ARCHIVES Danyliw Seminar 2014
The Challenge of Economic Reforms
The Anti-Corruption Effort in a Frustrated Ukraine
Disclaimer 1: The first part of this paper is based on VoxUkraine post “Comments on anti-corruption effort in Ukraine” written in July 2014. The second part describes new target areas that I believe I crucially important for success in fighting corruption in Ukraine, and some specific suggestions about ways to combat corruption, including qui tam laws advocated by Keith Darden in a VoxUkraine post: “How to fight corruption: Time for qui tam laws?” written in September 2014. Other key VoxUkraine posts on the topic are “Local Government Reform: Corruption and Accountability” by Donna Kim and Yuriy Gorodnichenko, “Georgia’s lessons from the reforms: Could they help Ukraine?” written by Nickolay Myagkiy, and “Corruption: The mistake you make...” written by me.
Disclaimer 2: The parliament has recently passed a set of anticorruption laws and the president has signed them. This is an extraordinary event for anticorruption effort in Ukraine. The laws curtail the possibility of abuse of power by prokuratura (prosecutor’s office), require transparency of the ownership, set criteria and procedures for lustration, and create a National Anticorruption Investigative Bureau. While analysts disagree about the desirability of the specific details of the laws, the mere fact that these laws were passed despite the resistance from vested interests is a sign of optimism for everyone interested in eradicating corruption in Ukraine. This paper, however, does not comment on this anticorruption package.
The mistake you make, don’t you see, is in thinking one can live in a corrupt society without being corrupt oneself. After all, what do you achieve by refusing to make money? You’re trying to behave as though one could stand right outside our economic system.
But one can’t.
― George Orwell, Keep the Aspidistra Flying
There is a broad consensus that corruption is the number one problem in Ukraine. This is a cross-cutting issue and no reform can be successful without eradicating or, at least, minimizing corruption. How can this goal be achieved? In my capacity as an economist with expertise in design of institutions and incentives, I would like to offer some remarks on the anti-corruption effort in Ukraine.
The are several widespread misconceptions in Ukraine that make it difficult to move forward.
Misconception #1: “It is a selected group of corrupt powerful people who are responsible for the current crisis”
We, Ukrainians, all are responsible for the state of the country because we routinely give bribes and use connections to further our daily goals and avoid responsibility for breaking the rules. Recent violence has helped us understand the enormous price, measured in human lives, we pay for allowing corruption to weaken and destroy the society’s vital institutions.
Misconception #2: “Stricter punishments and proper laws will reduce corruption”
A substantive amount of effort in Ukraine is devoted to drafting, passing, and implementing anti-corruption laws, including laws that increase punishment for corruption. There is no guarantee that these laws will be properly enforced, and will not be abused for extortion, prosecution of political opponents, and negotiating political deals. This has been done in the past and, allegedly, it is being done now by selected parts of the (new) government.
Misconception #3: ”There are bad and good people, and we need to replace bad with good”
I believe that behavior is shaped by incentives, and there are no intrinsically bad or good people. While it is important to identify and replace people who have been implicated in the most fragrant corruption schemes to send the right message, the problem of corruption is endemic and enters the daily life of almost every Ukrainian. It is unrealistic and unwise to punish everyone, and it will achieve nothing.
In my opinion, the following are the underlying principles that should guide all reform efforts.
Principle #1: “Focus on change the behavior of the society (new equilibrium), not punishment”
The focus of the reform should be on changing the rules of the game in the society. It is important for the new wave activists and the proactive part of the government to send the message that “business as usual” is over and focus on going after “new, post-Maidan” cases of corruption.
Principle #2: “Acknowledge and minimize resistance from the existing political elite, instead of threatening it”
The existing powerful oligarchs and entrenched politicians are a direct threat to the reforms. As they becomes threatened and their resistance to the anti-corruption reforms becomes extreme, some selective concessions can be made to reduce this resistance and make passage of the reforms possible. It is better to have some reform than none. Negotiate deals that there is more transparency and less corruption now and in the future in exchange for forgiveness of the old transgressions.
Principle #3: “Foster public engagement, instead of relying on the new government”
The public should know that in every country where the anti-corruption reforms were successful the change was possible only because of extreme and persistent pressure from the public (not unlike that of Maidan on Yanukovich). The government and business will not voluntarily cleanse itself from corruption. The public mood in Ukraine is volatile and a substantive part of the population does not accept or trust the new government. This limits the capacity for the reform. The public should be constantly encouraged through small, if necessary populist, steps that demonstrate change.
There are several key areas to which the public interested in anti-corruption effort should pay attention.
