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NATIONAL

SECURITY & DEFENCE ¹ 4 (40) 2003

Founded and published by:

UKRAINIAN CENTRE FOR ECONOMIC & POLITICAL STUDIES NAMED AFTER OLEXANDER RAZUMKOV

President Editor-in-Chief

Anatoliy GRYTSENKO Oleksiy MELNYK

This magazine is registered with the State Committee of Ukraine for Information Policy, registration certificate KB No. 4122 Printed in Ukrainian and English Circulation: 4,200 Editorial address: 46 Volodymyrska str., Office Centre, 5th floor, Kyiv, 01034 tel.: (380 44) 201-1198 fax: (380 44) 201-1199 e-mail: info@uceps.com.ua WEB-site: www.uceps.com.ua Reprinted or used materials must refer to the National Security & Defence The views expressed in this magazine do not necessarily reflect those of UCEPS staff

CONTENTS MARKET TRANSFORMATION OF POST-SOCIALIST ECONOMY AND MACROSTRUCTURAL SHIFTS IN UKRAINE (Razumkov Centre analytical report, Ukraine) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1. THE KEY INSTITUTIONAL FACTORS PERTAINING TO MACROECONOMIC SHIFTS IN UKRAINE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2. MARKET TRANSFORMATION POLICY IN UKRAINE: THE EFFECTS OF MACROSTRUCTURAL FACTORS . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3. MACROSTRUCTURAL SHIFTS IN THE ECONOMY OF UKRAINE IN THE CONTEXT OF INTEGRATION IN THE GLOBAL AND EUROPEAN ECONOMIC SPACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 4. CONCLUSIONS AND PROPOSALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

MACROSTRUCTURAL CHANGES IN POLAND UNDER MARKET TRANSFORMATION (Analytical report of the Institute of Strategic Studies, Poland). . . . . . . . . . . . . . . 42 1. POLICY FACTORS AFFECTING STRUCTURAL CHANGES IN THE POLISH ECONOMY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 2. COMPARATIVE ANALYSIS OF MACROSTRUCTURAL CHANGES IN THE ECONOMY OF POLAND, OTHER COUNTRIES UNDER TRANSFORMATION, AND ADVANCED COUNTRIES . . . . . . . . . . . . . . . . . . . . 49 3. PRODUCTIVITY CHANGE DURING MARKET TRANSFORMATION IN POLAND . . . . . . . .57 4. CONCLUSIONS AND PROPOSALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61 UKRAINE AND POLAND: GDP COMPARISON BY COMPONENTS . . . . . . . . . . . . . . . . . . . . 64

Photos: Ukrinform, cover; UNIAN pp.13, 37. Technical & computer support Anton Balitsky Layout and design Olexandr Moskalenko, Pavlo Voytenko

RAZUMKOV CENTRE ANALYTICAL REPORT

MARKET TRANSFORMATION OF POST-SOCIALIST ECONOMY AND MACROSTRUCTURAL SHIFTS IN UKRAINE A

Section one

Section two

Section three Section four

fter Ukraine's establishment as an independent state, its national economy saw fundamental changes. Their overall essence lay in the establishment of a market economy system based on the development of private ownership, enterprise and market competition. However, more than 11 years of market-oriented transformation brought very moderate results, in terms of growth of the national economic potential, international competitiveness and ability to satisfy the basic needs of the people. Moreover, many sectors saw rapid ruination of the development potential built up in the past, which brought a plethora of economic contradictions and mass impoverishment of broad strata of the population. Those processes continue to exert a negative influence on the prospects of establishment of a highly developed socially oriented economic system in Ukraine and the possibilities for the country's integration into the world and European economic structures. The problems of inconsistency between the high price paid and the losses, on the one hand, and the gains of reforms, on the other, have been in the focus of many analytical surveys and public discussion in Ukraine and abroad. Although today the critical importance of structural factors for market transformation of the economy is readily admitted, profound systemic analysis of macroeconomic structural proportions in this country has not yet been conducted. This bars clear identification of the most critical structural problems that should be solved in the first instance. This report is intended to analyse a set of macrostructural problems related to the process of market transformation of Ukraine's economy; a search for possible solutions; and grounding of relevant proposals for the Ukrainian Government's economic policies. The structure of this report is different from that of the report of Polish scholars also published in this magazine, which reflects the different stages of the process of transformation in Ukraine and in Poland and the related difference in priorities of structural transformations. Those differences however do not prevent us identifying the general laws of structural transformation formulated in the conclusions of this report. The analytical report consists of four sections*. analyses the key institutional (political and economic) factors of macroeconomic structural shifts and their impact on the development of market transformations, including analysis of the political processes that influence structural reforms in the economy, privatisation, competitive environment, development of small and medium business. reveals and systematises the processes taking place in the institutional sectors of the economy and distribution of income among them, analyses sector structural shifts in the economy under the influence of transformational processes, identifies structural reasons for the protracted transformational crisis in the country and reviews social consequences of structural transformation and the effects of differentiation of income on structural economic shifts. analyses structural problems related to Ukraine's integration into the world and European economic space. provides general conclusions and formulates proposals aimed at improving state regulation of the economy in the process of market transformation. The materials received by the parties to the PAUCI project are published in the short form. They will be published in full in a joint monograph of the Razumkov Centre and the Institute of Strategic Studies set to be published in 2003.

* Separate sections of the report were written by: V.Sidenko (1.2, 3.1 and 3.2), B.Kvasniuk (1.3), I.Kriuchkova (1.4, 2.1 and 2.2), Ò.Shynkorenko (2.2), V. Bevz (2.3). Insert comparing the GDP of Poland and Ukraine À. Revenko.

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1. THE KEY INSTITUTIONAL FACTORS PERTAINING TO MACROECONOMIC SHIFTS IN UKRAINE O

n the eve of market transformations in Ukraine, the instruments of planned state regulation of the economy were dismantled in absence of effective governance, political consolidation of society and set rules of market behaviour. In such a situation, subjective decisions taken on the level of state government bodies and a number of certain strong business entities that held a monopoly position on the market acquired decisive importance. I.e., a situation arose where state bodies and separate business entities appeared in an ideal situation for obtaining rent-type incomes1. Therefore, the formulation and implementation of the policy of economic transformation, as well as structural shifts in Ukraine's economy were often subordinated not to national interests but to the interests of a limited circle of business entities close to the authorities. This led to sharp social stratification, impoverishment of the majority of citizens, which squeezed domestic demand, magnified structural distortions in the economy and maintained priority development of its export-oriented (low-tech) branches. As a result, Ukraine saw the beginning of formation of an economic model inherent in third world countries2. This section analyses the impact of the key political and institutional political and economic factors on macroeconomic structural shifts.

1.1 POLITICAL FACTORS OF ECONOMIC TRANSFORMATION IN UKRAINE

Constitutional fundamentals of the system of state governance

On June 28, 1996, the Verkhovna Rada passed the Constitution, which brought both positive and negative consequences for the socio-political and socio-economic development of the country3. In particular, the Constitution fixed the unbalanced character of the system of state governance. This, in the first place, caused a permanent political conflict between the branches of power for the re-division of powers; second, impaired the influence of Parliament on the formation of the Government and, therefore, actually deprived society of legitimate levers of influence over the executive branch, rendering Parliament ineffective or incapable in the discharge of some functions, including the oversight function.

Before June, 1995, Ukraine lived under the amended Constitution of the Ukrainian SSR. The division of powers between Parliament (the Verkhovna Rada) and the President was unworkable; the lion s share of powers was actually vested in Parliament. The Constitutional Agreement On the Fundamentals of Organisation and Functioning of State Governance and Local Self-Administration in Ukraine till the Adoption of the New Constitution of Ukraine passed in June, 1995, heralded the re-division of powers in favour of the President.

The excessive presidential influence on Parliament is particularly promoted by the existing mixed (majoritarianproportional) election system through the employment

This subsection reviews the political factors that exert substantial influence on the process of economic transformation in Ukraine, such as the authority of the branches of power, the nature of relations between them, the role of political parties in the formulation and implementation of state policy, the authorities skill of strategic state management, and the effectiveness of the system of state governance in general.

Verkhovna Rada. The main feature of Ukraine s Parliament is the absence of any official status of the parliamentary majority granting it the constitutional right to form the Government and appoint the Prime Minister. Furthermore, the process of political structuring of Parliament is taking place under direct or indirect pressure of the President intended to ensure loyalty of the supreme legislative body to the head of state4.

1 Incomes whose origin is attributable to the natural limitation of specific production factors, as a result of which their use brings additional income (economic rent). 2 This problem is examined in more details in Section 2 of this Report. 3 The periodic history of the establishment of parliamentarism in Ukraine almost coincides with the stages of the economic crisis as given in Section 2. For more details on the stages of development of parliamentarism in Ukraine see: Parliament in Ukraine: the Trends and Problems of Establishment. Razumkov Centre analytical report. National Security & Defence, 2003, No.2, pp.2-29; http://www.uceps.com.ua. 4 For more details see: The Opposition in Ukraine. Razumkov Centre analytical report. National Security & Defence, 2002, No.7, pp.2-43; http://www.uceps.com.ua.

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of the local administrative resource during the preparation and conduct of elections, as well as at formation of deputy factions and groups. The existing system of formation of the deputy corps impedes the formation of a constructive majority and an effective system of lobbying political decisions and economic projects in the Verkhovna Rada. The President. Formally, pursuant to Article 85 of the Constitution of Ukraine, the definition of the fundamentals of domestic and foreign policy is vested in Parliament. Furthermore, Parliament approves the Programme of Action of the Cabinet of Ministers that provides for the implementation of the national domestic and foreign policies.

it is normally attained through individual and collective agreements between parties, their parliamentary factions and the President. There are also no effective legal mechanisms of political responsibility by parties and their blocs to voters, no system of feedback between voters and political parties (blocs) represented in Parliament. Some parties represent the interests of not social but financial-political groups. By and large, in Ukraine, political parties do not exert significant influence on the structuring of society or formulation and implementation of the state policy, and therefore bear no responsibility to voters for the results of their activity.

Effectiveness of the system of governance

However, in reality, the political course of the state, including definition of the fundamentals and guidelines of transformation of Ukraine s economy, is almost entirely decided by the President, since the range of his constitutional powers gives him full control of the executive branch from the Cabinet of Ministers down to local state administrations (formally not subordinate to him). Therefore, given the weak judicial branch and unstructured Parliament, the presidential office acquires exceptional significance in the system of state governance5.

The system of governance in Ukraine is ineffective. Socio-economic indicators prove this. For instance, in 1990-1999, Ukraine witnessed a decline in industrial and agricultural production. Over 1992-1999, the national external debt increased more than 30-fold. There are estimates that some 70% of citizens live below poverty line8. Wages are paid in arrears; as of January 1, 2003, the total arrears exceeded UAH 2.3 billion; the debt per employee amounts to UAH 837, which is 2.2 times higher than the monthly average wage in the national economy9.

The Cabinet of Ministers. Pursuant to the Constitution of Ukraine, the Cabinet of Ministers is the highest body within the executive branch. However, as we already noted, the Government is actually directed not by the Prime Minister but by the President while the latter remains legally not responsible for the results of the Government s activity. The Law of Ukraine On the Cabinet of Ministers has not been passed (the President has vetoed it eight times now), which makes it impossible to specify the powers of the Government and the list of issues falling under its competence, and therefore renders it irresponsible for the situation in society and in the economy. Such uncertainty makes the Cabinet of Ministers overloaded with secondary issues and significantly lowers its effectiveness. In Ukraine, the Government is actually an instrument of implementation of the presidential political course, it does not rely on the support of a stable parliamentary majority (coalition), and the Cabinet of Ministers Programme is in essence largely a formality6.

The actions of executive bodies show cases where the old administrative-command style of management reemerges, and the state unjustifiably interferes into the activity of economic entities, which hinders the development of enterprise in Ukraine. Some business entities, first of all, those close to the authorities, are granted unjustified privileges. The management of state property is ineffective; as a result, the huge production potential works for the interests of separate financialindustrial groups rather than for society. A significant sector of the economy remains grey .

Political parties. The absence of a constitutional provision for Government formation by the political parties elected to Parliament and the creation of majority there explains the poor influence of political parties on the process of formulation and implementation of the state policy by the executive bodies7. Hence,

The administrative system generally operates in a non-transparent manner. There is no effective public control of the authorities activity. This creates favourable conditions for progressing corruption rooted in the state machinery, which undermines the economic fundamentals of the state, blocks investment activity, and hampers economic reforms10. Therefore, the system of governance in Ukraine is ineffective and unable to ensure implementation of economic reforms to the benefit of entire society. On the contrary, the non-transparency of the authorities, domination of the corporate and group interests over the national ones, the high level of corruption hamper the process of market transformation in Ukraine.

For more details see: Ibid. None of the resigning Ukrainian governments reported about the fulfilment of its programme, and the Programme of Action of the Government of V.Pustovoitenko, who worked as Prime Minister for two years, was not approved at all. 7 For more details see: Ukraine s Political Parties on the Eve of Parliamentary Elections: the Present State and Trends. Razumkov Centre analytical report. National Security & Defence, 2001, No.12, pp.15-60; http://www.uceps.com.ua. 8 For more details see: Administrative Reform in Ukraine: Will It Be Possible to Break the Closed Circle? Razumkov Centre analytical report. National Security & Defence, 2000, No.5, pp.4-18; http://www.uceps.com.ua. 9 See: Address of the President of Ukraine to the Verkhovna Rada On the Internal and External Situation of Ukraine in 2002 . http://www.president.gov.ua. 10 For instance, according to Deputy State Secretary of the Ministry of Internal Affairs of Ukraine Ì.Korniyenko, in 2001 every tenth state official in Ukraine was brought to account for corruption. See: http://www.grani.kiev.ua/2001/text/42/News_week19L_ukr.htm. 6

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Formulation of the strategy of socio-economic transformation

Those deficiencies rule out concentration of resources, render strategic documents unrealistic, make the reformist measures ineffective, create preconditions for other-than-intended use of funds, lead to the lack of public trust in the state policy.

Despite the existing regulatory base (Insert Regulatory-legal fundamentals of strategic planning of state policy in Ukraine ), the state lacks not only an effective but any integral system of strategic planning whatsoever11.

The most troubling result of the above-mentioned deficiencies lies in the removal of the public from the processes of transformation, specifically lack of public support for the authorities, including on the economic reform. According to the figures presented in Diagrams Assessment of economic reforms taking place in Ukraine and Level of public support for the authorities in Ukraine 15, the overwhelming majority of Ukraine s citizens view economic reforms as a gradual irreversible

REGULATORY-LEGAL FUNDAMENTALS OF STRATEGIC PLANNING OF STATE POLICY IN UKRAINE v

Constitution of Ukraine;

Regulations of the State Scientific and Scientific-Technical Programme approved by the Cabinet of Ministers Ukraine Resolution No.796 of October 10, 1995 (partially); v

v Budget Code (adopted on June 21, 2001; defines the consequence of the processes of forecasting and development of programmes and budgets on the state and regional levels); v Law of Ukraine "On State Forecasting and Development of Programmes of Economic and Social Development of Ukraine" (of March 23, 2000); v departmental documents defining the structure and functions of departments of central executive bodies (dealing with participation in the development of conceptual, strategic and programme documents).

None of the regulatory-legal documents, whether individually or in their totality, contain an integral mechanism for drafting strategies and programmes of national socio-economic development12. According to expert estimates, the present system of state policy planning in Ukraine results from spontaneous combination of Soviet-style state plans and party programmes, largely declarative and not correlated with resource limitations, with formation of annual plans (Government s Programmes of Action) based on tactical budget priorities13. The priorities and guidelines of national development are set by strategic state documents, branch, intersectoral and state target-oriented programmes, concepts and strategies (the total number of state programmes hits 260). Specific of all those documents are: poor connection with one another (or total lack of such connection); too wide range of development priorities; lack of balance between the plans of events; detachment from the real conditions and resource limitations. This results in the poor performance of the decisions taken14, frequent revision of strategic priorities (a showy example is demonstrated by the declarations of the state leadership of its desire to join the EU and practical steps aimed at creation of the Single Economic Space with Russia, Belarus and Kazakhstan in absence of a deep and comprehensive substantiation of the two policies). 11 The previous system was officially removed by the adoption of the Law of Ukraine On the Budget System on December 5, 1990. Meanwhile, its portion accessible to the Government of Ukraine as a union republic of the USSR mid-term forecasting and formulation of budget proposals for the following year was preserved (the function of setting strategic goals was vested in Moscow). 12 Amendment of the Law of Ukraine On State Forecasting and Development of Programmes of Economic and Social Development of Ukraine or draft of a new document (documents) to define that mechanism are pending. 13 By the results of the projects Institutional Capacity to Develop Economic Programmes performed by the International Centre for Policy Studies and the Ministry of Economy and European Integration of Ukraine as part of the Canadian Policy Advice for Reform Programme (PAR). See: Information Bulletin of the International Centre for Policy Studies, No.155, June 24, 2002. http://www.icps.com.ua/docs/nl/full/eng/nl_eng_20020624_0155.pdf. 14 Conceptual State and National Development Programmes are permanently being developed for some branch in Ukraine but the coefficient of implementation of those programmes is no more than 10% . Interview of the people s deputy of Ukraine Ukraine V. Kyrylenko for the LIGA Centre, February 21, 2003. http://www.liga.kiev.ua. 15 Cited hereinafter are the results of sociological surveys conducted by Razumkov Centre. All-Ukrainian surveys are representative of Ukraine s adult population by the basic socio-demographic indicators. The sample encompassed some 2,000 persons.

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collapse of the economy (36.1%) or poorly controlled process of re-distribution of state property imitating reforms (34.8%) rather than a planned process of reforming the economy (2.8%). It is noteworthy that the number of citizens producing negative assessments was increasing even in 2001-2003 the period when Ukraine witnessed improvement of the key economic and socio-economic indicators. The dissatisfaction and disappointment with the economic reforms naturally affects the level of support for the central authorities, going down in 2000-2003. The continuation of such tendencies may lead to the complete loss of public interest to participation in the processes of economic and political transformation. Therefore, the system of governance in Ukraine is unbalanced and ineffective. Over the period of transformation, it failed to manifest its ability (and desire) of strategic planning and effective implementation of economic reforms. The authorities remain closed for the public, which, combined with the high level of corruption, hinders the processes of market transformation in Ukraine and deprives them of public support.

1.2 PROGRESS OF PRIVATISATION IN UKRAINE At the beginning of the market transformation of Ukraine s economy it was suggested that privatisation would make the basis for greater freedom of enterprise and implementation of competitive principles, which, in turn, would lead to the creation and maturity of a strong middle class, rapid accumulation of capital in the hands of effective owners and resultant economic modernisation of the country. However, privatisation, as effected in Ukraine, did not and could not lead to the formation of a numerous middle class as the main actor of market relations and democratisation of society, capitalisation of enterprises as the basis for economic growth, the appearance of effective owners and the arrival of strategic investors in Ukraine. This subsection deals with the forms and methods of privatisation in Ukraine, the reasons for its ineffectiveness and the present trends in privatisation.

Forms and methods of privatisation

In course of denationalisation , the managers of state enterprises were given a free hand in the pricing policy, choice of suppliers and markets, decision on the structure of production going beyond the limits of the state order, and distribution of profit. Various methods of privatisation were established by the law, dependent on the enterprise size, their state, possible ways of payment and types of buyers. The most spread variant of early privatisation presumed leasing of state enterprise property (with further buy-out or free transfer into ownership). Judicially, that strategy was implemented through the introduction of so-called collective enterprises or closed joint-stock companies, employees of such enterprises being their members. However, in 1997 that form of privatisation was prohibited, except for the privatisation of small enterprises. Statistically, the growth of the non-state sector in Ukraine over the years of transformation is impressive (Tables Ownership reform structure by kind of economic activity , p.7, and Number of entities that changed the type of ownership by kind of economic activity and method of privatisation , p.8)17. In the course of privatisation through leasing involving buyout and through the mechanisms of sale at certificate auctions, stocks (shares) of enterprises were scattered among a great number of people, which did not help attract strategic investors. As a result, in 1997 the privatisation policy was altered to provide in the first place for the sale of enterprises subject to privatisation through commercial and non-commercial tender. Since the hyperinflation of 1992-1994 in fact erased the savings of the population seen as the main financial source of cash privatisation, the overwhelming majority of citizens were barred from privatisation, and its pace was too slow. Hence, despite the change of the form of privatisation, its true effectiveness remained poor and the role of privatised enterprises in economic growth questionable (Table Share of entities that changed the type of ownership in total output [works, services] )18. Food processing, textile and some other sectors were the few exceptions.

In Ukraine, privatisation began on the basis of a number of laws passed in 199216 that provided for the small privatisation (i.e., the sale of small state-owned enterprises, mainly in the sphere of trade and services) and big privatisation .

In many cases privatisation led only to a formal change of the enterprise status. They largely continued to operate as state-owned, with ineffective development and marketing strategies, lack of investments, wage arrears, etc. They remained critically dependent on state subsidies and other state protection measures.

As in many other countries of the world, privatisation in Ukraine was preceded by the process of so-called corporatisation and commercialisation (together often referred to as denationalisation ) of state enterprises that transformed enterprises into joint-stock companies, which for a while remained under state control, weakening with time. Later, a part of their shares was offered for sale thus beginning privatisation as such.

Privatisation in Ukraine in the first place became a means of redistribution of public wealth, not of accelerated formation of capital necessary for fundamental structural modernisation and an increase in the competitiveness of the economy. The process was not only unfair and non-transparent but in many cases accompanied with gross violation of applicable laws. Quite often, privatisation only provoked the flight of

The Laws of Ukraine On Privatisation of State Property of March 4, 1992, On Privatisation of Small State-owned Enterprises (Small Privatisation) of March 6, 1992, On Privatisation Papers of March 6, 1992. 17 See: The Address of the President of Ukraine to the Verkhovna Rada On the Internal and External Situation of Ukraine in 2002 . http://www.president.gov.ua. 18 Ibid.

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PROGRESS OF PRIVATISATION IN UKRAINE

Ownership reform structure by kind of economic activity, % Total Economy in general, including:

100.0

Years 1994

1995

1996

1997

1998

100.0

1999

2000

2001

2002

100.0

state ownership

27.0

33.1

25.3

23.2

22.1

31.4

28.8

30.8

26.0

23.9

municipal ownership

73.0

66.9

74.7

76.8

77.9

68.6

71.2

69.2

74.0

76.1

Agriculture, hunting and forestry

4.0

2.7

4.2

6.9

5.8

3.4

2.2

2.5

1.2

1.1

Fishing

0.1

0.0

0.2

0.1

0.0

0.1

Industry, including:

9.7

17.2

12.4

8.9

6.4

7.6

4.3

4.6

5.2

6.1 0.2

mining and quarrying

0.2

0.1

0.4

0.1

0.2

manufacturing

9.3

17.0

12.2

8.7

6.0

7.1

4.1

4.4

4.5

5.0

electricity, gas and water supply

0.2

0.0

0.1

0.3

0.1

0.5

0.9

Construction

4.2

8.4

4.5

4.4

3.3

2.4

2.1

2.0

1.9

Wholesale and retail trade; repair of motor vehicles, motorcycles and personal goods, including:

39.8

35.7

44.5

42.0

39.1

44.9

39.4

32.5

38.6

38.5

trade in transportation means and repair thereof

0.2

0.1

0.0

0.1

1.1

0.9

wholesale trade and mediation in trade

4.2

3.2

3.7

3.2

9.0

3.8

3.6

6.4

6.5 31.1

retail trade in household appliances and repair thereof

35.4

32.4

40.8

38.8

35.9

35.5

28.9

31.1

Hotels and restaurants

7.2

7.5

8.1

7.4

6.4

5.3

6.6

6.9

7.9

7.5

Transport and communication

2.0

2.3

2.2

2.8

1.4

0.9

0.8

2.2

2.6

Financial intermediation

0.2

0.0

0.1

0.3

0.2

0.3

0.9

0.7

Real estate, renting and business activity

9.4

3.0

2.9

7.3

11.3

16.1

15.5

19.8

20.3

Public administration

1.1

0.1

0.6

2.8

3.5

2.4

2.9

0.5

Education

0.6

0.1

0.4

0.6

0.7

1.2

1.7

1.5

Health and social work

0.8

0.2

0.4

0.3

0.9

1.4

1.6

2.1

16.7

22.7

20.2

18.0

16.0

11.5

14.8

14.9

7.5

7.9

4.2

0.4

0.3

1.5

4.3

6.6

8.2

13.7

11.1

9.2

Community, social and personal service activities Construction in progress projects

Share of entities that changed the type of ownership in total output (works, services), % 1996

1997

1998

1999

2000

2001

Industrial output*

38.8

51.1

57.0

55.5

58.3

55.3

53.9**

Fixed capital investments made

12.5

14.1

14.9

15.2

19.4

18.8

23.4**

Commissioned residential buildings

2002

8.5

9.3

7.4

8.2

6.3

5.6

Volume of performed research and R&D works

15.5

17.1

15.1

13.3

12.6

13.3

13.7*

4.0**

Freight delivered to customers by motor vehicles

39.0

51.3

56.2

55.2

58.4

49.4

41.2

Passengers trasnported by motor vehicles

25.6

57.3

73.8

71.6

63.3

61.1

58.8

Retail trade turnover of enterprises - retail trade

32.9

28.6

26.5

23.1

20.9

18.7

15.6*

- restaurant business

31.9

30.4

25.5

21.7

18.9

15.0

13.7*

22.2

26.2

25.1

24.6

24.1

22.2

21.2

For reference: employment rate

* Starting from 2001, the data are cited after the Classification of Kinds of Economic Activity (CKEA). ** Data for January-September, 2002.

capital abroad and non-productive employment of funds. This to a large extent explains why even today, after several years of economic growth, the rate of gross fixed capital formation in the economy is only a third of the 1990 level.

Respectively, Ukrainian citizens are largely critical in their assessment of the results of privatisation (Diagram Assessment of the influence of privatisation on the development of Ukraine s economy 19, p.8). Only 13.2% of citizens view the influence of privatisation as more or less positive; the overwhelming majority of the polled produced negative assessments.

The Ukrainian model of privatisation left the majority of the population without savings and proceeds from property (its share in the GDP is very low and differentiates still more than income from work). By and large, the main goal of privatisation formation of a numerous strata of effective owners was never attained.

The reasons for the meagre effectiveness of privatisation in Ukraine The meagre effectiveness of privatisation in Ukraine is attributed to a tangled set of various external (inflow of investments, participation of foreign investors in

19 Cited are the results of the survey conducted as part of the PAUCI project. The poll was held on April 2-7, 2003. 2,013 respondents aged 18 years and above were polled in all of Ukraine s regions.

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THE KEY INSTITUTIONAL FACTORS PERTAINING TO MACROECONOMIC SHIFTS IN UKRAINE

Number of entities that changed the type of ownership by kind of economic activity and method of privatisation, as of 01.01.2003 Total

Economy, in general Agriculture, hunting and forestry Fishing Industry, including: mining and quarrying manufacturing electricity, gas and water suppy Construction Wholesale and retail trade; repair of motor vehicles, motorcycles and personal goods, including: trade in transportation means and repair thereof wholesale trade and mediation in trade retail trade in household appliances and repair thereof

% of the total number

Share of the privatisation method, % Buyout Buyout Buyout Auction Sale Sale Sale of privati- of objects of leased sale at nonat of shares sation under property commercial commercial of open objects an altertender tender joint-stock native companies plan

83,953

100.0

44.8

0.6

18.8

15.8

2.6

5.0

12.4

3,336

4.0

52.3

0.6

1.7

2.3

0.2

0.6

42.3

0.1

26.8

2.5

70.7

8,126

9.7

17.7

0.3

19.4

5.2

1.4

2.1

53.9

126

0.2

12.7

13.5

25.4

0.8

7.1

40.5

19.8

4.7

1.5

1.9

54.5

6.0

15.6

1.2

6.6

34.1

7,833

9.3

17.3

0.3

167

0.2

36.5

3,517

4.2

23.8

0.4

24.8

5.8

2.0

2.1

41.1

33,453

39.8

47.7

0.4

23.0

15.6

2.8

5.8

4.7

144

0.2

50.0

0.7

29.2

13.2

2.1

3.4

1.4

3,553

4.2

27.9

0.4

20.6

10.5

1.1

2.7

36.8

29,756

35.4

50.0

0.4

23.3

16.3

3.0

6.1

0.9

Hotels and restaurants

6,090

7.2

44.9

0.3

27.7

17.6

3.1

5.7

0.7

Transport and communication

1,705

2.0

18.3

0.2

11.1

7.3

0.5

2.3

60.3

194

0.2

67.5

0.5

16.5

6.7

0.5

5.2

3.1 4.6

Financial intermediation Real estate, renting and business activity

7,882

9.4

56.2

1.0

13.7

17.8

2.2

4.5

Public administration

905

1.1

73.7

0.9

7.3

12.7

1.2

3.7

0.5

Education

519

0.6

40.3

1.1

7.3

40.3

3.5

6.7

0.8

Health and social work

22.0

2.2

3.3

1.5

644

0.8

55.0

0.2

15.8

Community, social and personal service activities

14,040

16.7

57.3

0.9

16.8

13.0

4.0

7.2

0.8

Construction in progress projects

3,501

4.2

22.4

0.2

0.7

70.1

2.2

4.3

0.1

unofficial component. At that, state-owned enterprises formally remained under state control, but in reality due to the dramatic weakening of state control were not only arbitrarily managed by their directors but the distribution of their profit was largely subordinated to the interests of their executives. Meanwhile, the losses from the activity of such enterprises overburdened the budget and brought problems for the state (but not for concrete officials).

privatisation) and internal (economic, social, legal, etc.) factors. The following may be cited as the main ones. The large-scale substitution of official (legislatively regimented) privatisation with unofficial privatisation and subordination of the general process of privatisation to its

RAZUMKOV CENTRE

High level of monopolisation in the economy at the initial stage of privatisation. The effectiveness of privatisation appeared strongly dependent on the rate of monopolisation in one or another sector. At that, the transfer of property to the private sector in the so-called strategic branches was accompanied with the actual transfer of the title to receive economic rent. This presented a huge stimulus for the new owners to avoid structural modernisation of their enterprises in order to appropriate super-profit obtainable due to their monopoly status and the limitations of natural resources. For instance, the privatisation of regional power distribution companies has led not to an increase but to a decrease in their efficiency, since for natural reasons it

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ABSENCE OF A COMPETITIVE ENVIRONMENT

Today, a new approach to privatisation should be found to turn it from a factor of retardation into an effective instrument of progressive structural changes. In particular, the process of privatisation should incorporate a strategic view of the prospects, competitive principles and social priorities. However, the new approach is unlikely to be attained within the framework of the distorted and corrupt system of state and local governance that has not yet seen a true change-over as part of the political and administrative reforms.

could not remove the natural monopolisation in that sector and only complicated the management of the previously integrated system20. Too great a role of leasing with buyout at the initial stage of privatisation. As a rule, this involved establishment of collective enterprises and closed joint-stock companies where the process of privatisation was easily subordinated to the interests of their top executives. In the post-privatisation period, such enterprises usually failed to find strong outside investors, and the internal policy of their executives often was aimed not at resolute restructuring but at pressing out small rank-and-file co-owners and assumption of complete control of the enterprise. Paradoxically, the decrease in the effectiveness indicators of such an enterprise was often in line with that goal.

1.3 ABSENCE OF A COMPETITIVE ENVIRONMENT A competitive environment presents one of the key preconditions for the effective operation of the market. As a result, the removal of monopolisation, both inherited from the earlier system and the new one, predominantly based on inequality in access to state resources and political power, posed a serious problem of Ukraine s economy in the conditions of transformation22.

Noteworthy, Ukraine knows few examples of mergers and acquisitions of enterprises resulting in the establishment of more effective and competitive economic entities, typical for the present-day world economy. The transactions of enterprises with portfolio investment instruments (shares, bonds) are also minimal, which hinders the flow of capital into more productive and promising branches.

This subsection gives a brief description of the rate of monopolisation at Ukraine s markets and describes the main factors that hinder competition and the development of competitive environment in Ukraine.

The level of monopolisation on Ukraine s markets

Non-transparency of the privatisation process. The privatisation procedures were not only non-transparent but actually ruled out true competition in the acquisition of state property. The privatisation rules often have been formulated arbitrarily, under the influence of various informal politico-economic groupings. This also hinders the appearance of effective owners.

