How to avoid ‘failed state’ without Donbas and under permanent war actions

By the Editorial Board of VoxUkraine

Recent events with deployed regular Russian troops at the east of Donbas and decisive attacks of Russian forces to unlock the Donetsk encirclement of separatists have posed for the Ukrainian society a critical question: How can the country survive and develop while having Donbas occupied and facing permanent military actions or persistent instability akin to the situation in Transnistria, Abkhazia and South Ossetia.  Indeed all previous assumptions of Ukrainian authorities as well as international financial institutions (e.g., the IMF) presumed quite fast stabilization of situation and excluded presence of Russian regular forces on the Ukrainian territory. Under such scenario, the Ukrainian army was expected to finish anti-terrorist operation in a few months and the progress on encirclement of Donetsk in August indeed promised very fast conclusion of the conflict. 

On August 24 the situation has changed dramatically.  Now we are talking about long-run though still unannounced war with Russia on the Ukrainian territory with poor chances to put the situation in Donetsk and Luhansk oblasts under control of Ukraine’s authorities in the nearest future.  In other words, Ukraine received a constantly rotting wound on the body of its economy.  It will be killing the country slowly with very poor chances to fend off the smoldering conflict.  We are talking not only about military costs eating a large part of the government’s budget, but also about subsidies to the region which will not be paying taxes and not supplying raw materials (coal) to the rest of the country, about boom of smuggling and drugs supply through our territory (no border, no mechanism of control, no instruments of influence).  The Ukrainian society faces an incredible challenge how to start developing in such extremely tough environment.

Open Letter to the President and the Government of Ukraine

On September 9th VoxUkraine with the support of Kyiv School of Economics hosted discussion on "The urgency and priority of reforms in Ukraine." Discussion was held as an event in the series of VoxUkraine Clubs with participation of Roger Myerson, 2007 Nobel Prize Winner in Economics. Based on results, organizers prepared an Open Letter to the President and the Government with consolidated position of the participants.

To the President of Ukraine
Petro Poroshenko

To the Prime Minister of Ukraine
Arseny Petrovich Yatsenyuk

Dear Petro Oleksijovych!
Dear Arseny Petrovych!

Ukraine is in its most dire state since independence. The ongoing Russian aggression is claiming the lives of our best compatriots and bleeding the economy. Yet this is by no means an excuse to delay long overdue reforms.

The situation is on the edge, and failure to take immediate radical steps may lead to the loss of Ukrainian sovereignty. People and businesses are increasingly frustrated with the lack of change for the better. It is not long before they will start to question whether Ukrainian leadership really has the political will to combat corruption, institute the rule of law and improve the business climate. Moreover, the forthcoming parliamentary elections provide a fertile ground for political confrontation, which Russia may use to sow discontent and provoke another political crisis.

We praise your commitment to reforms and understand that you have to devote much of your time to military matters. However, in order to ward off domestic unrest and thwart Russian efforts to ruin our economy, we call on you to unite Ukrainian patriots and mount a joint effort to rescue the country by immediately launching radical reforms instead of waiting until after the parliamentary elections.

The list of required reforms is extensive and covers many areas that should be prioritized without procrastination. Yet we would like to emphasize that in addition to setting the priorities, another vital question is who will take up the implementation task. The primary task should be to overhaul the government bureaucracy in order to transform it into an efficient state institution staffed with a new generation of pro-European professionals. Reforms must be systemic and uncompromising, as half-hearted measures will have no definitive impact.

We stand ready to do our utmost to help accelerate reforms by engaging in a broad-based dialogue, contributing personally and attracting the best domestic and foreign talent.


Signatories:

VoxUkraine Advisory Board:

Roger Myerson, PhD, University of Chicago, 2007 Nobel Prize Winner in Economics

Gerard Roland, PhD, University of California, Berkeley
Jan Svejnar, PhD, Columbia University

VoxUkraine Editorial Board:

Olena Bilan, Dragon Capital
Volodymyr Bilotkach, PhD, Newcastle University
Dmytro Boyarchuk, CASE-Ukraine
Yuriy Gorodnichenko, PhD, UC Berkeley
Tymofiy Mylovanov, PhD, University of Pittsburgh
Veronika Movchan, Institute for Economic Research and Policy Consulting
Dmytro Sologub, Raiffeisen Bank Aval
Oleksandr Talavera, PhD, University of Sheffield

Invited to VoxUkraine Club

Vasyl Gatsko, Democratic Alliance party
Hanna Hopko, Reanimation Reforms Package civic initiative, Samopomich party
Semen Semenchenko, Donbass Battalion
Yegor Sobolev, Civic Lustration Committee, Volya party
Oleksandr Solontay, Institute for Political Education, Syla Lyudey party

