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5/5/2014

The Post-Soviet Ukraine An Analysis of the Obstacles to Ukrainian Development in the PostSoviet Era

Derek Bisaccio Jeremy Marsh


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Table of Contents Introduction…………………………………………………………………………………………………………..2 Economic Obstacles to Development…………………………………………………………………….2 Economic Freedom…………………………………………………………………………………….4 Fiscal Policy………………………………………………………………………………………………..7 Monetary Policy………………………………………………………………………………………...9 Energy Policy……………………………………………………………………………………………..10 Wealth Inequality………………………………………………………………………………………14 Challenges to Reform and Recommendations……………………………………….…..16 Political Obstacles to Development………………………………………………………………..……..18 Constitutional Structure……………………………………………………………………….……18 Judicial Policy………………………………………………………………………………………….…26 Conclusion…………………………………………………………………………………………………………….29 Works Cited…………………………………………………………………………………………………………..30


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Introduction As the Soviet Union was collapsing in the late 20th century, the state of Ukraine in Eastern Europe declared its independence from the Soviet system, a system it had been a part of since 1922. In the two decades since gaining its independence, Ukraine has made attempts to develop and modernize its economic and political structure, which was heavily influenced by the Soviet experience. Despite these attempts, many obstacles remain that stymie and even reverse Ukrainian developmental progress. In order for Ukraine to modernize, it will need to comprehensively address these pressing obstacles to development. The obstacles, which are economic and political in nature, are numerous and each are distinctly difficult to fix.

Economic Obstacles to Development Independence of the Soviet Union forced Ukraine to develop administrative institutions that it never previously possessed and create privatization that it had never before had experience with. The system Ukraine made was therefore imperfect and requiring constant revision. However, despite a general desire to restructure itself, Ukraine has been plagued by an unwillingness to reform its problems, causing them to grow worse over time. Diagram 1a,1 below, diagrams the change in GDP per capita in former Soviet states over the two decades that have passed since their independence. As can be seen in Diagram 1a, some of the former Soviet states were able to expand their GDP per capita quite significantly. Ukraine, however, has seen very little change in its GDP per capita over that time frame, with only an estimated change of about a 50% increase. This is meager compared to the other former Soviet states surveyed, who have seen

1

"Why Is Ukraine's Economy in Such a Mess?" The Economist, March 05, 2014.


3 change at least twice as high as Ukraine’s. This diagram suggests that there are factors hampering growth in Ukraine to an extreme degree. Table 1a

Ukraine's development is impeded greatly by economic realities within the country. While its gross domestic product (GDP) grew on average by 4% from 2000 to early 2014,2 prevailing economic conditions have hampered greater growth and particularly adversely affected the average Ukrainian. These conditions are broad and not limited to a single aspect of Ukraine's economy, making their effects much more ruinous. They include an overall lack of economic freedom, a burdensome fiscal policy, inadequate monetary policy, energy policy, and severe wealth inequality.

2

Trading Economics. Ukraine GDP Annual Growth Rate. 2014. Raw data.


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Economic Freedom In order to get a sense of the challenges wracking Ukraine’s economy, it is crucial to assess first the levels of economic freedom in Ukraine. While no country on the planet today has a system that is completely free, the pursuit of economic liberalization is a goal for many because it often breeds a wealthier society. An economy that is entirely free features institutions that “do not discriminate either against or in favor of individuals based on their race, ethnic background, gender, class, family connections, or any other factor unrelated to individual merit” and the “power of economic decisionmaking is widely dispersed.”3 While there are many different ways to calculate the freedom of an economic system, the Heritage Foundation, a think tank, takes into account 4 general areas of a country. These areas are the rule of law, government size, regulatory efficiency, and market openness,4 and they help the Heritage Foundation make assessments of the levels of economic freedom in different countries throughout the world. The most recent report on global openness from the Heritage Foundation, called the Heritage Economic Freedom Index, analyzed 186 states across the world. Of these, Ukraine scored 155th freest overall and 43rd in Europe,5 making it near the bottom of the globe in terms of freedom in its economy and the most repressed economic system in all of Europe. In those fields examined per the foundation’s assessment criteria, Ukraine scored very poorly in a number of categories, particularly freedom from corruption and investment freedom. Corruption in Ukraine permeates all aspects of society. It was able to flourish after independence because “Ukraine was left without the institutional capacity to address organized crime”

3

Terry Miller and Anthony B. Kim, "Defining Economic Freedom," in 2014 Index of Economic Freedom (Washington, DC: Heritage Foundation, 2014), 81. 4 Ibid. 5 Ibid.


5 leading to the “hijacking of the privatization process by former members of the nomenklatura” and other politically connected elites.6 Due to a lack of political will and the pressure that privileged elites put on the state, little to no steps have been taken that would combat corruption throughout the country. Corruption in Ukraine is a serious issue because it “undermines the certainty of business transactions making businesses vulnerable to exploitation by organized criminals” while also inhibiting “the foreign investment that Ukraine so greatly needs to repair its depleted infrastructure.”7 Profits largely disappear into the bank accounts of the elite, who capture the majority of the spoils to be had in Ukraine. The Heritage Foundation, while noting that Ukraine is on the whole unfree from corruption, also revealed in its index that freedom from corruption has not only not expanded in Ukraine, but has remained stagnant at best and deteriorated at worst.8 Stemming from corruption is the lack of investment freedom in Ukraine. Potential investors are likely to invest in neighboring countries over Ukraine for two main reasons: concern that projects are not safe from criminal pilfering and preferential treatment that state-owned enterprises (SOEs) receive. Investors seek first and foremost to protect their assets as that is their source of profit. Fearing that their assets may not be safe inside a country is likely to convince any potential investor to reconsider the venture. Nearly equally as unattractive is a country with that favors domestic firms and particularly SOEs over foreign firms. Ukraine is one such state, providing advantages specifically for its SOEs over other firms by means of subsidies, allowing Ukrainian SOEs to dominate domestic industries and erode local competition. Table 1b, below, lists the top 10 sites for investment in Eastern and Central Europe from the period 2006-2010. The relative number of jobs created by the projects initiated has also been calculated