Today, the share of monopolised sectors of economy in Ukraine s GDP hits 40%. In 2002, 4,561 business entities had a monopoly standing on 6,640 commodity markets. 348 of them were active at 562 national, 4,138 at regional commodity markets23. Monopolist trends were especially evident in the sphere of primary resources of production, where the prices far exceed the level attainable in the conditions of a true competitive environment and determined by the actual production cost.

Limited involvement of outside investors. In contrast to countries in transition of Central and Eastern Europe (CEE), the involvement of outside investors in the processes of privatisation in Ukraine was rather limited. The few exceptions were Ukraine s food-processing industry (in particular, confectionery), production of tobacco products and beverages.

The greatest remaining problem is the introduction of competition in the sphere of natural monopolies (especially energy and transport). The substantial indicators of the energy and transport sectors (in particular, their shares in gross value added)24 point to monopoly high prices rather than to the dynamic growth in those sectors25.

The Russian capital took the most active part in privatisation in Ukraine, resorting not only to open but also to covert mechanisms of control. The Russian capital plays a noticeable role in the petroleum industry, production of alumina and some other sectors and branches of the modern Ukrainian economy.

Factors impeding competition Imperfect taxation and pricing systems. There is a practice of artificial creation of competitive advantages (through preferences, in particular, in taxation, or increasing tax pressure on potential competitors) for some economic agents or some sectors of the economy, which leads to monopolisation of the relevant market sectors. Manifest examples are offered by the tax reduction for the enterprises involved in an experiment in the

Detachment of privatisation from the process of related changes in other sectors of the institutional environment. The formal privatisation process, despite its moderate character, went far ahead of the institutional changes in the enterprise management and state governance system, creation of the market infrastructure and implementation of the necessary legal norms21.

20 For more details see: Concept of the State Energy Policy of Ukraine through 2020 (Razumkov Centre s Draft). Razumkov Centre 2001, Kyiv, 2002, pp.400-453; http://www.uceps.com.ua. 21 See Golikov V. Transformation of the Model of Ukraine s Economy (Ideology, Controversies, Prospects). Ed. by V.Heyets. Kyiv, 1999, pp.291-292 (in Ukrainian). 22 Ukraine s practice shows that a monopolist needn t to be a big corporation. It may be a company of any size whose activity bars or restricts competition. This may occur as a result of seizure of sources of raw materials and markets, as well as conclusion of various types of portfolio agreements between two or more companies intended to press rivals out of the market and divide it between themselves. 23 As of January 1, 2002. See: Antimonopoly Committee of Ukraine. Annual Report for 2001. Kyiv, 2002, p.9. 24 Those issues will be reviewed in more details in Section 2 of this Report. 25 For more details about monopolisation and problems of its removal from the energy sector see: Concept of the State Energy Policy of Ukraine through 2020 (Razumkov Centre s Draft). Razumkov Centre 2001, Kyiv, 2002, pp.400-453; http://www.uceps.com.ua.

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THE KEY INSTITUTIONAL FACTORS PERTAINING TO MACROECONOMIC SHIFTS IN UKRAINE

mining and metallurgy complex or creation of preferential conditions for AvtoZAZ-DAEWOO JV with simultaneous restriction of the age of vehicles importable to Ukraine and the increase in import tariff thereon. There is some dependence between the rate of monopolisation of separate market sectors and the level of tax pressure on them. What strikes the eye is that the sectors enjoying preferential taxation procedures include trade, financial intermediation, real estate transactions and services for legal entities. This points to the imperfection of the existing taxation system, which often leads to unjustified tax discrimination, distorts the process of pricing and encourages tax-evasion schemes. Such factors (especially in the financial intermediation sectors) prevent the creation of conditions for balanced price formation; and hinder economic growth and attainment of acceptable macroeconomic structural proportions. At the same time, as well as many European countries, Ukraine retains rather primitive approaches to the establishment of the ceiling of prices of separate goods and services of the natural monopolies (the basic price is simply indexed in accordance with the inflation rate). Under such pricing system, the goal of effective price regulation cannot be attained. Lack of proper state control. Since the liberalisation of prices in 1992 and commencement of the general deregulation of the economy, the monopolisation of Ukraine s market shows a strong upward trend. The monopoly enterprises, freed from state control of prices, got an opportunity of setting monopoly high prices of their products, while the issues of restructuring of the market for encouraging competition at the initial stages of privatisation were not even raised. As a result, the former state monopolies were replaced by privatised monopolies free of effective state control. Alongside with the overstatement of prices, monopoly enterprises began to widely resort to nonprice forms of discrimination of consumers (supply of low-grade products, delay of shipment of and payment for raw materials, components, etc.). Enjoying some advantages in the payment for the services of corrupt state officials, as compared to consumers, they monopolised one more market of services at release from state control. Poorly thought out foreign trade policy of Ukraine. Accelerated liberalisation of foreign trade and pricing promoted the growth of monopolist tendencies in export-oriented sectors, first of all, in the energy sector, metallurgy and transport. The share of those sectors increased unreasonably, they obtained an opportunity to raise prices and tariffs for their goods and services more than other branches. Legal, organisational and administrative restrictions on the entry of new capital to markets and free movement of goods and capital inside the country26. Today, such restrictions pose the main obstacle for fair competition, since they lead to an artificial decrease in the number of companies in profitable sectors of the economy and encourage monopolisation of production, trade and financial activity. 26 27 28

The most dangerous are administrative restrictions for the entry of new capital to markets and movement of goods and capital inside the country, for instance: the practice of administrative restriction (including covert, unofficial) of the movement of goods and capital across internal (regional, district) borders, unequal access to infrastructure facilities; regionalisation of commodity and financial markets, especially in extreme forms of administrative prohibition of import or export of goods. Actual absence or insignificance of bankruptcies (market exit) preventing natural market selection of firms by the profit/loss indicator. One should admit however that in Ukraine, losses of a company do not always present a reliable criterion for the assessment of its market standing, since formal un-profitability often points to conscious overstatement of costs, distortion of financial accounts of an enterprise or marketing of goods for unaccounted cash. Furthermore, quite often the administration covertly resorts to the bankruptcy procedure to ensure illegal cheap privatisation of an enterprise. Criminalisation of business. There is monopolisation of markets by some intermediary organisations that often act outside of the law and operate grey (or even criminal) capital (agribusiness, coal mining, metallurgy, etc.) and do not admit new companies to one or another market. The connection of such organisations with regional and local authorities spread in Ukraine is especially dangerous. The activity of criminalised intermediary organisations leads to the distortion of the competitive environment and shrinkage of the market, where the freedom of manufacturers is strictly limited, non-bank settlements dominate, and overstated prices are imposed on customers. The mentioned factors prove that over the period of transformation, Ukraine failed to fully form a true market environment, which hinders the processes of further market transformation.

1.4 DEVELOPMENT OF SMALL AND MEDIUM-SIZED BUSINESS The development of small and medium enterprises (SMEs) is one of the key indicators of the effectiveness of market transformation and preconditions of progressive structural shifts in transitional economies 27. According to the survey performed by the World Bank jointly with the European Bank for Reconstruction and Development (EBRD)28, newly established enterprises usually obtain better results in output, employment, investments, introduction of new production and management technologies compared to the old ones. In course of transformation in the CEE states, small and medium-sized business received a great impetus. For instance, in Poland, Hungary and the Czech Republic newly established SMEs account for up to 50% of employed (which corresponds to the average EU indicator) and give 55-65% of the gross value added (GVA). According to the mentioned poll, in Ukraine, SMEs account for only 20% of employed and 20-30% of the

For the World Bank conclusions on legal and administrative restrictions of competition in Ukraine see: Transition, 2001, No.6. The main criteria of SME development are the number and share of employed, the volume and share of output or gross value added. The World Bank. Transition: The First Ten Years. Analysis and Lessons for Eastern Europe and the Former Soviet Union. Wahington, D.C., 2002.

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DEVELOPMENT OF SMALL AND MEDIUM-SIZED BUSINESS

GVA29. According to the calculations presented below, these figures are not entirely true, and employment at SMEs in Ukraine comes close to the level of other economies in transition.

and mediation: more than 41% of production falls on wholesale and retail trade, trade in transportation means and repair services; 17.2% on real estate transactions, rental and services for legal entities (Table Structure of entrepreneurship by kind of economic activity , p.12).

This subsection analyses enterprise structure by the number of employed, production volume and kinds of economic activity, giving a better idea of the level of SME development in Ukraine, and describes the factors that hinder further development of SMEs.

By the share in separate types of economic activity, in 2001, microbusiness accounted for (Table Share of SME in different kinds of economic activity , p.12): v wholesale and retail trade, trade in transportation means, and repair services 7.3%;

Analysis limitations

v real estate transactions, rent and services for legal entities 8.9%;

The analysis of SME development in Ukraine is complicated due to the widespread practice of concealment of large volumes of production in the small business group, which leads to the understatement of the true volume of production in the sector. The grey sector is viewed not only as a means of adaptation to excessive tax pressure and high charges on wages but also as a method of survival in competition with manufacturers enjoying protection of state bodies.

manufacturing 0.9%;

construction 4.4%.

Small enterprises group. By the volume of production and labour resources, that group in 2001 strongly increased its presence on the market (Table Share of SME in different kinds of economic activity , p.12). The share of small enterprises in the production of goods and services increased from 10% to 11.5%, in the average reported number of full-time employees from 13.7% to 16.1%.

A significant share of employed in Ukraine is not accounted by the official statistics at all. For instance, out of 21.3 million employed, less than half are on the staff of self-sustained companies possessing the status of a legal entity. In 2001, these self-sustained companies employed 10.8 million persons; another 2.4 million worked in the budget sphere and in other spheres of economic activity. 5.6 million were registered as selfemployed (in that, 2.4 million in part-time agricultural production)30.

Small enterprises by the spheres of their activity resemble microenterprises but are less concentrated on wholesale and retail trade, trade in transportation means and repair services only 30.3%, on real estate transactions, rent and services for legal entities 10.8%. Meanwhile, their positions are much stronger in manufacturing 25.8%, and construction 12.6%.

General description of SMEs in Ukraine

The share of small business is particularly high in the following kinds of economic activity (Table Share of SME in different kinds of economic activity): wholesale and retail trade, trade in transportation means and repair services (28.6%); real estate transactions, rent and services for legal entities (29.5%); manufacturing (7.4%); and construction (30.5%).

Proceeding from depersonalised primary statistical data submitted by self-sustained enterprises (legal entities) to the State Statistics Committee of Ukraine31, one can calculate the key indicators of four groups of enterprises: micro-, small, medium-sized and big. The enterprises with abnormally high indicators of produced goods and services and insignificant average reported number of employees present a separate group.

By and large, in total goods and services the share of small enterprises increased from 10% in 2000 to 11.5% in 2001 (Table Structure of entrepreneurship by kind of economic activity ). Since in that timeframe the share of

Microenterprises (microbusiness). The enterprises of that group (Table Groups of enterprises in Ukraine by their size ) in 2001 made up 54.8% of all Groups of enterprises in Ukraine by their size enterprises, offered jobs to 2.3% of all employed and produced only 2.2% of all Average reported number Share Share goods and services. of full-time employees, in total number in production Those figures seemingly show the low effectiveness of microbusiness. However, further analysis proves that some indicators of statistic reports do not reflect the actual process and are greatly understated. According to the calculations of the Institute for Economic Forecasting of the National Academy of Science of Ukraine, some two thirds of the volume of production in Ukraine s microbusiness is related with trade

29 30 31

limits

of enterprises, %

volume, %

Share in total number of full-time employees, %

2000

2001

2000

2001

2000

Under 5 (microenterprises)

53.6

54.8

2.0

2.2

2.3

2.50

6-50 (small enterprises)

33.7

34.1

10.0

11.5

13.7

16.10 27.30

51-250 (medium-sized enterprises) Total SME (under 250) Over 251 (big enterprises) "Atypical" enterprises Total

2001

9.8

8.6

15.5

28.0

97.1

97.5

27.5

29.2

44.0

45.90

2.7

2.2

67.8

63.6

56.0

54.00

0.2

0.3

4.7

7.2

0.0

0.07

100.0

100.00

Ibid, p.14 See: Statistical Yearbook of Ukraine for 2001. State Statistics Committee of Ukraine. Kyiv, 2002, p.378. Form 1-enterprise (annual).

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THE KEY INSTITUTIONAL FACTORS PERTAINING TO MACROECONOMIC SHIFTS IN UKRAINE

Structure of entrepreneurship by kind of economic activity

Kind of economic activity

Under 5

Agriculture, hunting and forestry Fishing Mining and quarrying Manufacturing Electricity, gas and water supply Construction Wholesale and retail trade; repair of motor vehicles, motorcycles and personal goods Hotels and restaurants Transport Financial intermediation Real estate, renting and business activity Public administration Education Health and social work Community, social and personal service activities Total

Share in production volume (% of total volume) of enterprises by the average reported number of full-time employees 6-50 51-250 SME, Over 251 total 2001 2000 2001 2000 2001 2000 2001 5.6 24.1 25.0 15.7 15.8 5.6 5.8 0.1 0.2 0.2 0.2 0.1 0.2 0.2 0.4 0.9 1.1 0.7 0.8 10.3 10.4 25.8 31.6 35.0 29.0 30.0 45.7 47.9 0.6 2.2 1.6 1.5 1.1 12.7 12.6 12.6 8.9 9.1 10.0 10.5 2.2 2.4

Atypical enterprises 2000 2001 2.6 1.7

2000 3.0 0.0 0.2 18.1 0.1 10.4

2001 3.9 0.0 0.1 16.7 0.2 9.6

2000 5.2 0.1 0.4 27.1 0.2 11.6

41.5 1.0 5.2 2.2 15.8 0.0 0.4 0.4

41.0 1.1 5.4 2.2 17.2 0.0 0.4 0.4

31.0 2.0 7.0 2.3 10.3 0.1 0.6 0.5

30.3 2.0 6.8 1.9 10.8 0.1 0.6 0.5

13.0 1.3 5.4 4.0 5.4 0.1 0.5 0.6

11.9 1.2 5.9 0.7 6.1 0.2 0.5 0.6

21.6 1.5 6.0 3.3 7.7 0.1 0.5 0.5

21.3 1.5 6.2 1.3 8.8 0.1 0.5 0.5

1.5 0.2 15.2 3.2 1.7 1.2 0.0 0.2

2.2 0.2 15.5 0.3 2.0 0.1 0.0 0.2

46.2

1.5 100.0

1.6 100.0

1.8 100.0

1.9 100.0

1.8 100.0

1.0 100.0

1.8 100.0

1.4 100.0

0.2 100.0

big enterprises decreased, it may be suggested that the development of small business was among the significant factors behind economic growth in 2001. Medium-sized enterprise group in 2001 somewhat shrank. By the production volume its share in 2000-2001 did not change and was equal to 15.5%, and by the average reported number of full-time employed somewhat decreased from 28.0% to 27.3%. The volumes of production at medium-sized enterprises are the greatest in manufacturing (31.6% in 2000 and 35% in 2001) and agriculture (respectively, 24.1% in 2000 and 25% in 2001). At that, medium-sized enterprises account for 46.1% of agricultural production (Table Share of SME in different kinds of economic activity ). It is worth notice that the main contributors

0.1 27.2 1.4 4.0

9.1 6.7 2.5 0.1

12.6 2.1 2.0

63.1 0.0 9.7 3.5 5.2

0.2 100.0

into Ukraine s agricultural production are households that do not report of their business activity32. The total representation of SMEs in Ukraine changed in the course of only one year of economic growth: in production from 27.5% to 29.2%; in the number of employed from 44.0% to 45.9%. According to the calculations made by experts from the Institute for Economic Forecasting of the National Academy of Sciences of Ukraine, SMEs conceal more than 60% of the total production volume; hence, their departure from the grey sector would raise the share of SMEs in total production from a third to roughly one half. In some kinds of economic activity the registered share of production at SMEs exceeded 50%, specifically:

Share of SME in different kinds of economic activity, % of production volume by kind of economic activity

Kind of economic activity

2000 0.7 0.3 0.0 0.9 0.0 4.7

2001 1.0 0.4 0.0 0.9 0.0 4.4

2000 6.3 6.4 0.6 6.7 0.6 26.4

2001 7.6 7.1 0.7 7.4 0.8 30.5

Share in production volume by the average reported number of full-time employees 51-250 SME, Over 251 total 2000 2001 2000 2001 2000 2001 45.3 46.1 52.3 54.7 46.2 43.8 18.7 21.2 25.4 28.7 74.6 71.3 2.0 2.5 2.6 3.2 97.3 96.8 12.2 13.5 19.8 21.8 77.0 76.0 3.8 3.0 4.4 3.8 94.9 94.4 31.5 29.9 62.5 64.9 33.2 32.1

9.0 3.7 0.8 1.3

7.3 4.1 0.9 6.0

34.0 37.1 5.6 6.8

28.6 38.6 6.3 27.6

22.2 36.7 6.8 18.1

15.2 30.5 7.5 13.6

65.2 77.5 13.3 26.3

51.1 73.2 14.7 47.1

10.9 22.5 83.3 64.4

11.4 26.3 79.7 21.0

23.9

9.2 0.1 4.7 3.1

8.9 0.5 5.1 2.9

28.5 1.3 32.8 18.7

29.5 15.0 35.1 20.3

24.5 1.9 49.4 33.9

22.3 27.5 42.5 29.5

62.1 3.3 86.9 55.7

60.7 43.0 82.7 52.7

34.4 96.4 13.1 44.3

30.4 57.0 17.3 47.3

4.6

6.1

28.5

38.0

45.3

26.3

78.4

70.4

20.1

27.7

Under 5

6-50

For more details see Section 2 of this Report.

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"Atypical" enterprises 2000 2001 1.5 1.4

Total

2.3 1.8 3.1

100.0 100.0 100.0 100.0 100.0 100.0

37.4 0.5 5.6 31.9

100.0 100.0 100.0 100.0

3.4 0.3

8.9

100.0 100.0 100.0 100.0

1.5

2.0

100.0

0.0 3.2 0.7 4.2

3.5 9.3

DEVELOPMENT OF SMALL AND MEDIUM-SIZED BUSINESS

in education 82.7%; in the sphere of collective, public and personal services 70.4%; in construction 64.9%; in agriculture 54.7%; in wholesale and retail trade, trade in transportation means, repair services 51.1%. Specific to atypical enterprises is the clear incongruity of some indicators of their activity with one another and with those of SMEs. While the SME sector to some extent conceals its operations, in the group of atypical enterprises everything is vice versa. They report extremely high volumes, mainly of intermediary services, inconsistent with other indicators, especially the number of employed. One employed accounts for one million to several hundred million hryvnias worth of output. The main kinds of economic activity of those enterprises include wholesale and retail trade, trade in transportation means, repair services. (That kind of economic activity also encompasses the activity of converters, not distinguished in Ukraine, by contrast to the EU countries [Insert Converters ]). At that, while in 2000 that kind of economic activity accounted for 46.2% of total production volume in the group, in 2001 its share hit 63.1%. In 2001 atypical enterprises produced 7.2% of the total production volume given their average reported number of employed equal to 0.07% of the total number (Table Groups of enterprises in Ukraine by their size , p.11).

and assets, defend the rights of shareholders and creditors, the developed countries employ mandatory procedures of not only proper banking control but also of revelation of related party transactions by independent experts. Those procedures are elaborately regimented and classified. In Ukraine s legislation, the relevant measures are still not regimented, which creates favourable conditions for such business .

Converters entities selling goods and services under their name but arranging for their production by others. Such entities are distinguished by the Statistical Classification of Economic Activities in the European Community (NACE) in G sector (wholesale and retail trade), except where they play the key role in the design and promotion of products and share production risks (for instance, own the raw materials used for production). 33 In this event they are classified as direct manufacturers of goods .

Factors hindering the development of SMEs At the beginning of the transition the factors hindering the development of SMEs included: lack (due to hyperinflation) of the required savings; macroeconomic instability; excessive regimentation of the enterprise establishment procedures; tough state control and tangled accounting procedures; and lack of business experience. In the recent years, some legislative steps have been made in support for the development of enterprise (Insert Specific measures for the encouragement of entrepreneurship in Ukraine ), but their effectiveness is insufficient.

For Ukraine s economy, only beginning to overcome the long crisis, the development of such mediation and its strong presence on the market, in the conditions of limited solvent demand of the population, is a dangerous phenomenon, moreover that the activity of Ukrainian pseudo-converters is concentrated in wholesale mediation. This proves the necessity of closer examination of the highly productive operation of atypical enterprises and distinction between true converter enterprises and converters of others incomes. There is every reason to believe that Ukrainian enterprises of that group act only as agents (or tunnels ) for the flow of incomes through the mechanisms of so-called price transfers (via the intermediary margin) from large enterprises to the benefit of some individuals for their further use with the purpose of personal enrichment and for political goals.

SPECIFIC MEASURES FOR THE ENCOURAGEMENT OF ENTREPRENEURSHIP IN UKRAINE Laws were passed that determined the attitude of the state to small business: On State Support for Small Business , On the National Programme for Promotion of Small Business in Ukraine ; On Licensing of Certain Kinds of Economic Activity , etc. They: v regimented the procedure of state registration of small and mediumsized enterprises; established the uniform licensing procedure and the single list of kinds of economic activity subject to licensing; established that licensing cannot be used to limit competition in business activity; v introduced a streamlined system of small business taxation (before its introduction, businessmen were to pay 16 taxes, after one); v put in order the system of inspections of financial and economic activity; v introduced separate elements of the state regulatory policy in the sphere of entrepreneurship aiming at the weakening of administrative interference, removal of legal and economic obstacles for the development of entrepreneurship.

A showy development here was the increase in the share of atypical business in 2000-2001 and during the 2002 election campaign, when the flow of proceeds transferred through pricing mechanisms was especially great. This was witnessed by a sharp (by 75%) decrease in the return of big and medium-sized enterprises in January-March 2002 against the same period of 200134. The legislation and practice of the majority of developed countries refers such pricing and other transfers as related party transactions. To avoid the outflow of funds 33 34

European Commission Term Bank. http://www.europa.eu.int/eurodicautom/controller. Calculated after the statistic bulletins Ukraine s Economy in January-May, 2001 and Ukraine s Economy in January-May, 2002 .

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THE KEY INSTITUTIONAL FACTORS PERTAINING TO MACROECONOMIC SHIFTS IN UKRAINE

Meanwhile, enterprises continue to conceal a great deal of their operations, in fact, in defiance of the mentioned steps. This may be attributed to a number of unresolved problems: v

men;

remaining administrative pressure on business-

v still insufficient protection of the rights of business entities; v

imperfect licensing system;

v requisitions persisting both in the form of bribes and contributions to voluntary funds ;

absence of effective financial and resource support for small business; v

v absence of adequate legislative support for the sufficient funding of the events envisaged by the National Programme of Development of Small Business; v unsettled issues of leasing state-owned and municipal premises out to entrepreneurs; v absence of a system of encouragement of innovative activity of SMEs.

A systemic factor conducive to small enterprises escaping to the grey sector is the fragmentation of the market, where the principle of equality of competitive conditions is violated and broad illegal possibilities exist for abuses through the creation of tunnels for the flow of funds and assets in the form of related party transactions. Without the removal of such systemic factors no forcible measures or incentives for the development of SMEs will ever work, hence, the opportunities for stepping up progressive structural shifts cannot be employed in full.

CONCLUSIONS The transformation processes in Ukraine took place in the conditions of underdeveloped market economy infrastructure and absence of political consolidation in society. The imbalance of powers and lack of effective interaction between the branches of power had a negative impact on the processes of formulation and implementation of the socio-economic policy largely confined to tactical actions. The existing political

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system did not promote democratic relations between the public, its institutes and the authorities, conditioning instead a closed character of the state policy. The inherited and newly formed disproportions in the structure of Ukraine s economy increased due to the absence of effective national strategic management. A great many state programmes were not implemented in full due to the lack of institutional capabilities of the Government, poor funding and insufficient public support. Their partial fulfilment was conducive to the expenditure of funds on unsubstantiated projects and deepening of the systemic crisis. The unsatisfactory results of the first steps of privatisation were manifested in the undermined trust of the population in the authorities and new financialeconomic formations. In defiance of their declarations, the authorities failed to secure the expected proceeds to the budget, the appearance of effective owners, accelerated capital formation or large investments. For the majority of enterprises, privatisation neither marked the beginning of their restructuring and modernisation nor led to the enhancement of their competitiveness. The level and character of monopolisation in Ukraine and not very effective antimonopoly policy of the state are the factors conducive to the distortion of the principles of market competition and means of attainment of the interests of influential financialeconomic groups. The great share of monopolised sectors of the economy (40% of Ukraine s GDP) hinders the establishment of a market pricing system and impairs the rights of consumers. Today, Ukraine lacks proper conditions for the transformation of SMEs into a driving force of economic reforms. The economic agents in that sector waste too much efforts and funds to withstand the arbitrariness of state officials and oppose stronger (due to state preferences) rivals. Of particular concern here is the development of enterprises acting as intermediaries in transfers from big enterprises to persons occupying executive positions within the system of state governance or enjoying influence in the political circles. n

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2. MARKET TRANSFORMATION POLICY IN UKRAINE: THE EFFECTS OF MACROSTRUCTURAL FACTORS T

ransformational processes in Ukraine's economy took place on the background of a deep and protracted structural crisis caused not only by objective factors (breach of economic ties, skyrocketing prices of energy resources, evening of domestic and world prices, etc.) but also by a series of erroneous actions of the Government. This resulted in the breach of the balance between incomes and expenditures of the institutional sectors of economy, decline of investments into industrial and human development, waste of funds on budget support for unprofitable enterprises, conservation of the obsolete energy-consuming structure of industry. Resumption of economic growth began with the harmonisation of distribution of incomes among institutional sectors of the economy. Exactly this will determine the ability of GDP reproduction and progress on the path of market reforms. This section analyses the main macrostructural factors influencing the development and market transformation of Ukraine's economy, reviews the most important branch structure shifts in the period of transition to the market system, identifies the reasons for the transformational crisis and the possibilities of their removal.

2.1 INSTITUTIONAL SECTORS OF THE ECONOMY AND INTERSECTORAL DISTRIBUTION OF INCOMES

Intersectoral distribution of incomes Proper and steady intersectoral distribution of disposable incomes is a guarantee and precondition for steady economic growth. Its proportions vary in different countries but there are world-tested limits whose breach produces imbalances in the economy (Insert Intersectoral distribution of incomes in developed European countries , p.16).

The macrostructural factors of market transformation of the economy include: first, formation of the institutional market environment i.e. (1) development of market relations between institutional sectors of the economy; (2) minimisation of state interference into business activity; (3) establishment of harmonious proportions in the intersectoral distribution of incomes; second, (1) stepping up the state s role in creation of a favourable business environment, (2) support for macroeconomic stability and (3) provision of effective operation of the budget sphere to avoid merger of the power with business (capital).

For instance, excessive concentration of the gross disposable incomes in the general government sector (GG) in the conditions of insufficient transparency and poor control of their use inevitably leads to economic decay. Large-scale appropriation and ineffective use of the disposable incomes by the GG sector (in excess of 24%) leads to the breach in the proportions of reproduction (deinvestment of economy), significant material and financial losses, grey economy, and deepening of crisis. This, in turn, ruins the trust of business entities in the state.

This subsection gives definition of the institutional sectors of market economy and proportions in the intersectoral distribution of incomes intrinsic in developed countries and reviews the effects of the intersectoral distribution of incomes for the formation of a certain model of economic development.

It is worth notice that in the countries oriented towards strong support for human capital (for instance, within the framework of the Scandinavian model ) the level of GDP redistribution by the state is rather high: the share of disposable income in the GG sector ranges between 24-30% of the gross disposable income. However, specific of such countries are high confidence in the government, effectiveness and controllability of budget expenditures, and therefore the high level of development of human capital and social protection. Additionally, their tax system makes

Institutional sectors of the economy Stable economic development of a country depends on: (1) proportions in distribution of disposable incomes between institutional sectors of the economy (Insert Institutional sectors of the economy , p.16); (2) ratio between consumer expenditures and investments into economy; (3) amounts and methods of employment of foreign investments.

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INSTITUTIONAL SECTORS OF THE ECONOMY 35

Non-financial corporations enterprises (legal entities) whose activity aims at production of goods and non-financial services with the purpose of making profit; non-profit organisations established by different groups of manufacturers (associations of entrepreneurs, chambers of trade, etc.). Financial corporations commercial institutional units specialising in financial mediation activity: credit institutions (including the National Bank) and insurance companies. General government sector state governance bodies of all levels; non-profit organisations producing and rendering: free or preferential individual services in education, medical care, culture, sports, recreation, social security, etc.; collective services in the spheres of state governance, defence, motorway services, forestry, agricultural services, etc. The sector covers social insurance and social security funds, the pension fund, state target-oriented and extrabudgetory funds formed at the expense of contributions of enterprises, organisations and individuals. Households sector the totality of physical persons as consumers (in separate cases as agents of non-corporate entrepreneurial activity) whose accounts cannot be separated from those of the household either legally or economically. Such production activity encompasses, in particular, individual subsidiary plots, small industrial works, individual construction, capital repair of housing, rendering of services in the sphere of social amenities, education, medical care, etc. Non-profit institutions serving households institutional units established by separate groups of households to secure their interests. Funds of such organisations are formed at the expense of voluntary contributions. Social and cultural units of enterprises maintained at the expense of mainline business and rendering non-market services to employees of those enterprises (housing, recreation, medical, etc.) viewed as a specific type of non-profit organisations of transition economy in the System of National Accounts. Sector of the rest of the world . Foreign economic units with which Ukraine s residents effect some operations. In fact, represent the nonresidential sector of the economy. Distinguished in the System of National Accounts.

The consequences of excessive concentration of disposable incomes in the GG sector and households can be mitigated by significant (at a level of 20-30% of domestic capital formation) inflow of foreign direct investments (FDI), as they assume the task of donors at capital formation and actively modernise the economy. Excessive concentration of disposable incomes in the sector of financial corporations breaches the balance between the incomes of enterprises and financial corporations, at first rendering lifeless the former and then the latter, since financial intermediaries can increase their incomes only on the condition of expanded reproduction in the production sphere. The main mechanisms of influence on the distribution of incomes and its stability are: (à) the tax and budget system; (b) the system of deductions to social insurance funds; (c) annual tariff agreements and procedures of settlement of disputes among employers, trade unions and the state.

Influence of intersectoral distribution of incomes on the formation of the model of economic development In the result of primary distribution of incomes among institutional sectors of economy and subsequent financial relations forming the basis for deductions to social insurance funds, direct taxes, transfer of incomes from property, etc., gross disposable incomes of the sectors of economy are formed. The model of economic development is formed dependent on the proportions of distribution, methods of use of those incomes, as well as on the inflow if foreign investments into the economy: innovatition and investment-oriented, consumptionoriented or the worst case scenario protectionist model (Insert Models of economic development ).

INTERSECTORAL DISTRIBUTION OF INCOMES IN DEVELOPED EUROPEAN COUNTRIES In the developed European countries the proportions of intersectoral distribution of disposable incomes (calculated as the share of disposable incomes of the sector in total gross disposable income) are as follows: v households around 69%; v enterprises 9-10%; v general government sector 22% on the average (the lowest in Italy [12-14%], the highest in Norway [to 30%]); v financial corporations 1-1.5%. If those proportions are observed, the economy functions in a balanced manner; its institutional sectors have enough resources for consumption and capital formation and therefore opportunities are ensured for continuous reproduction and development. A breach of the proportions in the distribution of incomes among sectors lays down preconditions for the crisis that will burst out sooner or later.

Innovatition and investment-oriented formed on the condition of concentration in the enterprise sector of the share of funds (disposable incomes) sufficient to secure formation of fixed capital and excess of investment demand growth over consumer demand growth. Consumption-oriented appears where the rate of consumer expenditure exceeds the rate of fixed capital formation, which does not guarantee renovation of fixed assets, leads to their ageing, obsolescence and, with time, to decline in production. Protectionist formed in presence of large-scale direct or indirect state support for specific enterprises (sectors, territories) by means of preferential taxation, write-off of debts, subventions, subsidies, extension of guaranteed credits, state orders given at overstated prices, etc. In such a situation substantial part of the state budget is redistributed to the benefit of some business entities (taxes paid by effective market agents turn into incomes of unprofitable entities or entities close to the authorities).

emphasis not on the preservation of high tax rates but on minimisation of tax exemptions, which secures the broad base and high level of effective taxation, i.e., an even distribution of the tax burden encourages production. Excessive concentration of disposable incomes in the households sector leads to temporary expansion of the consumer market, but also to the decline of investment in the official sector of the economy and, in the long run, to inevitable stagnation.