Anatoliy Amelin, Association Aspen-Ukraine
Anna Derevyanko, European Business Association
Oleg Derevyanko, PhD Association Aspen-Ukraine
Daniil Pasko, PhD, Harvard Club

George Logush, PhD, Kyiv School of Economics
Mykhailo Vynnytsky, PhD, Kyiv Mohyla Business School
Sergiy Garmash, OstroV online newspaper
Alexander Noynets , edition “Petr and Mazepa”
Alexander Zholud, International Centre for Policy Studies
Victoria Podgornaya, Center for Social and Political Planning
Ivan Lukerya, Ukrainian Center for Independent Political Research
Agnieszka Piasecka, Open Dialogue Foundation

Igor Buinyi, Democratic Alliance party
Denys Bigus, channel ZIK
Ostap Yednak, Reanimation Reforms Package civic initiative
Pavlo Illyashenko, Center for Economic Solutions, Open Dialogue Foundation, AYA Capital
Pavlo Kyshkar, Donbass Battalion, Samopomich party
Paul Kuchta, Center for Economic Solutions, Open Dialogue Foundation
Jaroslav Markevich, Donbass Battalion
Elena Minitch, Young Presidents Organization (YPO), Kiev Chapter, Democratic Alliance party
Andriy Pylypenko, Open Dialogue Foundation
Vira Prokura, Civic Lustration Committee, Volya party
Yuri Ryfyak, Democratic Alliance party
Volodymyr Vakhitov, PhD, Kyiv School of Economics
Pavlo Prokopovich, PhD, Kyiv School of Economics
Elena Besedina, PhD, Kyiv School of Economics
Anna Vakhitova, PhD, Kyiv School of Economics
Oleg Korenok, Virginia Commonwealth University
Ilona Sologoub, Kyiv School of Economics
Natalia Shapoval, Kyiv School of Economics
Sergei Kubakh, agriculture and land expert, Reanimation Reforms Package of Reforms
Roman Bakhovskyy, public activist

A German perspective on the situation in Ukraine

By Raphael Schoenle (Brandeis University, USA)

In the perception of the German public, the recent events in Ukraine have simply been outrageous and shocking. It is all too clear to Germans what is happening: we have seen it before in Europe, in 1938. That time, however, Germany was on the wrong side of history, and the leading aggressor wasn’t called Vladimir Putin.

Following WWII, then, starting with voluntary integration into the European Coal and Steel Community, Germany has tried really hard to make sure an event like WWII will “never happen again.” Ultimately, this has lead to the creation of the European Union and more than 70 years of peace and prosperity.

Avoiding an event like WWII is still a strong, deep motivation of German politics today. Without doubt, it is pre-eminently in the mind of German politicians in the Ukrainian crisis as well, as for example the recent speech of President Gauck in Gdansk or Merkel’s visit to Kyiv prove.

However, Germany has been holding back from playing a more active role in granting support to Ukraine. It does not seem far-fetched to consider a stronger response, for example, imposing a complete embargo towards Russia. That would mean no exports of food, technology or medicine to Russia, no travel for an elite to Europe that has tasted the sweet fruits of consumption, and no easy access to finance on capital markets for Russia and Russian companies. Putin’s cronies would turn against him very quickly. The hope then is that this would quickly stop any current and future aggression. Yet so far, only minor sanctions have been imposed. Why hasn’t Germany taken any stronger steps?

The Rules of Engagement for 3G in Ukraine

By Dmytro Ilin (Institute for Economic Research, Kyiv) and Tymofiy Mylovanov (University of Pittsburgh, USA)

The Ukrainian government is about to decide on the format of the 3G license auction. What are the best international practices for the spectrum auctions?

Format. The standard format in the world is "open ascending (clock) auction", not sealed bid. This helps transparency of the auction and reduces possibilities for collusion among the participants. This is the format that the government of Ukraine intends to use.  

It is not (only) about revenue. The government heralds the auction as a way to raise revenue in the difficult time of the economic and security crisis. An important objective of the auction, however, should be increasing competition in the downstream market. This might require discrimination in the auction and/or offering more licenses than there are current market participants in order to provide incentives for new domestic and foreign companies to enter the market and create competition. Competition will drive prices down and will increase consumer surplus. The government in Ukraine might overlook or fail to understand this criterion.  

Land Moratorium: Guess who benefits from the status quo?

By Denys Nizalov (Kyiv School of Economics) 

It is a common understanding that agriculture is in the list of top prioritized industries in Ukraine (see recent post by Oleksandr Zholud for highlights). However, one would not find in the media and among the policy debate much attention to land, the factor that contributes more than 50% of the value of agricultural product. If land is used effectively and sustainably, agriculture might become a solid base for long-term development for the country and its rural areas. Thus, the question is to set new “rules of game” for agricultural land use. The success of lend reforms would define how much land is available for agricultural production, who has access to land, how productively and sustainably the land is used, and, finally, what is the cost of using Ukrainian agricultural land. All these issues are related to the quality of land governance and functionality of the land market.