6

Louise I. Shelley, Organized Crime and Corruption in Ukraine, 2. Louise I. Shelley, Organized Crime and Corruption in Ukraine, 2. 8 "The Countries," 2014 Index of Economic Freedom, 89. 7


6 in Table 1b. As a result of such unattractive conditions on the ground in Ukraine, foreign direct investment (FDI), the riskier type of investment, remains relatively low compared to its neighbors. From 2006 to 2010, only 178 FDI projects were initiated in Ukraine, compared with 740 in Russia and 719 in Poland during the same time frame.9 Also, the share of jobs created by the investment is noticeably very low in Ukraine compared to its neighbors. Table 1b

In 2014, Ukraine inked a deal with the International Monetary Fund (IMF) to rectify some of the prevailing problems. The IMF deal would authorize $17 billion to Ukraine, provided Ukraine meets certain stipulations, one being corruption. The deal focuses on Ukraine “decisively breaking with problematic past governance practices,�10 among them being inadequate anti-corruption measures.

9

Alexei Kredisov, Ukraine FDI Report (Ernst & Young, 2011), 5. International Monetary Fund. "IMF Executive Board Approves 2-Year US$17.01 Billion Stand-By Arrangement for Ukraine." News release, April 30, 2014. 10


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Fiscal Policy Fiscal Policy, a subset of a country’s overall economic program, is meant to regulate the various expenditures made by the state in order for it to carry out its functions. These expenditures are possible for the government to make by means of tax revenue and debt-financing. Ukrainian fiscal policy has been a very important tool for the government since independence, but a number of problems persisting in the policy itself have caused trouble for Ukraine and proved to be obstacles to the development of Ukraine as a whole. The two main issues evident in Ukraine’s fiscal policy are its lack of an overall strategy and excessive spending, with the latter often being a product of the former. Little existence of planning and consistency in Ukrainian fiscal policy ensure that its benefits are mitigated. Because the Soviet system was highly centralized, administration structures were concentrated in Moscow and St. Petersburg. Thus, after the collapse of the Soviet Union, the successor states, Ukraine among them, had little administrative institutions present and had to create these institutions among the process of liberalization. Ukraine has struggled in developing its approach to fiscal policy. Not until the adoption of a new budget code in 2010 was the Verkhovna Rada given the possibility of controlling “the implementation of the law on the state budget of Ukraine,”11 meaning the country’s legislature has had very little oversight in establishing the national budget. The majority of decisions made in the budget have looked specifically at short-term interest, which is oftentimes political, meaning that medium-term and long-term implications are neglected. Resources in the country are often inappropriately allocated. Excessive government spending is a big issue for Ukraine. Many inefficient state-owned enterprises (SOEs), like Naftogaz, receive subsidies from the central government to offset their unprofitability. Such subsidies are often a product of endemic corruption as connected individuals in

11

Anatolii Akhlamov and Svetlana Osadchuk, Basic Directions of the Modern Fiscal Policy in Ukraine (2013), 2.


8 control of large SOEs have secured funding from the government. Naftogaz, the biggest employer in Ukraine, highlights this corruption, with allegations abound that “Naftogaz is being driven toward bankruptcy as management uses purchases of equipment and gas to embezzle cash.”12 Government spending keeps the firm afloat while its managers allegedly siphon money out of the company for personal profit, in effect meaning that the government finances the personal bank accounts of Naftogaz’s management. In addition to the subsidies, government expenditure on social projects is very in Ukraine. One of the more expensive programs is the pension system. Ukraine “has the highest share of pension spending in GDP in the world” at “18% in 2009” and, because of such excessive spending, “the pension fund ran a broad deficit of almost 7% of GDP in 2010.”13 Rather than cut back on pension spending, Ukraine’s central government has shown an appetite for increasing spending for it. Pension spending highlights Ukraine’s emphasis on social stability in the short term despite the fact that it is not sustainable in the long-term. Large subsidies, together with rampant social spending, have produced an immense burden on the budget, which, in 2013, ran a deficit of 4.6%.14 Ukraine has made attempts to fix these issues, with the most recent being with the 2014 IMF deal. In terms of fiscal policy, the IMF deal seeks to “strengthen [Naftogaz’s] transparency and governance” and it “put in place a package of revenue enhancements and expenditure restraints.”15 Greater oversight on the activities of Naftogaz would ensure that nefarious practices such as those mentioned above would not occur to the extent that they currently do, perhaps even increasing Naftogaz’s profitability. By raising taxes and cutting spending, the

12

Daryna Krasnolutska and Kateryna Choursina, "Naftogaz Subsidies Bleed Ukraine as President’s Options Wane," Bloomberg, August 2, 2013 13 "Contributing to the Pension Reform Debates." Editorial. World Bank, April 5, 2011. 14 Trading Economics. Ukraine GDP Annual Growth Rate. 2014. Raw data. 15 International Monetary Fund. "IMF Executive Board Approves 2-Year US$17.01 Billion Stand-By Arrangement for Ukraine,” 2014.


9 government can address its deficit and create a path for spending that will be sustainable in the future, rather than the course it is currently on. This aspect of the deal is crucial, because Ukraine needs to restructure its fiscal policy in a way that will promote growth rather than inhibit it. Of the $17 billion to be made available to Ukraine, around $3 billion is available for immediate disbursement,16 which should help Ukraine begin the necessary reforms as soon as possible.