For instance, concentration of resources in the enterprise sector at above 12% of the gross disposable income automatically produces the investment-oriented model, since enterprises raise their credit rating and have sufficient own funds for investment. In Ukraine s economy that has no sufficient inflow of FDI and experiences an urgent need of technical renovation of production and increase in its nonprice competitiveness, the share of enterprises in gross disposable income should be maintained at a level of 13-15%.

MODELS OF ECONOMIC DEVELOPMENT

This Report focuses on production activity aimed at making profit. So, the notion of enterprises will be used to denominate non-financial corporations, unless stated otherwise.

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TRANSFORMATIONAL CHANGES IN INSTITUTIONAL SECTORS OF UKRAINE S ECONOMY

freely convertible currency allowed some businessmen to make huge piles. On the level of institutional sectors, financial corporations appeared in the win: in 1992-1993 alone they managed to increase their disposable incomes 4.3 times39.

However, in the years of the transformational crisis Ukraine saw the beginning of formation of the protectionist model of economic development. This was caused by the excessive concentration of resources in the GG sector, where they not only were used ineffectively but also were channelled to support separate privileged enterprises through creation of flows of preferential credits and transfers, write-off of debts, etc.

Another factor of deformation was presented by the state s desire to retain budget revenues at any price through the increase of tax pressure. For instance, in 1993 net taxes increased 6.7 times. As a result, the share of GDP redistributable to the GG sector rose from 24.1% in 1992 to 43% in 1994 and 47.8% in 1996 (the highest level over the entire period).

2.2 TRANSFORMATIONAL CHANGES IN INSTITUTIONAL SECTORS OF UKRAINE S ECONOMY

Excessive concentration of disposable incomes in the general government sector. In 1996 the share of the GG sector in the gross disposable income hit 38.0%, and the year average in the period of 1994-1999 32.5%. (For comparison: in Poland in the period of transformation the GG sector share of disposable income did not exceed 17.2% [1995-1999], in 2000 was equal to meagre 16.1%40).

The structural problems that arose in Ukraine in the period of transformation were caused by the absence of tested institutional market mechanisms to provide for harmonisation of the interests of different agents of market economy and co-ordinate them with the critical interests of entire society36. This resulted in distortion of distribution of both primary and disposable incomes, leading to their general instability and unsteadiness of the model of national economic development.

At that, the disposable incomes of the public sector were used ineffectively, a significant share of budget losses fell on credits and subsidies extended to manufacturers of unmarketable goods. Budget funding was effected through the schemes of feeding separate enterprises and branches with state investments, credits under government guarantees, offsets combined with state order, reimbursement of value added tax (VAT) to intermediaries and pseudo-exporters, etc.

Formation of a protectionist economic model (1992-1996) The economic policy of that period may be described as antimarket, aiming to support separate enterprises at the expense of others, create favourable conditions for initial accumulation of capital by separate economic entities close to the authorities.

As a result, the reduction of real disposable incomes of households and enterprises (in 2.6 and 15 times respectively) and the growth of disposable income in the GG sector by 40% led to strong distortions in the distribution of disposable incomes (Table Sectoral distribution of disposable incomes in Ukraine ).

In the conditions of economic decline and hyperinflation of 1992, 1993 and 1994 (in those years, consumer prices grew 21, 102 and 5 times, respectively)37 substantial inflationary redistribution of current incomes 38 and devaluation of savings took place; those were the years of abnormal enrichment of separate business entities that had access to certain types of resources.

The data presented in the Table show that before 1996, the share of disposable incomes of enterprises was rapidly falling to the level of 2.2%, while the GG sector increase its share to 38%. Excessive concentration of incomes in the GG sector distorted the processes of reproduction, led to substantial reduction of investments into fixed capital, growth of grey incomes and a crisis of settlements.

The big gamble on inflation and use of a dual foreign exchange rate that created opportunities for making huge profit from the difference between the value of loans obtained and returned after devaluation or between the official and market exchange rates of

Sectoral distribution of disposable incomes in Ukraine, % GDP Disposable incomes

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Non-financial corporations

26.0

13.3

9.5

4.8

2.2

5.9

4.5

9.7

10.9

15.4

3.3

9.0

6.6

1.0

0.9

0.8

1.3

1.6

1.2

1.8

GG sector

15.9

24.3

34.5

37.4

38.0

33.8

33.6

29.9

28.5

24.3

Households

50.9

47.2

45.4

51.3

54.3

56.4

58.2

55.8

57.0

58.5

4.1

5.1

4.5

3.5

3.1

2.5

2.3

2.0

Financial corporations

Non-profit institutions

For instance, the World Bank Director for Ukraine and Belarus L.Barbone said that the international community had made many mistakes in supporting reforms in the result of underestimation of the deficiencies of the institutional system of the countries in transition. The institutional system covers not only organisations but also ideas, ideologies, norms of behaviour, related with the culture of those countries. See: Transition, 2001, No.6, p.1. 37 Statistical Yearbook of Ukraine for 1997. State Statistics Committee of Ukraine. Kyiv, 1999, p.64. 38 The peak of the negative structural consequences of that process fell on 1996. 39 Calculated after: National Accounts of Ukraine in 1990-2000. Statistical Yearbook of Ukraine for 2001. State Statistics Committee of Ukraine. Kyiv, 2002, p.378. 40 Calculated after: National Accounts and Supporting Tables. Paris: Head of Publication Service. OECD, 2002.

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The soft, protectionist and high-deficit budget policy created a situation where incomes of effectively working enterprises were used to fund ineffective ones (in 1992, the deficit was equal to 13.8% of the GDP, or 56.7% of the aggregate budget revenues; in 1993 respectively, 5.1% and 15%; in 1994 8.9% and 21%; in 1995 6.6% and 13.1%; in 1996 4.9% and 13.8%41). This led to the exit of significant assets from circulation and their transformation into stockpiles of output. For instance, in 1992-1994, circulating assets equivalent to 40% of the 2001 GDP were transferred from circulation to inventories42. This resulted in significant (by 75%) reduction of investments into fixed capital43, general shrinkage of domestic demand, delay of exit from the crisis and delayed initiation of progressive structural changes in the economy. Hence, the first stage of market transformation in Ukraine resulted in formation of a protectionist model of economic development, antimarket by its essence. Such a model made distribution of financial resources highly ineffective, ruled out exit from the crisis on the basis of large-scale modernisation of economy, for a long time conserved technological backwardness of the country. In such a situation, economic growth was possible only within the limits of idle capacities and surplus of labour resources of the old qualification, for instance in export-oriented but technologically obsolete and energy-intensive industries44.

Departure from the protectionist model (1997-2001) The year of 1997 marked the beginning of gradual movement towards harmonisation of intersectoral distribution of incomes, strengthening of the position of enterprises and households in that process, growth of fixed capital investments. The state budget was ceasing to be a feeding-rack for ineffective enterprises, taxes on production and direct taxes on enterprises were decreasing, prices and exchange rates were stabilising (in course of the year consumer prices increased by only 10%; the official exchange rate of hard currency remained actually intact), which resulted in the growth of disposable incomes of enterprises, for the first time in the years of crisis, gross fixed capital formation increased. The financial crisis of August 1998, destabilised the economic situation but at the same time created a new factor of growth: devaluation of the hryvnia raised price competitiveness of Ukraine s economy and therefore opened new opportunities for export growth. The overstatement of hard currency value and low domestic prices (the margin between domestic and world prices) made production for export profitable, and from May 1999, it began to grow rapidly. Foreign demand became the dominant factor of economic growth, with internal demand being a secondary one. Meanwhile, expensive hard currency produced kind of an economic filter for imports of, first of all, consumer goods, the national economy witnessed the

beginning of the process of import substitution: domestic manufacturers drove importers out of the market of consumer goods. In 1999, the share of disposable incomes of enterprises reached the level observed in developed countries 9.7% (standard is 9-10%), which enabled stepping up investments in the enterprise sector in 2000 (the rate of fixed capital formation made up 117.7%), enhancement of domestic investment demand and GDP growth. In 2000, GDP rose by 5.9%, in 2001 by 9.2%. In 2001, the level of disposable incomes of enterprises reached 15.4%, which in the conditions of stabilisation of prices encouraged not only growth of investments into fixed capital but also loans for the real sector of economy. In the first three quarters investments into fixed capital increased by 7.4%, 10.2% and 14.2%, respectively, and one might hope for the establishment of an investment-oriented development model, but political factors interfered. In the last quarter of 2001 (six month before the elections to the Verkhovna Rada) the situation changed fundamentally, the economy model acquired consumptionoriented traits, seen till the fourth quarter of 2002. That period was characterised by the following tendencies: v substantial excess of the rate of real growth of incomes of the population and the GG sector over GDP growth rate. For instance, in 2002, compared to the same period in 2001, real GDP grew by 4.8%, money incomes of the population by 22.2%, aggregate budget revenues by 19%; v heating up of the consumer market and real growth of consumption of goods and services by the population by 11.8% (cumulative index of retail trade turnover reached its peak in May 2002 118.1%, although at the year end it fell to 116.4%); v substantial growth of savings of the population, shifts in the structure of its financial assets in favour of cash in hryvnias and deposits with commercial banks (at that, 87% of deposits were below UAH 1,500, i.e., the overwhelming majority of savings was concentrated in the accounts of a small group of depositors); v decrease in incomes of large and medium-sized enterprises involving cooling of investment activity and conservation of technological backwardness; v rapid transition from the investment-oriented to the consumption-oriented model of development witnessed the general instability of Ukraine s economic development, stay of the economy under strong influence of politics and inability of the effective legislation to provide for regulation and control over the distraction of enterprise funds for political purposes.

General results By and large, over the years of transformation, intersectoral distribution of disposable incomes in the institutional sectors of Ukraine s economy saw great changes that resulted in the following.

See footnote 37, pp.38-39. Calculated after: National Accounts of Ukraine in 1990-2000. Statistical Yearbook of Ukraine for 2001. State Statistics Committee of Ukraine. Kyiv, 2002, p.378. 43 Ibid. 44 For more detail see Section 3 of this Report. 42

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BRANCH STRUCTURAL CHANGES IN UKRAINE S ECONOMY

v Sharp decrease in the share of disposable incomes of households in the disposable gross national income, that in combination with the inflationary devaluation of savings undermined the financial basis for the development of small and medium-sized business.

Only a series of stabilisation measures (gradual rehabilitation of the state financial system, decrease in inflation, reduction of pension and wage arrears) commenced movement towards optimisation of the intersectoral distribution of incomes.

In 1990-2000, while official GDP dropped by 51%, remuneration of household labour fell by 61%, gross mixed incomes by 20%; and the share of labour remuneration in GDP fell from 53.1% to 42.3%45, while the bulk of the population had no savings whatsoever.

2.3 BRANCH STRUCTURAL CHANGES IN UKRAINE S ECONOMY The transition of post-socialist countries to the market economy is objectively accompanied with significant changes in the branch structure of their national economies, in particular: (1) removal of systemic structural deformations formed within the framework of administratively planned economy; (2) formation of the market infrastructure segment, lacking which, employment of market mechanisms is impossible; (3) modernisation of production factors and resumption of growth in separate branches of economy.

v Declines in production, dismissal of employees and shift of economic activity to rural area, where the number of self-employed and employed at subsidiary plots increased significantly (from 0.4 million people in 1990 to 2.6 million in 2001; by and large, in 2001, 5.2 million persons were employed in agriculture, against 4.5 million in industry)46. These data point to the tendency of the country s transformation from industrial into predominantly agrarian one.

Branch structure of Ukraine s economy on the eve of reforms

v Radical change of the role of households and enterprises in the production of gross value added in agriculture was observed between 1993 and 1999. While in 1993, the share of enterprises was equal to 74.5%, in 1999 it fell to 24.7%, and the share of households increased accordingly from 24.8% to 73.3%. However, the overall level of households development in Ukraine remains insufficient: in Ukraine they account for only 17.5% of GVA, in Poland more than 33%.

By the structure of economy Ukraine belonged to the group of countries with hypertrophied industry and especially agriculture and underdeveloped sphere of services. Say, in 1990 the share of industry in the GDP made up 45%, of agriculture 25% (Table Dynamics and branch structural changes in GDP of CEE, Baltic and CIS states in 1990-2000 , p.20), which far exceeded the average indicators of the developed countries 3.4%.

v Tendency towards reduction of agricultural production, especially its marketable part, and growth of subsistence economy at private subsidiary plots that from 1999 reversed to the trend of growth of production at subsidiary plots for market sale: in 1999 the share of incomes from sale of agricultural produce made up only 14.2% of all funds obtained from subsidiary plots; in 2001 it rose to 28.6% (in rural area to 35.6%), and by the results of three quarters of 2002 to 44.7% (Table Separate monthly average indicators of households by the results of sampling observation 47).

Ukraine s industry, as compared to the developed countries of the world, was overloaded with heavy industry branches, first of all, ferrous metallurgy (11.0% of total industrial output), chemical, petrochemical (5.6%) and fuel industry (5.7%) with a low degree of product processing. The high share of machine-building and metal working (30.5%) was largely attributed to the needs of the USSR defence industry complex (Table GVA branch structure and scale of structural changes in Ukraine s economy , p.22). Apart from the structural differences of Ukraine s economy from the developed countries, there was a substantial technological lag that revealed itself in full after the rise in prices of energy resources, when the

Hence, in Ukraine over the crisis period of the transformation the Government s economic policy was accompanied with numerous mistakes that resulted in substantial macrostructural distortions.

Separate monthly average indicators of households by the results of sampling observation, per household In that those who live Household indicators

All households

in urban settlements

in rural areas

1999 2000 2001 2001 2002 1999 2000 2001 2001 2002 1999 2000 2001 2001 2002 Q3 Q3 Q3 Q3 Q3 Q3 Share of products for sale, %

14.2

23.6

29.6

37.9

38.6

6.8

12.4

13.8

18.5

19.4

17.6

27.8

35.6

44.7

44.5

Share of products for consumption, % 85.8

76.4

70.4

62.1

61.4

93.2

87.6

86.2

81.5

80.6

82.4

72.2

64.4

55.3

55.5

3.8

5.3

5.5

6.0

5.5

0.9

1.1

0.9

9.4

13.4

15.0

16.4

15.0

Share of the cost of products obtained from individual subsisiary plots in aggregate resources of households 23.0

17.1

13.1

9.8

8.7

8.0

6.4

44.4

4.9

3.9

44.4

34.9

27.1

20.2

18.8

Share of incomes from sale of agricultural produce in aggregate resources of households

45 46 47

See footnote 42. Statistical Yearbook of Ukraine for 2001. State Statistics Committee of Ukraine. Kyiv, 2002. p.361. Calculated after the State Statistics Committee of Ukraine Digests Sampling Observation of Households in Ukraine for the relevant periods.

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industry by more than 66%; in agriculture by 51%; in transport and communication by 80%; in construction by 88%48.

rising of the cost of crude oil and gas on the Ukrainian market closer to the level of the world prices immediately demonstrated the high energy intensity and low competitiveness of Ukrainian goods both on the internal and foreign markets.

By and large, specific of the transformational recession was too low reaction of manufacturers to the new pricing proportions and changes in the volume and structure of demand with simultaneous effects of two negative factors: decline in price competitiveness on both internal and foreign markets and sharp decline of the solvency of the population and enterprises as a result of deformation of the structure of incomes and devaluation of savings.

Structural changes in the process of transformation The economic reform brought the deepest ever decline of GDP that varied by branches and the change of their roles in overall economic development. By now, two stages may be distinguished: transformational decline (1991-1999) and economic revival (since 2000). The structural transformational changes in the economies of separate countries are demonstrated by the data cited in Table Dynamics and branch structural changes in GDP... , whereby Ukraine has one of the worst results both by the depth and length of transformational recession and by the indicators of economy restructuring.

Transformational recession (1991-1999)

Decrease in production of goods. As is clear from the Diagrams Dynamics of GVA in Ukraine in 19912000 and Dynamics of the volume of GVA in Ukraine in 1991-2000 , the decline of economic activity was in the first place caused by the decrease in production in the group of goods-making sectors, while the sphere of services was decreasing less rapidly and therefore somewhat mitigated the overall economic decline.

Decline of the total output. In 1991-1999, the total production of goods and services fell by 60%, in that: in

The rates of decline in separate branches and industrial enterprises were different and depended on

Dynamics and branch structural changes in GDP of CEE, Baltic and CIS states in 1990-2000* Countries

Period of economic decline, years

Decline in production volume, %

GDP in 2000, % (1990=100)

Share in GDP, % Agriculture 1990

Industry

Services

2000

1990

2000

1990

2000 23

Central and Eastern Europe Albania

110

Bulgaria

Croatia

Czech Republic

Hungary

109

Poland

112

Romania

144

Slovakia

Slovenia

105

58 67

Baltic countries Estonia

Latvia

Lithuania

Armenia

Azerbaijan

CIS

Belarus

Georgia

Kazakhstan

Kirghizstan

Moldova

Russia

Tajikistan

Turkmenistan Ukraine Uzbekistan

* Compiled referring to World Bank data: World Development Indicators, 2002; see also: The World Bank. Transition: The First Ten Years. Analysis and Lessons for Eastern Europe and the Former Soviet Union. Washington, D.C., 2002, p.55. Data unavailable.

Calculated after the Statistic Digest National Accounts of Ukraine in 1990-2000 . State Statistic Committee of Ukraine. Kyiv, 2002, p.378.

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BRANCH STRUCTURAL CHANGES IN UKRAINE S ECONOMY

industries, relying on the competitive reserves of devaluation. The influence of external demand at the beginning of economic revival in 1997-1999 was visually demonstrated by the growth of output and exports in such branches as ferrous metallurgy (respectively, by 7% and 14%), non-ferrous metallurgy (respectively, by 40.7% and in 2.4 times), woodworking industry (respectively, by 30% and in 2.9 times), and light industry (respectively, by 14.2% and 18%)51. Structural consequences of the period of transformational recession: 1991-1999. The structural changes were the most manifestly reflected in the ratio between goods and services. The data cited in Table GVA branch structure and scale of structural changes in Ukraine s economy show that the share of the branches producing goods fell from 70.7% in 1990 to 52% in 1996, and after the resumption of goods production in some export-oriented branches of industry somewhat increased to 52.8% in 1999 and 53.4% in 2000; the group of service-producing branches grew from 29.5% in 1990 to 48.3% in 1999.

Branches of the goods production sector Among all goods-making branches, the share of agriculture fell the most (from 25.6% in 1990 to 13.8% in 1996 with a further increase to 14.2% in 1999 and 17.1% in 2000. At that, in 1990-1996 real GVA in agriculture fell by only by 40%, while the total real GVA decreased by 53%. Hence, the substantial reduction of the branch s share is attributed purely to the price factor, not to progressive changes in other branches52. Strong deinvestment of the economy had a ruinous effect on construction, whose share in GVA decreased drastically from 8.5% in 1990 to 5% in 1999 and 4.2% in 2000. The share of industry in GVA fell from 36% in 1990 to 31% in 1996, and after the re-activation of metallurgy enterprises and some other branches increased to 32.8% in 1999. By and large, before 1999, the process of restructuring of Ukraine s industry showed a clearly regressive trend (Table Structure of industrial production in Ukraine, at current prices ). She share of the branches producing goods for final use (machine-building, light and food-processing industry) substantially decreased to the benefit of heavy industries with a low degree of value added and high energy intensity.

the character of changes in the final demand structure. The worst hit were the branches producing products for final use: light industry (75%); machine-building (65%); food processing (59%); production of building materials (78%)49.

Services

Slowdown of decline and beginning of revival in separate branches of industry

In the period of general economic decline the share of trade and public catering was growing at a faster rate than other services: its share rose from 4.5% of the total GVA volume in 1990 to 6.4% in 1996, reached 8.5% in 1999 and 10.6% in 2000. In the developed economies, trade and public catering traditionally account for a weighty share of the GVA, so, such a tendency is welcome.

In 1997-1998, the rate of economic decline slowed down to 3% and 1.9%, respectively, and in 1999 the recession almost stopped (0.2%)50. Under the influence of growing external demand, export-oriented branches (ferrous and non-ferrous metallurgy) were the first to step up operation. After the August, 1998 financial crisis and associated upsurge in price competitiveness of Ukraine s economy, the tendency of growth of exported output consolidated. The economy embarked on the path of revival of capacities in the old energy-intensive 49 50 51 52

The temporary and somewhat hypertrophied growth of the role of financial intermediation took place in the years of hyperinflation and dual currency exchange

See footnote 36. Ibid. Calculated after Statistical Yearbooks of Ukraine for the relevant years. See footnote 39.

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GVA branch structure and scale of structural changes in Ukraine's economy, at actual market prices, %

Goods-making branches: industry agriculture (including services, fishery and forestry) construction other goods-producing branches Service-producing branches: transport (without road maintenance) communication trade and public catering material supply and sales procurement computer services real estate transactions general commercial activities to support market operation geology and sub-soil prospecting, geodetic and hydrometeorological services housing and public utilities household services for the population health care, physical culture and social security education, culture and arts science and scientific services finance, credit, insurance, pension security management and defence public organisations Subtotal by branch Financial intermediation services Total

Structural changes of 1996 to 1990 -18.7 -5.0

53.4 31.4

Structural changes of 2000 to 1990 -17.3 -4.6

-11.4 -3.5 0.2 18.8 5.2 1.4 4.0 0.0 -0.1 0.0 0.6

17.1 4.2 0.7 47.8 11.1 2.6 10.6 0.5 0.2 0.2 0.7

-8.5 -4.3 0.1 18.3 4.6 1.5 6.1 -0.1 -0.2 0.0 0.7

0.6

0.7

0.0 3.1 0.2

0.2 5.3 0.6

0.1 2.8 0.3

0.2 3.9 0.5

0.1 1.4 0.2

2.8 2.9 -0.9 1.9 0.0 0.0 1.3 1.3

3.4 5.9 1.2 1.9 4.5 0.3 101.1 -1.1 100.0

1.0 1.9 -0.9 1.5 0.5 0.1 0.9 0.9

3.1 5.6 1.1 2.1 4.5 0.2 101.2 -1.2 100.0

0.7 1.6 -1.0 1.5 0.5 0.0 1.0 1.0

Structural changes of 1990 to 1999

Structural changes of 1990 to 2000

13.0 5.5 12.8 1.1 -0.2 -16.4 -0.7 -0.3 -9.2 -3.5 -2.1 32.4

9.0 4.4 16.3 1.4 0.2 -17.3 -0.6 -0.8 -9.2 -1.2 -2.3 31.4

1990

1996

1999

70.7 36.0

52.0 31.0

25.6 8.5 0.6 29.5 6.5 1.1 4.5 0.6 0.4 0.2

13.8 6.7 0.5 49.5 12.9 2.0 6.4 1.1 0.5 0.1 0.0

-11.8 -1.8 -0.1 20.0 6.4 0.9 1.9 0.5 0.1 -0.1 0.0

14.2 5.0 0.8 48.3 11.7 2.5 8.5 0.6 0.3 0.2 0.6

0.3

0.1 2.5 0.3

0.1 5.6 0.5

2.4 4.0 2.1 0.6 4.0 0.2 100.2 -0.2 100.0

5.2 6.9 1.2 2.5 4.0 0.2 101.5 -1.5 100.0

52.8 32.8

Structural changes of 1999 to 1990 -16.3 -3.8

2000

* Calculated after Statistic Digest National Accounts of Ukraine in 1990-2000 . State Statistics Committee of Ukraine. Kyiv, 2002, p.378. The branch was not separated by statistics.

Structure of industrial production in Ukraine, at current prices, %

Industry total, including: electricity fuel industry ferrous metallurgy non-ferrous metallurgy chemical and petrochemical machine-building and metal working wood and woodworking construction materials light industry food processing industry other brunches Regrouping coefficient **

1990

1991

1996

1999

2000

100 3.2 5.7 11.0 1.1 5.6 30.5 2.9 3.4 10.8 18.6 7.2

100 3.5 3.8 9.9 1.0 5.4 26.3 2.9 3.7 12.3 24.4 6.7

100 12.6 12.1 21.6 1.4 6.7 14.9 2.2 3.3 2.1 16.3 6.7

100 16.2 11.2 23.8 2.2 5.4 14.1 2.2 3.1 1.6 15.1 5.1

100 12.2 10.1 27.4 2.5 5.8 13.2 2.3 2.6 1.6 17.4 4.9

* Calculated after Statistical Bulletins of the State Statistics Committee of Ukraine On the Socio-economic Situation of Ukraine for relevant years. ** Calculated as a sum of absolute values of structural changes for a group of branches divided by 2.

rate, when such business was especially attractive. As a result, the share of credit and finance, insurance and pension services in the GVA structure increased from 0.6% in 1990 to 10.2% in 1993, and in 2002 returned to 2.1%53. In other economies in transition (with the exception of Poland whose indicator is comparable with the Ukrainian) it ranged from 7% to 10%; in the developed countries was stable at above 20%. The share of transport and communication in the GVA structure increased almost two-fold (from 7.6% in 1990 to 14.2% in 1999). However, those structural changes were primarily conditioned by the growing 53 54

cost of transport services, not development of the branch. For instance, the total GVA in the sphere of transport decreased in real terms, compared to 1990, by 76.1%54, far ahead of the general economic decline. The transformational recession in some branches was accompanied with the appearance and development of new branches, such as real estate transactions , general commercial activities to support market operation and finance, credit, insurance, pension security . In 2000 those services accounted for 3.5% of total GVA, far less than in other countries in transition and developed economies.

Ibid. Ibid.

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STRUCTURAL AND TECHNOLOGICAL CONSEQUENCES OF THE GROWTH PERIOD

production of consumer goods. In practice, however, the lion s share of state support fell on agriculture and coal industry.

Through 1996, the share of health and social work was up (from 2.4% in 1990 to 5.2% in 1996), along with education (from 3.3% to 5.9%), due to high concentration of gross disposable income in the GG sector; in 2000, as a result of a decrease in the share of GG sector in gross disposable income, the shares of those branches fell to 3.1% and 5%, respectively.

At that, no effective mechanisms of state programme implementation providing for efficacious control over their performance and the effectiveness of use of the allocated budget funds were offered56.

Given the need of human capital development, the decrease in the share of science and scientific services (from 2.1% in 1990 to 1.1% in 2000) and stabilisation of the share of culture and arts at an extremely low level (0.7% in 1990 and 0.6% in 2000) were negative structural phenomena.

Concentration of state support in said branches did not encourage modernisation of industry, development of knowledge-intensive, hi-tech kinds of economic activity critical for economic growth at the present stage. The system of state preferences applied by the state is ineffective: the majority of them are intended for the branches and enterprises that do not modernise production.

Specificity of the transformation recession in Ukraine lied in the reduction of real amounts of paid services for the population. In 1995-1999 alone, the real value of paid services decreased almost two-fold, which reflects the scale of the grey sector rather than the depth of decline.

As a result, the share of agriculture in Ukraine remains too high (despite its decrease to 13.4% in 2002). In industry, structural changes favourable for the branches producing final products are just beginning: from 2000 in food processing, from 2001 in machine-building. In 2002, the share of food processing reached 18%, of machine-building 12.4%.

By and large, despite the development of new kinds of market services, the lag of Ukraine in creation of market infrastructure branches persisted, hampering the improvement of the business climate.

Meanwhile, the share of manufacturing grows mainly at the expense of development of its low-tech (with the exception of machine-building) branches, largely employing obsolete technologies, through the increase in the rate of employment of the existing capacities. I.e., Ukraine witnesses restoration of the former structure, without fundamental progressive technological changes. The structure of Ukraine s industry remained overloaded with energy-consuming primary branches (in 2002, metallurgy 22.8%, chemical and petrochemical industry 6.3%), which restrains possibilities for economic growth57.

Economic growth in 2000-2002 The revival of some kinds of economic activity in 2000-2001 was uneven and unsteady, which conditions the instability of the structural changes. While in 2000, production revived primarily in export-oriented branches of economy, agriculture, trade and public catering, in 2001 the growth of production was higher in the sphere of wholesale and retail trade, repair of motor vehicles, motorcycles and personal goods; extremely high growth rates were observed in many manufacturing branches; high growth rate in agriculture persisted. In 2002, the leaders manufacturing, wholesale and retail trade, repair of motor vehicles, motorcycles and personal goods were joined by transport; agriculture quitted.

The calculations made using the OECD methods58 (Insert Groups of industries based on thechnology level ) on the basis of the World Bank data (for 1981-2000) and primary statistical data for Ukraine (for 2000-2001) allow comparing the technological structure of the manufacturing industries of Ukraine and some other countries, including Singapore the country for several years occupying the second place after the U.S. by the economy competitiveness rating, South Korea one of the Asian tigers , India whose information sector has been booming in the recent years, etc. (Table Technological structure of manufacturing , Labour productivity, investment volumes and return on investments in Ukraine s manufacturing , p.25).

2.4 STRUCTURAL AND TECHNOLOGICAL CONSEQUENCES OF THE PERIOD OF ECONOMIC GROWTH Structural changes in Ukraine took place in absence of a comprehensive strategy of economic restructuring55, through the development of separate branch programmes lacking harmonisation, financial support, proper co-ordination, logic and consistency. The structural policy and related elements of economic policy were developed by different agencies without proper co-ordination. Too many uncoordinated structural priorities were for the solution of current issues. The list of priorities traditionally included the energy complex, agriculture, machine-building and

The results of analysis of the above data point to the following. v Ukraine lags far behind both the developed and other countries (with the exception of Turkey) by the technological level of manufacturing. Some 62.8% of all

55 Two attempts of drawing a comprehensive State Programme of Restructuring of the Economy (in 1996 and 2000) never ended with the adoption of documents. 56 The experience of implementation of the programme of coal industry restructuring is demonstrative, where despite the expenditure of some UAH 3 billion in course of six years, none of the ineffective and loss-making coal industry enterprises was struck off the state register of enterprises. See: official WEB-site of the Accounting Chamber of the Verkhovna Rada Ukraine. http://www.ac-rada.gov.ua/Ua/5/20021007.htm. 57 Statistical Bulletin of the State Statistics Committee of Ukraine On the Socio-economic Situation of Ukraine in January-December, 2002 . 58 Calculation was based on the methodology of 1999, not of 2001, since the statistical data were collected in the period when the 1999 methods were effective.

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Groups of industries based on technology level À group High-technology industries

aircraft and spacecraft Pharmaceuticals Office, accounting and computing machinery Radio, television and communication equipment Medical, precision and optical instruments

B group Medium-high-technology industries

Electrical machinery and apparatus n.e.c. Motor vehicles, trailers and semi-trailers Chemicals excluding pharmaceuticals n.e.c. Railroad equipment and transport equipment n.e.c. Machinery and equipment n.e.c.

C group Medium-low-technology industries

Coke, refined petroleum products and nuclear fuel Rubber and plastic products Other non-metalic mineral products Building and repairing of ships and boats Basic metals Fabricated metal products, except machinery and equipment Manufacturing n.e.c., and recycling Wood, pulp, paper and paper products, printing and publishing Food products, beverages and tobacco Textiles, textile products, leather and footwear

D group Low-technology industries

enterprises are concentrated in the Ñ and D sectors accounting for 75.4% of the total output (per worker) and 77.2% of gross fixed capital investment of manufacturing enterprises. v The group of hi-tech branches shows the lowest indicators of output per worker (labour productivity) and the rate of return on investments, which points to the low effectiveness of the employment of production factors (Table Labour productivity, investment volumes... ).

By and large, more than 10 years of transformation in Ukraine not only failed to remove the deformations that existed initially (too high shares of industry and agriculture); on the contrary, the basic deformations still aggravated, and new one emerged (too low share of construction, and market services), hindering economic growth. The country made no progress towards structural parameters of the developed countries, on the contrary widened the gap in times, especially in hi-tech industries.

