improving the business climate in ukraine 2004

8/14/2019 Improving the Business Climate in Ukraine 2004

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Second Opinions and the Institutionalizationof Public Consultation in the Policy Development Process

in Ukraine project

Improvingthe Business

Climate


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This handbook was prepared as part of the Second Opinions and the

Institutionalization of Public Consultation in the Policy Development Process in

Ukraine Project, a joint initiative of the Secretariat of the Cabinet of Ministers, the

Ministry of Economy and European Integration and the International Centre for

Policy Studies implemented under the Policy Advice for Reform (PAR) Project of

the Canadian Bureau for International Education (CBIE) with the financial support

of the Canadian International Development Agency (CIDA).

Ideas and ideological management by Vira Nanivska.

This paper was prepared by specialists Vitaliy Bigdai, Ildar Gazizullin,

Oleksandr Tatarevskiy.

Canadian advisors who provided their experience in policy analysis and organizing

the public consultation process were Paul Brown, Bohdan Krawchenko and

Larissa Lozowchuk.

External experts who provided commentary and recommendations for this paper

were Olena Adamovych, Larysa Bezdudna, Viacheslav Bykovets,

Svitlana Khodakova, Valeriy Kokot, Yuriy Paperniy, Volodymyr Prytula,

Maya Rudenko, and Yuriy Sosedko.

The component on institutionalizing public consultation was implemented by

Natalia Dniprenko, Viktoria Horshkova, Tetiana Markina, and Andriy Shpychko.

The directors of regional partners who organized consultations in their respective

regions were Serhiy Knurenko, Yusuf Kurkchi, Oleh Levchenko, and Vitaliy Zeliuk.

Texts were translated and edited by Oleksiy Blinov, Oleksandra Boliachevska,Nadia Tsisyk and L.A. Wolanskyj.

A number of other specialists and analysts took part in preparing this document,

organizing the consultation process and coordinating the project: Yevhenia Akhtyrko,

Andriy Beha, Tetiana Beha, Andriy Blinov, Daria Hlushchenko, Volodymyr Hnat,

Natalia Hnydiuk, Viktoria Humeniuk, Liudmyla Kotusenko, Natalia Martynenko,

Vira Nanivska, Volodymyr Nikitin, Oksana Remiga, Ihor Shevliakov, Yevhen Shulha,

Olha Shumylo, Yegor Sobolev, and Ostap Stasiuk.

Printed in Ukraine byKyivska Typografia Publishing House.

2004 International Centre for Policy Studies


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Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Improving the business climate as a government policy priority . . . . . . . . . . . . . . . . . . .

Indicators of a healthy business climate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The business climate in Ukraine today: a diagnosis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Regulatory and bureaucratic barriers to market entry . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Difficult access to resources and business infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . .Lack of protection of property rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Absence of clear and fair rules of the game . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Unfair distribution of incomes through taxationand mandatory social payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The consequences of current problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Why is Ukraines business climate sick? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

What causes barriers to business startups? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .What prevents access to resources? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Why are property rights not adequately protected? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Whats missing in the regulatory environment? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Why is the system of mandatory contributions so unbalanced? . . . . . . . . . . . . . . . . . . . .

The main aims of reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Priorities: The first steps to fixing the business climate . . . . . . . . . . . . . . . . . . . . . . . . .Improving the regulatory environment (legislation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Reforming the tax and social contributions systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Reforming the system of public administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Protecting property rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The next steps in reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Additional ways of instituting regulatory policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Greater reduction of payroll pressures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Decentralization, optimization and increased governmentaccountability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .A better court system to protect property rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Stronger state guarantees and fewer property rights violations . . . . . . . . . . . . . . . . . . . . .

Appendix . About this project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Appendix . How the projects public hearings were organized . . . . . . . . . . . . . . . . . .

Appendix . Responses to first round of public debates . . . . . . . . . . . . . . . . . . . . . . . . .

Appendix . List of stakeholders in first round of public debates . . . . . . . . . . . . . . . . .