Monetary Policy Supplementing fiscal policy is monetary policy, a tool used to manage the economy, generally by manipulating a national currency and the money supply. Usually, this policy is conducted through a central bank that is subservient to its national government. By determining the size and growth of the money in a country, a central bank can adjust the money supply in a means that will combat problems like inflation. Monetary policy also includes shifting interest rates to better economic conditions. With a relatively short history of monetary policy in Ukraine, the country faces a credit crunch among its populace, which was particularly exasperated by the 2008 financial crisis. The use of monetary policy in Ukraine did not emerge until very recently. During periods of transition, like Ukraine’s attempts at liberalization following independence, “fiscal instruments are usually more effective and efficient than the tools of monetary and regulatory policy” in addressing economic issues.17 Although the National Bank of Ukraine (NBU), which is the country’s central bank, was given “broad regulatory and supervisory functions in the banking sector,”18 these powers were not

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International Monetary Fund. "IMF Executive Board Approves 2-Year US$17.01 Billion Stand-By Arrangement for Ukraine,” 2014. 17 Akhlamov and Osadchuk, Basic Directions of the Modern Fiscal Policy in Ukraine, 2. 18 Financial Services & Insurance in Ukraine. InvestUkraine, 2011.


10 institutionalized. There was “no independent monetary policy” in Ukraine until 2008 and discourse of the subject was limited.19 The 2008 financial crisis demonstrated how weak the Hryvnia, Ukraine’s currency, was structurally. Before 2008, the economy of Ukraine had been steadily growing and the financial sector, in particular, was becoming more of a source of foreign investment. In 2008, however, the economic growth evaporated, giving way to severe decline, and the Hryvnia experienced rapid inflation. In light of “60% depreciation of the Hryvnia against the US Dollar,” the pace of deposits in banks decreased significantly and the banks themselves became more skeptical of loaning money,20 fomenting a credit crunch in Ukraine. Repair has been slow, with “recovery of most Ukrainian banks” taking “2-3 years.”21 Price stability is incredibly important for Ukraine as it works to leave behind the damage of 2008. To this end, Ukraine is refining a flexible exchange rate, perceiving that a flexible exchange rate would allow it to respond to shocks in a stronger way. The NBU, possessing tools to manage the economy, could then be much more effective in targeting inflation, which has proved itself to be one of the biggest concerns of the Hryvnia.

Energy Policy The energy sector in Ukraine a significant obstacle to the country's development. Like much of Ukraine's problems, its energy deficiencies stem from excessive government influence, namely government ownership of production and subsidization of the market. Stifled market forces have created a situation where technology is outdated and investment in capital is badly required. Ukraine

19

Ricardo Giucci, Robert Kirchner, and Vitaliy Kravchuk, Current Issues of Monetary Policy in Ukraine, German Advisory Group, November 2009, 5. 20 Edilberto Segura et al., "Ukraine's Financial Crisis: Past, Present, and Future," US-Ukraine Business Council, April 29, 2009. 21 Iryna Shkura and Barbara Peitsch, Assessing Ukrainian Banking Performance Before and After the Crisis, Gerald R. Ford School of Public Policy, 2011, 15.


11 will have to make serious efforts to reform its energy sector if it wishes to see long-term sustainable growth and development. Most of the energy Ukraine consumes is not domestically produced, and the country heavily depends on oil and gas imports. In 2012, Ukraine produced 37% of the natural gas it consumed, and only 25% of the liquid fuels, with the remainder in both cases being imported from Russia.22 Likewise, despite some gains in the energy efficiency of the industry sector, the Ukrainian economy is one of the most energy-intensive in the region. If energy efficiency is measured in the ratio of total primary energy supply (TPES) to GDP, then Ukraine is 3.2 times higher (in PPP terms) than the average for OECD member states.2324 Consequently, shocks in energy supply trends often have significant impacts on the domestic economy. As a former Soviet state, Ukraine's energy sector has historically been bedfellows with the government, being under direct or indirect control of the state. Naftogaz is the state-run national oil and gas company of Ukraine, subordinate to the Ministry of Fuel and Energy. It carries out the production, refining, transportation and distribution of natural gas and crude oil for the entirety of the country, producing 90% of Ukraine's natural gas production.25 Further, the energy sector is heavily subsidized. It is estimated that Ukraine spends 7% of its total GDP on natural gas subsidies for consumers.26 These subsidies take the form of price caps, artificially keeping prices affordable for consumers, or are administered as tax breaks to domestic oil producers, who then pass on their savings to consumers. Ukraine's energy inefficiency can be largely attributed to these subsidies, as they protect the gas

22

US Energy Information Administration (US EIA). "Ukraine: Overview/Data." IEA/OECD, Energy Policies Beyond IEA Countries: Ukraine 2012 (Paris, France, 2012), 14-15. 24 Note: Ukraine is not a member of the OECD, but does have similar geographic circumstances. 25 Ministry of Energy and Coal Industry. Ukraine Special Report: Natural Gas and Ukraine's Energy Future (IHS CERA, 2012)., 2-3 26 Brenden Greeley, “Why Fuel Subsidies in Developing Nations are an Economic Addiction,� Businessweek, March 13, 2014. 23


12 industry from market forces and discourage structural adjustments.27 It is estimated that Naftogaz loses as much as $2.5 billion annually from consumer subsidies.28 While Naftogaz and the state take the lion's share of gas production, independent fuel companies do exist. There are more than fifteen private gas production companies operating in Ukraine. Independent gas production has tripled since 2001, although few companies produce sizable volumes of gas. Naftogaz is the only entity actively working in the area of geological exploration, which is an important sector given that other companies cannot produce gas without this phase.29 A major problem for Ukraine is its energy dependence on Russia, both in terms of its reliance on the exporting country for a majority of its gas supply and its role as a Eurasian transit hub. The volume of transit gas in Ukraine has been declining since 2004, mainly due to the construction of the Blue Stream pipeline to Turkey and the Nord Stream pipeline beneath the Baltic Sea. The planned construction of the South Stream pipeline in the Black Sea bypasses Ukraine and the increase in the role of Turkey in European gas supply adds additional strife.30 Compounding the problem, the country's domestic production of natural gas is stagnating. During much of the Soviet era the USSR as a whole relied heavily on gas fields in Ukraine. However, as gas fields went into decline in the late 1970s, the Soviets turned to gas sources in Siberia and Central Asia, shifting its investment in capital and technology as well. While Ukraine was able to manage two decades of generally stable gas production levels from its independence in 1991, the lack of investment has begun to wear down the system, and production levels are beginning to stagnate. Total gas production declined by 8% in 2010, and is predicted to gradually decrease in the future without proper management.31