Area #1: “Media and whistleblower protection.” A necessary condition for public engagement is that the public becomes informed about corruption scandals. This requires creating incentives for media for investigative journalism and offering legal and de facto protection to media and whistleblowers who break important stories. The public should demand legislation that safeguards media independence, offers legal rights to whistleblowers, but most importantly the public should understand importance of zero-tolerance policy with respect to the government and businesses imposing pressure on the media and activists fighting corruption. Several recent incidents suggest that media freedom and independence are fragile and that the new government will impose pressure if they find media reports unpleasant. Those incidents include (1) pressure on Zerkalo Nedeli and their writers after the broke the story about arm trading between the Ministry of Defense and some companies and volunteer batallions, (2) accusation of political bias and claims of journalism for hire pointed at Denys Bigus for his investigations about procuratura, and (3) generic pressure experienced by editors of many outlets from their owners and other inviduals and organizations of influence.
Area #2: “Money laundering – «obnal».” A pervasive issue in Ukraine is money laundering. A typical scheme works as follows. A company finds a «service provider» with whom it signs a contract for delivery of some goods or services. The payment is made and the service provider returns the amount in cash, without any documentation, minus a fee. The services or goods, of course, are never delivered. This method is used to evade taxes and to provide, among other things, for unaccounted cash required for bribes, which is a normal operational expense in Ukraine. Under Yanukovich, this money laundering was centralized. Now, the monopoly on money laundering is gone. For obvious reasons, there is no reliable data. The anecdotal evidence is mixed. Some reports suggest that money laundering centers are still present and have dropped their fees due to competition, while other claim that money laundering has been eradicated to a substantive degree. The same reports claim that businesses respond in multiple ways to the new situation: some delay receiving payments from their counterparties until the situation stabilizes, some pay taxes, and some shut down their business operation due to inability to avoid excessive official tax burden. Interstingly, the «simplified» payroll tax has increased by 25% relative to the same period of the previous year, suggesting that there might be an increase in compliance. Whatever the true situation is, it might be time for the Ukrainian authorities and the public to stop pretending as if money laundering problem were not there and think carefully about how a proper tax reform can remove the economic distortions caused by necessity for money laundering. As a side remark, it would be interesting to know if MP immunity is instrumental in maintaining money laundering schemes.
Area #3: “Budget fraud and rent extraction due to regulatory barriers.” Another key problem in Ukraine is that a substantive amount of budget is diverted through fraud. In addition, barriers to entry to some markets and some specific transactions important for business operations provide rich opportunities for rent extraction by superfluous entities created by powerful groups. Many of such schemes have been destroyed since the change of the regime, but many others continue to function. Transparency, accountability, non-governmental audit of the government, clear budget rules, and deregulation are standard recommendations for reducing waste and fraud in this situation.
The vested interests in Ukraine that stand to benefit from lack of transparency and from their political connections have been refining their strategies of resistance to anticorruption effort by the public since the fall of the Soviet Union. The standard approaches have been tried and have not always been fully successful. Of course, up until the current government there has been lack of political will to fight corruption. Nevertheless, even the new government might find it easier to succeed in reducing corruption if it chooses to employ non-standard tool which have not been used in Ukraine. The new methods can catch the vested interest off guard increasing the chances of moving the new equilibrium with less corruption. Thus, the government might want to experiment with qui tam laws, mandating jury trials, electing judges by direct popular vote, introducing municipal police and locally elected sherifs, granting tax amnesty coupled with destroying money laundering companies and simplifying tax code, importing judges and police from outside of the country, conducting non-government audit of the government on large scale, introducing performance based measures and ranking of competence, quality, and satisfaction for its bureaucracy, law enforcement agencies, and procurement projects, and outsorcing government functions whenever possible.
In Ukraine, corruption is pervasive and takes multiple forms. There is no simple solution and fighting corruption requires multilayered pressure to disorient vested interests. This pressure should come from outside of the government, since the government agents tend to be coopted and included in the corrupt networks quickly after they take office. Corruption, however, is a symptom of systemic distortions in the economy and the best strategy to fighting corruption is to remove those distortions by liberalizing the markets, simplifying tax code, making the government more transparent and accountable, and increase the role of the public and civil society in monitoring the government.
Ukraine is moving in the right direction. The signs are many, including the recent anticorruption legislation, the demise of many corrupt schemes of draining the budget, increased public awareness, and the close attention paid by media and investigative journalists to the issue of corruption. Ultimately, those in power should have incentives to fight corruption, and these incentives are provide by political process and the threat of loosing the next elections. This connection is broken in Ukraine, but there are reasons for optimism. The public pressure is strong and no one is secure in the office. While typically the threat of removal from office outside of the political process is a danger to democracy, in the frustrated Ukraine with very weak political institutions, the threat of accountability of the government through violence from the public is inevitable and can provide the government with just the right motivation to carry on the fight with corruption and conducting other reforms essential for survival of the country.