Technological structure of manufacturing in terms of industrial output, employment and fixed capital investment, % Years

Output A

Employment C

Investments

USA* 1981

10.5

28.9

31.5

29.1

13.2

27.4

26.3

33.1

17.4

27.5

25.7

29.4

2000

17.7

29.0

23.8

29.5

11.4

25.8

28.6

34.2

19.9

25.6

26.6

27.9

Canada 1981

3.0

26.0

31.9

39.1

4.4

20.6

28.2

46.7

1998

5.7

39.0

22.5

32.9

5.9

21.5

28.8

43.8

South Korea* 1981

7.3

17.2

39.0

36.5

9.1

14.7

29.2

47.0

11.4

26.9

39.2

22.6

1997

15.5

36.5

25.0

23.0

12.8

32.0

25.0

30.2

19.2

25.9

37.5

17.4

India** 1981

3.1

30.1

31.7

35.0

2.6

22.2

20.7

54.4

4.6

34.2

35.2

26.0

1995

5.6

31.1

30.5

32.8

4.4

25.5

22.1

48.0

4.5

36.2

34.2

25.1

Singapore** 1981

27.3

20.5

29.7

22.5

26.3

19.0

27.1

27.6

43.5

23.5

17.5

15.5

1994

58.9

14.4

17.1

9.6

37.3

19.0

26.9

16.8

48.6

18.9

21.7

10.8

Turkey*** 1981

2.3

18.9

41.6

37.2

2.1

18.6

28.3

51.0

3.8

17.1

50.5

28.6

1997

4.5

21.8

32.3

41.4

3.1

18.4

23.1

55.3

3.2

24.2

30.4

42.2

Ukraine 2000

4.2

19.3

46.5

30.0

6.1

32.0

29.8

32.1

4.0

15.9

44.7

35.4

2001

4.5

20.0

43.9

31.5

5.8

31.4

30.7

32.1

4.0

18.8

40.5

36.7

* share of fixed capital investments given for 1992 and 1995. ** in the line of 1981, share of investments is given for 1989. *** in the line of 1981, share of investments is given for 1990. data unavailable.

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SOCIAL CONSEQUENCES OF THE MARKET TRANSFORMATION

Labour productivity, investment volumes and return on investments in Ukraine's manufacturing Output per worker, thou. UAH

Manufacturing High-technology (A) Medium-high-technology (B) Medium-low-technology (C) Low-technology (D)

2000 24.39 21.45 55.56 33.27 25.94

Investment into fixed assets per worker, thou. UAH 2000 2001 15.2 15.1 17.8 14.1 15.2 14.3 12.4 11.3 9.7 8.7

2001 33.33 27.34 61.15 42.04 31.61

2.5 SOCIAL CONSEQUENCES OF THE MARKET TRANSFORMATION

Output per one UAH of investment 2000 1.61 1.21 3.65 2.68 2.66

2001 2.21 1.94 4.27 3.71 3.63

socio-demographic indicators show a general decline of the standard of life of the population in the past 12 years, i.e., deterioration of the quality and structure of the national labour resources.

One of the main goals of market reforms in Ukraine lies in the improvement of the standard of life of the population in line with the European standards and betterment of social protection. In course of 12 years of transformation, the social sphere saw some positive changes: citizens obtained the right to free enterprise, privatisation of houses and land; the range of goods and services offered on the consumer market is incomparable with the situation in 1990. At the same time, the social price of the attained economic indicators is too high, as witnessed by the key socioeconomic and demographic indicators.

Unemployment. In 1992-1998, unemployment was on the rise in Ukraine; since 1999 it has been stable at below 4% (as of September 1, 2002 3.7%)60. 27.7% of all unemployed are young people below 28 years. The trend of an increase in the average duration of forced job search leading to dequalification of workers is especially negative (Table Unemployment and duration of job search ). Social stratification, spread of poverty. The years of 1990-2002 brought sharp social stratification by the level of welfare: according to official data, the ratio between the standard of life of the 10% richest and 10% poorest citizens equals 7.1 61; poverty and destitution flood the country. Under the official criteria, by the results of 2002, 27.9% of the population was classified as poor , 15.0% as extremely poor 62. In 2000, those indicators were equal to, respectively, 27.8% and 14.2%63. Poverty limits public access to medical care and education, which is inadmissible from the point of view of human capital growth. For instance, by the results of a sociological survey, 54.4% of citizens had to refuse from medical services due to the shortage of funds for that (Diagram Did you have to refuse from medical assistance because of lack of funds? ).

Demographic indicators. Life expectancy at birth is considered a summary indicator of the quality (standard) of life. In Ukraine the indicator of life expectancy at birth decreased from 65.9 years for men and 74.2 for women in 1989-1990 to 62.4 for men and 73.6 for women in 2000, ranking among the lowest in Europe (for comparison, in Germany 74.5 and 80.5 years, respectively)59. Since 1991 there has been a steady tendency towards the reduction of the country s population, annual mortality rates exceed birth indicators, the rate of natural increase of population is negative and since 1996 has been close to 6. Health indicators of the population deteriorate; from 1995, Ukraine experiences an epidemic of tuberculosis, the spread of HIV/AIDS is growing. Therefore, the key

Unemployment and duration of job search 2001 1996

1997

1998

1999

Total number of unemployed in the age of 15-70 years, thou.

1437.0

1997.5

2330.1

2937.1

2698.8

2707.6

2516.9

2519.2

2232.4

in that, searched jobs, tried to establish own business

1219.8

1666.2

1995.4

2825.4

2565.1

2628.7

2431.3

2433.4

2143.7

in that, by the length of job search, % up to 3 months

2000

2002

1995

In that, 9 months 9 months year-average

32.4

26.7

20.4

17.9

14.9

13.2

14.0

13.8

14.7

4-6 months

21.1

20.2

20.4

19.1

13.9

11.0

10.8

11.3

7-9 months

10.3

11.1

11.9

10.7

12.0

12.2

10.1

10.5

10.3

8.2

9.3

15.0

15.3

12.9

13.1

10.1

10.2

9.7

28.0

32.7

32.3

37.0

46.3

50.5

54.8

54.7

54.0

7.0

8.0

9.0

10.0

10-12 months more than a year Average time of job search, months

Note: after the results of selective surveys of the population on the issues of economic activity, in 1995-1998 average for the 4th quarter, in 1999-2002 average for the period, with account of seasonal fluctuations. 59

See: Statistical Yearbook of Ukraine for 2000. State Statistic Committee of Ukraine. Kyiv, 2001, p.548. At the same time, according to some expert estimates, the level of unemployment is up to 40% of the able-bodied population (with account of latent unemployment). 61 By the results of nine months of 2002, by the indicator of gross expenditures. See: Address of the President of Ukraine to the Verkhovna Rada On the Internal and External Situation of Ukraine in 2002 . http://www.president.gov.ua. 62 See: ibid. 63 See: Address of the President of Ukraine to the Verkhovna Rada On the Internal and External Situation of Ukraine in 2000 . Kyiv, 2001, p.67. 60

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MARKET TRANSFORMATION POLICY IN UKRAINE: THE EFFECTS OF MACROSTRUCTURAL FACTORS

Lack of savings, low solvency. As we noted above, in the period of hyperinflation of early 1990s Ukraine s population lost its pre-reform savings; we also spoke about the concentration of savings (bank deposits) in the hands of a small group of people. The results of sociological surveys64 give grounds to conclude that in the recent years, the majority of the population neither managed to collect weighty savings nor spent the proceeds on high-priced durables. According to the data presented in Diagram Should you lose job, how long will you be able to live on your savings? , half (50.5%) of all citizens has no savings, another 34.4% will be able to live on savings for one to six months. Only 3.2% of the polled reported possession of savings sufficient for a year and more. At the same time, the majority of the population (89.5%) after 1991 did not acquire any durables (Diagram Do you own durables acquired...? ), i.e., did not spend their potential savings on the solution of current household problems. By and large, the negative social consequences of the long economic transformation in the conditions of a crisis in Ukraine may turn into a factor reducing the rate and level of development of Ukraine s economy, since: (à) lowering of the standard of life leads to the deterioration of the quality of labour resources both by education, qualification and health indicators; (b) low solvency of the population continues to limit domestic demand and does not encourage domestic manufacturers.

CONCLUSIONS Comparison of the indicators of transformations taking place in Ukraine with the commonly recognised institutional standards of the market economy, the results of similar processes in CEE and Baltic states gives reasons to conclude that despite almost equal initial conditions, Ukraine has failed to achieve the level attained by its neighbours. Ukraine has seen no systemic changes that might not only lead the country out of the crisis but also give an impetus for its dynamic progressive development. State support for separate branches of the economy did not rest on a planned long-term basis. Its concentration (at the initial stage) in agriculture and coal industry, as well as ineffectiveness of the mechanisms of taxation and preferences encouraged the formation of a protectionist model of development and an economy with an excessive share of general government in Ukraine. The absence of a strategy of restructuring of the economy and its separate sectors linked to plans of

their privatisation and modernisation, ineffective concentration of the scanty resources lead to intersectoral disproportions hindering the progress of economic reforms (or, in fact, having delayed their start). The imperfect state policy resulted, inter alia, in the lag of developing hi-tech branches. Ineffective economic reforms caused grave social consequences, in particular, spread of poverty, unemployment and general deterioration of the standard of life, and, therefore, deterioration of the quality of labour resources which, in turn, may now affect economic development of the country. n

Cited are the results of the survey conducted as part of the PAUCI project. The poll was held on April 2-7, 2003. 2,013 respondents aged 18 years and above were polled in all of Ukraine s regions.

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3. MACROSTRUCTURAL SHIFTS IN THE ECONOMY OF UKRAINE IN THE CONTEXT OF INTEGRATION IN THE GLOBAL AND EUROPEAN ECONOMIC SPACE T

he analysis of macrostructural shifts in the economy of Ukraine requires comprehensive estimation of: (1) the degree of inclusion of the Ukrainian economy in the process of economic globalisation, and the dynamics of its dependence on the world economy; (2) the presence or absence, and the character of structural shifts caused by integration into European and global economic structures; (3) the level of the international competitiveness of the country and components which form it. In this context, it is necessary, on the one hand, to determine the impact of international exchange and the present structure of Ukraine's competitive advantage on the development of structural characteristics of the Ukrainian economy, and on the other hand, to find real opportunities and macrostructural restrictions which relate to the policies of international integration of Ukraine's economy. This section of the report analyses the main structural problems which appear in the context of Ukraine's integration into world economy, and in particular into European economic space, the core of which is formed by the European Union.

3.1 MACROSTRUCTURAL PROBLEMS OF UKRAINE S INTEGRATION INTO THE WORLD ECONOMY

A.T.Kearney/Foreign Policy Magazine Globalization Index The methodology of calculating this Index envisages, in particular, estimation of national economies along the following four groups of indicators. 1. Political Engagement: number of memberships in international organisations, UN Security Council missions in which each country participates, and foreign embassies that each country hosts. 2. Technology: number of Internet users, Internet hosts, and secure servers. 3. Personal Contact: international travel and tourism, international telephone traffic, and cross-border transfers. 4. Economic Integration: trade, foreign direct investment and portfolio capital flows, and income payment and receipt. In 2002, 62 advanced market economies and key emerging markets were estimated. The 2002 aggregate index of globalisation ranged the leading countries in the following order: 1. Ireland; 2. Switzerland; 3. Sweden; 4. Singapore; 5. Netherlands; 6. Denmark; 7. Canada; 8. Austria; 9. United Kingdom; 10. Finland; 11. USA; 12. France; 13. Norway; 14. Portugal; 15. Czech Republic; 16. New Zealand; 17. Germany; 18. Malaysia; 19. Israel; 20. Spain.

The most comprehensive estimation of inclusion of separate countries in the processes of globalisation is carried out within the framework of A.T.Kearney/ Foreign Policy Magazine Globalization Index (Insert A.T.Kearney/Foreign Policy Magazine Globalization Index 65), which takes into account four groups of indicators, with their relationship enabling to determine a relative level of inclusion of a particular country into world economy. The indicators for Ukraine and Poland summarised according to the methodology of this Index are presented in the Table Rankings of Ukraine and Poland according to separate indicators in the Globalization Index , and they testify to the following. 1. As regards indicators of the Globalization Index, Ukraine is first of all integrated into global political processes, lesser to global economic processes, and least of all to personal contacts, and especially to the development of global technologies. Compared to Ukraine, Poland, on the contrary, is actively included in personal international contacts and the development of global technologies, and least of all into global economic structures. 65

2. One should emphasise the extremely high level of Ukraine s involvement into international trade (11th position among 62 countries), a relatively high level of international income payment and receipt (alongside

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Rankings of Ukraine and Poland according to separate indicators in the Globalization Index Indicators

Ukraine

Poland

Overall ranking

Political Engagement

Number of memberships in international organisations

UN Security Council missions in which country participates

Foreign embassies that country hosts

Technology Number of Internet users

Number of Internet hosts

Number of secure servers

Personal Contact

International travel and tourism

International telephone traffic

Cross-border transfers

Economic Integration

Trade

Foreign direct investment

Portfolio capital flows

Income payment and receipt

See.: The 2003 A.T. Kearney/Foreign Policy Magazine Globalization Index. Country Detail. http://www.foreignpolicy.com/issue_janfeb_2003/countrydetail.php.

NETWORKED READINESS INDEX Includes two components: v the Network Use index; v the Enabling Factors index. The Network Use index is calculated on the basis of the following indicators: Internet users per hundred inhabitants; cellular subscribers per hundred inhabitants; Internet users per host; percentage of computers connected to the Internet; availability of public access to the Internet. Enabling Factors index comprises the following indices: n Network Access (comprises Information Infrastructure index; Hardware, Software and Support index); n Network Policy (formed by the indices of Information and Communication Technologies [ICT] Policy, and Business and Economic Environment); n Networked Society (comprises indexes of Networked Learning, ICT Opportunities, and Social Capital); n Networked Economy (consists of the indexes of E-Commerce, E-Government , and General Infrastructure).

The development of economic integration For today, Ukraine has reached a very high level of economic openness as regards foreign trade (Diagram The share of exports of goods and services in Ukraine s GDP )68. In terms of foreign trade dependence, the economy of Ukraine demonstrates an indicator more

very low indicators of foreign direct investment66), and a considerable lag as regards indicators of Internet global network development. Along all these indicators Poland has a diametrically opposite stand. Thus, the macrostructure of participation of the two countries in globalisation processes does not merely differ substantially. It reflects absolutely different models of inclusion into the global space. At that, if the Polish model has, in general rational parameters (priority of domestic market development and prevention of excessive dependence of the economy on external markets; active attraction of foreign direct investment (FDI) alongside restriction of hot money flows; the priority of entrance into global high-tech networks, etc.), the Ukrainian model comprises all the typical deficiencies inherent in underdeveloped countries. The peculiarities of this model in the aspects of the development of global technologies and economic integration are further analysed below.

The development of global technologies Backlog on a complex of conditions of functioning in global networks is evident (Table Networked Readiness Index [NRI] 67), and it displays, in particular, a backlog in information technologies (Insert of the same title). At the same time, it is necessary to take into account, that, probably, parameters of Ukraine in this aspect will look a little bit better if to allow for a low level of registration of computer owners, and also the prevailing type of the use of networks in Ukraine (collective, instead of individual).

than twice as high, in comparison with the world s average, and substantially higher with regard to developed European countries which are EU members, and the Polish economy (which could be compared to the Ukrainian economy by its scale and general structure). At the same time, there is an asymmetrically low level of dependence of Ukraine s economy on global capital flows (Table Some indicators of integration of national economies and regions of the world into the global economy 69, p.30). The data presented in the Table indicate a substantial imbalance between the development of foreign trade and the domestic market of Ukraine. This imbalance results in excessive foreign trade dependence of the economy, which alongside with low potential to attract investments, and the conservation of now present

In comparison with this, a higher ranking is observed for portfolio capital flows, which in the case of Ukraine points to enhanced dependence on hot money flows. 67 World Economic Forum. Global Information Technology Report 2001-2002. 68 Calculated on the basis of the data of Annual Statistical Yearbooks of Ukraine for the relevant years. 69 The World Bank. World Development Indicators 2002. Washington, D.C., 2002, pp.331-334.

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Networked Readiness Index (NRI) NRI rank Country 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 * **

USA Iceland Finland Sweden Norway Netherlands Denmark Singapore Austria United Kingdom New Zealand Canada Hong Kong SAR* Australia Taiwan** Switzerland Germany Belgium Ireland Korea. Rep. Japan Israel Estonia France Italy Spain Portugal Czech Republic Slovenia Hungary Greece Argentina Slovakia Chile Poland Malaysia Uruguay Brazil Latvia South Africa Turkey Lithuania Thailand Mexico Costa Rica Trinidad and Tobago Dominican Republic Panama Jordan Venezuela Mauritius Peru Bulgaria India El Salvador Jamaica Columbia Philippines Indonesia Egypt Russia Sri Lanka Paraguay China Romania Ukraine Bolivia Guatemala Nicaragua Zimbabwe Ecuador Honduras Bangladesh Vietnam Nigeria

Aggregate NRI

Network use

Enabling factors

6.05 6.03 5.91 5.76 5.68 5.68 5.56 5.47 5.32 5.31 5.23 5.23 5.23 5.22 5.18 5.17 5.11 4.90 4.89 4.86 4.86 4.84 4.73 4.71 4.70 4.62 4.57 4.38 4.24 4.14 4.13 4.01 4.01 4.00 3.85 3.82 3.80 3.79 3.78 3.71 3.67 3.59 3.58 3.58 3.57 3.52 3.52 3.42 3.42 3.41 3.40 3.38 3.38 3.32 3.30 3.29 3.29 3.27 3.24 3.20 3.17 3.15 3.15 3.10 3.10 3.05 3.04 3.00 2.83 2.78 2.65 2.64 2.53 2.42 2.10

6.07 6.35 5.71 5.67 5.68 5.61 5.43 5.29 5.13 4.95 5.26 4.80 5.06 5.04 5.17 4.74 4.57 4.51 4.52 4.82 4.49 4.45 4.51 3.95 4.55 4.18 4.35 3.93 3.91 3.60 3.91 3.69 3.38 3.36 3.32 3.34 3.30 3.21 3.26 3.17 3.25 3.08 2.88 3.13 3.06 3.04 3.13 2.88 2.71 3.01 2.95 3.13 3.09 2.71 2.87 2.66 2.89 2.68 2.70 2.50 2.71 2.58 3.08 2.41 2.85 2.63 2.91 2.69 2.64 2.50 2.03 2.22 2.40 1.80 1.24

6.03 5.71 6.11 5.86 5.67 5.74 5.69 5.65 5.50 5.67 5.21 5.66 5.40 5.39 5.19 5.60 5.66 5.29 5.26 4.90 5.22 5.23 4.95 5.46 4.85 5.06 4.79 4.84 4.58 4.68 4.36 4.34 4.63 4.65 4.38 4.29 4.29 4.38 4.31 4.24 4.09 4.11 4.29 4.03 4.09 4.01 3.91 3.97 4.12 3.82 3.86 3.64 3.67 3.93 3.73 3.92 3.68 3.86 3.77 3.90 3.63 3.72 3.22 3.79 3.35 3.46 3.17 3.30 3.02 3.06 3.27 3.06 2.65 3.04 2.96

Information infrastructure 6.45 6.27 6.65 6.62 6.41 6.32 6.46 6.10 6.12 6.22 5.92 6.36 6.24 5.90 5.68 6.22 6.21 6.03 5.48 6.02 6.02 5.70 5.28 6.11 5.82 5.77 5.57 5.29 5.13 5.37 5.33 5.38 5.23 5.46 4.56 5.14 5.08 5.00 4.96 4.92 5.26 4.82 5.13 5.06 4.26 4.55 4.92 4.72 4.91 5.03 4.53 4.88 4.37 4.06 4.68 4.03 4.49 4.64 4.99 4.87 4.04 4.59 3.67 4.58 4.39 4.00 4.30 4.62 3.88 3.21 4.31 3.66 3.59 3.23 2.96

Networked economy 5.15 4.98 5.29 5.11 4.90 4.94 4.93 5.04 4.68 4.92 4.35 4.95 4.81 4.60 4.55 4.69 4.96 4.43 4.37 4.35 4.42 4.41 4.31 4.84 4.37 4.45 4.13 4.09 3.91 3.77 3.66 3.71 3.76 3.80 3.86 3.78 3.67 4.01 3.70 3.88 3.50 3.63 3.85 3.57 3.17 3.26 2.98 3.26 3.60 3.06 3.21 2.96 3.21 3.57 3.01 3.45 2.93 3.02 3.11 3.48 3.12 3.05 2.86 3.35 2.45 3.35 2.38 2.65 2.48 2.53 2.65 2.51 2.35 2.55 2.63

e-Commerce 4.91 4.42 4.88 4.74 4.26 4.52 4.33 4.27 4.13 4.56 3.93 4.53 4.36 4.17 4.18 4.41 4.86 4.01 4.02 4.21 4.10 4.20 3.99 4.47 4.12 3.96 3.60 3.66 3.39 3.46 3.18 3.76 3.33 3.49 3.81 3.37 3.16 4.17 3.34 3.91 3.64 2.83 3.38 3.37 2.90 3.00 2.90 3.16 3.13 3.14 2.53 2.77 2.66 3.82 2.68 2.78 2.82 3.39 3.38 3.26 2.84 3.04 2.74 3.18 2.06 2.92 2.29 2.66 2.60 2.63 2.48 2.54 2.57 2.31 2.82

Separate administrative region of China. Separate customs territory.

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Some indicators of integration of national economies and regions of the world into the global economy Countries

Trade in goods

% of GDP

World Low income countries Middle income countries High income countries East Asia & Pacific Europe & Central Asia Latin America & Carib. Middle East & N.Africa South Asia Sub-Saharan Africa Europe EMU United Kingdom Italy Canada France Germany USA Japan Australia Israel Ireland Netherlands New Zealand Finland Switzerland Sweden Argentina Brazil Egypt China India Indonesia Nigeria Korea, Rep. Malaysia Mexico South Africa Saudi Arabia Singapore Chile Hungary Poland Russia Ukraine Czech Republic

1990 32.4 26.7 36.6 32.0 48.8 28.7 23.2 45.4 16.5 41.2 44.9 41.3 32.0 43.8 37.1 46.0 15.8 17.1 26.4 55.0 93.9 87.3 44.1 39.2 58.4 46.9 11.6 11.6 27.4 32.5 13.1 41.5 67.8 53.4 133.3 32.7 37.5* 65.4 309.9 52.9 61.5 43.9 16.5 ... 84.0

% of goods GDP

2000 40.0 41.3 53.5 37.1 65.6 65.6 37.7 51.6 24.3 56.8 56.3 43.9 44.2 75.8 46.6 56.3 20.7 17.7 34.7 62.9 139.3 112.5 54.5 65.5 68.9 70.3 18.1 19.1 18.9 43.9 20.3 62.4 80.3 72.8 201.3 60.8 47.4* 66.0 295.3 51.4 131.9 51.1 60.0 89.7 120.5

1990 96.2 ... 77.3 100.6 84.9 53.1 68.8 80.9 ... 76.1 112.3 104.7 83.3 103.1 101.6 106.2 ... 44.4 71.3 ... 186.7 228.9 122.3 86.5 ... 119.8 27.0 ... 54.2 47.4 ... 64.4 91.2 102.7 232.1 76.9 75.2* 106.7 892.4 100.1 102.4 75.2 35.0 ... ...

2000 118.9 ... 114.0 124.4 112.6 110.4 115.2 89.7 ... 96.4 141.9 126.7 121.7 ... 136.3 156.6 ... 55.2 89.5 ... 273.9 289.2 ... 150.1 193.3 175.5 49.8 ... 35.3 65.8 ... 97.2 105.3 153.8 356.5 155.3 101.3* ... 858.0 110.7 214.8 99.7 117.3 152.9 ...

Changes in trade as shares of GDP % change 1980-1999 55.6 68.5 113.3 63.1 40.6 99.1 39.3 72.9 25.1 129.1 44.4 67.5 57.6 50.6 67.0 154.9 72.1 -40.9 ... 61.6 -16.5 -39.9 121.6 124.8 223.4 23.2 ... ... 65.5 81.8 ... ... ... ...

Growth in real trade less growth in real GDP Percentage points 1990-2000 3.9 3.8 5.4 4.2 3.4 5.0 2.6 3.8 4.1 6.8 2.4 3.0 5.4 2.7 5.3 7.0 5.8 -1.3 -2.7 4.4 1.3 2.1 7.5 4.2 10.2 4.2 ... ... 3.3 8.8 8.4 0.7 6.3 9.8

Gross private capital flows**

Gross foreign direct investment

% of GDP

1990 10.3 3.0 7.6 11.0 5.3 ... 7.9 11.5 1.4 5.1 14.1 35.3 10.6 8.1 20.6 9.8 5.7 5.4 9.3 6.2 22.2 29.7 18.0 17.4 15.9 34.2 8.2 1.9 6.8 2.5 0.8 4.1 5.9 6.2 10.3 9.2 2.2 9.8 54.6 15.0 4.6 11.0 ... ... ...

2000 29.1 4.8 12.0 33.6 13.3 13.6 10.5 7.5 3.1 11.0 49.4 125.1 23.6 30.0 36.1 40.8 16.9 10.3 17.4 19.5 299.9 103.6 19.2 88.6 113.4 77.0 10.9 10.9 6.7 12.7 3.0 8.5 13.0 11.5 16.8 6.3 13.1 10.8 48.5 24.1 25.0 13.3 13.3 9.5 23.7

1990 2.7 0.5 1.0 3.0 1.5 ... 0.9 0.9 0.1 1.0 2.9 7.4 1.3 2.7 3.9 1.8 2.8 1.7 3.7 0.7 2.2 8.3 11.6 3.6 5.8 7.0 1.3 0.4 1.7 1.2 0.0 1.0 2.1 0.7 5.3 1.0 0.2 1.8 20.7 2.2 0.0 0.2 ... ... ...

2000 8.8 1.6 3.8 10.1 3.9 3.8 4.5 1.0 0.6 1.8 14.8 38.7 2.4 16.1 16.4 13.3 5.1 0.9 5.3 6.7 49.2 35.3 8.3 34.4 25.0 27.3 4.5 6.0 1.3 4.3 0.6 4.2 2.9 3.2 2.0 2.3 1.2 1.1 11.6 12.0 5.0 6.6 2.4 1.9 9.3

Source: The World Bank. World Development Indicators 2002. Washington D. C., 2002. * Data refer to South African Customs Union (Botswana, Lesotho, Namibia, the Republic of South Africa, and Swaziland). ** The sum of the absolute values of direct, portfolio, and other investment flows and outflows recorded in the balance of payments financial account, excluding changes in the assets and liabilities of monetary authorities and general government. Indicator not applicable. ... Data not available.

structural proportions, will make it problematic to ensure high long-term dynamics of economic growth.

Structural parameters of international trade. The model of international specialisation The analysis of the data contained in the Table Comparison of world export structure with the structure of Ukraine s exports in 2000 shows that the process of Ukraine s inclusion in the world economy is accompanied by the formation of an adverse export structure, and consequently of an unpromising model of international specialisation. The main features of the present model of international specialisation of the Ukrainian economy are the following: 70

(1) concentration on deliveries to international markets of those goods and services which have relatively slow dynamics and are characterised by reducing share in global sales of goods and services (foodstuff, ores, metals [first of all ferrous metals], transport services). These markets of goods and services are dominated by severe price competition, and therefore, advantages in price terms are likely to go over to other countries, especially in cases when a country faces restrictive, discriminatory trade measures; (2) sparce deliveries to highly dynamic markets which determine the prospects of the world economy (office and telecommunication equipment, other commercial services 70).

Include services which are high-tech, following the OECD definition.

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Comparison of world export structure with the structure of Ukraine's exports in 2000 Commodity group

World exports value, $ bln.

Share in world exports, % 1990

2000

Ukraine's exports value, $ mln.

Ukraine's share in world exports, %

Share in Ukraine's exports, %

1,587.7 1,341.8 2,45.9 2,698.0 1,255.7 807.7 634.6 10,040.1 5,156.6 1,475.5 727.2 1,893.7 146.1 93.6 1,654.0 126.2 417.7 243.3

0.28 0.30 0.21 0.33 2.03 0.13 0.53 0.22 3.58 0.26 0.16 0.07 0.03 0.01 0.16 0.08 0.21 0.04

10.9 9.2 1.7 18.5 8.6 5.5 4.4 68.9 35.4 10.1 5.0 13.0 1.0 0.6 11.4 0.9 2.9 1.7

2,917.3 60.4 509.1

0.88 0.01 0.08

83.7 1.7 14.6

Exports of goods À. Primary products Agricultural products Food Raw materials Mining products Ores and other minerals Fuels Non-ferrous metals B. Manufactures Iron and steel Chemicals Other semi-manufactures Machinery and transport equipment Automotive products Office machines and telecom equipment Other machinery and transport equipment Textiles Clothing Other consumer goods Transportation services Travel services Other commercial services

558 442 116 813 62 631 120 4,630 144 574 449 2,566 571 940 1,055 157 199 541 330 465 640

12.2 9.0 9.3 7.2 2.9 1.9 14.3 13.1 1.6 1.0 10.5 10.2 2.1 1.9 70.5 74.9 3.1 2.3 8.7 9.3 7.8 7.3 35.8 41.5 9.4 9.2 8.8 15.2 17.6 17.1 3.1 2.5 3.2 3.2 8.8 8.8 Exports of commercial services 28.5 23.0 33.9 32.4 37.6 44.6

used properly, and this is proved by gaps between the levels of patenting activities, on the one hand, and royalties, license payments and high technology exports, on the other.

It is self-understood that the above-mentioned structural characteristics of the Ukrainian foreign trade, which reflect the structure of the competitive advantage of the Ukrainian economy, from the point of view of world economic criteria, are strategically loss-making for the country, and must be drastically changed in the process of forthcoming market transformations.

Thus, today the economy of Ukraine in its structural development does not correspond to the most important global trends, and this disables its efficient integration into the world economy. The elimination of these inadequacies must become a priority of the highest order in the Government s economic policy.

However, the above-pointed indicators only partially reflect the level of the countries participation in globalisation. Despite a high level of dependence of its economy on foreign trade, Ukraine cannot be considered a country with a high level of integration into the global economy, because it: (a) has, in fact, an extremely insignificant influence on the formation of world trade flows (Table Comparison of world export structure with the structure of Ukraine s exports in 2000 71); (b) is almost imperceptible in international capital flows (Table Some indicators of integration of national economies and regions of the world into the global economy ); (c) has not yet acquired membership in the World Trade Organization (WTO), and consequently is beyond the framework of the global regulative system as regards trade and traderelated activities.