27

Ibid. Ministry of Energy and Coal Industry. Ukraine Special Report: Natural Gas and Ukraine's Energy Future (IHS CERA, 2012), 5. 29 Ibid, 3-4. 30 Ibid, 2. 31 Ibid, 3. 28


13 The problems that plague the Ukrainian energy sector are many and vast. Some of the most pressing have been already been addressed, and stem largely from government control and subsidies discouraging innovation and modernization. If Ukraine is to meaningfully reform its energy sector and spur development, it must radically reform both the supply and demand dimensions of its energy chain. On the supply side, it must increase domestic energy production and energy independence. On the demand side, it must reduce its energy intensity and inefficiency. These two policy objectives are the pillars of energy reform in Ukraine, and with proper investment and management, Ukraine could be nearly self-sufficient in energy in fifteen years. The Ukrainian government is well aware of its energy deficiencies, and has taken several steps to try to address them at a federal level. The Program of Economic Reforms for 2010-2014 acknowledges the problems of energy dependence and inefficiency, as well as their myriad causes.32 It sets out several objectives, namely improving energy efficiency, increasing energy security, and reducing environmental impacts from such efforts. The method of achieving these objectives includes many aforementioned solutions, including the development of a regulatory framework to incentivize competition, the increasing of energy diversity, increased efforts toward exploration and development of natural resources, domestic measures to reduce energy inefficiency, and improving the investment climate.33 In terms of actually implementing these strategies, Ukraine has made modest advances. In 2010, it joined the Energy Community, an EU-backed multilateral organization that brings together the EU and its southern neighbors with the expressed purpose of improving energy security via energy market integration and legal harmonization. However, although it has implemented the Law “On the Principles of the Functioning of the Natural Gas Market� in 2010 as a condition of Energy Community accession,

32

Ministry of Energy and Coal Industry. Ukraine Special Report: Natural Gas and Ukraine's Energy Future (IHS CERA, 2012). 33 Ibid.


14 the progress Ukraine has made toward legitimate reforms is mixed, particularly in regard to the phasing out of gas subsidies.34 If Ukraine is to truly see energy dependence by 2030, it must seriously ramp up its institutional efforts.

Wealth Inequality The discrepancy between the incomes of social classes in a country is generally referred to as wealth inequality. While the degree of inequality varies country to country, at higher levels it often causes a number of problems when small portions of the population control disproportionate portions of the share of wealth. Ukraine is one such country with high wealth inequality and all of the obstacles to economic development noted above contribute to severe wealth inequality in Ukraine. The elites in Ukraine, many of whom were carried over from the Soviet era, stand to reap the benefits from the economic system while the much larger lower classes are denied such ability. During the Soviet era, privileged members of the Communist Party, known as the nomenklatura, were able to secure large amounts of wealth and take control of Soviet industries. Although with a different face, these elites did not go away with the dissolution of the Soviet Union, but, rather, used their connections to gain or maintain top positions in the new republics. Even though the emerging states attempted to liberalize their systems, the Soviet experience made that hard to do and so many of the former Soviet states formed oligarchic capitalist structures. The elite in Ukraine control the bulk of the wealth in the country, thanks to favorable positions in SOEs and bribes. They profit immensely off of a lack of transparency in transactions throughout Ukraine. Some estimates put the wealth of the richest 100 individuals, about 0.00003% of the

34

Ibid.


15 population, in Ukraine at around 80% to 85% of GDP.35 In other words, over 99% of the population collectively only control up to 20% of the wealth. Unsurprisingly, there is a stark divide between the very wealthy and the very poor. The existence of a middle class usually has a mitigating effect on wealth inequality, however, in Ukraine, there is a “vanishing middle class.” While a middle class was able to develop following liberalization efforts in the 1990s, the institutions that allow a middle class to thrive are not present in Ukraine and their lacking constricts the middle class that does exist, preventing it from growing. The majority of Ukrainians are either lower than middle class or perceive themselves to be lower than middle class. Of those in the lower class, only 4.2% report “a stable income that guarantees a high standard of life and making savings.”36 According to polling conducted by Gallup, 60% of Ukrainians see themselves as struggling while 29% of Ukrainians would consider themselves suffering.37 A very slim portion of the population think of themselves as thriving in Ukraine. Given the other problems that Ukraine’s economic system has, addressing the subject of wealth inequality has proved to be a near impossibility. The Heritage Foundation states that the “world’s freest economies have less human poverty and higher living standards,”38 suggesting free markets as an antidote of sorts to poverty that is more effective than social welfare programs. If Ukraine were able to boost the economic situation in these fields, it could well also empower the lower class and support the growth of the currently small middle class. Independent, small enterprises are key to this. While Ukraine’s economic system is repressed, however, relief will be slow in coming.

35

Olha Holoyda, Ukrainian Oligarchs and the “Family”, a New Generation of Czars—or Hope for the Middle Class? (Washington, DC: IREX, 2013), 3. 36 Andriy Bychenko, Ukrainian Middle Class: Perceptions and Actual Signs, vol. 7 (Razumkov Centre, 2008), 8. 37 Gallup, Ukraine Data, June/July 2013, raw data. 38 Sergio Daga, "Antidote to Poverty: Economic Freedom, Not Government Dependency," in 2014 Index of Economic Freedom, 67-8.