Comments on the draft law "On lustration" and recommendations for the second reading

By Maxim Cherkasenko, Democratic Alliance

In short, the bill does not create an impression of a comprehensive legislative act introducing a mechanism for effective lustration, designed in line with European and international experience, as well as recommendations of the Council of Europe. Hence, if adopted without substantial revision, the bill is unlikely to achieve the purposes of lustration procedure, such as fighting corruption within the governmental bodies. In addition, there is a high probability that bill’s implementation in its current version is likely to result in a range of negative consequences, e.g. biased and selective use of the law such as dismissal of “unwanted” persons in governmental agencies, violation of some constitutional rights, etc. The cumulative effect of such legislation may discredit the concept of lustration as such, despite the fact that there’s a high social demand for lustration now.

Putin’s Endgame

By Yuriy Gorodnichenko and Gerard Roland (UC Berkeley)

There is every evidence that Russian troops are fighting the Ukrainian army on the Ukrainian soil. This Russian invasion is a further escalation of the war between Ukraine and Russian-sponsored separatists and terrorists in the East of Ukraine. As soon as the Ukrainian forces were about to take over cities in Eastern Ukraine, Mr. Putin raised the stakes and sent Russian military to rescue the separatists from certain defeat. Both sides have experienced heavy losses, but the Russian government denies any involvement. The excuses sound increasingly surreal (e.g., Russian paratroopers got lost). Furthermore, dead Russian soldiers appear to be buried in secret and journalists trying to reveal these losses are harassed, intimidated and severely beaten. Finally, Russia shows no sign of being willing to engage in genuine negotiations to establish peace—all previous attempts turned into farce when Russian calls for peace were followed with more Russian weapon deliveries and casualties.

After the cut-off of gas supplies in 2014, the infamous annexation of Crimea earlier this year, the delivery of weapons (including  tanks, artillery and BUKs that shot down Malaysian airline civil airliner MH17) to separatists, and now an invasion in Eastern Ukraine, one may ask where Mr. Putin is going to stop. We believe that Mr. Putin has been making calculated choices all along the way. His objective in Ukraine is to destabilize the new government that emerged from the Euromaidan movement that toppled Yanukovich. The ultimate motivation for this is to consolidate his own power at home and to prevent a similar democratic revolution in Russia. In each step of the Ukrainian conflict, he has weighed the benefits of each move, from the point of view of this strategic objective, against the costs. The current invasion is motivated by the need to prevent a military defeat of the separatists and to keep the conflict in Eastern Ukraine alive.

Turn the Ukrainian army into a Swiss one?

By Roman Khimich (Ukraine)

 

Mid-August was marked by a series of statements by Ukraine’s Ministry of Defense. These statement signal a fundamental change in the system of manning the armed forces and, in a broader perspective, vision of the entire defense doctrine.

 

The system of basic military training is declared to be mandatory and should cover all reservists, that is, effectively a major part of the adult population, including both men and women. Citizens who have passed such training should form a people's militia, which, in turn, should serve as the basis for a national territorial defense system. Finally, the authorities voiced the aim to create guerrilla, sabotage and intelligence networks on the basis of volunteer corps in cases of external aggression.

All these steps, taken cumulatively, comprise the elements of a comprehensive reform, a model set by the organization of the Swiss Armed Forces.

 

This is not the first attempt undertaken by Ukrainian authorities to solve the problem of mobilizing population in the event of hostilities. In mid-March 2014, in the midst of a military confrontation on the Crimean peninsula, several working groups were created at the request of Andrii Parubiy, the former secretary of the NSDC (National Security and Defense Council). The experts were required to prepare a regulatory framework and trigger the establishment of the mass mobilization system. Specific forms of this system were to be clarified in the working process.

 

The author participated in one of these groups, which developed the project of Ukrainian Army Reserve. The working group proposed a framework governing territorial defense forces in different states and developed a holistic view on the matter. Based on this experience and knowledge, author offers his assessment of the ideas expressed by Ministry of Defense leadership.

Draft Law on the Budget Code is not about decentralization, although it has some positive developments.

By Ilona Sologub (Kyiv School of Economics, Ukraine)

On August 8^th, the government registered the Draft Law on changes to the Budget Code concerning decentralization. The draft law has already received some complimentary as well as some negative (here and here) feedback. Since the Draft Law was supposed to become an integral part of the decentralization reform package, this post analyzes it from this point of view. The main conclusions are:

1. The proposed amendments to the Budget Code do not correspond with the logic of the reform and with the Decentralization Concept adopted by the government.
2. It seems that the main motivation behind the proposed Budget Code amendments was “making the central government look good” by transferring all problematic issues, such as cultural and ecological projects, renovation of housing, etc. to the local level while keeping the most “electorally valuable” spheres, such as education, healthcare, and social protection under the central government hand.
3. The Draft Law contains some positive developments, such as the new system of calculating inter-budgetary subsidies and somewhat eased procedures for obtaining external loans by local governments.