It is important for Ukraine to form the most appropriate model of participation in globalisation a task that has remained unresolved. This, in turn, requires a search for an adequate type of economic policy. International experience has worked out several types of such policy, which could be defined on the basis of analysis of the data presented in the Table Some indicators of integration of national economies and regions of the world into the global economy , and in the Insert Types of economic policies regarding globalisation (p.32). Following formal characteristics, Ukraine may be attributed to countries using the policy of active inclusion into foreign trade, and cautious approach as regard attraction of foreign investments, restricted dependence on global financial flows (see the above Insert, type 2). However, this type of policy is rather not the result of a conscious choice but a consequence of a number of objective factors, the most important of them being the following:

Indicators of the level of high-technology development Ukraine is characterised by low parameters of export of high-tech goods and services (Table Some indicators of the level of high-technology development of Ukraine in comparison with other countries and regions of the world 72, p.32). They are caused by the formation during the 1990s of a model of international competitiveness that has been based primarily on price factors and comparative advantages in the cost of natural resources and labour. At the same time, available preconditions for formation of high-tech competitiveness have not been

v limited solvent domestic demand (a narrow internal market), caused by an impoverished population and destroyed savings base from the pre-reform years. The narrow market of the country does not create incentives for capital inflow (both for domestic and foreign

Source: International Trade Statistics 2001; calculations of Razumkov Centre experts in the system of the Standard International Trade Classification, Revision 3 (SITC.3) on the basis of the data of the State Statistics Committee of Ukraine, which are presented according to the current foreign trade nomenclature based on the Harmonised System (HS). 72 Calculated and compiled on the basis of the data: The World Bank. World Development Indicators 2002. Washington, D.C., 2002; World Development Indicators 2001. Washington, D.C., 2001. RAZUMKOV CENTRE

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Some indicators of the level of high-technology development of Ukraine in comparison with other countries and regions of the world* Patent applications filed (per 100 thou. inhabitants) Residents Non-residents in 1999 in 1999

Regions and countries

World

13.8

East Asia & Pacific Europe & Central Asia Latin America & Carib. Middle East & N.Africa South Asia Sub-Saharan Africa Europe EMU

3.1 7.6 0.7 0.3 0.0 0.03 42.3

Australia Argentina Brazil United Kingdom Israel Ireland Italy Canada Germany USA Finland France Switzerland Sweden Japan China Korea, Rep. Malaysia Mexico Singapore South Africa Chile Estonia Poland Hungary Russia Ukraine Czech Republic

50.2 2.5 1.2 52.6 44.7 32.3 16.7 17.0 90.4 56.2 50.8 35.8 90.3 102.5 285.2 0.01 119.9 0.8 0.5 9.4 0.3 1.3*** 1.0 5.9 7.8 13.8 10.8 6.0

103.3 Regions 16.3 289.5 60.0 2.2 6.0 136.7 564.3 Countries 283.3 15.2 30.0 271.5 765.3 3,146.6 206.0 211.7 178.5 49.7 3,007.5 200.4 2,197.1 1,752.0 64.1 4.2 164.0 27.6 51.3 1,278.0 62.6 11.8*** 2,981.6 116.8 437.5 32.7 85.7 433.9

Royalty and license fees (per 100 thou. inhabitants) Receipts, Payments, $ thou. $ thou. in 2000 in 2000 1,191.9 1,222.5 42.3 66.0 97.1 35.9 6.4 12.4 3,624.7

291.6 369.6 517.0 208.0 24.9 43.0 7,704.6

1,786.5 35.1 73.9 12,330.0 8,064.5 13,263.2 975.7 4,461.0 3,431.9 13,505.0 21,884.6 3,921.9 ... 14,325.8 8,059.1 6.3 1454.5 0.0 43.9 ... 144.9 671.1 142.9 87.9 1,120.0 62.5 2.0 427.2

5,203.1 1,237.8 830.4 10,261.3 5,629.0 207,868.4 2,076.3 10,607.1 6,635.0 5,717.3 10,519.2 3,482.2 ... 10,112.4 8,673.8 101.5 6809.7 0.0 415.3 ... 331.8 289.5 571.4 1,431.5 2,570.0 21.3 1,339.4 796.1

High-technology exports** $ thou. in 2000 (per 100 thou. inhabitants) 1,6571.6

% of manufactured exports in 2000 20

5,416.4 3,282.1 7,852.8 460.2**** 9.9**** 185.1**** 91,310.9 14,239.6 2,073.0 3,508.8 121,634.8 119,645.2 823,105.3 33,459.3 106,175.3 100,922.1 69,969.1 202,538.5 100,843.8 198,055.6 289,202.2 100,368.8 3,234.6 114059.2 176,052.9**** 31,686.7 1,841,075.0 49.1 657.9 59,285.7 2,165.4 64,020.0 2,116.8 2,814.1***** 20,281.6

25 10 16 1 3 8 16 15 9 19 32 25 48 9 19 18 34 27 24 19 22 28 19 35 59**** 22 63 1 3 30 3 26 14 10***** 8

* Calculated and compiled on the basis of the data: The World Bank. World Development Indicators 2002. Washington. D.C., 2002; World Development Indicators 2001. Washington. D.C., 2001. ** High-technology exports, according to the World Bank methodology, includes exports of aerospace industry, computers, pharmaceuticals, scientific instruments, and electrical machinery. *** 1998 **** 1999 ***** Razumkov Centre experts' estimate made on the basis of the data: Foreign Trade of Ukraine in 2000. Vol.1, 3. Statistical Abstract of the State Statistics Committee of Ukraine. Kyiv. 2001.

TYPES OF ECONOMIC POLICIES REGARDING GLOBALISATION (1) Policy aimed at maximal use of the advantages of globalisation, i.e. at significant increase both in the share of foreign trade, and the share of foreign investments in GDP. Countries, which pursue this type of policy, consider the broadest involvement of foreign capital as the main lever of their international competitiveness in global economy (Canada, Ireland, Netherlands, Finland, Sweden, Hungary, etc.). (2) Policy based on a rather cautious approach to attraction of foreign capital alongside with high and/or growing dependence on foreign trade. Countries, which pursue this type of policy, obviously try to retain positions of national capital in export-oriented growth (Malaysia, Mexico, Republic of Korea, Brazil, the Russian Federation). (3) Policy putting an accent first of all on participation in international capital markets. It retains an active foreign trade policy, but avoids an export-oriented bias of the national economy (Switzerland, USA, United Kingdom, Germany, France, Israel, China, Chile). Poland, to a certain extent, approaches this type of policy.

(5) Policy directed on restriction of the influence of international trade and investment on national economic development. It may be subdivided into two policy subtypes:

investors). That is why exports become an hypertrophied important factor of development, which is not normal both from the point of view of the country s economic security, and the prospects of expanding its influence on global economic processes;

v an unfavourable investment climate, caused by the incompleteness of market-oriented institutional transformations, high level of discretionary interference by government authorities and officers in economic activity, corruption, low level of market infrastructure

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(4) Policy of retaining the status quo. It is targeted at parallel development, at approximately identical rates, of internal and external economic processes, which produces only a moderate growth of the shares foreign trade in GDP and the shares of foreign capital in gross capital formation (Italy, Argentina, Indonesia, Nigeria, etc.), or makes them more or less stable and limited (Japan, New Zealand ).

n Policy of partial adjustment of excessive dependence of the economy on global economic processes, as a further increase in corresponding parameters of economic internationalisation has proved to be practically impossible (Singapore); n Policy following from a general economic development strategy (Egypt, Saudi Arabia).

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The other concept does not reject the Eurointegration course of Ukraine, but treats it, first, as an objectively long-term process; and second, as a process, which emphasises not accession to the EU but the formation of a common European economic space. Intensive development of integration processes in the post-Soviet area (first of all, of Ukraine-Russia relations) are not only considered a factor not hindering European integration but, on the contrary, as its precondition, which allows to enhance considerably the economic potential of the country, and make it more prepared to integration with the EU.

development. Alongside a narrow domestic market, it diverts main capital flows from the country; v relative weakness of own political and economic institutions, financial and economic corporate structures, low capitalisation of enterprises, which creates grounds for a possible loss of the country s sovereignty, provided foreign capital inflow is considerably activated.

The elimination of these fundamental deficiencies may provide an opportunity for an adjustment of the type of policy aimed at inclusion in economic globalisation. The main features of this policy must be:

Each of the mentioned concepts has certain political, expert and public73 support, thus the changing balance of power between these support groups causes permanent and unpredictable fluctuations of the Ukrainian integration policy.

n priority of development of the internal market. Under conditions of retained sizeable foreign trade share as regards GDP reproduction, certain decreases in this indicator must take place. Such a development trend in no way contradicts the country s course aimed at economic openness, the level of which, on the contrary, will rise, after WTO accession, in the functional aspect of this term (i.e. from the point of view of the open character of the country s trade regime). It implies an accelerated development of internal demand and supply relative to external demand and supply. At that, this process will be fostered not only by internal factors but also by external ones, i.e. by the decelerated dynamics of the world economy, especially in the group of the most advanced countries;

Thus, the prospects of Ukraine s European economic integration largely depend on overcoming of contradictions among the forces, which support different policy directions, and on a co-ordination of the competing vectors within the framework of a single strategic course of European integration. In order to solve this task, it is necessary to take into account structural preconditions and obstacles to the development of regional integration, both on the EU and CIS direction.

n intensification of the process of internal and external investing into the country, under conditions of a considerable increase of the role of foreign investments. At that, alongside with the removal of the existing limitations of domestic demand, foreign investments will be directed, to a larger extent, not to export-oriented branches but to use the growing capacity of the internal market, the latter becoming more and more integrated into the structures of global markets.

The potential and structural problems of integration of Ukraine s economy to the EU The implementation of the course aimed at integration to the EU, from the point of view of macroeconomic structural preconditions, encounters significant obstruction. First, the Ukraine s lag behind the EU members as regards the level of economic development now exceeds by far those threshold values, which are acceptable to participants of integration unions74. By the level of per capita gross national income (GNI), Ukraine is far behind the poorest member countries of the EU but also of the present candidate countries (Table Correlation of per capita GNI levels in Ukraine, EU member states, and EU candidate countries in 2001 75, p.34). For 2001, Ukraine s per capita GNI made up 1.7-6.7% of the corresponding indicators for the EU members (8.6-24.0% when measured at PPP), and 5.8-22.1% of the indicators for the candidate countries (20.0-54.5% at PPP).

3.2 MACROSTRUCTURAL PROBLEMS OF UKRAINE S INTEGRATION INTO EUROPEAN ECONOMIC SPACE The general structural problems revealed in the analysis of Ukraine s integration into the world economy, on the whole, are determinants of the integration of the Ukrainian economy into European economic space as well. However, there exist specific factors in the process, which are analysed in this subsection.

Political preconditions for economic integration

Second, an international integration process, for its subsequent success, needs to be based on high potential in the international division of labour and economic internationalisation, performed on the level of economic agents. Meanwhile, Ukraine, having a GDP export quota which is almost twice as high as the EU average, accounts for only 5% of the EU per capita exports. And its per capita FDI is scanty at all: 0.6% of the EU average in 2000, and 1.9% in 2001.

The main problem of Ukrainian policy as regards participation in projects of regional integration on the European continent lies in the presence of two competing development concepts, which, to a great extent, neutralise each other. One of them is based on the priority of integration to the EU, while integration processes in the CIS region are considered only in the aspect of the possible creation of a free trade area. Everything flowing out of this framework is regarded as an obstacle to the course of European integration.

Third, the EU interest to Ukraine tends to weaken due to considerable difference in social standards. In the contemporary world, human capital is acquiring an ever-growing

73 For more details see materials of thematic publications of the National security & Defence magazine: 2001, No.11; 2002, No.12; 2003, No.1. http://www.uceps.com.ua. 74 Under threshold values we understand the average indicators of the starting conditions which characterise the EU candidate countries. 75 Calculations made by Razumkov Centre experts based on: The World Bank. World Development indicators 2002. Washington, D.C., 2002, p.18-20, 36; World Development Report 2002. Washington, D.C., 2002, Statistical Annex; Sidenko V. The Conceptual Foundations of the Strategy of Ukraine s Integration into the European Union Structures. Economy & Forecasting, 2001, No.2, p.30 (in Ukrainian).

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Correlation of per capita GNI levels in Ukraine, EU member states, and EU candidate countries in 2001 Country

Per capita GNI, $

EU-15 average Bulgaria Estonia Cyprus Latvia Lithuania Malta Poland Romania Slovak Republic Slovenia Turkey Hungary Czech Republic Ukraine

21,546 1,560 3,810 12,370 3,260 3,270 9,120 4,240 1,710 3,700 9,780 2,540 4,800 5,270 720

Ukraine's per capita GNI to per capita GNI of other countries, % 3.3 46.2 18.9 5.8 22.1 22.0 7.9 17.0 42.1 19.5 7.4 28.3 15.0 13.7

Per capita GNI at PPP, $

24,339 5,950 10,020 20,780 7,870 7,610 16,530 9,280 6,980 11,610 18,160 6,640 12,570 14,550 4,150

Ukraine's per capita GNI to per capita GNI of other countries, at PPP, % 17.1 69.7 41.4 20.0 52.7 54.5 25.1 44.7 59.5 35.7 22.9 62.5 33.0 28.5

thereof 22.6%, including ferrous metals and hardware 17.2%; products of the agro-industrial complex (including foodstuffs) 16.2%; textiles and textile products 11.9%. In the aggregate, the above-mentioned commodity groups accounted for 72.9% of exports. Meanwhile, the share of machinery, equipment, and instruments amounts only to 10.9%. Such a structure of export potential objectively pushes the country rather to the third world than to regional integration with the EU countries; (b) in imports of goods the basis of the imports of goods to the EU is formed by: machinery and equipment, electrical equipment 30,5%; products of chemical and associated

role as a leading factor in international competitiveness. That is why lagging behind as regards the level of human development means the absence of capacity to cope with international competitive pressure an indicator of readiness to EU membership following its Copenhagen criteria. Fourth, the structure of Ukraine s foreign trade potential does not comply with the strategy of EU economic development, and does not foster an accelerated inclusion of Ukraine into the EU economic space. During the process of Ukraine s market transformation, spontaneous priority was acquired by relatively old, and even obsolete, elements of the country s industrial structure (raw material intensive and power-consuming production facilities), which have no prospects of efficient competition on the highly competitive EU market. This could not but result in the following disproportions in the structure of Ukraine s foreign trade and its market presence: (a) in the exports of goods structural and technological limitations of the export potential, which, alongside with the low competitiveness of Ukrainian products, makes the EU markets, to some extent, closed to it. The share of Ukraine in the EU foreign trade balance is extremely small only 0.4% of its total trade. Trade relations are mostly focused on Ukraine s exports to two of the EU member countries Germany and Italy. At that, the re-orientation of exports towards the EU is evidently moderate, while there is an explicit domination of the re-orientation towards countries, which lie beyond both the CIS and the EU (Diagram The dynamics of Ukraine s exports of goods to different regions of the world )76. This situation has largely been caused by the present profile of international competitiveness of Ukrainian exporters, which is based primarily on price competition on the markets of low value added and low-tech products. Ukraine holds leading positions specifically in those sectors, which are of low interest to EU member states (Table The structure of Ukraine s trade in goods with the EU in 2002 ). Thus, in general, the share of mineral products in Ukraine s exports in 2002 made up 22.2%; non-precious metals and products

industry 15.8%; means of transport, transport equipment, their units and accessories 9.1%; textile and textile products 8.6%; pulp, paper and carton, and analogous products 6.9%; polymeric materials, plastics, products thereof, and similar products 6.8% (Table The structure of Ukraine s trade in goods with the EU in 2002 ); (c) in exports-imports of services the largest share in the Ukraine s total of services exports to the EU in 2002 belonged to transport services (79.6%); in the total of services imports to transport (19.9%), various business, professional and technical (25%), government (15.7%), financial (10.2%) services77; (d ) market access restriction the process of development of Ukraine s trade and economic relations with the EU is restrained, in particular, by the complex of problems related to the regime of access of Ukrainian exporters to EU members markets. Despite a certain progress due to the Agreement on quota-free trade in textiles as of end 2000, Ukraine still faces quotas in trade in metals, which are supplemented with

It should be taken into account that the trend towards increasing the share of the Central European Free Trade Area (CEFTA) is, to a great extent, caused by the accession to it of new members: Slovenia (1995), Romania (1997), and Bulgaria (1999). It proportionally decreased the share of other countries . 77 Foreign Relations of Ukraine with Economic Groupings. Express-report of the State Statistics Committee of Ukraine, No.127, April 18, 2003 (in Ukrainian).

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The structure of Ukraine's trade in goods with the EU in 2002* Commodity groups according to the Commodity Nomenclature of Foreign Economic Activity of Ukraine I Live stock; cattle-breeding products II Vegetable products III Fat, butter, vegetable oil, and related products IV Products of food-processing industry; alcohol and non-alcohol beverages, vinegar; tobacco and its substitutes V Mineral products VI Products of chemical and associated industry VII Polymeric materials; plastics and products thereof; rubber and rubber products VIII Raw hides, skin, leather raw fur and products thereof IX Timber and wood products; charcoal; cork and products thereof; straw products, etc. X Pulp; paper and carton waste; paper, carton and products thereof XI Textile and textile products XII Footwear, headgear, umbrellas, sticks, feather and products thereof, products made of hair, etc. XIII Products from stone, plaster, cement, asbestos, mica, or analogous materials; ceramics, glass and glassware XIV Pearls natural or cultured, precious or semiprecious stones, precious metals, metals plated with precious metals; products thereof; coins XV Non-precious metals and products thereof XVI Machinery and equipment; electrical equipment XVII Means of transport, transport equipment, their units and accessories XVIII Optical, photo, cinema, control, medical, and other instruments and apparatus; watches; musical instruments; their units and accessories XIX Weaponry, ammunition; their units and accessories XX Miscellaneous industrial goods XXI Works of art, art collection articles or antiquarian goods Miscellaneous

Ukrainian Exports 0.2 12.3 2.8

Ukrainian Imports 0.9 1.4 1.2

0.9 22.2 5.4

3.5 1.1 15.8

0.5 2.5

6.8 0.9

3.2 0.0 11.9

0.5 6.9 8.6

1.3 0.5

... 22.6 7.0 2.1 1.8 ... 1.2 0.0 1.5

* Calculated on the basis of the data of the State Customs Service of Ukraine. http://www.customs.gov.ua.

anti-dumping measures. But the main obstacle is put by actually closed (i.e. through political preferences) of the access to European high-tech product markets, even in those areas where Ukraine produces rather competitive products (for example, cargo aircraft).

Ukraine s integration prospects in the context of the Wider Europe concept The prospects of development of Ukraine s integration into European economic structures, in the nearest decade to come, will be substantially determined by the official concept put forward by the European Commission entitled Wider Europe Neighbourhood: A New Framework for Relations with our Eastern and Southern Neighbours 78.

dilemma: in what direction integration is to develop to the West or to the East, because both integration vectors would be interrelated within the framework of a single integration process aimed at the formation of a common European economic and political space. At the same time, the abovementioned fundamental opportunity is not unconditional and easy to use. There is a number of serious obstacles on its path.

First, ascending to higher levels of integration will be determined by enhanced administrative, institutional, 0.3 and legislative capacity of the countries, 1.4 which will be controlled by the system of political and economic criteria, including ratification and implementa... tion of international commitments, 4.9 30.5 which demonstrate adherence to 9.1 common values. Neighbour countries are most likely to receive an actually 2.9 different status with regard to the EU. ... And this circumstance could not but 1.5 complicate the formation of a homo0.0 1.8 geneous common economic and political space. At that, differing speed of approaching of post-Soviet neighbouring countries to the EU will complicate their mutual interaction, because here will emerge a trade and investment diversion effect in the direction of more dynamic sectors of interaction. Consequently, one cannot exclude that growing integration into the EU structures, under its clearly differentiated approach to neighbour countries, may become a factor of growing disintegration of the post-Soviet space. Second, the Wider Europe concept envisages the formula: sharing everything with the Union but institutions 79, which contains an internal contradiction. Really, at that stage of maturity of an integration process, which is characterised by the notion of a single market , it is simply impossible to evade creation of common institutions, i.e. endowed with supranational powers, for governing the integration process. It is difficult to imagine in what way the neighbour countries could integrate into the single European market without sharing its institutions . Theoretically, this could happen in case of full-scale participation in the activity of the EU institutions but without the right to vote, that is, without influence on the formation of the single market rules. It is doubtful that such a perspective would satisfy Ukraine.

The essence of the proposed concept is implied in the refusal to consider the neighbour countries, at least for the nearest decade, as candidates for EU membership. Instead, they are proposed an opportunity for rather advanced integration, the framework of which is very similar to that of the status provided for European Economic Area participants. The main elements of this concept are described in the Insert Main elements of the Wider Europe concept, which could be used by Ukraine .

Therefore, only one variant is left the formation of specific institutions for governing integration process namely for the Wider Europe format, with neighbour countries taking an equitable part therein. But in this case, a lawful question arises: why should specific institutions be set up if the neighbour countries are to participate in the same mechanisms of the EU single internal market as the EU members do? Obviously, this may

Certainly, the cited complex of proposals creates favourable opportunities for Ukraine s integration into the EU structures. Their use could become a basis for development of integration processes among certain post-Soviet countries, which are EU neighbours, as well. For Ukraine, it would create a principally new situation, and would resolve the existing geopolitical and geo-economic 78

Wider Europe Neighbourhood: A New Framework for Relations with our Eastern and Southern Neighbours: Communication from the Commission to the Council and the European Parliament. Commission of the European Communities, Brussels, 11.3.2003, COM (2003) 104 final. 79 A Wider Europe A Proximity Policy as the Key to Stability: Speech by Romano Prodi, President of the European Commission / Peace, Security and Stability International Dialogue and the Role of the EU, Sixth ECSA-World Conference, Jean Monnet Project. Brussels, December 5-6, 2002; http://europa.eu.int/ comm/external_relations/news/prodi/sp02_619.htm. RAZUMKOV CENTRE

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MAIN ELEMENTS OF THE WIDER EUROPE CONCEPT, WHICH COULD BE USED BY UKRAINE 1. Possible extension to the neighbours of the EU internal market and regulatory structures, with the establishment at pan-European level of an open and integrated market functioning on the basis of compatible or harmonised rules acquis communautaire. The key role in this aspect is played by the provision of the four freedoms for the movement of persons, goods, services, and capital. It is quite evident that this target may be achieved only in a long-term perspective. 2. Preferential trading relations and market opening. It envisages, first of all, an implementation of the idea of a free trade area, which was provided for in the Partnership and Co-operation Agreement between Ukraine and the European Communities. For Ukraine, this target seems to be the most imminent and realistic. 3. Perspectives for lawful migration and movement of persons, including: extension of the practices of a long-stay visa policy; wider application of visa-free regimes; facilitating the crossing of external borders for nationals living in the border areas or participating in EU programmes and activities. At the same time, these benefits envisage more efficient mechanisms of readmission, common efforts to combat illegal migration. 4. Extension to neighbours of EU programmes and activities in such spheres as research, education, intensified contacts in the field of media and information, and the development of the relevant infrastructure. 5. Integration into transport, energy and telecommunications networks and the European Research Area. This provides for the creation of compatible

and interconnected infrastructure and networks as well as harmonised regulatory environments in the relevant spheres. It speaks to greater EU support for the development of telecommunications markets, improving the availability of Internet access, stimulating innovations, and developing human resources and research capacities, and generally, encouraging the growth of knowledge-based economies. Obviously, it is just the above-mentioned sectors that may to become, in a sense, centres of economic integration development. By creating multiple inter-sectoral links, they will stimulate the inclusion of the entire national economies into integration. 6. Provision of new instruments for investment promotion and protection. This envisages reciprocal provisions granting companies national treatment for their investment operations (now Ukraine is given only most favoured nation treatment), enhancement of business-to-business dialogue initiatives, setting up of corresponding bodies representing entrepreneurs and EU business associations in the neighbouring countries. However, the document contains no concrete proposals as regards far-reching liberalisation of capital movement. 7. Provision of new sources of finance. It envisages not only the development of financial assistance on the part of the EU on the whole and the EBRD in particular, but a use of the resources of the European Investment Bank, which is a principally new opportunity for Ukraine. On the whole, co-operation with Ukraine and the EU is to be developed up to the level of specific objectives and benchmarks.

be justified only if the participation of the neighbouring countries in the EU single internal market would be not full-scale but restricted both in terms of spheres, depth, and mechanisms of interaction.

Moreover, instead of the relations of interdependence, competition often emerge here between the participants of an integration association (i.e. competition between the Russian and the Ukrainian metallurgical complexes);

Thus, the Wider Europe concept, for all its significance, still looks contradictory, and does not fully fit Ukraine s vision of its European integration strategy.

Opportunities for the development of integration in the CIS area The integration experiments in the CIS area have not yet resulted in the creation of a truly effective international structure capable of efficient inclusion of its member countries into the European economic space. The main reason of this was that a number of important principles underlying the policy of regional international integration has been ignored. The implementation of integration projects is hindered, in particular, by the following economic factors: (a) the low level of the development of market structures in the majority of countries, which causes the prevailing concentration of integration measures at the macroeconomic level, with noticeable lag of integration processes at microeconomic level (the development of intra-branch specialisation and co-operation, mutual investment flows, setting up of transnational and multinational corporations with the participation of the partner countries, etc.); (b) the process of structural simplification of the economies of practically all post-Soviet countries resulting in a decreased significance of manufacturing (i.e. machine-building), which are the main carriers of integration processes at microeconomic level. The considerable expansion of the scope of production of primary products and semi-manufactures, in the economy in general and in foreign trade, objectively decrease the potential to integrate, because the abovementioned products may, depending on the market situation, easily be re-oriented to alternative markets. The above-said branches of economy do not create a space for a development of production co-operation.

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(c) the growing difference between the models of social and economic development of certain countries. For example, Russia has already become a market economy, with an over 70% share of the private ownership; Ukraine has a similar indicator, but in Belarus this amounts only to 20%; Ukraine and Russia actually have free price-formation, free foreign exchange market, while in Belarus these are severely restricted by administrative measures; (d ) the noticeable lag by the level of quality, technology, and generally by the level of competitiveness, from competitors outside these regional integration associations; for the most advanced companies and enterprises, this makes more expedient to enter the markets and develop co-operation relations outside the integration association; (e) substantial differences in the attained levels and the potentials of economic development of certain countries, which objectively creates diverging economic interests and does not allow to co-operate effectively. A very negative impact was exerted by the amorphous principles, on which the activity of common integration bodies within the CIS was based. The domination of the principle of unanimity, the absence of the necessary levers to secure the implementation of commitments, have become important determinants of the inefficiency of the entire institutional mechanism of this integration . The excessive scale and excessively short implementation terms of integration measures harmed their consistency and substantiation, and this has been used to discredit even promising ideas. Proceeding from the above-said, we may formulate the following principles of the development of integration in the post-Soviet area, which are to be observed in order to enhance the efficiency of this process.

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CONCLUSIONS

The integration process must be: (1) evolutionary and well-phased by proceeding from the lower stages of integration to the higher, as the targets of the previous stages have been attained and the relevant internal economic, social, and political preconditions have been created. It means the priority of solving the problem of setting up a genuine free trade area without reservations and exemptions. The issue of a customs union, and what is more, of providing conditions for free movement of capital and labour, requires a more prolonged implementation term. But it would be expedient to determine, from the very start, the terms (which will depend on the actually attained results) for solving the problems associated with the transition to the higher stages of interaction; (2) open and considered within the context of creating the common European economic space, taking into account the Wider Europe concept. The single economic area of Belarus, Kazakhstan, Russian Federation, and Ukraine must be formed in a way that would not hinder but foster the creation of new opportunities for their inclusion into the common European economic space, with the EU being at the core of the latter. On the other hand, such a mode of development is to envisage a creation of new development perspectives for co-operation in the East (with China, India and other countries), by means of joint consolidation of their positions on the markets of the developing countries;

the scantiness of the share of high-tech products in exports (the share of office and telecommunication equipment makes only 0.6%), the lack of the country s readiness to actively participate in the global information processes (by the Nnetworked Readiness Index Ukraine ranks only 66th among 75 countries of the world, which have been classified). In order to accelerate Ukraine s institutional preparation to regional international economic integration it is necessary that its economic policy be targeted, first of all, at the creation of: v both public and market institutions fostering the generation and dissemination of innovations, and the formation of the decisive factor of the contemporary competitiveness the human capital;

(3) based on the principle of priority given to major projects, which will become locomotives for the development of integration, and will provide the basis for its successive generalisation;

v equitable conditions for the enhancement of international competitiveness of Ukrainian firms and companies in the open market environment;

(4) deep by active involvement of large companies (enterprises) directly in the formation of integration projects, and providing support to integration initiatives coming from below .

v efficient mechanisms (with the participation of the state, associations of economic agents, large companies, i.e. foreign) for investment and credit resources flows, with their concentration in the field of priority high-tech sectors and activities (aircraft and spacecraft, biotechnology, new materials, pharmaceuticals, computer equipment, etc.);

CONCLUSIONS By its structural parameters, the economy of Ukraine does not correspond to modern development trends of the world economy as a whole, and of the economy of the European Union in particular. This is proved, inter alia, by the underdevelopment of the domestic market, which causes exporting , during the recent years, up to 60% of the country s GDP, the exclusion of the country from global FDI flows (they account for about 2% of the country s GDP),

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v stimuli (by means of legislative and economic regulators) to enhance capitalisation of the country s enterprises, their innovation activity, as well as to activate demand for advanced R&D results and highly qualified personnel. n

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4. CONCLUSIONS AND PROPOSALS The process of macrostructural transformation of Ukraine s economy in the course of a transition to the market system appeared extremely difficult, controversial and was accompanied with not only positive but also strong negative tendencies. This was caused by the underdeveloped institutional environment of the market economy and democratic system, as well as the weakness of civil society institutions. From the early 1990s, structural changes have taken place under conditions of ruinous macroeconomic regulation characterised by a high-deficit budget policy and clearly emissive monetary policy that provoked hyperinflationary tendencies, the erosion of savings, and sharp changes in relative prices and competitiveness. Public funds were invested into hopeless sectors on a large scale. Structural shifts in Ukraine were in fact spontaneous and lacked a single strategy of restructuring due to the development of specific branch and target-oriented national programmes lacking coherence, proper financial support, logic and co-ordination. Setting too many uncoordinated structural priorities mainly aimed at solution of current issues is a widespread phenomenon. The absence of effective state management is the main reason why the disproportion between branches existent on the dawn of reforms was not only mitigated but, on the contrary, still aggravated, compared to the pre-reform period. The structural imbalance of the economy exerts negative influence on the potential of further economic growth. The absence of an effective structural policy is a direct consequence of the lack of balance and ineffectiveness of the system of state governance existing in Ukraine that appeared unable to outline the prospects and provide for implementation of economic reforms in the interests of the entire society. The success of progressive structural transformations is badly affected by the existing imbalance of powers between the branches of power, their non-transparency for society, dominance of corporate and personal interests over the national ones, the high level of corruption, absence of an integral system of strategic planning. Privatisation in Ukraine became in the first place an instrument of redistribution of public wealth, not of accelerated capital formation necessary for fundamental structural modernisation of the economy and provision of its competitiveness. Meanwhile, today, the formation of a true private sector of economy is manifested mainly in the emergence of new enterprises rather than privatisation of existing ones. Huge disproportions in the economic and social structures of Ukraine s society are attributed to the hypertrophied monopolised sectors of economy, whose share in Ukraine s GDP presently reaches 40%.

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Development of small and medium-sized enterprise in Ukraine is characterised by wide spread of the grey sector (micro- and small enterprises conceal over 60% of production), absence of systemic preconditions for positive influence of MSE sector on progressive structural shifts. The activity in that sector of a special variety of highly productive mediators acting as agents effecting transfer of incomes from large enterprises to the benefit of separate persons, for their illegal personal enrichment and for political purposes, is of particular concern. The transition to the market system in Ukraine is accompanied with strong spontaneous shifts in the branch structure of the economy. They are especially manifestly displayed by the decrease of the share of goods-making branches from 70.1% in 1990 to 53.4% in 2000 and the increase in the share of services from 29.5% to 47.8% respectively. By and large, this is a positive trend in line with the world tendencies. Meanwhile, in the process of market transformation, Ukraine formed a protectionist model of economic development characterised by excessive concentration of funds in the general public administration sector and selective support for specific enterprises. This became a decisive factor in spurring unfavourable structural economic changes. In the early and mid-1990s there was significant inflationary redistribution of incomes associated with distortions in the distribution of incomes to the benefit of the general government sector and financial corporations at the expense of households and non-financial corporations. Only in 1997 did Ukraine see the beginning of a gradual harmonisation of intersectoral distribution of incomes and consolidation of positions of enterprises and the population in that process, which formed the basis for the resumption of economic growth of the late 1990s. However, that turnaround has proven unstable, depends on temporal political factors and generally does not lead to the formation of a rational macroeconomic structure. The present trend of excessive concentration of disposable incomes in the household sector, in the absence of compensatory inflow of foreign direct investments, strengthening of differentiation of individual incomes, high interest rates, and the low share of long-term credits in the bank credit portfolio is leading to a temporary expansion of the consumer market, but also to the decline of investment in the official sector of the economy. Optimisation of macrostructural proportions and activation of market mechanisms for the flow of funds to the spheres of priority development are hindered by the preservation of numerous preferences and imperfect legislation, which allows privileged businessmen to obtain excessive profit.

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CONCLUSIONS AND PROPOSALS

So far, the development of integration processes involving separate post-Soviet states has been ineffective. In the long run, it may exert positive structural influence on Ukraine s economy only if employed for the formation of the common European economic and political space.

Huge distortions in the institutional fundamentals of economic development and the structure of incomes of the key institutional sectors have created a favourable climate for the spread of negative tendencies in the branch structure of the economy. Of particular concern is the trend of deepening deformations in the structure of industry, and more rapid development of low-tech (with the exception of machine-building) branches relying mainly on obsolete technologies by increasing the rate of employment of the existing capacities.

To speed up the process of formation of Ukraine s institutional readiness for regional international economic integration, its economic policy should in the first place aim at creation of both state and purely market institutions promoting innovation and formation of the decisive factor of competitiveness, for the time being human capital; it should pursue the goal of creation of equal conditions for the enhancement of international competitiveness of Ukrainian firms and companies in an open competitive environment.

Given the need of human capital development, the decrease in the share of science and knowledge-based services, culture and arts is an extremely dangerous phenomenon. Ukraine greatly lags in the creation of market infrastructure branches, which presents a serious obstacle for the introduction and development of market mechanisms.

Proceeding from these conclusions and being aware that the desired positive effect will depend not only on steps in the sphere of macroeconomic structural policy as such but, first of all, on systemic actions in different spheres of economic policy, the set of necessary measures may be identified in the domains listed below.