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Challenges to Reform and Recommendations The most recent IMF deal may have the intended effects if it is implemented correctly. However, there are a number of obstacles to its implementation. One such obstacles is the fact that, in 2010, the IMF and Ukraine signed a similar deal that was ultimately shelved because of the fact that Ukraine made very little actual effort to abide by the deal’s tenets. Lack of political will for reform has plagued Ukraine since its independence, with examples of reform legislation being “strongly resisted by the directors from the industrial lobby groups who realized the economic consequences for the inept and for uncompetitive producers” going as far back as 1994.39 Lobby groups, and particularly politically connected elite, oppose many of the restructuring that is necessary due to the fact that those reforms would significantly adversely affect their companies. Such opposition has seen Ukraine renege on a number of agreements, notably the IMF deal of 2010 but others as well. Another obstacle to the 2014 IMF deal is the state of affairs with Russia. Following instability in Ukraine that began in late 2013 and continued into 2014, Russia reinforced its bases in Crimea, part of Ukraine since 1954. Upon Crimea’s Parliament declaring its independence and the Crimean people voting in a referendum to join the Russian Federation, Russia formally annexed Crimea.40 The crisis has since enveloped eastern Ukraine amid fears that Russia may attempt to dismember Ukraine further. Thanks to the tentative nature of the crisis, Ukraine’s current government will likely be forced to proceed cautiously, stymying the pace of reform and throwing the entire IMF deal into doubt. While foreign aid through such institutions as the IMF is useful for Ukraine, it is not a substitute for domestic reform. Even where aid money has been tied to reform, successive Ukrainian administrations have resisted making the necessary restructuring due to the political difficulties

39

Peter Sochan, The Banking System in Ukraine (Warsaw: Center for Social & Economic Research, 1996), 10. Marie-Louise Gumuchian, Victoria Butenko, and Laura Smith-Spark, "Russia Lawmakers Vote to Annex Crimea; U.S. Steps up Sanctions," CNN, March 21, 2014 40


17 surrounding such reform. However, they are demonstrably not blind to the problems wracking Ukraine. In 2004, following the protests of the Orange Revolution, the eventual president, Viktor Yushchenko, advocated a platform that promised to fight corruption, rehabilitate the financial sector, and attract foreign investment.41 However, these stances were abandoned as they proved difficult to address. Appetite for reform may again grow in Ukraine. The protests in 2013 and 2014 that overthrew President Yanukovych were instigated by President Yanukovych’s decision to reject an association agreement with the European Union, however, the poor shape of the economy can be cited as a reason the protests maintained their intensity. Anger over the opulent lives of the elite has spurred a demand for reform. The deal that Ukraine’s interim government signed in April with the IMF outlines the path Ukraine must take, and, with popular support, the government may be able to initiate the proper restructuring. Meeting the five key terms of the agreement42 will unlock additional funds for Ukraine while putting it on course to rectify its glaring economic problems. Specifically, Ukraine will need to wholeheartedly maintain a flexible exchange rate in order to combat resurgences in inflation in the future. Doing so will help stabilize prices within the country. Easing off of subsidies will help open the country’s market up to foreign investment, something that is crucial to economic development. Reducing subsidies, as well as raising taxes, would also decrease government expenditures, particularly if expenditure in social programs were scaled back. In terms of energy policy, Ukraine must dramatically boost its domestic production of natural gas in order to lessen its dependence on Russia. Other sources of energy, like nuclear power and shale gas, should be invested in. Of Ukraine’s current energy infrastructure, much is outdated and in desperate need of modernization

41

Roman Woronowycz, "Yushchenko Introduces His Platform, Promising Paradigm Shift in Ukraine," Ukraine Weekly, July 18, 2004 42 The goals are “(i) maintaining a flexible exchange rate to restore competitiveness; (ii) stabilizing the financial system; (iii) gradually reducing the unaffordable fiscal deficit; (iv) eliminating losses in the energy sector, while enhancing social safety nets; and (v) decisively breaking with problematic past governance practices.”


18 to become efficient. None of these reforms, however, will be much meaningful if Ukraine does not tackle its issues with corruption and respect for the law. As such, reform cannot be asymmetrical; it needs to encompass all of the areas that Ukraine struggles in, and not just a few.

Political Obstacles to Development In addition to the economic obstacles to development are political obstacles to development. These are perhaps equally as challenging for the Ukrainian government to deal with, due to the fact that the same unwillingness to reform that stymies restructuring the economic system is prevalent in political aspects as well. Considerations made to the political obstacles facing Ukraine are made with respect generally to two fields, the structure of the country’s constitution and the nature of the judiciary.

Constitutional Structure The Ukrainian Constitution was adopted by Parliament on June 28th, 1996, roughly five years after its independence. One of its most important features is it sets up the structure of the government. Under the constitution, the Ukrainian government is modeled as a mixed European republic. Its legislature consists of a unicameral parliament called Verkhovna Rada, which consists of 450 deputies who each serve four-year terms. The head of government is the president, who is elected by popular vote for five year terms. There is also a prime minister, who is appointed by the president with the consent of parliament. The Cabinet of Ministers is appointed by collaborative effort between the president and the prime minister. According to the constitution, justice is administered exclusively by the courts. The highest court in Ukraine is the Supreme Court, whose jurisdiction includes criminal, civil, administrative and commercial cases. The appointment of judges is made by parliament with no fixed term limits. Unlike in the US, the Supreme Court does not have the authority to interpret the constitution. These responsibilities are exercised by the Constitutional Court of Ukraine. Here, the


19 eighteen judges are appointed in equal shares by the president, the parliament, and the Congress of Judges, the highest body of judicial self-government in the country. Areas where Ukraine is notable different from the standard model of a European mixed republic include: the ability of the president to dismiss individual ministers or an entire Cabinet, a power normally reserved exclusively for parliament, who also retains this right; the right of the president to annul certain acts of the Cabinet of Ministers; and the fact that the Cabinet resigns with every election of a new president, but not with the election of a new parliament.43 However, what the constitution stipulates and what the political reality of Ukraine actually is are significantly different. From the onset of its life as an independent democratic republic, Ukraine has had problems with its constitution. Initially, outsiders looked positively at Ukraine's constitution, which, while imperfect and endowed with a worryingly strong executive branch, seemed like a step in the right direction toward democracy. However, Leonid Kuchma, second President of Ukraine and the first to serve under its new 1996 Constitution, was quick to abuse his power. He transformed the office of the president into the supreme executive authority, a role that constitutionally was reserved for the Cabinet of Ministers. Likewise, his usurpation of political power was not just at the expense of the federal Verkhovna Rada, but at that of the judiciary and local governments as well, establishing a situation of highly centralized power that continues to plague Ukrainian governance. Political corruption flourished, and political parties were unable to function in a democratic fashion. Further, during this period the Constitutional Court failed to take an active role in shaping governance, abandoning an opportunity to become an integral institution for establishing and reinforcing the rule of law, which created a precedent of passivity.44

43 44

Centre for Political and Legal Reforms. “Constitutional Development in Ukraine�. Ibid.


