BUSINESSEUROPEOPINION

Doing business in Ukraine – Part 2

By Joshua Noonan

The following op-ed is part of the three-part series of articles providing anoverview of financial and social reforms Ukraine is set to go through. This is Part 2 (here are Part 1 and Part 3)

Introduction

As I wrote in my previous article in this series, Ukraine is facing structural economic issues that cannot be wished away. Thankfully, the current Prime Minister, Arseny Yaseniuk sees his government on a “kamikaze mission” of structural economic reforms. The planned reforms include a 50% rise in the price of natural gas from 1 May 2014 as well as the elimination of energy subsidies by 2016. According to the report, the value-added nature economy of Ukraine is segmented into 8% agriculture, 18% manufacturing industry, 14% non-manufacturing industry, and 60% services.  This indicates that the economy is already on the track to focus on a more human-capital centric mode of value creation, but for it to succeed deep reforms must be enacted.

These major reforms which are not being addressed to promote trade, entrepreneurship, and state building. These were highlighted in the 2014 Doing Business Report for Ukraine put out by the World Bank. The major factors that could improve the state and the state of business were easing the payment and administration of taxes.  The second issue we looked at concerned streamlining customs clearance. Finally, the role of investor protection was highlighted in order to boost the sustainable flow of FDI into Ukraine as it modernizes and diversifies its economy.

Global Competitiveness Index

In the Global Competitiveness Index of 2013-2014, Ukraine ranked 84th out of 148 economies examined.  This was a notable fall in the rankings in 2012-2013 when it ranked 72nd.  In the 2011-2012 index Ukraine ranked 82nd.  This is based on the twelve pillars and sub-pillars of the index.  I will use this article to look at the Global Competitiveness Index 2013–2014 from the World Economic Forum (WEF) to shed further light on other parts of the economy, polity, and society which must be reformed in order to have a strong, stable, and successful Ukraine.

The WEF placed Ukraine and thirty other states in the Stage 2 Efficiency-driven economies. This means that their economies are shifting from factor-driven growth such as cheap-labor and natural resources to being driven by an educated population, an efficient labor market, goods markets, capacity of the financial system, ability to integrate technologies, and domestic and foreign market size. Thus the weights for Ukraine were assigned for efficiency at 50%, basic factors, at 40%, and innovation factors at 10%. Concerning basic factors, Ukraine ranked 91st, for efficiency factors, 71st, and for innovation factors it ranked 95th.

Overall, Ukraine outperforms other efficiency-driven economies on the factors of health, primary, and tertiary education, market size, and infrastructure. It lags comparatively on institutions, financial market developments, and the macroeconomic environment. The comparative strengths must be harnessed while the challenges are rectified in order to guarantee Ukraine’s place in the world, its role as an effective partner to the European Union and a source of stability to its neighborhood.

Ranking the Factors of Development

Ukraine has much room for improvement when it comes to institutional, financial, and the control of corruption. Concerning basic factors of development, Ukraine ranked 137th in the status of its institutions, macroeconomic environment ranked 107th, infrastructure ranked 68th, and health and primary education ranked 62nd. On the issue of efficiency factors of development, Ukraine ranked 124th in goods market efficiency, 117th, in financial market development, 94th in technological readiness, 84th in labor market efficiency, 43rd in higher education and training, and 38th in market size. Finally, factors of development for innovation were ranked at 97th for business sophistication and 93rd for innovation.

Priorities for Business

In 2013 the WEF surveyed 108 executives from Ukraine on the 12 pillars and sub-pillars compromising the index. The biggest problem addressed by 16.7% of these individuals was the problem of access to financing. This issue could be addressed by attracting additional foreign banks into Ukraine.  Since the 2008 financial crisis and the retrenchment of European financial institutions from concomitant frontier markets with a 30% reduction in Western European Exposure to Ukraine.  Ukraine has seen a decrease in foreign (no Ukrainian and non Russian) banks assets from 40% to 20%. Since 2013 five banks currently control 40% of the Ukrainian market. The reduction of foreign firms in the economy will incentivize the collusion of these local firms which tend to be quite politically connected.  Further competition would reduce the market power and thus decrease rentier income.  Moreover, strengthening the laws surrounding the resolution of bankruptcy and insolvency would incentivize  Moreover, further qualitative improvements in the financial sector will be driven in Ukraine as globally benchmarked banks enter the market and bring modern practices.

The second issue of import faced by executives was corruption, with 15.5% of individuals stating it was a key problem in their businesses. The new government in Ukraine has been acting to reduce the pernicious corruption through its lustration (blanket elimination of top-level bureaucrats from the Yanukovych regime) and the addition of new anti-corruption bylaws. Ukrainian civil society has been acting against petty corruption through actions to expose bribery. The “I Paid A Bribe” website of Dav Khabara which is useful for highlighting post-Euromaidan bribe-giving. Inefficient government regulation at 13.4% and policy instability at 10.1% were issues that were partially driven by bribery as well as the unstable nature of Ukraine since the Orange Revolution. Finally, tax regulations at 11% and tax rates at 8.4% percent highlight the issue of collection and administration of taxation faced by both business and government in Ukraine.

Conclusion

What ties the issues facing business in Ukraine is the source of their solution.  The government of  Ukraine alongside civil society and international partners can resolve many of problems.  Through a series of governmental and legal reforms the lagging portions of Ukraine can be improved in order to strengthen its economic prospects as well as improving its political stability. In this article we focused on the strengthening of its competitiveness, reducing corruption, streamlining bureaucracy and governance, and improving the the system of taxation.  I will focus the third article in this series on the issue of corruption, highlighting the history, current status, and possible resolution of the biggest problems in Ukraine in the opinions of both business leaders and the people who went to protest at the Euromaidan.

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Joshua Noonan

Joshua Noonan is an Azerbaijan News Analyst; John Hopkins SAIS MA Candidate in Russian and Eurasian Studies, International Economics and is the Presidential Management Fellowship Finalist. Joshua Noonan is a frequent contributor to Foreign Policy News.

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