In the period of market transformation in Ukraine, the principle of dependence of progressive structural transformations on large-scale involvement of social capital into reforms was grossly violated, which resulted in the unprecedented growth of poverty and social stratification. This undermines the prospects of stable development and further market-oriented structural reforms.

Macroeconomic structural policy The Cabinet of Ministers of Ukraine, with the purpose of setting reasonable macrostructural priorities of development and more effective regulation of structural shifts in the economy, should:

Specific to structural changes in Ukraine s economy is their performance in light of the proclaimed course of integration into the world and European economic community. Over the years of market transformation, Ukraine has achieved a very high level of openness of its economy in the sphere of foreign trade, exceeding the respective world indicator two-fold, with a very low level of dependence of the economy on global flows of capital. Meanwhile, there is substantial imbalance between the development of foreign trade and the domestic market in Ukraine.

v perform revision of the existing programmes of development of specific types of activity, territories, infrastructure objects; assess the expediency of their further implementation and sufficiency of funds, as well as the possibility of involvement of foreign investments into those programmes; v analyse the effectiveness of the system of branch preferences for the attainment of the economic and social goals set during their establishment;

The process of integration into the world economy was accompanied with the formation of an unfavourable structure of exports and, therefore, of an unpromising model of international specialisation. Ukraine specialises in exports to relatively inert markets of goods and services whose share in the world trade is decreasing. Its deliveries to the highly dynamic markets that are shaping the world economy are miserable. Ukraine s backwardness in terms of participation in global networks and development of information technologies is clear. By its present structural development, Ukraine does not fit into baseline trends, which makes its economy unprepared for effective integration into world economic organisations. The removal of these inconsistencies should become one of the main priorities of the economic policy of the Government.

v move from branch development priorities to support for specific trends, stages and processes in the adoption of new industries and technologies; v during development of state concepts and programmes of socio-economic development, and proceeding from the priority of internal market development, provide for some decrease in the indicator of the country s GDP dependence on foreign trade while preserving the significant role of foreign trade in the process of reproduction; make emphasis on accelerated development of domestic demand and supply, compared to external ones; v in defining the strategy of attraction of foreign investments, take as the main priority the diversion of foreign investments from export-oriented branches to the sectors supplying the internal market to make it more integrated into the global market structure;

Ukraine has taken leading positions in the sectors that are of relatively little interest for the EU member states. The structure of the country s export potential is objectively pushing it towards the third world rather than in the direction of integration with the European Union, since it does not suit the EU economic development strategy. In the process of market transformation in Ukraine, those relatively old and even archaic elements of the structure of Ukraine s industry (raw material and energy intensive branches) that cannot compete effectively on the EU market spontaneously obtained a priority. Today, Ukraine s access to the European markets of hi-tech products is in fact barred.

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v amend effective regulatory-legal acts and drafts in the spheres regimenting innovative activity of enterprises through specification of the list of innovative facilities and conditions of exemptions in taxation of incomes from innovation; v establish a system defending Ukraine s economy from turning into a dump of rejected , obsolete technologies that cannot lead Ukraine s economy to the trajectory of dynamic growth;

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CONCLUSIONS AND PROPOSALS

v introduce a system of support for hi-tech exports through the promotion of Ukrainian goods on foreign markets, streamlining and simplification of export control procedures; v work out measures promoting participation of foreign banks in investment projects on the territory of Ukraine.

The National Bank of Ukraine should: step up investment activity at enterprises manufacturing products with the highest share of gross value added and ensure a balance between the interests of exporters and importers, when regulating the exchange rate of Ukraine s currency to foreign currencies seeking a gradual revaluation of the national currency to a level 10-14% below the rate observed before the devaluation of August-September, 1998. v

Antimonopoly policy The Verkhovna Rada and the Antimonopoly Committee of Ukraine should improve the legal foundation for de-monopolisation of the economy, antimonopoly control and regulation with the purpose of prevention and elimination of abuse of the dominant position on the market and actions resulting in restriction of competition and unfair competition, in particular, provide for measures aimed at: v creation of conditions for the development of competition on monopolised markets of goods with a high rate of concentration of supplies, removal of barriers for the development of competition and entry of new business entities to the markets; v opposition to creation of new monopoly structures in the result of re-distribution of property, pursuance of the corporate investment policy and processes of integration, including at establishment of industrial-financial groups;

adoption of a law on the protection of competition on the market of financial services to lay down legal fundamentals for regulation of the markets of banking, insurance, exchange, audit and other financial services; v

v harmonisation of antimonopoly legislation in line with the international agreements of Ukraine, adaptation of the competition policy with the purpose of the country s integration into the world economy;

removal of legal, organisational and administrative restrictions on the entry of new capitals to the markets and free movement of goods and capital inside the country. v

The Cabinet of Ministers and the Antimonopoly Committee of Ukraine should work out and implement measures for consolidation of the institutional fundamentals of competition, including by means of: v removal of monopoly of intermediary organisations with often criminal roots that emerge on the path of capital, goods or services moving from big producers to mass consumers (agrarian business, coal and metallurgical industry, etc.) and bar new companies from one or another market;

legislative and administrative provision of equal access of new companies to the national and regional v

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economic infrastructure facilities (railways, pipelines, terminals, warehouses, stores, etc.); v consolidation of competitive fundamentals of contracts of government procurement, including access of foreign companies; v prohibition of any practice of administrative restriction on the movement of goods and capital across local (regional, district) borders, since regionalisation of trade and financial markets undermines competition; v shortening of the list of activities subject to licensing and employment of the released personnel of supervisory (tax, law-enforcement, etc.) bodies into the spheres where control is really necessary (production of arms, ammunitions, drugs, alcohol, etc.); v encouragement of restructuring of companies, transformation of competitive units into separate firms; v broader application of bankruptcy procedures to loss-making enterprises, since actual absence or insignificance of bankruptcies (market exit) hinders natural market selection of companies by the profit/loss indicator.

Income regulation policy The Verkhovna Rada and the Cabinet of Ministers of Ukraine should: enhance interaction between the Government and Parliament and the Government s influence on the process of harmonisation of the distribution of incomes among institutional sectors of economy and mitigation of social inequality, in particular: v purposefully reduce taxes on labour incomes through calculation and limitation in accordance with the EU taxation methods accounting not only income tax but also social allowances; v synchronise amendment of the tax legislation with changes in the system of social contributions and charges and with the pension reform; v set a new tax-free minimum of income equal to the minimum wages; v reduce the minimum rate of tax on individual incomes to the level of taxes on incomes of legal entities; v introduce a real-estate tax and legislatively set the level of market value of immovable property subject to taxation; set a system of measures in support for the introduction of such a tax; v introduce a tax on interests on private deposits setting the limit of aggregate non-taxable income from deposits; v introduce differentiated rates of value added tax substantially reducing taxes on some foodstuffs (especially baby formulas), popular medicines, training aids and school equipment (including computers procured for schools); v raise the rate of effective corporate tax through the limitation of the system of exemptions; v when amending the system of corporate income taxation, make emphasis on the formation of a fair competitive environment.

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CONCLUSIONS AND PROPOSALS

Budget policy

The Verkhovna Rada, the Cabinet of Ministers and the National Bank of Ukraine should:

To enhance the effectiveness of use of budget funds, the following measures should be taken.

v amend effective regulatory-legal acts regimenting operation of enterprises, trusts, banks, insurance companies and the procedure of bankruptcy;

The Cabinet of Ministers of Ukraine should: v introduce the practice of choosing contractors for budget-funded projects on a tender basis and encourage involvement of public and private (including foreign) funds into funding of such projects; put an end to the practice of state support for the sole winner of such tenders;

v introduce legislatively regimented procedures of independent control over financial transactions of enterprises with account of the experience of the developed countries, in particular, provide for the introduction of effective control over so-called related party transactions employed to effect price transfers to the benefit of a narrow circle of owners to the detriment of the rights of small shareholders and creditors.

v ensure publicity in the tenders of budget-funded project of particular cost and socio-economic significance.

The Cabinet of Ministers, the State Committee of Ukraine for Regulatory Policy and Enterprise should:

The Accounting Chamber of Ukraine should: v develop methods of assessment of the effectiveness of use of budget funds and implement them into the treasury control practice.

v perform thorough inspection and assessment of the importance and effectiveness of the programmes of state support for enterprise to identify the reasons hindering the departure of bussiness from the grey sector and development of new spheres of entrepreneurship.

The Ministry of Finance of Ukraine should: v introduce monthly accounts with detailed elaboration of budget expenditures at all levels and publish them in the Internet.

The Razumkov Centre experts believe that implementation of those proposals will help remove structural deformations admitted in the course of transition of Ukraine s economy to the market system, create preconditions for accelerated economic growth and effective integration of the national economy into the world and European economic organisations. n

Development of enterprise Measures for the creation of a civilised business environment and protection of shareholder and creditor rights.

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ANALYTICAL REPORT OF THE INSTITUTE OF STRATEGIC STUDIES

MACROSTRUCTURAL CHANGES IN POLAND UNDER MARKET TRANSFORMATION T

he analytical report was drawn by Polish economists for this publication as part of the research performed within the framework of the joint PAUCI project since September 2002. The report touches upon the following issues: influence of economic transformation in Poland on macrostructural processes (with an emphasis on creation of new small and medium-sized enterprises and privatisation); institutional support for small and medium business; foreign direct investments as a factor of economic growth and structural changes; accession to the EU as a determinant of industrial policies; innovativeness of the Polish industry; shifts in primary and disposable incomes in the institutional sectors of the economy and in the differentiation of the household incomes; impact produced by changes in the Poland's legislation and Government macroeconomic policy on macrostructural processes and economic growth; development of non-governmental sectors of economy; free media and changes in political environment. Due to its limitations, the magazine publication reviews only some problems dealing with macrostructural changes in the Polish economy and the key factors thereof. The analytical report consists of four sections*. Section one

analyses the key political factors affecting structural changes in the Polish economy in 1990-2001 with an emphasis on the importance of political factors of economic transformation; cites examples of politics determining structural changes and the growth of the economic efficiency in Poland.

Section two

examines the efficiency of the production factors. It is argued that a fundamental enhancement of the efficiency of use of the production factors is a prerequisite for catching up with the EU and other developed countries for Poland and other countries in transition. The conclusion is argued that in the 1990s Poland made a major step in that direction.

Section three

reviews the economic gap Poland is experiencing compared with the EU and other developed countries; compares production structure by sector and the changes in the labour force.

Section four

gives some general conclusions and formulates proposals dealing with the measures necessary for balancing and harmonisation of macrostructural processes.

The materials received by the parties to the PAUCI project are published in the short form. They will be published in full in a joint monograph of the Razumkov Centre and the Institute of Strategic Studies set to be published in 2003.

Separate sections of the report were written by: J.Klich (1 and 4, insert on page 55), Z.Zolkiewski (2 and 3) and M.Radziukiewicz (3).

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1. POLICY FACTORS AFFECTING STRUCTURAL CHANGES IN THE POLISH ECONOMY T

he aim of this section is to present key features of the policies affecting structural changes in the Polish economy between 1990 and 2001. The analysis covers both political and economic spheres. The role of good governance, transparency and accountability of governments in supporting economic growth is widely and increasingly recognised by the world community in recent years1. The experience of Poland as well as the countries of Central and Eastern Europe seems to support the hypothesis that good political and economic institutions do matter a lot. This is why we place political factors before economic ones here. This section shortly presents political factors shaping the institutional progress of transition, followed by factors influencing macroeconomic changes and connected with institutional progress in the transition period.

1.1 POLITICAL DETERMINANTS OF TRANSITION

interdependent and exert influence upon each other, i.e. democracy and the market economy are mutually reinforcing4. On the one hand, democracy increases the transparency of government actions, constrains rentseeking opportunities5 and capturing of state institutions, and gives a chance for long-term guarantees and stability of property rights. On the other hand, the market system helps to develop civil society institutions, a broad middle class, and culture of co-operation based on selfinterest what reinforce democracy.

The results of economic transition in post-communist countries are uneven. Poland belongs to the group of leading reformers (middle-income countries of democratic capitalism of the Central Europe and Baltic region). The second group is composed of lower- and lower-middle-income countries of the Commonwealth of Independent States (CIS) where both capitalism and democracy are still immature and sometimes heavily distorted.

The role of political and economic institutions such as constitutional division of power, electoral systems, political parties, free mass-media, civil society organisations, rule of law, independent and efficient judiciary, central bank independence and others cannot be overestimated when explaining Polish economic achievements between 1990 and 2001.

Analysts2 explain this differentiation mainly by the transition strategies adopted and political factors determining them in particular countries. Also the prospect of European integration has played an important leveraging role. Fast reform in Poland permitted a shortening of the period of a temporary system vacuum , breaking down the inertia of the old system, and maximally exploiting the initial political window of opportunity.

Three components of institutional design, reinforcing each other, have had a great impact on the ultimate outcome of the process: electoral law, regulations regarding formation and activity of political parties and constitutional model of the state (Insert Main political institutional components of transformation in Poland , p.44).

The ability of Poland to follow an effective (i.e. fast) reform strategy was determined by the scale of the initial political changes and further developments in the sphere of institutional and political reform.

Political and economic reforms during transition

Political reform and its interrelation with the economic transition

A combination of broad participation in political process, open and free elections and rationalised parliamentary system resulted in a sharp political break with the prior regime. The situation in Poland proved

One can establish a very strong correlation between economic indicators of transition and political and civil liberties index3. Political and economic factors are 1

The World Bank. World Development Report 2002: Building Institutions for Market. Washington, 2002. Dabrowski M., Gortat R. Political Determinants of Economic Reforms in Former Communist Countries. CASE, Studies & Analyses, No.242, 2002, Warsaw 2002. 3 For example, those used by the EBRD: private sector share of GDP, privatisation, governance and enterprise restructuring, price liberalisation, trade and foreign exchange system, competition policy, banking reform and interest rate liberalisation, security market and non-bank financial institutions. The Freedom House defines political and civil liberties index. See: Dabrowski M., Gortat R. Political Determinants of... p.14. 4 EBRD, Transition Report 1999. European Bank for Reconstruction and Development, 1999, p.113. 5 Benefits, which origin is determined by natural limitation of certain industrial factors, therefore their use brings an extra benefit (economic rent). 6 Ordynacja wyborcza do Sejmu Rzeczypospolitej Polskiej. Journal of Law (Dziennik Ustaw Dz.U), 1991, No.59, item 252. 2

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POLICY FACTORS AFFECTING STRUCTURAL CHANGES IN THE POLISH ECONOMY

MAIN POLITICAL INSTITUTIONAL COMPONENTS OF TRANSFORMATION IN POLAND Electoral Law 6 The Electoral Act adopted on June 28, 1991 , tended to promote the idea of representation rather than of creating a stable political power. The system of proportional representation in fairly large constituencies and the method of assignment of seats7 accepted by this Act led to the comminution of the political scene. In the general elections in 1991, the strongest party polled only 12.3% of the votes and 17 parliamentary clubs (factions) were formed8. This influenced parliamentary processes in a very negative way and a new Electoral Act was passed in May 1993. The proportional system of election was maintained but it was tied to the liminal clause, reduction of constituency size and a different system for measuring voting results9. Law on Political Parties Constitutional reform of December 29, 1989, removed the provisions for the leading role of the Polish United Worker s Party (PZPR) giving way to the freedom of establishing political parties. Simultaneously, Poland introduced a set of incentives to accelerate this process. The first condition relied on rela10 11 tively low legal requirements concerning membership and simple procedures of registration . Some schemes of financial support were also launched (such as the direct state subsidies to political parties since 1997, or refunding costs of parliamentary elections campaigns, proportionately to the number of seats gained in both chambers of Parliament since 1993)12. Political parties have been also allowed to run some business activities free of taxation. As a result, the political system in Poland is institutionalised relatively well with a reasonable number of parties and a clear left-right division. Constitutional model of the state The above-mentioned 1989 constitutional reform accomplished a solid reconstruction of constitutional foundations of the socio-economic system. The special role and protection of state property was abandoned for the sake of equal protection of all forms of property. Regardless of property form, the principle of free economic activity replaced the centrally planned economy. 13 In 1992, a new constitutional act, the so-called Small Constitution, was passed . It summed up the three-year experience of the relationship among Parliament, President and Government within a so-called presidential and parliamentary system. It aimed at reduction of excessive presidential power and at strengthening the ties between the Government and Lower House of Parliament the Sejm. On April 2, 1997, the General Assembly passed the Constitution of the Polish Republic, which further decreased the President s prerogatives. According to the Constitution executive power is vested mainly in the hands of Government backed by the parliamentary majority. The President is directly elected for a five-year term with a maximal two-term limit; plays mostly a representative role (with some exceptions related, for example, to the right to impose veto on laws adopted by Parliament); nominates the Prime Minister and ministers.

that deeper changes in elite had happened since the outcome of the first elections meant that quicker and deeper economic reforms were undertaken thereafter14. The Government s economic programme (the socalled Balcerowicz15 Plan) proposed two components: the programme of economic stabilisation and the programme of systemic changes (Insert Components of the Balcerowicz Plan ). Implementation of the above programmes was accompanied by appropriate changes in the law. In particular, norms protecting ownership rights and execution of contracts were introduced to create incentives for private investments. The institutional developments, economic policy and politics of transition have had a mutually reinforcing character. Poland, which experienced the initial political momentum in favour of radical reforms and managed to use it in the effective way, achieved a serious progress in forming the new political and economic system in a relatively short period of time. The accomplished critical mass of changes made them irreversible. The orientation towards European integration and transatlantic security co-operation (membership in NATO) declared in a relatively early stage of transition became the important external anchor strengthening the process of both political and economic reforms.

COMPONENTS OF THE BALCEROWICZ PLAN The programme of economic stabilisation The programme was aimed at curbing inflation and required: v a rigorous budgetary policy (strengthening the discipline of exacting budgetary revenues and the adequate management of expenses, reducing preferential rates and tax exemptions as well as export subsidies); v liberalisation of the pricing system (relinquishing control over the majority of prices); v a restrictive income policy, high and progressive taxation of rising wages and salaries; v bringing interest rates to more realistic levels in accordance with the rate of inflation, regulating credit obligations; v internal exchange rates for the Polish zloty and stabilisation of the value of the U.S. dollar. The programme of systemic changes The programme applied to: v ownership changes (privatisation and development of new private firms); v introducing market-economy mechanisms and institutions, ending monopolies and decentralising the economy; v reform of the financial and banking systems.

When in September 1993 the post-Solidarity parties lost the parliamentary elections (mainly because of the restrictive monetary and fiscal policies and the high costs of the transformation process), and the coalition of the Democratic Left Alliance16 took power, the new

According to this Act, constituencies delegated 10-11 deputies, on the average; the assignment of seats was made according to the Hare-Niemeyer method. Mlodawa T. Political and Constitutional Transition of Poland between 1989 and 1999 in: Wojtaszek K. (ed.), Poland in Transition. Warsaw University, Institute of Political Science, Warsaw 1999, p.71. 9 Liminal clauses were established at 5%, 8% and 9% thresholds. Constituencies were granted to delegate 7-8 seats, on the average. The assignment of seats was made according to the d Hondt method. 10 A support of 15 adults was enough for a political party to be registered. 11 Ustawa z dn. 28 lipca 1990r. o partiach politycznych, Dz.U. 1990, No.54, item 312. 12 From 1997 election, proportionally to the number of votes obtained over the threshold of 3%. 13 Ustawa z dn. 30 lipca 1992 o zmianie Konstytucji Rzeczypospolitej Polskiej, Dz.U. 1992, No.75, item 367. 14 Fish S. The Determinants of Economic Reform in the Post-Communist World. East European Politics and Societies, 1998, Vol.12, No.1. 15 L.Balcerowicz, in 1989-1991 the Vice Prime Minister and Minister of Finance of Poland, Chairman of the Cabinet of Minister s Economic Committee. 16 Emerged from PZPR and the Polish Peasant Party. 8

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POLITICAL DETERMINANTS OF TRANSITION

Government did not stop nor reverse the economic and political reforms. The new political institutions were established and they became effective barriers against temptations to restore old regime. This concerns, first of all, a free mass media and civil society organisations17 fighting corruption, nepotism, political clientism18, and abuse of power.

Consequences of the political and economic reforms of the transition period The early and radical macroeconomic stabilisation and liberalisation as well as early start of the privatisation process helped to limit the scale of the transformation recession and brought earlier output recovery on a sustainable basis, for they created broader and more equal access to the new entrepreneurial and employment opportunities the speedy development of new private firms turned out to be the most effective factor in cushioning the social costs of transition19. Distribution of the foreign direct investment stock by branches,* $ mln.

The relative macroeconomic stability, institutional progress, political predictability and prospects of EU integration attracted a significant inflow of foreign investments mainly in manufacturing (especially in high-tech branches such as electrical and optical machinery), financial intermediation, trade and repairs, transport, storage and communications, and construction (Diagram Foreign direct investment stock in Poland and Table Distribution of the foreign direct investment stock by branches ).

Capital invested

Investment plans

Manufacturing

23,300.2

5,184.3

Food processing

5,932.7

619.2

Transport equipment

5,517.1

827.7

Other non-metal goods

3,241.2

861.5

Branches**

All these factors helped to increase income per capita in the second half of the last decade, start the process of catching up with more developed countries, and strengthen constituencies in favour of democracy and the market system.

1.2 POLICIES DETERMINING STRUCTURAL CHANGES AND GROWTH OF ECONOMIC EFFICIENCY IN POLAND20 Priority directions of structural changes in Polish economy are as follows: (1) private small and mediumsized firms development and privatisation; (2) international trade and European integration; (3) industrial policies aimed at coal mining, and the steel and iron sector, and sulphur mining restructuring.

Pulp and paper & publishing and printing activities

1,667.1

285.4

Electrical and optical machinery

1,656.5

348.0

Chemicals and chemical products

1,613.0

707.1

Wood and wooden products

1,296.9

193.2

Rubber and plastics

629.1

233.2

Metals and metal products

542.5

691.7

Other products

502.4

285.5

Other machinery and equipment

436.8

84.2

Fabrics and textiles

250.3

47.1

Private small and medium-sized enterprises development and privatisation

Leather and leather products

Development of new private small and medium-sized enterprises (SME) was the first and the biggest source of private sector development in Poland. Second was privatisation. 17

It is estimated that the number of non-profit organisations registered in Poland in 1997 was between 18.5 thousand and 48 thousand, Transformacja spoleczno-gospodarcza w Polsce, Rzadowe Centrum Studiow Strategicznych, Warszawa 2002, p.226. 18 Clientism here: relations built on protectionism of government for economic entities in exchange of their support. 19 See: Jackson J., Klich J., Poznanska K. Firm Creation and Economic Transition. Journal of Business Venturing, September/November 1999, Vol. 14, No.5/6; Jackson J., Klich J., Poznanska K., Chmiel J. An Aggregate and Regional Analysis of the Dynamics of the Polish Economy, 1990-1997. Research Bulletin, Research Centre for Economic & Statistical Studies of the Central Statistical Office & the Polish Academy of Sciences, Vol. 9, 2000, No.2. 20 The Editorial Board of the magazine points out that hereinafter certain data may mismatch due to different sources used by the authors which applied different calculation methods.

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14.6

0.5

13,442.9

143.5

Trade and repairs

7,176.2

1,019.8

Transport, storage and communications

5,872.0

478.9

Construction

2,818.4

1,062.7

Community, social and personal services

1,769.1

586.0

Power, gas and water supply

Financial intermediation

1,663.6

1,746.5

Real estate and business activities

707.6

1,836.1

Hotels and restaurants

597.0

242.2

Mining and quarrying

218.5

7.0

44.8

16.3

57,610.3

12,323.3

Agriculture Investments over $1 million Estimated investments under $1 million

3,990.1

Total foreign direct investments in Poland

61,600.4

* Source: PAIZ, 2002. ** On the basis of European Classification of Activities as of June 30, 2002.

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POLICY FACTORS AFFECTING STRUCTURAL CHANGES IN THE POLISH ECONOMY

Private small and medium-sized enterprises development. At the beginning of the 1990s there were approximately 400 thousand private firms registered in Poland. After introduction of the principle of free economic activity and liberalisation of trade, new private entities were growing in numbers very fast in 2000, there were 1,766,073 active firms, of which 1,759,639 were SMEs21. Acknowledging the importance of new small firm creation for the Polish economy on the one hand and harmonising Polish law with the acquis communautaire, the Government initiated (after 1994) a number of steps to assist the SME sector (Insert Measures for small and medium-sized enterprise promotion and development ). It is broadly accepted that the plan of Poland s accession to the European Union resulted in building a legal and organisational network to support the SME sector. Privatisation. Between 1990 and 2001, 5,350 state owned firms were privatised. Privatisation with the involvement of foreign investors led towards substantial changes in the food-processing industry as well as the beverages, tobacco, and automotive sectors. Despite progress in privatisation, the public sector constitutes an important part of the Polish economy (as of December 31, 2001, about 64% of the state-owned enterprises registered in 1990 had been privatised). Public sector expenditures between 1994-1997 accounted for 45% of GDP and were spent exclusively on private (through transfers to households) and public consumption. Distribution of spending between domestic investments and consumption, and between domestic savings and consumption in 199722 suggests that private sector creates nearly all domestic savings thus finances both private and public investments (Table Expenditures, revenues and savings in public and private sector in 1997 ). Expenditures, revenues and savings in public and private sectors in 1997, % of GDP Item

Public sector

Expenditures Out of which investments Revenues Domestic savings

Private sector

44.6

55.4*

Total 100

3.3

16.7

41.8

58.2*

100

0.5

19.5

* Expenditures and revenues without transfer from public sector. Source: Ministry of Finance of the Polish Republic.

International trade and integration to international structures Economic reforms in Poland in the 1990s were aimed to create a highly productive open market economy, capable of competing internationally. Poland s Government considered participation in the world economic system as an anchor for its domestic reforms.

As a result, Poland became a member of the WTO (1995) and the OECD (1996) and initiated efforts to join the European Union. In 1990 the EU included Polish exporters in the Generalized System of Preferences, which helped to reorient sales from the Soviet Union to Western markets. The formal integration process with the EU began in 1992, when the so-called Interim Agreement on trade issues between Poland and the EU took effect. In April 1994 Poland submitted an official Application Concerning Poland s Accession to the European Union and in December the Europe Agreement (Association Agreement) concluded in 1991 between Poland and the EU, entered into force. In March 1998 Poland began accession negotiations with the EU which ended in December 2002.

Industrial policy Industrial policies aimed at restructuring so-called rusty sectors are among factors influencing changes in the macrostructure in Poland as well. One should, however, distinguish between the first half of the 1990s when state intervention in the economy was limited and the second half when three below mentioned strategies were developed. The liberal orientation of the Solidarity governments between 1990 and 1993 led to passive industrial policies. As T.Syryjczyk, the former minister of industry in H.Suchocka s Government put it bluntly: Our industrial policy is an absence of policy . In the second half of 1990s when problems with restructuring of certain sectors occurred, particular policies were developed and aimed at: restructuring the steel and iron industry, coal mining industry and sulphur mining industry. These strategies have been implemented with mixed results so far. Restructuring strategy for steel and iron industry. The first attempt to restructure the steel industry was made in 1992 when so-called Canadian consortium had developed a programme of steel sector restructuring. In the conclusion the programme opted for: closing-down seven steel mills; freezing all the investments in the sector; reducing the number of employed by 100 thousand; and consolidation of three steel mills ( Katowice , Sendzimira and Zawiercie ). The estimated cost for the restructuring was about $4.4 billion. Unfortunately, this programme was abandoned. There were next attempts to restructure this sector leading to privatisation of 16 out of 25 steel mills. The results of privatisation as evaluated by the Supreme Chamber of Control (SCC) were far from satisfactory. Despite the fact that about $1.3 billion were spent on investments in the steel industry between 1993 and 2001, it did not result in improvement of competitiveness of the Polish steel industry.

Raport o stanie sektora malych i srednich przedsiebiorstw w Polsce w latach 1996-1997. Polska Fundacja Promocji i Rozwoju Malych i Srednich Przedsiebiorstw, Warszawa 1997, p.25; Raport o stanie sektora malych i srednich przedsiebiorstw w Polsce w latach 2000-2001. Polska Agencja Rozwoju Przedsiebiorczosci, Warszawa 2002, p.25. 22 The shares in 1997 did not differ from those between 1991 and 1997.

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POLICIES DETERMINING STRUCTURAL CHANGES AND GROWTH OF ECONOMIC EFFICIENCY IN POLAND

Measures for small and medium-sized enterprise promotion and development Organisational and administrative measures In September 1995 the Ministry of Industry and Trade created the Polish Foundation for Small and Medium Enterprise Promotion and Development. The main objectives of the Foundation are the following: v supporting the Government and groups shaping State policy concerning SMEs; v supporting the institutional environment of private entrepreneurship in Poland through development of services for organisations of entrepreneurs, employers and institutions belonging to the so-called business environment ; v disseminating knowledge, promoting entrepreneurship, and creating a favourable climate for opinion leaders and generators and among the public; v ensuring rational use of foreign assistance funds in order to support the SME sector. The council of the Foundation consisted of representatives of various ministries, central government offices, banks, and organisations of entrepreneurs. * * * 23 On January 1, 1997, as a result of the reform of the economic centre the Office of the Minister of Economy was created . The Minister is obliged to initiate and co-ordinate the industrial policy of the State and to measure its implementation including pro-export policy and policy favouring developments of small and medium-sized enterprises. A new Department of Craft, Small and Medium Enterprises was created in the Ministry of Economy24 (a continuation of a similar unit functioning within the former Ministry of Industry and Trade). Measures foreseen by economic development programmes Industrial policy programme International Competitiveness of Polish Industry 25 The Task Force for Structural Policy within the framework of the Programme formulated over one hundred recommendations concerning liberalisation of markets, development of the legal and institutional market infrastructure, promotion of competition, and development of an innovation system26. Recommendations concerning SMEs were the following: Liberalisation of markets: v making the labour market more flexible; v removal of barriers hindering the entry of new entities to the market (among other things, reduction in the number of concessions required and difficulties facing foreign entities). Development of the legal and institutional market infrastructure: v liberalisation of concession regulation regarding mutual insurance companies; v extension of legal forms of business activity, adjusted to the needs of developing markets; v strengthening of commercial courts, as well as personnel and technical services for the land and mortgage register departments in courts; v development of a system of commodity exchanges and wholesale markets; v support for initiatives and entities contributing to increased transparency of the market (e.g. central pledge registry, institutions collecting insurance statistics). Promotion of competition: v support for the inflow of foreign capital through consistent removal of restrictions within the scope of starting and conducting business activity; v introduction of regulations regarding the provision of public assistance to enterprises. Development of an innovation system: v support for the development of regional systems of entrepreneurship and innovation; v involvement of public funds in the seed capital of high-risk funds. * * * 27 Program of Support for the Development of Regional Institutions Acting for the Transfer of Technology (adopted in 1997) The Programme supported the facilitation of SMEs access to modern technologies. * * * 28 Assumptions of the State Policy Towards Small and Medium-Sized Enterprises for the Years 1998-2001 The development of the SME sector was declared depending mainly on the size of development capital and on adequate relations between ability to selffinance development and the amount of financial burden such as taxes, costs of depreciation, and costs of employment. The main objectives of the document included: (1) the competitiveness of the SME sector; (2) Ensuring real growth in investment in the SME sector; (3) ensuring real growth in exports by the SME sector. Measures aimed at adoption of the European Union s classification norms 1992 reform of the classification of business activity, adoption of European Industrial Classification Code; 1997 changes in defining small and medium-sized enterprises. Poland introduced a definition, according to which a small firm is an entity employing up to 50 employees, and a medium-sized one up to 250*. * This change resulted in serious problems in comparing the dynamics of SME sector in the 1990s.