20 The Ukrainian government floundered along for the next decade, and no meaningful changes to the constitutional situation were made until the Orange Revolution of 2004. The origins of the Revolution can be found in the 2004 presidential elections. Despite being in his second term in a country where the constitution outlawed the serving of two consecutive terms, Kuchma ran for a third term in 2004. The Constitutional Court had ruled that Kuchma's current term should be deemed his first rather than his second, a decision which not only undermined public confidence in the Constitutional Court, but led to public opposition to Kuchma in general. As a result, Kuchma stepped down and supported then-Prime Minister Viktor Yanukovych. When Yanukovych was announced as the winner of the 2004 election, there were cries of rigged voting and prolonged public protest erupted, kicking off the Orange Revolution.45 The Orange Revolution drove institutional changes. Protests led the Supreme Court to rule that the results of the election were void and ordered a revote. However, in order to ensure that elections were truly fair, free and honest, amendments to the electoral law were required. These amendments were subject to heavy political bargaining in parliament. Meanwhile, separate amendments proposed by the Kuchma government that reduced presidential power were already being developed. In exchange for support for the electoral amendments, the ruling majority agreed to support the Kuchma amendments. The result was a combined voting process in December 2004 which passed both the electoral amendments and the Kuchma ones, a bill more properly known as the Law “On Amendments to the Constitution of Ukraine� (No. 2222). Shortly after, Viktor Yushchenko won the election46. In short, as a result of Law No. 2222, the president's power was reduced and the parliament's was increased. The amendments limited the president's powers by eliminating the office's ability to

45 46

Ibid. Ibid.


21 nominate the Prime Minister, a task which now fell to the Parliament. Likewise, the President could no longer appoint his/her entire Cabinet of Ministers with the exception of the Minister of Defense and the Foreign Minister. He/she could also no longer dismiss members of the Cabinet. However, he/she could now dissolve parliament, the logic being that if no parliamentary coalition could be formed to appoint a Prime Minister, the President would be able to call new parliamentary elections to remedy the situation. Unfortunately, the passing of Law No. 2222 did little to empower the rule of law in Ukraine. Although it was conceptually a step in the right direction, it fell short of its intended goals, creating an imbalance of power.47 According to the Venice Commission's Opinion on the 2004 Constitution, “a number of provisions, such as the rights of legislative initiative conferred on both the Cabinet and the President . . . might lead to unnecessary political conflicts and thus undermine the necessary strengthening of the rule of law [in Ukraine].”48 The Commission did, however, praise those amendments which “[increased] the parliamentary features of the political system.”49 The opinion of the Venice Commission proved correct. Following the 2006 parliamentary elections, when most constitutional amendments went into effect, Ukrainian politics were marked by “regular public conflict between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko, the blocking of the Constitutional Court, the early elections of the Verkhovna Rada, and the lack of even trying to find a consensus.”50 Attempts to declare these amendments unconstitutional and repeal them were stymied by political interests and institutional ineptitude. Calls for Law No. 2222 to be rendered actum nullum ab initio (act invalid from inception), such as those made by the Center for Political and Legal Reforms and the Ukrainian National Commission on Strengthening Democracy and the Rule of

47

Ibid. European Commission for Democracy through Law (Venice Commission), Opinion on the Constitutional Situation in Ukraine by Angelika Nussberger, et al. 2010, 3. 49 Ibid, 3. 50 Centre for Political and Legal Reforms. “Constitutional Development in Ukraine”. 48


22 Law, went unheeded. New Prime Minister Tymoshenko and her party wished to exploit and maintain the new powers of the Cabinet. Likewise, in 2007 a petition to the Constitutional Court was put forth by a group of parliamentarians hoping to render Law No. 2222 unconstitutional. The decision reached by the Constitutional Court in 2008 on this matter found that the new amendments had become “an integral part of the Constitution of Ukraine.”51 But constitutional change came yet again in 2010. In April of that year, 252 MPs from the parliamentary majority filed a constitutional petition to recognize Law No. 2222 as unconstitutional, echoing similar attempts made in 2007. This time, however, the Constitutional Court ruled differently. Despite the fact that since 2004, it had de facto recognized the amendments established in Law No. 2222 as legitimate, and despite its 2008 ruling of the amendments as constitutional, the Constitutional Court of Ukraine proclaimed that Law No. 2222 “On the Amendments to the Constitution of Ukraine” was unconstitutional. The previous 1996 incarnation of the Constitution was revived, diminishing the powers of Parliament and the Cabinet and expanding those of the President.52 If Ukraine's constitutional woes could be described in one word, that word would be “centralization”. Perhaps the most striking feature of the Ukrainian administrative system is that the President has the complete authority to appoint and remove regional governors (i.e. governors of oblasts). Throughout the years of constitutional reforms, never once was this ability removed from the President's executive powers.53 While it is true that each oblast has locally elected councils, these councils have no real say in who their governor will be.54 This type of structure creates a hosts of political problems. Because they are appointed by the President, regional governors have no real incentive to serve the people within their oblasts. They are loyal to the President, not the people.

