. It is worth mentioning the Yanukovych era alone, when oligarchs, alongside the regime and using their monopoly on power, took part in corporate raiding, rewrote laws to suit themselves and carved up the budget. Let's hope that this phase will forever remain a thing of the past.

It is also worth mentioning state-owned companies, many of which are natural monopolies. Since they were only used to extract cash flow, no one was ever interested in their development. Moreover, the absence of changes in the regulation of entire sectors led to the fact that the relevant state enterprises preserved their status as monopolies and new businesses were simply unable to emerge. Here is the "limitation of technical and technological development" of public companies, which was caused by their state ownership and the cash cow function of these assets, as well as "restrictions on market access" due to the rejection of adequate regulation. Naftogaz [oil and gas], UkrGasVydobuvannya [gas production] and Ukrainian Railways, among others, serve as a good example here. In all developed countries, the fields in which these companies operate are not monopolies and they can maturethanks to adequate regulation. Inactivity and public ownership are factors of an anti-competitive environment. I do not even want to recall incidents such as the reduction of railway tariffs for the oligarchic metalworking industry at taxpayers' expense.

The somewhat less than economic factors of monopolisation and the distortion of competition that are inherent in the Ukrainian economy cannot be ignored either. First, the entire political class was until recently a closed club, which monopolised power and eliminated competition, drawing revenue from state monopolies. Second, as a result, the same class monopolised the right to withdraw capital from the country, which is sorely missed by genuine entrepreneurs. Third, in preserving and protecting the position of their inefficient businesses, oligarchs and top politicians (electronic declarations show that the political class may be inferior to oligarchs in their number of assets, but by no means in lifestyle) keep the number of jobs in the country low. They have a monopoly on hiring workers, which Ukrainians pay for in low salaries and pensions, as well as the shortage of jobs that results in systematic emigration.

The AMC has no bearing on an absolute majority of these forms of restrictive practices, as no laws give it the necessary powers. Effective competition policy in Ukrainian conditions can mean nothing but massive transformations and widespread reform. Only they can provide complete and profound de-monopolisation of the economy. Moreover, the actions of the committee alone are not enough – coordinated work will be required from most government agencies, supported by targeted pressure from civil society.

Translated by Jonathan Reilly

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