It was no earlier than in 2001 when the Act on Restructuring of the Steel and Iron Industry was passed through the Parliament29. The main provisions of the act were the result of earlier intensive negotiations between Poland and the European Commission. The Polish

Government had to accept nearly all the conditions Brussels had been putting forward for years. The Government was forced to concede their position when the Huta Katowice metal works lurched to the brink of bankruptcy. According to the Association Agreement,

Act of June 21, 1996, On the Office of the Minister of Economy, Dz.U.1996, No.106, item 490, and Act of August 8, 1996, Provisions Introducing Acts Reforming the Functioning of Economy and Public Administration, Dz.U. 1997, No.106, item 497. 24 Regulation of the President of the Council of Ministries of December 24, 1996, Regarding the Issuing of a Statute to the Ministry of Economy, Dz.U. 1996, No.157, item 798. 25 Task Force for Structural Policy appointed by the Polish Government and the European Commission operated from November 1996 to October 1997. 26 The recommendations were formulated within the framework of the document entitled Poland s Structural Policy with a View to Integration with the European Union. Final Report . 27 Program wspierania rozwoju instytucji regionalnych dzialajacych na rzecz transferu technologii. Warszawa, 1997. 28 In March 1998, the Ministry of Economy prepared a draft programme entitled State Policy Towards Small and Medium-Sized Enterprises for the Years 1998-2001 . 29 Ustawa z dn. 24 sierpnia o restrukturyzacji hutnictwa zelaza i stali, Dz.U. 2001, No.111, item 1196. RAZUMKOV CENTRE

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POLICY FACTORS AFFECTING STRUCTURAL CHANGES IN THE POLISH ECONOMY

as of 1997 Poland is not allowed to give public support to the metallurgy sector without the European Commission s consent. Brussels will closely supervise the implementation of the programme. Poland has also been obliged not to increase present levels of production (around 10 million tonnes of unprocessed steel per year and 7.5 million tonnes of finished product), even if the country s economy develops dynamically. The plan also assumes a radical decrease in investments (from $230.7 million to $51.3 million), so that they correspond with the mills capabilities30. State support will mean that the Industrial Development Agency (ARP) will take over a large part of the mills debt, worth around $2.56 billion, for which the ARP will issue bonds. The programme covers 20 steel mills (out of the total number of 69 steel producers). Three steel mills declared insolvency. Three of the biggest still mills ( Katowice , Sendzimira and Zawiercie ) were consolidated and now they face privatisation. It is planned to reduce further the production capacity by 901 thousand tonnes a year by 2006 and to spend about $840 million for restructuring and modernisation31. It should be noted that the spontaneous restructuring of the steel industry initiated in 1990 led to reduction of production capacity of the Polish steel sector by 35%. Restructuring strategy for the coal mining industry. Restructuring of the coal mining industry is proving lengthy and costly. Between 1990 and 2001 there were four programmes developed and then partially implemented. According to the Supreme Chamber of Control, between 1990 and 2001 about $8.9 billion were spent on restructuring of the coal mining industry. As it had been planned in the last restructuring programme32, based upon the Act on Adjustment of Coal Mining Industry to Market Economy33, between 1998 and 2001 about $1.53 billion were spent on restructuring which resulted in reduction of employment in coal mining sector by 97 thousand people (at the beginning of 1990s there were above 240 thousand people employed in coal mining), closing down of 16 mines and reduction of production by 31.5 million tonnes (from 116 million tonnes in 1998 to 102 million in 2001). The average cost of production is about $35.4 per tonne34. Coal mining is still loss-making: in 2001 it was $307 million, in 2002 $153 million, and there is a heavy debt to the social security fund and internal revenue service (about $5.1 billion). Thus the Government developed another Programme of Restructuring of Coal Mining Industry for 2003-2006 . It is planned to reduce further the production capacity by

12.7 million tonnes, to close 27 mines and to reduce employment by 18 thousand people. Restructuring strategy for the sulphur mining sector. Due to the decrease of the prices of sulphur on the world markets (from about $138.9 per tonne in 1986 to $31.4 per tonne in 1993) it was necessary to decrease production and to reduce the level of employment. Production was down from 2.002 thousand tonnes in 1996 to 1.533 thousand tonnes in 1999. Between 1993 and 2000 for restructirisation in sulphur mining sector $112 million were spent.

CONCLUSION The most important factors determining the scope and intensity of structural changes in the Polish economy in the last decade originated from the changes in the political system. In general, the factors at hand could be grouped into wider categories: creating an environment for economic development, creating incentives for needed business actions and creating conditions for starting businesses (or undertaking restructuring). The list of factors illustrating the above is composed of: v creation of an environment conducive to economic development by: (a) changes in political system aimed at pluralistic political democracy through appropriate changes in (among others): electoral law, regulations regarding formation and activity of political parties and constitutional model of the state; (b) introduction of the state of law principle and among others judiciary system; (c) introduction of civil society principles (non-governmental sector development); (d) introduction of watchdog institutions: ombudsman, competition protection office and free media; v changes in the regulations defining directly the conditions of performing economic activity: (a) protection of property of all kinds and intellectual rights; (b) implementation of the principle of free economic activity; (c) trade liberalisation; (d ) easy entrance to market; (e) privatisation; (f ) liberalisation of labour code; v changes in the law motivating citizens to start businesses (lowering the entry barriers for small and medium-sized enterprises, red tape reducing) and corporations to restructure (liberalisation of trade, competition and privatisation); v motivating the Government to proceed with liberalisation and restructuring despite social reluctance or even social protests. Here, the necessity to comply with the EU regulations worked as an incentive for the Government. n

Steel Sector. The Warsaw Voice, No.29, July 2001. Modyfikacja Programu Restrukturyzacji Hutnictwa Zelaza i Stali przyjeta przez Rade Ministrow, 5 listopada 2002. 32 Programme entitled: Reforma gornictwa wegla kamiennego w Polsce na lata 1998-2002 was accepted by the Government on June 30, 1998. 33 Ustawa z dnia 26 listopada 1999 r. o dostosowaniu gornictwa wegla kamiennego do funkcjonowania w warunkach gospodarki rynkowej oraz szczegolnych uprawnieniach i zadaniach gmin gorniczych, Dz.U. 1998, No.162, item 1112. This act was amended in December 2000, Dz.U. 2001, No.5, item 41. 34 There were coal mines, which sold coal on foreign markets for about 70 zlotys per tonne while the real cost per tonne was 140-150 zlotys. 31

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2. COMPARATIVE ANALYSIS OF MACROSTRUCTURAL CHANGES IN THE ECONOMY OF POLAND, OTHER COUNTRIES UNDER TRANSFORMATION, AND ADVANCED COUNTRIES S

ince 1989, when political change and systemic transformation began in Poland, the country has travelled a long path of painful reforms, building up the fundamentals of market economy and then reaping the first fruits of the new system in the form of a decade of continuous growth, while experiencing also all the negative effects in terms of large unemployment and poverty. the surplus of the Polish average rate of growth of GDP against those countries has been 0.7-0.9 percentage points, it did not mean essential change in the development gap between Poland and EU countries. For instance, GDP per capita according to Eurostat estimates of purchasing power parities (PPP) was in 1991 approximately 30% of the EU average and it increased to 38.6% in 2000.

Aggregate figures show clear growth effects of reforms: gross domestic product (GDP) increased by 45% in 1990-2001, and by 43% in per capita terms; final consumption expenditures increased by 59% and gross capital formation by 92%; output of industry increased by 72% (1990-2001) and in manufacturing almost doubled (increase by 92%); exports increased by 53% and imports by 343%.

Behind the aggregate growth figures, structural changes are hidden. As was mentioned above, some critical mass of structural change was a prerequisite for building up potential for growth in the open, competitive international environment.

These figures confirm that: (1) the growth effect has been very strong (see GDP figures in the Table Growth of GDP and components of final demand in Poland and some other countries, 1990-2001 35); (2) production potential has been almost completely modernised through intensive investment activities (see investment figures); (3) the standard of living of population significantly increased (see consumption figures); (4) opening of the economy to the world was a major factor behind financing domestic investment activities and providing Poland with modern production and consumer goods (see foreign trade data). These figures, which generally corroborate the opinion of the success story of the Polish transformation, should be however confronted with the developments in the world economy, and especially the European Union and other countries of the region, to have proper perspective for assessment. Comparison of GDP and its components in 1990-2001 is presented in the above mentioned Table. The progress of the Polish economy in terms of accumulated growth of GDP and its components has not been satisfactory from the point of view of a significant decrease of the distance to European Union countries. If we take the poorest EU members, like Greece, Portugal and Spain, then although 35

Structural change is a very general concept, and even if restricted to macrostructural shifts, it may still cover a lot of processes, important for countries in transition (CIT). For instance, one may analyse composition of GDP, looking for different patterns of growth (e.g., investment, consumption or export driven, outward or inward, etc.) or analyse the supply side of the economy, by identifying change in the sectoral pattern of output. Growth of GDP and components of final demand in Poland and some other countries, 1990-2001 Accumulated growth of GDP, 1990-2001, % GDP

Exports

Imports

145

159

192

153

443

Germany

119

120

125

221

184

France

121

117

113

185

168

Netherlands

134

129

130

196

190

Ireland

213

166

200

407

268

Spain

132

128

127

271

252

Portugal

134

135

164

184

231

Poland

Consumption Investment

Greece

131

123

146

195

180

Czech Republic

118

100

124

243

281

Hungary

127

108

221

267

310

Source: Statistical Yearbook 2002, Central Statistical Office. Warsaw, 2002.

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COMPARATIVE ANALYSIS OF MACROSTRUCTURAL CHANGES IN THE ECONOMY OF POLAND

Also analysis of the change in structure of production factors (labour and capital, potentially extended to technical progress) may be a part of the macrostructural change story. This section focuses on some aspects of structural change in the Polish economy during transition and compares them with the figures for other countries. More interest is paid rather to the change in the pattern of sectors generating GDP than on change in the composition of final demand (accumulation versus consumption). Additionally, structural changes concerning labour force are analysed together with consequences for the situation of households. The target is to draw as full as possible picture of the structural change in Poland during transition, including both economic and social side of the whole process. The change in the production structure is analysed by sector, using two classifications into main and strategic sectors. A separate section is devoted to changes in the labour force.

2.1 STRUCTURAL CHANGES BY SECTOR Very important aspects of structural change in Poland are the complete transformation of the ownership set-up of the economy and of distribution of firms by size. The key factor in this respect has been a remarkable drop of the share of the public sector in GDP from about 90% at the beginning of the 1980s to about 25% in 2001. Approximately 75% of the total labour force was employed within the private sector in 2001 as compared to 48% in 1990. The private sector has also become dominant in foreign trade activities, with the shares of 86.4% for exports and 90.7% for imports. Dynamic growth of the private sector was the result of both establishment of new firms and privatisation of public firms. Liberalisation of the law on economic activities caused a dramatic increase in new firms. Only during 1995-2001, the total number of economic units more than doubled. Most of the new firms were rather small units (with less than 250 employees), amounting to 99.8% of all the economic entities (net of agriculture and fishery) registered in the REGON36 register in 2000. The vast majority (approximately 95%) of the SMEs sector are small units, with less than 9 employees. The other channel of building up private sector was privatisation. In 1990-2001, a total of 6,884 state-owned enterprises were subject to ownership transformation37. As a result, there were only 2,054 state-owned enterprises operating in Poland in 2001.

Main sectors of the economy The Table Structure of gross value added by the main sectors of the economy 38 presents the data on structure of gross value added (GVA) by the three main aggregate sectors of the economy, i.e. agriculture (including forestry and fishing), industry (including construction) and services.

The above figures show very clear the main development pattern during 1990s: decrease of the share of agriculture and increase of the share of services. Among the most developed countries, the notable exception is Norway, which recorded significant increase of the share of industry (by 8 percentage points) due to special position and expansion of its oil sector. All the accession countries follow this regularity. As for Poland, change in the structural composition of GVA is very clear: increase of the share of services from 54% in 1990 to 62% in 2001, and decrease of the share of agriculture in those years from 7% to 4%. Also, radical changes in the sectoral composition of GVA were recorded in Estonia, Lithuania, Bulgaria, Ukraine and some other countries of the region. Despite so intensive a change in the pattern of output by the main sector, the Polish economy is still evidently very different from the one observed in the well-developed countries. For instance, in European Union countries in 2000, the share of services was typically close to 70% and the share of agriculture was not greater than 4%. In Eastern European countries services usually contribute to total GVA with 50-60% and the figures for agriculture are very differentiated from 3% for Slovenia to 13% for Romania and 14% for Ukraine. Even in the most advanced CITs like Slovenia, Hungary, the Czech Republic or Estonia there is usually a relative underdevelopment of the services sector, and a relatively excessively large agricultural sector. By and large, Poland s empirical figures (shares of agriculture and services) are very close to the theoretical proportions between gross value added and the level of development of a country.

Strategic sectors An analysis of the change in the sectoral structure of GDP provides with some basic knowledge on whether particular country follows the development pattern observed world-wide. However, such a general analysis is far from satisfactory for proper assessment of the progress made by countries and their growth potential. Moreover, reasoning based on these general indicators may be deceptive. For instance, some part of the service sector, the growth of which is recognised as contributing to higher development level, may be inefficient public administration or healthcare system. This is a typical legacy of centrally planned economic system in CITs. Also, the transport sector might be too large in some of these countries, relative to their production potential and relatively low consumption of private means of transport. For the reasons mentioned above, it is necessary to distinguish the strategic sectors of the economy at the second stage of the analysis. The strategic sectors are those production activities that provide society with new

REGON register (Business register) includes legal entities, organisational units without status of legal personality and natural persons carrying out economic activities. 37 According to 2002 data of the Central Statistical Office of Poland. 38 The data are presented according to the ISIC (International Standard Industrial Classification). The shares analysed hereinafter have been measured in current prices. Given significant changes in relative prices in CITs in the 1990s, deflating value added figures into constant prices could have considerably changed the picture.

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STRUCTURAL CHANGES BY SECTOR

Structure of gross value added by the main sectors of the economy 1990 Countries

Agriculture, forestry and fishing

2000

Industry and construction

Services

Agriculture, forestry and fishing

Changes in 1990-2000

Industry and construction

Services

Agriculture, forestry and fishing

in per cent

Industry and construction

Services

in percentage points

Argentina

-3

-8

Australia

-1

-3

Austria

-2

Belgium

-1

-4

Belarus

-9

-10

Brazil

-1

-10

Bulgaria

-3

-23

China

-11

-1

Estonia

-11

-23

Finland

-2

France

-1

-3

Greece

-3

-5

Spain

-3

India

Denmark

-6

-1

Ireland

-5

Japan

-1

-7

Canada

Lithuania

-19

-1

-10

Latvia

-18

-21

Mexico

-3

Netherlands

-1

-4

Luxembourg

Germany

-1

-7

Norway

-1

-7

New Zealand

-1

Poland

-3

-5

Portugal

-4

-1

Czech Republic

-4

-7

Korea, Republic of

-4

South Africa

-2

-9

Russian Federation

-10

-9

Romania

-7

-14

Slovakia

-3

Slovenia

-3

-8

-3

United States Switzerland Sweden

-1

-4

Turkey

-3

-4

Ukraine

-12

-7

Hungary

-4

Great Britain

-1

-6

Italy

-4

regarded as the single most important factor underlying economic growth and improvements in the quality of life 41 (Insert High-tech industries and services 42, p.52).

technologies and products, i.e., high-tech industries and services 39. In according to modern endogenous growth and knowledge-based society concepts40, knowledge and development of knowledge-based economy may be 39 40 41 42

Hereinafter a term of high-tech means high-tech and knowledge-based . Romer, Paul M. (1990), Endogenous Technical Change. Journal of Political Economy, October 5, 1998, part II. OECD Science, Technology and Industry Scoreboard 1999. Benchmarking Knowledge-Based Economies, Paris. Source: OECD Science, Technology and Industry Scoreboard 2001. Benchmarking Knowledge-Based Economies, Paris.

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COMPARATIVE ANALYSIS OF MACROSTRUCTURAL CHANGES IN THE ECONOMY OF POLAND

HIGH-TECH INDUSTRIES AND SERVICES OECD proposes the following definition of high-tech industries and services (ISIC codes are presented in brackets): High-tech manufactures: v Manufacture of pharmaceuticals (2423); v Manufacture of office, accounting and computing machinery (30); v Manufacture of radio, television and communication equipment (32); v Manufacture of medical, precision and optical instruments (33); v Manufacture of aircraft and spacecraft (353); Medium-high-tech manufactures: v Manufacture of chemicals, excluding pharmaceuticals (24, exc. 2423); v Manufacture of machinery and equipment n.e.c. (29); v Manufacture of electrical machinery and apparatus (31); v Manufacture of motor vehicles, trailers and semi-trailers (34); v Manufacture of railroad equipmentand and transport equipment n.e.c. (352-359); High-tech services: v Post and telecommunications (64); v Finance and insurance (65-67); v Business (excluding real estate activities): renting of machinery and equipment; computer-related services; R&D; legal; accounting; market research and management consultancy activities; architectural, engineering and other technical activities (71-74).

Additionally, education and health are added as sectors important to the high-tech potential of the economy. Using this definition let us look at the figures on high-tech industries and services in OECD countries43 (Table Shares of high-tech industries and services in total GVA of some CITs and developed counties ). Looking at those figures the following general conclusions can be drawn: 1. The total share of the high-tech and knowledgeintensive industries (including education and healthcare), in the GVA in the most developed countries is close to 40%; for example, in 1998 in the U.S. 41.6%, United Kingdom 39.8% and France 38.1%.

economy. The United Kingdom (only 3% share of hightech manufactures) and France (2.5%) seem to follow this pattern of development. On the opposite site, such leader countries in hightech manufactures like Switzerland, Belgium, Ireland or Netherlands (6.2% of high-tech manufactures) base their high-tech development strategy on modern manufactures, which is, possibly, a more traditional model. The composition of the CITs high-tech sector is rather similar to low shares of high- tech manufactures (e.g., 1.2% in Poland and 1.4% in the Czech Republic) and solid figures for education and healthcare (7-9%). Again the notable exception here is Hungary with its relatively high share of high-tech manufactures (3.5%) in GVA. The data on share of high-tech manufactures for Slovakia (7.9%) seems to show some problems with statistical measurement, which seems to happen time and again in international comparisons. The figures on level and composition of high-tech and knowledge-intensive industries and services show that better developed and richer countries usually have this sector relatively larger and that the important feature of their model of development is a focus rather on services (including education and healthcare) than high-tech manufactures. For this reason analysis of the performance of high-tech sector, restricted to industrial sector, is no more sufficient to draw conclusions on the level of technological and economic development of specific country or a group of countries. The Diagram Interdependence between a share of high-tech manufactures and a level of country s economic development shows that while there is some relatively robust statistical dependence between the share of hightech and knowledge-intensive industries (including education and healthcare) and development level, measured by GDP per capita, then there is practically no such regularity for high-tech manufactures.

2. For most of the Eastern European countries, represented in the Table, and poorer EU members this share does not exceed 30%; for example, in Poland 25.3% (1999), the Czech Republic 30.1% (1997), Greece 22.1% (1998)); Hungary with the share of 35% is a very positive exception. It is interesting to observe that there is very diverse distribution of the aggregate components among countries. For instance, while the U.S. is one of the leaders in terms of this aggregate, it is relatively low ranked in terms of high-tech manufactures (3.7%). It is more than the average in OECD (3.1%) but not a half of this indicator for Belgium (8.3%), Ireland (7.6%) or the best performer, Switzerland (11.5%). The American model, if we might call it like that, rests on a large share of high-tech and knowledge-intensive service sectors: finance and insurance services (8.3%), business services (9.8%) and education and healthcare (11.6%). Acknowledging global American supremacy in terms of technological and economic development, these proportions within the most modern sector of their economy indicate the latest trends of the frontier post-industrial

The countries in transition should apparently follow the pattern of growth observed in the most developed countries and expanding knowledge-intensive services, first of all R&D. However, given their scientific and

Based on Table D.5.1, OECD, 2001, supplemented by the authors figures for Poland.

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THE LABOUR MARKET

Shares of high-tech industries and services in total GVA1 of some CITs and developed counties High-tech manufactures

Mediumhigh-tech manufactures

Rev 3

2423, 30, 32, 33, 353

24 excl. 2423, 29, 31, 34, 352-355

Australia

1998

5.72

Austria

1998

2.1

Belgium

1998

8.32

Country ISIC

Post and Finance Business telecommuni- and insurance services cations services (excluding real services estate activities)

5.2

65-67

3.1

6.8

2.3

6.8

1.6

6.9

Total

71-74

Education Total including and education healthand healthcare care 80,85

10.8 7.5

23.9

9.7

33.6

12.6

Canada

1997

2.0

5.3

3.0

5.4

5.5

21.1

12.2

33.3

Czech Republic

1997

1.4

8.3

2.7

4.1

6.5

23.1

7.0

30.1

Denmark

1998

2.0

4.4

2.4

5.0

7.3

21.2

15.4

36.6

Finland

1998

4.5

5.5

2.7

3.7

5.8

22.1

12.7

34.9

France

1998

2.5

4.9

2.1

4.7

12.3

26.4

11.7

38.1

Germany

1998

2.1

9.6

2.4

4.8

12.1

31.0

10.3

41.2

Greece

1998

0.6

1.2

2.5

4.4

3.0

11.8

10.4

22.1

Hungary

1998

3.5

6.8

3.8

4.1

7.7

25.9

9.1

35.0

Iceland

1997

1.62

2.0

5.9

4.3

13.7

Ireland

1997

7.6

8.8

2.6

3.9

Italy

1998

1.6

5.6

2.1

6.0

7.9

23.3

Japan

1998

3.6

7.1

1.9

5.2

7.0

24.8

10.7 9.5

32.8

Korea

1998

5.6

7.0

2.3

7.0

4.2

26.1

7.8

33.9

Mexico

1998

2.4

5.9

1.5

3.0

5.7

18.5

8.7

27.1

11.3

37.2

Netherlands

1998

6.22

2.4

5.9

11.5

25.9

New Zealand

1996

3.72

3.3

5.7

5.1

17.8

Norway

1997

0.9

2.6

2.1

3.9

5.7

15.1

12.9

28.0

Poland

1994

0.8

5.23

1.4

1.0

3.3

11.7

7.8

19.6

Poland

1999

1.2

6.33

1.6

2.2

5.6

16.9

8.4

25.3

Portugal

1997

1.2

3.2

2.9

5.8

Slovak Republic

1998

7.92

3.0

4.8

5.1

20.8

7.6

28.5

Spain

1998

1.3

5.1

2.7

5.3

5.5

19.9

10.1

30.1

6.5

2.8

3.5

8.5

24.8

2.7

14.3

7.5

36.0

11.9

Sweden

1998

3.5

Switzerland

1998

11.52

United Kingdom

1998

3.0

5.1

2.8

5.9

11.2

28.1

11.6

39.8

United States

1998

3.7

4.8

3.4

8.3

9.8

30.0

11.6

41.6

European Union4

1998

2.2

6.2

2.4

5.3

10.0

26.1

10.9

37.0

Total OECD4

1998

3.1

5.7

2.7

6.5

9.0

27.0

1 2 3 4

Value added measured at basic prices; for Canada, United States, Japan, Korea and Iceland measured at factor costs. Includes medium-high-tech manufactures. Includes Shipbuilding (ISIC 351). EU does not include Luxembourg; OECD does not include Luxembourg, Poland and Turkey.

technological distance to the centres of world science, it seems that in foreseeable future these countries will modernise their economies rather by importing foreign R&D (through FDIs and imports). That means that most probably their progress in building knowledge-based society will be measured more by the growing share of high-tech manufactures than services. Basing upon the data, presented above, we may say that Hungary seems to be ahead of other countries of the region in that respect.

employed on a background of significant increase in the number of persons in the working age as a result of the demographic baby boom of the early 1980s; decreased level of economy activity of the population; considerable transformation in the employment structure (according to employer s ownership status, type of business activity and employment status); wide-spread employment in the grey economy; and massive unemployment.

2.2 THE LABOUR MARKET

The most important change that affected the Polish labour market during the course of transition was a significant decline in demand for labour force. This brought the most serious consequences to the labour situation along with massive unemployment.

Employment

Among the many changes we can observe in Poland, those that took place on the labour market were especially dynamic. In a very short time the Polish labour market shifted from a place suffering from an acute shortage of labour supply to the one with demand insufficiently high to meet the supply. The most relevant changes were: a significant drop in the number of the

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During the initial period of transition (1989-1992), the Polish economy experienced more than 2 million job losses. Employment stopped falling in 1994 according to

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COMPARATIVE ANALYSIS OF MACROSTRUCTURAL CHANGES IN THE ECONOMY OF POLAND

the employment register, while measured by the LFS (Labour Force Survey) only in 199544. In the years 1994-1997 the number of employment increased very modest. Employment statistics do not reflect the strong GDP growth over recent years, implying significant productivity increases: while GDP grew cumulatively by over 27% in the 1993-97 period employment was up by nearly 2% (LFS) and over 7% (by registration data) respectively. Unfortunately, in 1998 decrease in number of people employed was observed. In the period of 1998-2000 decrease in employment was significant. Employment by ownership sector. Changes in the demand for labour varied with the ownership status of the sector. In the years 1989-2000 demand for labour from the public sector continued to decrease. Over 11 years this demand decreased by 5.3 million, reflecting the scale of the transformation process that the Polish labour market has undergone. At the end of 2000, employment in the public economy accounted for 45% of the employment recorded for the end of 1989.

growth of demand for high-skilled employees (having completed tertiary education, especially growth of demand for employees in academic service sectors). As a result, the common thing for post-industrial economies with dynamic economy growth is decreasing employment in agriculture sector and remarkable employment growth in services. Economies of transition countries do not correspond to such a tendency so far. As the Diagram Structure of employment in Poland and separate EU countries by major sectors of economy in 2000 45 shows, the sectoral structure of employment in Poland differs drastically from average values for the EU. Prior to the transformation, a significant percentage of the population was employed in the industrial sector (manufacturing and construction). This sector recorded the biggest decline in employment. Share of industry in total employment decreased from 34.9% in 1989 to 26% in 2000. Comparing it to desired structure of employment such changes should be considered as positive.

Demand from private sector showed an opposite trend. Over the years 1990-1993, the number of employees in private sector increased only by 588 thousand. In 1994, the private sector started playing a more significant role in creating jobs in one year employment in the private sector increased by 345 thousand and in all years 1989-1999 were bringing an increasing demand for labour. However, in 2000 the employment in the private sector decreased by 12 thousand. There is no doubt that the economic recession that has been taking place in Poland for over two years, for the first time has brought unfavourable changes to the labour market through a decreased demand for labour from private firms. And the end of 1989, the majority of the employed population (54.3%) was hired by public organisations, but at the end of 2000, a significant majority (72%) was employed in the private sector (based on registration data). Employment by sectors of the economy. Revolutionary advances in techniques and technologies of the second half of 20th century had both direct and indirect influence on the change in employment demand. Direct influence manifests itself mostly in decreasing demand for workers and towards complete vanishing of working class (with their replacement by fully automated production systems). Indirect influence manifests itself in changes in the structure of economy. They are the effect of modern manufacturing techniques, which reduce the need for raw materials and materials for products (at the same time they limit the demand for mining industry products) and create the demand for research projection and information services. Two basic trends in change in employment demand observed in high-developed EU countries are: (1) low employment and further reduction of employment in agriculture, decreasing or stable employment in industry and increasing employment in services sector; (2) sudden

In the years 1990-1993 the number of persons employed in agriculture decreased. Most of this reduction was a consequence of liquidating state-owned farms. At the end of 1989 the agriculture sector was providing jobs to 28% of the total employed population, at the end of 2000 28.5%. The percentage of employment in agriculture is still very high several times higher than in EU countries and other highly developed countries. The employment situation in services sector remained in the best shape. Its share in total employment increased from 37.1% as of 1989, to 45.5% as of the end of 200046.

The wide gap between the two measures is mainly resulting from the different employment definition, especially of employment in agriculture. Source: Employment in Europe 2002. Recent Trends and Prospects. European Communities, Luxembourg, 2002; Employment and Labour Market in Central European Countries, 2001, No.1, 2, 3. 46 Survey data (LFS) convey a somewhat different picture: for the year 2000 the share of agricultural employment given at 18.7% and of the services sector 50.3%. 45

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SOCIAL INEQUALITY

Not all branches of services had a change towards developed countries during the years of system transformation. The number of employees in financial services and insurance (110 thousand) and in trade (203 thousand) increased the most.

EMPLOYMENT CHANGE IN POLAND The structure of unemployment is dramatic: the share of registered unemployed whose rights to unemployment benefits have expired is above 80% of the total of registered individuals. The unemployment rate among the young workers below 25 is very high, reaching almost 35%. The recent rise in unemployment has resulted primarily from an acceleration of job destruction that began with the wave of enterprise restructuring, and has persisted in part because of an imbalance in the 49 fiscal-monetary policy mix . In addition the problems with the ongoing restructuring of the Polish labour market have been compounded by an increase in new labour market entrants, primarily recent school graduates joining the labour force (demand side of the labour market). From the supply side, there exist broadly acknowledged barriers to job creation: a binding minimum wage, high taxes on labour income, limitations in the Labour Code, and a relatively easy access to early retirement and other social benefits. Some of the individuals that fall into unemployment find that living on social transfers (social assistance, family benefits, unemployment benefits, etc.) is preferable to working at the minimum wage, losing benefits, and paying taxes. Early withdrawals from the labour force through early retirement, and widespread abuse of disability pensions, have resulted in a heavy burden on current contributors to the social security system, with the system s old age dependency ratio (pensioners to contributors) rising to 67% in 2000, up from 43% in 1990. Job creation depends on several factors, including a better fiscalmonetary policy mix. The current combination of lose fiscal and tight monetary policies has lead to a weakening in domestic demand by slowing down investment, while still making foreign holdings of zloty-denominated assets very attractive. This in turn has lead to a strong appreciation of the currency, which affects export growth. Both these developments (lower investments and slower export growth) limit the opportunities for sustained growth in employment. There is a direct effect of lowering real GDP growth, and an indirect effect of reducing long run productivity growth. The latter is key for non-inflationary wage increases. Three main barriers emerge in this transition from old to new jobs: v Wages for less-skilled workers are set above market clearing levels, limiting their employment and encouraging their substitution for better skilled workers earning slightly higher wages. v Taxes on labour income are high, accounting for 51% of gross wages. This creates a wedge between labour costs and wages that both burdens employers and discourages labour supply, especially when early retirement and access to other social benefits are an option. Job creation has been slow in less-developed regions. Job creation has been very unevenly spread across Poland, leading to large regional disparities in unemployment. In general, job creation hinges more on a favourable investment climate at the firm level than on government support to a particular industry.

The structure of employment in Poland is typical for underdeveloped countries and differs from the structure of employment in fully developed countries, although recent observations indicate advantageous changes. At the same time, as the Diagram Structure of employment in Central European countries 47 shows, the employment pattern in Poland also differs considerably from that of other advanced transition countries there is still a high proportion of employment in agriculture.

Unemployment The high rate of unemployment continuing to show an upward tendency is a serious social and economic problem during the past years. Among all other countries in transition the unemployment rate was already above the Central European countries average in FYR Macedonia at over 30% and Bulgaria and Slovakia at almost 20%. Only Slovenia, Romania and the Czech Republic had relatively low unemployment rates between 7-9%. At the same time in EU countries despite slower economic development systematic decrease in the unemployment took place in 2000 its rate amounted under 7%.

and expenditure. There is universal agreement that poverty is something more than a lack of money. Great inequality in incomes causes even more difficulties in access to healthcare and education (especially when one has to pay for it) and consequently ruins condition and development of human capital.

During the first period of transition (1991-1993) unemployment rate in Poland suddenly increased and amounted 16.5%. It was the effect of the introduction of new market mechanisms to economy. Since 1993 the unemployment rate has been falling, (10.4% in December 1998)48. Recently the trend seems to have changed: the rate has increased (from 12.6% in 1999 to 16.6% in 2000).

Income distribution in 1990s in transition countries Inequality of incomes at the end of the communist period was relatively low. In general, in Central European countries (except Croatia) lower inequality was observed. In the late 1980s the largest differentiation in incomes was found in Russia and the Baltic countries.