51

Ibid. Ibid. 53 Roger Myerson, and Tymofy Mylovanov. “Fixing Ukraine's Fundamental Flaw,” Kyiv Post, March 7, 2014. 54 Roger Myerson. “A Call for Political Decentralization in Ukraine,” Huffington Post, March 5, 2014. 52


23 Likewise, because the President appoints individuals who will serve his/her interests, the pool of potential governors is limited to those whose views fall in line with that President. A homogeneous, selfserving political elite is put in power and reinforces itself. Real diversity of positions and views is nonexistent, a fact of which the Ukrainian people are sorely aware, putting little trust in their government as a whole. Further, while in healthy democracies local and regional governments give politicians experience and allow them to earn a reputation for competence that can serve as a springboard to national leadership positions, the centralized government in Ukraine makes competence hard to come by.55 Thus, when there is a void in experienced leadership – such as that which exists now – there is increased risks that presidential elections will bring in easily corruptible demagogues, potentially fueling a vicious cycle.56 The highly centralized nature of Ukrainian governance also explains regional and ethnic tensions in Ukraine, particularly the Russian annexation of Crimea and the potential desire for separatism in the Russian-heavy east. The centralized structure of Ukrainian government inherently disenfranchises citizens, especially those with minority interests. Russian-speaking populations in the less industrialized eastern Ukraine and the Crimea feel the central government is not listening to their concerns, or favor the concerns of the more developed, more ethnically Ukrainian west.57 The situation has allowed Putin's government in Russia to capitalize on the opportunity to increase its influence in the region.58 As such, not only does centralization threaten democracy and development, but it threatens the territorial integrity of Ukraine itself.

55

Roger Myerson, and Tymofy Mylovanov. “Fixing Ukraine's Fundamental Flaw,” Kyiv Post, March 7, 2014. Scott Gehlbach, Roger Myerson, and Tymofiy Mylovanov. “A Way Forward for Ukraine,” New York Times, March 19, 2014. 57 Timothy Frye. “Is Greater Decentralization a Solution for Ukraine? The Mylovanov Initiative,” Washington Post, March 5, 2014. 58 Scott Gehlbach, Roger Myerson, and Tymofiy Mylovanov. “A Way Forward for Ukraine,” New York Times, March 19, 2014. 56


24 Luckily, there are many in Ukraine who are attuned to these structural flaws, and aim to alleviate them through a process of decentralization. By amending the Constitution so that governors are elected locally (most likely by endowing the already existing local council with the power to choose their own governor), many of the problems of centralization would be diminished59. Even a quick executive grant of more power to the local councils would be a promising, and arguably more achievable, first step, while a constitutional amendment could come later.60 Support for such a proposal in Ukraine is growing. Strong voices that have shaped the discussion of a “decentralization initiative” include Tymofiy Mylovanov, a University of Pittsburgh economics professor, and the Nobel Prizewinning social scientist Roger Myerson, among others. Mylovanov and Myerson have put forth a petition calling for debate on decentralization that has been signed by over one hundred political scientists, economists and lawyers in Ukraine, Russia, the US and elsewhere.61 There is also strong support within Ukraine. A survey administered in Eastern and Southern Ukraine by the Kiev International Institute of Sociology in April 2014 found that 45% of those surveyed supported the notion of decentralization (25% supported federalization), while 68% supported the direct election of governors.62 Likewise, several Ukrainian politicians have expressed support for decentralization, including the deputy prime minister Volodymyr Groysman, and the mayor of the western city of Lviv, Andriy Sadovyi.63 The System Capital Management (SMC) company, a major Ukrainian financial and

59

Timothy Frye. “Is Greater Decentralization a Solution for Ukraine? The Mylovanov Initiative,” Washington Post, March 5, 2014. 60 Scott Gehlbach, Roger Myerson, and Tymofiy Mylovanov. “A Way Forward for Ukraine,” New York Times, March 19, 2014. 61 Roger Myerson, and Tymofy Mylovanov. “Fixing Ukraine's Fundamental Flaw,” Kyiv Post, March 7, 2014. 62 Zerkalo Nedeli staff. “The Views and Opinions of Residents of South-Eastern Ukraine: April 2014,” Zerkalo Nedeli, April 18, 2014. 63 Scott Gehlbach, Roger Myerson, and Tymofiy Mylovanov. “A Way Forward for Ukraine,” New York Times, March 19, 2014.


25 holding company centered in eastern Ukraine, has also issued a statement of support for decentralization.64 Certainly, decentralization has become a hotly discussed topic in Ukraine. Nonetheless, it should be approached cautiously. When assessing the democratic transition of post-Franco Spain, Al Stepan and Juan Linz used evidence to argue that when attempting to establish a strong democracy in unitary post-dictatorial states, it is important to hold national elections before holding regional elections. This more strongly ensures national commitment and reduces the risk of ethnic nationalism and possible secession.65 While identity politics in Ukraine are very different from those in Spain, it is still a lesson to be heeded. Taking into account the recent identity politics in eastern and southern Ukraine, allowing local councils to choose their own governors may run the risk of candidates making extreme appeals to their co-ethnics. However, the regions of Ukraine are likely large enough to provide some diversity of views.66 Another issue that could impede lasting decentralization is the ease with which it can be reversed. There is a tendency to assign the Constitution much more credit than it may deserve in terms of causing political problems. In general, politicians fail to subordinate themselves to the authority of the Constitution, and a political culture with such an entrenched history of disregarding the rule of law does not go away overnight. The greater public also has questionable respect for the Constitution as a binding document, an issue that will likely be resolved given the greater political integrity decentralization would theoretically bring.67 What this means is that it is not necessarily difficult for political elites to alter the structure of the government. Myerson warns of the possibility of

64

System Capital Management. “SCM Statement.” Scott Gehlbach, Roger Myerson, and Tymofiy Mylovanov. “A Way Forward for Ukraine,” New York Times, March 19, 2014. 66 Timothy Frye. “Is Greater Decentralization a Solution for Ukraine? The Mylovanov Initiative,” Washington Post, March 5, 2014. 67 Centre for Political and Legal Reforms. “Constitutional Development in Ukraine”. 65


26 “recentralization” after the fact of a decentralization. In this scenario, officials in the central government can use veto powers or general authority of command to nullify certain decisions made by regional governments. Likewise, it is not farfetched to envision officials appointed by the central government monitoring the decisions and budgets of regional governors. Such a development occurred in Russia during the 2000s with the notion of presidential representatives, who were endowed with the authority to check the legality of regional decisions. The result was a reduction in the powers of the regional authorities and a strengthening of the central government, that is, recentralization.68 However, with these risks in mind, the benefits Ukraine could see from decentralization in terms of growth, development, peace and democracy are numerous.