The more detailed analysis is presented below.

Kyiv People’s Republic: A threat to Ukraine

By the Editorial Board of VoxUkraine

It has been six months since the Maidan movements toppled President Yanukovych. Yet, there has been little progress in reforming the country. In this post, we summarize our obsevartions and dicuss how Ukraine should move forward.

Observation 1. There is a lack of sense of urgency among players in Kyiv.

Ukraine is in danger. There have been no radical reforms since the departure of Yanukovich and after a brief pause the corrupt reactionaries are back and “business as usual” is at full swing. High expectations of local businesses for positive changes are waning quickly. The government, the president, and the new and old political forces are talking a lot about reforms, but instead are reading themselves for the new elections and have put serious reforms on hold until the new distribution of power becomes clear. There is a profound lack of sense of urgency among the players in Kyiv. This can prove to be a death sentence for the sovereignty of Ukraine. 

The situation is very dramatic. The economy has entered recession and the projected GDP growth is negative, systemic corruption has not been touched, the risk of gas shortage in the winter is growing, foreign exchange market remains turbulent endangering already heavily hit banking, and there is no feasible lasting solution in sight for the war in the East. The capacity of the executive power continues to be extremely limited, with incompetent bureaucrats populating most of the offices, and their incentives have not been aligned with that of the public. The public is increasingly disillusioned with the political will of new government and the president to reform the country, as well as with some of the new wave activists.

If Ukraine Needs Lustration in 2014

By Bohdan Vitvitsky (Former Federal Prosecutor and Assistant U.S. Attorney, U.S. Department of Justice; New Jersey, USA)

The two principal rationales for lustration in countries such as Czechoslovakia, Hungary and Poland that implemented lustration projects in the 1990s were a fear of penetration by communist or Russian secret services and a fear that former informers or collaborators of such secret services could be blackmailed into serving interests other than local national interests.

If Ukraine as represented by the Deputies in the Rada believes that either or both of such fears continue to be justified in Ukraine today, then a lustration project that addresses those fears might be implemented.  It should, however, be understood from the outset that lustration is not the tool for dealing with corruption or with the absence of integrity and professionalism among public servants.

Comments on the Ukrainian Draft Law on Lustration

Comments on the Ukrainian Draft Law on Lustration

By Bohdan Vitvitsky (Former Federal Prosecutor and Assistant U.S. Attorney, U.S. Department of Justice; New Jersey, USA)

A bad law on lustration is worse than no law on lustration.  There is a popular draft of a law proposed by Yegor Sobolev and others and supported by a number of NGOs.  In its present form, the Ukrainian draft law on lustration prompts many serious reservations.  These reservations arise mainly because the draft law violates key provisions contained in Council of Europe recommendations relating to laws on lustration; because the draft law is in important respects altogether impractical; and because perhaps what Ukraine needs now, as reflected by all surveys of public opinion, is a significant reduction in levels of corruption rather than a post-communist style lustration.  

How to restart lending in Ukraine despite unfavorable macroeconomic and legal conditions

By Yuriy Gorodnichenko (UC Berkeley) and Dmytro Sologub (Raiffeisen Bank Aval)

Bank lending dries up in recessions and Ukraine is no exception. In January-July 2014 total loan portfolio of the banking system shrank by 8% as both loan demand and supply nearly vanished in response to looming political and economic risks. Whether tight credit is a cause or an amplification mechanism in recessions is perhaps not so important from a practical standpoint because in either case the key issue is how to restart lending to minimize adverse effects of depressed economic activity. This is a challenge because default/counterparty risk in recessions is high and so banks are reluctant to issue new loans. In Ukraine, this risk is further magnified by imperfect legal environment (i.e.  pervasive loan fraud as well as weak and slow legal enforcement of loan agreements) and tight funding conditions (the access to global debt markets is shut down, while the banks faced strong deposit outflows in the first half of this year) .

Source: IIF

So, how can Ukraine’s government restart lending? In an ideal setting, the right answer is that the sustainable lending growth should be based on the stable macroeconomic conditions, adequate legal framework, and healthy and transparent banking system. Unfortunately, none of that is feasible in the short-run and even if comprehensive economic and structural reforms are started now, we will not see effects for some time. Therefore, the question is what should be done here and now to facilitate bank lending in Ukraine. This task could be understood as a constrained optimization problem: the objective is to restart lending subject to constraints, such as macroeconomic instability, imperfect legal environment and low confidence in the banking system.