2.3 SOCIAL INEQUALITY The social inequality is measured by the distribution of household incomes. Thus particular attention is paid to differences in incomes and to low levels of income 47 48 49

Source: Employment and Labour Market in Central European Countries, No.1, 2, 3, 2001. LFS data differed only slightly 10.6%. Poland Labor Market Study The Challenge of Job Creation. The World Bank Report No.22490-Pol, June 2001, p.3. RAZUMKOV CENTRE

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COMPARATIVE ANALYSIS OF MACROSTRUCTURAL CHANGES IN THE ECONOMY OF POLAND

Transition has resulted in increases in measured inequality. Income inequality was already relatively high in the period of high dynamic economic growth. The Gini coefficient (measure of inequality in household incomes) in Poland increased from 0.275 in 1989 to 0.334 in 199950. The average Gini coefficient in Central and Eastern Europe at the end of the 1990s was almost at the OECD value (0.310). In the Baltic countries it is somewhat above and in several of the Central European countries is still well below. Another way of looking at income differences is to consider the decile ratio 51. This ratio during 1989-1999 increased as follows: in Poland from 3.3 in 1989 to 4.3 in 1999; in Hungary from 2.5 to 3.0; in Estonia from 3.2 to 4.5; and in Russia from 3.1 to 8.8 respectively. Changes of income differentiation in social groups. In the period of 1989-1994 income differences increased significantly in all the social groups of Polish society. As we can see from the Table Distribution of income in social groups: decile ratio there was a peak in 1994 and in the subsequent years the changes in these values were moderate (except for households of employees-farmers where differentiation heavily increased). Following general trends may be drawn by the analysis of the above data concerning distribution of income in social groups. The biggest differentiation of incomes can be observed in the farmers households. High differentiation of incomes can be also observed in households of the self-employed. It is easily understandable because both types of households represent the social groups, which are firmly connected with market economy. Lower differentiation but also increasing can be observed for households of employees and the lowest one for the households of retired and pensioners (caused by

binding pension scheme). Differentiation of income for households of employees is similar to the one for households of employed-farmers. In general, after 1994 the biggest diversity was observed in incomes of farmers households and households depended on non-earned income sources; then in incomes of self-employed households, employees households, employed farmers households and finally in retirees and pensioners households. Changes in the income level depending on level of education. It turned out that at the beginning of the period of transition there were radical changes in the income level depended mostly on the level of education (Table Distribution of income in households in according to the level of education of household s head: decile ratio ). During the period of centralised economy the highest income was generated by households with the primary and vocational education levels. Households characterised by the higher educational level achieved much lower income. During the first years of the transformation this tendency changed. The person with university education can find the job easier and tend to lose it rather seldom. In market economy they are more frequently represented in the higher income groups than in the lower incomes. Structural changes in the economy of Poland had both positive and negative consequences. As positive ones the following may be mentioned: significant increasing standard of living of population; freeing business undertakings; fixing relation between quantity and quality of work and remuneration. The negative ones are: unemployment growth, social stratification, significant income differences between social groups and inside them. n

Distribution of income in social groups: decile ratio income per capita Households

1989

1990

1994

1995

1996

1997

1998

1999

Employees

3.286

3.883

3.867

3.908

4.142

3.906

3.985

2000 4.232

Employed farmers

3.229

3.553

3.637

3.448

3.770

3.653

3.718

3.621

Farmers

5.644

7.954

7.399

7.049

7.623

7.311

7.769

8.146

Retired and pensioners

2.862

3.166

3.119

3.072

3.230

3.700

3.262

3.439

Self-employed

4.597

4.380

4.416

4.443

4.318

4.492

4.741

Maintained from non-earned sources

4.769

4.360

4.227

4.832

5.564

5.167

5.413

Total

4.088

4.188

4.299

Distribution of income in households in according to the level of education of household's head: decile ratio income per capita Households

1994

1995

1996

1997

1998

1999

2000

Level of education of household s head

Tertiary*

3.514

3.764

3.911

4.200

3.895

Secondary*

3.896

3.501

3.483

3.559

3.413

4.174 3.610

Basic vocational

3.333

3.223

3.250

3.475

3.265

3.264

Primary and no education

3.328

3.507

3.393

3.653

3.496

3.697

* Complete and incomplete, since 1997 only complete.

50 Source: UNICEF (2001), A Decade of Transition, Regional Monitoring Report, No.8, Florence: UNICEF Innocenti Research Centre. If there were no differences in household incomes, the Gini coefficient would equal zero and if all income were held by one person its value would equal 1 . 51 Ratio of the income of a rich person to that of a poor person. A rich person is defined as someone at the 90th percentile of the distribution per capita income and a poor person as someone at the 10th percentile.

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3. PRODUCTIVITY CHANGE DURING MARKET TRANSFORMATION IN POLAND E

conomic transformation during the 1990s brought about substantial structural change. It is especially the increase of the share of high-tech industries and services that gives evidence to the hypothesis that there must have been vigorous productivity increase behind the GDP and industrial output growth figures in Poland.

3.1 PRODUCTIVITY CHANGE AT AGGREGATE LEVEL

The following conclusions may be drawn from these results:

The most widely used measures of productivity are labour productivity and total factor productivity. In the case of the first of these measures, changes in the ratio of output against inputs of labour define productivity change. Using the second of these explains how the inputs of all production factors interact with output. Usually labour productivity is used at rather disaggregated level when one may assume that technology (proportions of factors of production) are at least to some extent similar (e.g., the same branches of industry in different country or branches of manufacturing). Total factor productivity (TFP) will be rather used at the aggregate level when the share of some specific production factor (e.g., labour) is not that important. Following this approach, an assessment of total factor productivity during the 1990s for Poland s national economy and manufacturing was conducted. The results are shown in Tables GDP, factors of production and TFP in Poland and GVA in manufacturing, factors of production and TFP in Poland and then illustrated in the analogous Diagrams (p.58).

v total factor productivity, which may be interpreted as the rate of growth of efficiency of the use of production factors, was important factor that explains the growth of the Polish economy in the 1990s; TFP average rate of annual growth was equal to more than 60% of the rate of growth of GDP and almost 98% of the rate of growth of GVA in manufacturing, v in the mid-nineties, when the Polish economy was developing very quickly (5-7% in the period of 1994-1997) rates of growth of TFP were exceptionally high according to international experience52 (e.g., 5.1% in 1995 for the national economy and 12.5% in 1997 for the manufacturing).

The dynamics of TFP is explained first of all by factors affecting technical progress, like expenditures on research and development (R&D) or some measure of human capital, like share of highly educated labour in the total labour. However, in case of Poland and other economies in transition changes of overall productivity are also caused by the processes of microeconomic

GDP, factors of production and TFP in Poland, 1991-2001, annual rate of growth, % 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

GDP

93.7

102.6

103.8

105.2

107.0

106.1

106.8

104.8

104.1

104.0

101.0

Average 104.3

Employment

94.1

95.8

97.6

101.0

101.8

101.9

102.8

102.3

97.3

100.7

96.8

100.2

Fixed capital

99.9

104.6

102.6

102.1

104.8

103.5

103.9

104.2

102.7

103.2

TFP

96.8

104.9

102.8

103.4

105.1

102.8

103.7

101.7

103.7

101.6

101.4

102.6

GVA in manufacturing, factors of production and TFP in Poland, 1991-2001, annual rate of growth, % 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Average

Gross value added

89.7

105.1

111.9

111.2

113.7

108.8

114.4

107.5

104.0

107.1

99.2

107.7

Employment

84.7

84.5

97.6

99.7

104.3

99.8

100.7

99.3

93.2

91.5

96.4

98.2

Fixed capital

100.7

102.4

103.6

107.6

104.0

104.1

105.4

103.7

103.5

99.0

114.6

113.2

110.5

109.7

106.1

112.5

106.4

106.3

111.1

100.2

107.5

TFP

For instance, average annual rate of growth of TFP in the U.S. was 0.8% in 1980-1993, 1.4% in Sweden (1980-1994) and 2.6% in Finland (1980-1987).

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PRODUCTIVITY CHANGE DURING MARKET TRANSFORMATION IN POLAND

rationalisation as triggered by privatisation and reforms of the public sector enterprises. Moreover, according to real convergence hypothesis, one may expect that growth rates are the faster, the bigger is distance from the benchmark level of well-developed economies. This assumption shall be applied not only to GDP growth rate but also to TFP dynamics. With an application of the following general model (Insert Regression model for TFP dynamics ) an analysis of TFP on Poland s national economy level was performed for the period of 1991-2001. Apparently, as long as the Polish economy become more mature and stable, one may expect declining importance of reform variables (e.g., a share of private sector) and development distance, and increasing significance of R&D and human capital factors. To reinforce the latter point, an enlarged definition of capital formation as expenditures for development (EFD) shall be introduced instead of traditional understanding of capital as the stock of fixed assets53. EFD would comprise traditional capital formation expenditures plus expenditures on R&D and on education. Therefore the new definition of capital involves both tangible (i.e., fixed assets) and intangible part (i.e., education and R&D). The latter part of EFD might be called as investment into knowledge. The results of corresponding regression analysis confirm the hypothesis that expenditures on human capital explain relatively well the level of development of nations. However, there is substantial differentiation of the relative investment in knowledge with respect to GDP per capita levels (Diagram Investments into knowledge (% of GDP) and GDP per capita ). From these results one can conclude that the EU candidate countries, covered by the analysis (the Czech Republic, Hungary and Poland), perform relatively well in terms of building up human capital stock, taking into account

REGRESSION MODEL FOR TFP DYNAMICS TFP = f (REFORMS, MODERNISATION, DEVELOPMENT GAP), where the following variables were used for the subsequent blocks of explanatory factors: Reforms v share of private sector in gross value added, Modernisation v foreign direct investments (as percentage of GDP); v imports (as percentage of GDP); v expenditures on R&D (as percentage of GDP); v share of labour force with secondary and higher education in total labour force. Development gaps v a ratio of GDP per capita in Poland against average GDP per capita in European Union countries (according to PPP). The most important conclusions from the analysis are as follows: v all the factors, identified as potential explanatory variables for TFP change appeared valid regressors in various models; v at national economy level, a share of private sector turned out significant as the measure of reforms, share of labour force with secondary and higher education in total labour force as a measure of modernisation, and development distance as a variable representing dynamics of real convergence; v at the manufacturing level, the same variables as in a case of national economy plus FDIs (as percentage of GDP), representing modernisation of the economy, turned out significant; v development distance, as measured by the GDP per capita in Poland against EU average, appeared to be the most robust variable in all regressions.

their real level of GDP. However, the results for the accession countries are not satisfactory if their ambition is to speed-up the process of real convergence. Then their efforts in investments in knowledge should be to a larger extent above the tendency as it seems to be the case now.

Zienkowski L., Zolkiewski Z. Expenditures for Future Development (EFD) in Poland the Role of Government and Enterprise Sectors, Paper presented at 4th Triple Helix Conference, November 6-9, 2002, Copenhagen, Denmark Lund, Sweden.

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LABOUR PRODUCTIVITY GROWTH IN POLAND AND OTHER COUNTRIES

3.2 LABOUR PRODUCTIVITY GROWTH BY BRANCH IN POLAND The general picture of productivity change at the aggregate level should be supplemented by a more detailed examination at the level of branch of manufacturing, using a concept of labour productivity (gross bale added per employee). Even acknowledging increasing role of services, manufacturing and especially its high-tech sub-sector is the most dynamic part in most of the countries in terms of productivity. In Poland during 1990s, labour productivity was growing at very fast pace. Average annual rate of growth of labour productivity in Polish manufacturing, in 1990-2001, was 9.5%. That means that in 2001, the average level of labour productivity in manufacturing in Poland was 2.7 times higher than in 1990. There are no comparable figures on labour productivity for the entire period under consideration and therefore the data on 1996-2000 to assess branch distribution of this growth are used54. The Diagram Labour productivity change in manufacturing shows graphically the ranking of the branches of manufacturing in terms of labour productivity change.

3.3 LABOUR PRODUCTIVITY GROWTH IN POLAND AND OTHER COUNTRIES Relatively fast growth of labour productivity is one of the indicators of potential realisation of real convergence process55. Compared rates of growth of labour productivity in Poland against OECD countries during 19962000 are schematically drawn in the Diagram Labour productivity change in Poland and some OECD countries (p.60). These numbers show that in the Polish economy labour productivity was growing at much faster pace than in the well developed countries of the OECD. For instance, the accumulated growth for 1995-2000 was in percentage terms twice as high as in Germany, and this proportion was more favourable to Poland with respect to the USA, the Netherlands or Belgium. The figures for Poland are comparable to those for Finland, which is a good example of GDP and productivity growth in the second half of 1990s.

The absolute leader was the office machinery and computers industry that increased labour productivity by almost 150%. In industries producing: other transport equipment, rubber and plastic products and motor vehicles, trailers and semi-trailers labour productivity approximately doubled during this time. It worth noting as well that such high-tech industries as electrical machinery and apparatus, radio, television and communication equipment and medical, precision and optical instruments also recorded increases in labour productivity greater than the average for manufacturing. On the other hand, the low-tech branches (the right sector of the Diagram) experienced slower increases or even a decrease (leather products, tobacco products, coke, refined petroleum products). Therefore, it may be concluded that productivity change in Poland had an efficiency increasing character since all the branches with higher than average productivity growth (all hightech branches in that group) were also developing faster than average during this period.

It is worth mentioning that among 17 industries (NACE56 divisions) Poland was superior to Denmark, the USA and Italy in terms of labour productivity dynamics during 1995-2000, including in advanced technology industries (e.g., office machinery and computers, electrical machinery and apparatus, radio, television and communication equipment, and medical, precision and optical instruments). While these rates of growth of labour productivity indicate progress in economic and technological catching-up of the Polish economy against welldeveloped OECD countries, the distance is still

54 Kolasa M. Wydajnosc pracy w przemysle przetworczym w Polsce na tle krajow OECD w latach 1995-2000 (Labour Productivity in Manufacturing in Poland and in OECD Countries, 1995-2000), National Bank of Poland (mimeo). OECD, 2001. 55 Orlowski W. Forecasts of the Economic Growth in OECD and Central and Eastern European Countries, 2000-2040, Research Bulletin vol.11. 56 General Industrial Classification of Economic Activity in the European Community.

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PRODUCTIVITY CHANGE DURING MARKET TRANSFORMATION IN POLAND

productivity exceeded 50% and in two of them: tobacco manufacturing, and publishing and printing, labour productivity in Poland was either higher than in Spain or comparable (respectively, 122% and 83%).

CONCLUSIONS

substantial. With respect to Germany, the average level of labour productivity was 46% when calculating GVA in PPP units. The most competitive Polish industries with respect to labour productivity were high-tech branches of precision and optical instruments (approximately 90% of the German level), and office machinery and computers (approximately 80%). The relatively least productive were industries producing transport equipment (about one third of the German level). As for comparison with Spain, the average level of labour productivity in Polish manufacturing was about half of the Spanish. In 11 industries in Poland, labour

RAZUMKOV CENTRE

A substantial increase in productivity was an important source of economic growth in Poland during transition. The average rates of growth of total factor productivity for 1990-2001, calculated for the national economy and manufacturing, were exceptionally high comparing to international benchmark. Factors of reforms, modernisation and development gap appeared significant in explaining TFP dynamics in Poland. Reforms and development gap are especially responsible for such a fast growth of productivity in 1990s. The first factor is transitory and will not boost TFP as the economy gets more mature. Also, the development gap factor will have diminishing importance as Poland, hopefully, is catching up, step by step, with developed countries. That is why investments in R&D and knowledge are coming to the foreground. Also figures on labour productivity for manufacturing by branch confirm the good productivity dynamics of Poland. Industries with large content of high-tech products were the leaders of labour productivity growth in 1990s. Relative to welldeveloped countries, growth of labour productivity was much higher in Poland, in particular for high-tech industries. However, it has been demonstrated as well that the level of labour productivity in Poland is still on average much lower than in even poorer European Union members like Spain. n

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4. CONCLUSIONS AND PROPOSALS CONCLUSIONS

following: an increase in fixed costs as the result of the oil price shock and an increase in VAT and excise duties60; an increase of a paperwork due to the reform in social insurance and health care services61; an increase of initial capital needed to register a limited liability company62; and discrepancy between fiscal and monetary policies63.

One can maintain that systemic changes and liberalisation of trade initiated positive changes in the structure of the Polish economy. The economic growth experienced by Poland throughout 1990s was one of the highest in the region and between 1990 and 1998 Gini coefficient (as compared to other post-communist countries) was the lowest in Poland indicating lower disparities between the most well-off and the poorest in the country57. There are, however, some still exiting problems.

Restructuring in the economy between 1998 and 2001 continued under unfavourable conditions (growing unpredictability of the economic and political environment, an increase of fixed costs, demand and price external shocks strengthened by the policies aimed at increase of duties on petrol, globalisation processes, strong national currency [zloty], and high interest rates). Not only traditional heavy sectors (mining and ferrous metallurgy) faced needs of restructuring, but sectors with comparative high effectiveness (banks, insurance companies, telecommunication, media, and information technology sector) as well. Restructuring took place in all kind of enterprises, despite their size. Its overall goal was to adjust assets in current use (mainly human resources and capital) to the scope of activity a given firm was performing and the size of the market. Private enterprises were in general much more successful with restructuring.

Despite all the changes, the structure of Polish industry is still behind the structures of the modern economies of EU countries. A share of agriculture58 and industry59 in the GVA in the Polish economy is considerably high (in 2000 it was 4% and 34% respectively). At the same time the share of services is lower than in developed economies (despite its substantial increase between 1990 and 2000 from 54% in 1990 to 62% in 2000). The structure of Polish industry is obsolete and not compatible with growing and future needs. There is a high share of low value added and low-tech products. Hi-tech branches face stagnation in respect to production and employment, and in some sub-branches (microelectronics, computers and telecommunication) a decrease in production has been observed. Such a tendency is doubly negative since the GVA in this sector is still much lower than in EU countries.

Transformation of the Polish economy has stimulated the renewing or building of fixed assets and technologies. However, despite these positive changes, the quality of fixed assets is so low that it can be perceived as a potential threat for further economic growth. The share of machines in fixed assets increased between 1990 and 2000 from 17% to 25%64. At the same time, the structure by branches, items and age of fixed assets (the average level of depreciation of machines in 2000 was 58.5%) are inappropriate which results in a very low economic competitiveness of the Polish economy in general.

The structure of the service sector has improved between 1990 and 2000, however, still certain services are underrepresented. New services were introduced in the Polish market (professional business services, professional real estate agencies) and traditional ones like trade, tourism, hotels and restaurants have experienced substantial increases. However, inadequate is the share, for example, of financial intermediary services, in which threre is roughly 11% of the workforce employed in EU countries compared with 2% in Poland.

The quality of the technical infrastructure is still far from satisfactory. There are some achievements in some areas. The number of wire telephone subscribers in 2000 was nearly three times more than in 1990, and the number of cellular phones exceeds 12.5 million. At the same time, the energy sector, which is 70% based on

The number of newly created firms is decreasing (from 1999). The most important reasons are the 57

Keane M., Prasad E. Inequality, Transfers and Growth in Transition. A Quarterly Magazine of the IMF, March 2001. Including hunting, fishing and forestry. 59 Including construction. 60 During 2000-2001 7% VAT was introduced on agricultural products (not processed), newspapers and magazines, communal services, art and culture services (in the last two cases with exceptions) while in 1998-1999 they were not taxed or fell under zero VAT. 3% VAT was also introduced on books (in 1998-1999 0%); legal services were taxed by 17% although they had been not taxed or fell under 7% VAT earlier. 61 After 1999 small enterprises were forced to report monthly on each of the employees to the social security fund. In addition, due to the provisions of National Court Register and Partnership Code, many partnerships had been forced to change their legal forms (and to cover necessary costs). 62 In 2001 a new Commercial Company Code increased initial capital from four thousand to 50 thousand zlotys. 63 Due to existing regulations, monetary policy is reserved for the National Bank of Poland and Monetary Policy Council. Since these two bodies are independent and autonomous, this results in clashes between them and the Government. The Monetary Policy Council is being constantly accused of too restrictive policy regarding interest rates, and the Government is being criticised for increasing budget deficit and too much spending. 64 Transformacja spoleczno-gospodarcza w Polsce. Rzadowe Centrum Studiow Strategicznych. Warszawa, 2002, p.17. 58

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CONCLUSIONS AND PROPOSALS

coal consumption and extremely dependant on oil and gas import from Russia, needs modernisation keenly. Quality of roads and railroads is even more questionable. The potential of Polish R&D sectors is still eroding. R&D spending in 2000 was estimated for 0.7% of GDP (in comparison to 1.84% at average spent in EU countries in 1998) and was one of the lowest among all the post-communist countries. In addition to this, only about 24.5% of investment in R&D came form industry which illustrates serious irregularities in relationships between research institutes and research centres and industry. Special attention should be paid to agriculture. This sector was one of the first victims of side-effects of economy liberalisation and restructuring. Market prices for food and agricultural products accompanied by massive import of cheap products from the EU market, and withdrawal of state subsidies for agricultural products led towards dramatic decrease in incomes of peasants families. After a period of improvement (1994-1995), an agricultural sector gained comparative equilibrium to loose it in 1998. The agriculture sector is fragmented and a vast majority of farms are neither selfsustained (only about 10% can finance their growth) nor able to restructure. Radical changes were registered in respect to foreign trade. However, the dynamic of export is slow due to the lower attractiveness of Polish goods and services and low competitiveness of the Polish economy in general. The capacity of the Polish economy to export is low: in 2001 Poland exported for $934 per capita in comparison to about $6,000 per capita in EU countries and $2,800 in the Czech Republic and Hungary. Unemployment constitutes one of the most profound problems Poland is facing nowadays. The level of unemployment rate as noticed in February 2003 (18.8% or about 3.3 million people) is the highest ever in Poland. Rising unemployment and decreasing incomes of the poorest leads towards diminishing aggregate demand. As a research by National Chamber of Commerce showed, despite a small statistical increase in incomes, consumers reported diminishing disposable incomes65. A rising Gini coefficient during 2000 and 2001 is the effect of diminishing incomes of the poorest rather then growing incomes of the richest.

PROPOSALS A list of recommended actions can be grouped around the following six main goals: v to proceed further with privatisation using two basic strategies: to create favourable conditions for bottom-up development of the new private sector and to privatise state-owned enterprises which left; v to introduce and then to implement a policy agenda for job creation; v to develop strategies; v

and

implement

export-oriented

to develop further financial markets;

v to liberalise fully telecommunication, energy, and insurance sectors as well as to proceed further with restructuring steel and iron, coal mining, and sulphur sectors; v to increase investment in R&D, education, and technical infrastructure.

These goals require that several conditions be met.

Private sector development policy Small and medium-sized enterprises. Since small and medium-sized enterprises (SME) as it was documented in previous section are the main source of job creation, and SMEs prevail in the service sector, the development of SMEs will assist with: (1) increasing of share of the service sector in GDP; (2) improving the structure of service sector; (3) combating unemployment. It should be mentioned that some actions by the Government leading towards helping SMEs are undertaken66. In 2001 alone about $18.2 million were spent on various projects supporting SMEs. A list of further initiatives should cover: supporting technology transfers; further development of counselling and consulting services for SMEs; better access to training in management for entrepreneurs; assistance in implementation of quality systems at enterprises (there are about 2,700 firms having ISO 9000 certificate, 190 firms having ISO 14000 certificate, 61 entities having QS 9000 and only 32 possessing VDA 61)67; better access to external financing and to stock exchange; development of information centres on EU regulations; better access to business information. Privatisation of state-owned companies. It is advisable to proceed gradually with privatisation of energy sector, steel and iron sector, defence and insurance sector, and some others. In order to achieve better equilibrium between domestic and foreign capital involvement in privatisation one could emphasize importance of management and management-employee buy-outs in the privatisation plans.

Employment Creation Policy To countervail unemployment needs an immediate and decisive action. Rather than trying to stop job destruction, it is far more important to intensify job creation. That is why to introduce a policy agenda for job creation is an urgent must. Such a policy agenda should be composed of 68: v Defining a better fiscal-monetary policy mix: lowering official interest rates, fiscal consolidation; reducing real interest rates; increasing of fiscal discipline at all levels (stepping up the enforcement of tax and social security payments, and enforcing a hard budget constraint on the operations of the sickness funds, and governmental agencies); reduction of public spending (restructuring and privatisation of remaining state-owned enterprises, opening energy and transport infrastructure operations to private investors, and improving the design of the tax) and boosting the production potential of the economy.

Polska gospodarka w obliczu szybkiej restrukturyzacji. Raport KIG. Warszawa, maj 2001, p.7. Kierunki dzialan Rzadu wobec malych i srednich przedsiebiorstw do 2002 roku. Warszawa, 1999; Kierunki dzialan Rzadu wobec malych i srednich przedsiebiorstw od 2003 do 2006 roku. Dokument przyjety przez Rade Ministrow w dniu 4 lutego 2003 roku. Warszawa, luty 2003. 67 Polska gospodarka w obliczu szybkiej restrukturyzacji. Raport KIG. Warszawa, maj 2001, p.31. 68 Poland Labour Market Study The Challenge of Job Creation. The World Bank Report No. 22490-Pol, June 2001, pp.5-7. 66

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v Introducing greater flexibility in the wage structure, especially at the lower-end of the skill distribution. This can be achieved by differentiating the minimum wage either by age (setting a lower minimum wage for new labour market entrants) or by region. v Reducing taxes on labour income, lowering the cost of job creation. v Proceeding with further changes in the Labour Code. The latest changes (in 2002) are concerning temporary contracts, substitute employees, employment in small firms (with less than 50 employees) and payment for overtime work. Further changes are necessary. v Investing in worker s education and training (especially in rural areas). v Re-aligning the incentives under labour market programmes. The necessary actions should be aimed at: giving re-employment bonuses to workers who find a job before ending their first six months on unemployment benefits; tightening the eligibility to pre-retirement benefits to eligible unemployed workers over 60; and targeting active labour market programmes toward individuals likely to be caught in unemployment and underemployment traps less-skilled workers, youth, the disabled, and workers in high unemployment areas. v Lowering the costs of starting and running businesses. Since most new jobs are created in the private sector, and almost half of the new jobs are created by business start-ups, actions to lower the costs of starting and running businesses would have a high payoff. These actions include: establishing a transparent business environment that is free of undue privilege and administrative discretion; simplifying the tax system; and setting high standards in public administration services.

invest on the Warsaw Stock Exchange should be raised. In addition, the system of regional banks should be further developed.

Liberalisation of telecommunication, energy, and insurance sectors; continued restructuring of the steel and iron, coal and sulphur mining sectors To liberalise sectors now exercising monopoly positions (telecommunication, energy, and insurance) seems to be a logical consequence of implementation of the market mechanism in Poland. In return, one can expect improvement in quality services and lower prices. Restructuring of the steel and iron sector will have to be continued. After consolidation of this sector the next will be privatisation. In respect to the coal mining sector, organisational and financial consolidation should lead towards identification of a group of coal mines which could compete on the market while the rest should be terminated.

Increase in investments in R&D, education and technical infrastructure Since Poland belongs to countries with the lowest R&D spending in Europe, it is an urgent need to reverse this negative trend. Because it is absolutely necessary to improve competitiveness of Polish products and goods on international markets (as it was indicated in item Export support policy ), investments in R&D and technical infrastructure seem to be a step in the right direction. Taking into account budgetary constraints on the one hand and the role of private sector in investments in Poland on the other, it is highly advisable to promote public-private partnership and co-operation in this respect. Public-private partnership projects occurred to be a workable solution in developed countries (namely in Great Britain) and there are no visible contraindications to use this vehicle in Poland.

Export support policy Polish export will have to be increased and the trade deficit eliminated. This can be achieved by: v more effective mechanism to absorb foreign exchange fluctuations (stabilisation of the national currency, loan insurance); v programmes of goods and producers promotion (financed partially from EU funds); v financial backing of exports (i.e. export credits guarantee funds); v an increase in the quality of goods and products. These measures, in turn, require monetary ease and harmonisation of the National Bank of Poland monetary policy with the policy of the European Monetary Institute. An eventual reversal of the recent appreciation of zloty seems to be necessary.

The above six goals do not pretend to be a complete set of recommendations to harmonise the macrostructural processes and ensure sustained growth of the Polish economy. This list can be extended by a recommendation to stimulate investments, especially to increase investments in fixed capital expenditures and to improve allocation decisions. However, it is important to notice, that decreasing corporate income tax by many economists seen as the main stimulant to increase investment does not necessarily lead to an increase in investment: in 1997, corporate income tax was 38%, investment rate was 22.2% higher in comparison to the previous year, unemployment rate 10.3%; in 1999, corporate income tax decreased to 34%, and investment rate increment was only 5.9%, and unemployment rate grew to 13.1%69. n

Financial market development The Warsaw Stock Exchange should be strengthened and further developed. Some limits for pension funds to

Polska gospodarka w obliczu szybkiej restrukturyzacji. Raport KIG. Warszawa, maj 2001, p.26.

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UKRAINE AND POLAND: GDP COMPARISON BY COMPONENTS

UKRAINE AND POLAND: GDP COMPARISON BY COMPONENTS The best basis for comparing Ukraine s and Poland s GDP is the triennial Eurostat and OECD monitoring of GDP within the framework of the Programme of European Comparison. Poland has been taking part in such comparisons since 1980, while Ukraine since 1993. The latest comparison covered the year of 1999. Its latest separate components are presented in the Table. The comparison covers the GDP by standard components of final use. It is worth notice that comparison is made not on the basis of official annual average exchange rates, but on the basis of the purchasing power parity (PPP) of the national currencies. A comparison of the volume of services remains the most complex from the methodological point of view. Hence, their comparison is based on the number of employed by speciality and their average salaries. The qualitative side is almost entirely disregarded in the comparison. If we move to the analysis of separate GDP elements, Ukraine has somewhat better indicators of home consumption of food (49%) and provision with housing and utilities (50%). These are the elements of the final household expenditures that offer far scantier possibilities for saving in comparison with, say, expenditures on clothing and

footwear (25%), goods and services for houses (10%), transport (16%), or on restaurants and hotels not connected with business trips 23%. With regard to consumer goods, Ukraine has shown results much inferior to Poland s. For total goods Ukraine s per capita indicator is 26% of Poland s. The ratio gradually decreases from essential non-durables (foodstuffs and hygienic items) 36%, to 20% for semi-durables (clothing and footwear) and just 7% for durables (cars, furniture, house appliances etc.). As for services, the gap is much smaller, at 51%, of that, 24% is for expenditures on consumer services. As for the relatively smaller gap of Ukraine behind Poland in personal and public expenditures on education (81%) and medical care (61%), the rather good ratio may partly be attributed to the above-mentioned specific methods of comparison of the extension of the services. 101% for Ukraine s government services may be explained by the very same reason. The gap of Ukraine behind Poland in gross fixed capital formation is still greater than in the elements of final consumption of households only 20%. Those expenditures, especially on machinery and equipment, to a large extent determine the possibilities for future economic growth.

GDP and components thereof in Ukraine, Poland and EU-15 in 1999, $ per capita on the basis of PPP Ukraine GDP by category of final use Final consumption of population food at home alcoholic beverages, tobacco clothing, footwear gross rents, fuel, power household equipment and operation medical care transport communication recreation, culture education hotels, restaurants, cafes miscellaneous goods and services net purchased abroad Government services Gross fixed capital formation construction machinery and equipment Changes in stocks Balance of imports and exports

3,665 2,755 529 42 47 1,018 22 509 77 43 54 756 26 199 1 740 328 335 66 -28 35

final consumption expenditures households government - collective - individual

3,382 1,554 2,332 740 1,661

Total goods Consumer goods - non durable goods - semi durable goods - durable goods Capital goods Total services Consumer services Government services - collective services - individual services Addenda: GDP at an official exchange rate, $ per capita GDP total, billions $ Population, thousand Average exchange rates of national currency to US$

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1,066 749 727 63 16 328 2,666 670 2,332 740 1,661

630 183.6 50,106 Hryvna 4.130

Poland

8,939 23,005 6,808 16,305 1,072 1,760 325 544 189 742 2,056 2,991 219 920 834 1,965 469 1,654 47 297 335 1,346 929 1,129 114 950 600 1,915 0 -66 976 1,859 1,608 4,396 1,081 2,136 570 1,806 47 75 -255 262 GDP, of which 7,771 18,180 5,383 13,516 2,307 4,556 976 1,859 1,329 2,680 GDP by type of products 4,160 10,963 2,529 6,519 2,016 3,617 321 1,453 230 1,443 1,608 4,396 5,202 11,664 2,814 7,032 2,307 4,556 976 1,859 1,329 2,680

4,011 345.5 38,654 Zloty 3.967

22,681 8,670.6 376,906 EUR 0.938

NATIONAL SECURITY & DEFENCE

Ukraine as % of Poland 41 40 49 13 25 50 10 61 16 91 16 81 23 33 x 76 20 31 12 x x

Ukraine as % of the EU 16 17 30 8 6 34 2 26 5 14 4 67 3 10 x 40 7 16 4 x x

Poland as % of the EU 39 42 61 60 25 69 24 42 28 16 25 82 12 31 x 53 37 51 32 x x

44 29 101 76 125

19 11 51 40 62

43 40 50 53 50

26 30 36 20 7 20 51 24 101 76 125

10 11 20 4 1 7 23 10 51 40 62

38 39 56 22 16 37 45 40 50 53 50

15.7

2.8

17.7

No.4, 2003