Judicial Policy While the executive and legislature are key areas of deficiency in the Ukrainian government, specific attention should also be paid to the problems of the judiciary as a whole, rather than simply the Constitutional Court. The court system is arguably the most corrupt state organ in Ukraine, and is frequently described as “rotten to the core.”69 In 2013, a Transparency International Global Corruption Barometer revealed that 66% of Ukrainian citizens saw the judiciary as the most corrupt institution in the country.70 Similarly, according to a survey issued by the Ministry of Justice in 2009, only 10% of respondents had faith in the national court system.71 Bribing is the norm, not just among business and political elites, but among the greater public as well. The same Transparency International report found that 21% of Ukrainian citizens admitted to bribing judicial officials.72 Further the conviction rate in 2012

68

Roger Myerson, and Tymofiy Mylovanov. “Advantages and Disadvantages of Polar Cases of Decentralization Reforms in Ukraine,” Zerkalo Nedeli, April 11, 2014. 69 Peter Byrne. “Moskal: 'Rotten to the Core',” Kyiv Post, March 26, 2010. 70 Ukrainian Week staff. “Transparency International Global Corruption Barometer: Ukraine Has Become More Corrupt over the Last Two Years,” Ukrainian Week, July 9, 2013. 71 Peter Byrne. “Jackpot,” Kyiv Post, March 26, 2010. 72 Ukrainian Week staff. “Transparency International Global Corruption Barometer: Ukraine Has Become More Corrupt over the Last Two Years,” Ukrainian Week, July 9, 2013.


27 was at 99.83%, with suspects often serving long periods of incarceration before their trials.73 This type of legal environment not only violates human rights, but stifles the rule of law. Further problems with the judiciary lie in the president's influence over it. Following the judicial reform of 2010, which consisted of adopting the “Law on the Judiciary and the Status of Judges”, almost the entire judicial system became dependent on presidential decisions. Among other things, the reform gave the president the ability to control the assignment, transfer, and dismissal of judges, which essentially amounts to control over their entire careers. It also allowed the president to indirectly control the judiciary's self-governing mechanisms by abusing deficiencies in an overcomplicated system.74 As such, judicial independence is lacking. The problems that plague governance in general – that is, the centralized power of the president – also plague the court systems. Since the developments in 2010, there has been several efforts to more meaningfully reform the Ukrainian judiciary. In July 2013, a draft law with a positive opinion from the Venice Commission entitled “On Enhancing the Guarantees of Independence of Judges” was submitted to parliament. It hoped to alleviate some of the problems of the 2010 reform, particularly by giving the Congress of Judges more independence and more power over their own affairs. However, while the draft law was generally supported by the parliamentary majority, the opposition opposed it and it fell short by 56 votes. As a result, the law was not passed. Months later, in November 2013, a similar draft law dubbed Law No. 3678 was proposed that also aimed to give judges more independence and agency. The draft law has been tabled due to the political crisis that arose in the same month following Yanukoych's refusal to sign the EU association agreement.75

73

Peter Byrne. “Jackpot,” Kyiv Post, March 26, 2010. Centre for Political and Legal Reforms. “Judicial Reform in Ukraine: Challenges and Recommendations”. 75 Ibid. 74


28 Ukraine is currently in a position to significantly reform its judicial sector and spur badly needed development. The new political situation that born from the Euromaidan protests and the ousting of Yanukoych's government gives rise to new political opportunities, not least the ability to adopt proposed laws that can help establish meaningful judicial change. The most notable of these is the aforementioned draft Law No. 3678, “On the Enhancement of the Judicial Self-Governance”, which should be adopted as soon as possible. In order to fully implement these changes, the members of judicial self-governance bodies must be reelected, and new presidents and deputies of courts need to be appointed. Likewise, draft Law No. 2522, “On Amending the Constitution” should also be immediately adopted. Developed and proposed in 2013, this law alters the Constitution of Ukraine itself and aims to reduce the judicial powers granted to the president in the 2010 judicial reform, most notably by limiting the president's judicial influence to only the appointment of judges, as opposed to the current setup in which he/she has control over the appointment, transfer and dismissal of judges. The adoption of this law would more strongly guarantee judicial independence. Likewise, certain previous judicial laws will obviously have to be abolished, particularly a law passed on 23 February 2014, immediately after the toppling of Yanukovych's regime, that gives parliament an undemocratic role in appointing judges. Further, other reforms must be considered, such as reforming certain aspects of the Constitutional Court to be in line with new laws, as well as developing a strong legal framework for the lustration76 of judges, which is necessary to boost public confidence in the national court system77. Ukraine must capitalize on its situation and make the necessary legal changes to ensure a strong, independent judiciary that has the confidence of the government and of the people.

76 77

Note: lustration is the regulation of the government participation of former Communists in post-Soviet states. Ibid.


29

Conclusion The obstacles to development in Ukraine are numerous and each present the government with unique policy challenges. For Ukraine to develop and reach its full potential, it will need to not only address these issues but comprehensively resolve them as well. Successive Ukrainian governments have made efforts to fix the problems at hand, however, their efforts have not amounted to any real change that would see Ukraine embark on a path toward true development. Despite such a bleak current outlook, Ukraine has the opportunity and the ability to restructure its ailing economic system and retool its political apparatus in order to bring about greater economic growth and prosperity. Particularly in light of fervor from the 2013-2014 protests, Ukrainian politicians may find that the appetite for reforms now is high. It is imperative that they act upon it quickly, for Ukrainians can hardly wait much longer as their country remains stagnant.


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The Post-Soviet Ukraine