Appendix . Responses to second round of public debates . . . . . . . . . . . . . . . . . . . . . . .

Appendix . List of stakeholders in second round of public debates . . . . . . . . . . . . . .


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Open government and public participationin the policymaking process in between

elections are important elements of democratic governance. After the transition froma totalitarian to a democratic system ofadministration, the Government of Ukrainewas faced with the need to develop skills inmaking and implementing decisions underconditions where there are differing opinions of government policies within the society. In developing the skills and proceduresto engage the public and take various opinions and interests into account is the

Governments main task in order tostrengthen democracy and improve thequality of government policy in Ukraine.

The Second Opinions and the Institutionalization of Public Consultation in thePolicy Development Process in Ukraineproject, which includes the development ofthis paper, is aimed at helping the Government improve the quality of public involvement in the policymaking process. During

the implementation period, public policyprocesses were applied for the first time inUkraine under the project: a series of consultations with stakeholders on public policypriorities using the rules and procedures ofGovernments in developed democracies.The project looked into such governmentpolicy priorities as drawing personalincomes out of the shadows, improving thebusiness climate, and reforming the systemof privileges. Under the project, policies ineach of these areas were analyzed, along withvarious possible options, the positions of allstakeholders were heard as to these problems, their root causes and possible options,and recommendations were put together forfurther Government actions to improve thesituation.

As a result of the project, a paper was developed that analyzed international and

domestic experience in public consultationsand provided recommendations on how to

improve this process. The project expertsalso prepared guidelines for civil servants toorganize an effective consultation processand thus to improve the quality of government decisionmaking.

The project was implemented with the consultative support of Canadian advisors withextensive practical experience in policyanalysis and public consultations for theCanadian Government: Paul Brown (profes

sor, School of Public Administration,Dalhousie University, Halifax), BohdanKrawchenko (Vice Rector, National Academy of Public Administration, Office ofthe President of Ukraine), and LarissaLozowchuk (Deputy Government Secretary,Saskatchewan).

The key distinction of this project comparedto other technical assistance projects is thatall outputs were developed by Ukrainian

experts: the international advisors only pro vided consultations and transferred theirknowhow. In our opinion, such anapproach is most effective in terms of thegoal of the projectpassing on experienceand developing capacities for analyzing policy and organizing consultations in Ukraine.

This publication presents one of the analytical reports developed under the project.Improving the Business Climate identifieskey problems in this area and provides recommendations for further Governmentactivities in terms of instituting new, qualitative transformations and achieving a level ofsocial wellbeing similar to that of EU countries. The appendices contain a descriptionof the consultative process that accompanied the development of this paper and provide the responses to consultations and a listof participants.

improving the business climate

Introduction


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Ukraines economy has been growing at asolid pace for several years now. The last few years saw reforms launched with regard tothe tax regime and some significant improvements were introduced in regulating property and the financial sector. Nevertheless,improving the business climate has toremain a top priority in government policy.

Why?

Despite the number of positive changes inthe business environment in Ukraine, without new qualitative transformations the country, its economy and the welfare of its citizenswill not reach the levels seen today in the EUand leading countries around the world.

The speedy growth of Ukraines economy in should not lull anyone. Even taking into account the current acceleration ofthe economy, the level of GDP at the end of

was only about % of GDP for .Unless Ukrainians remove barriers to commercial activity, increase the rate of investment and raise the efficiency of industrialcapacity utilization, it will be a long timebefore they reaches the level of prosperity ofEU countries.

This conclusion is supported by many examples.

In , Ukraine saw a record influx ofinvestment, and the GDP share of investment reached .%. It would seem that thisis a considerable achievement. Still, whenthese numbers are examined more closely, adifferent picture emerges: even if the GDPshare of investment stays at % every year,it will take for Ukraine years to reach the

average indicator for per capita GDP inOECD countries.

Today, Ukraines per capita GDP is lowerthan the per capita GDP for most its nearestneighbors. (See CHART )

The high level of pessimism among thegeneral population testifies to the fact thatthe business environment in Ukraine hasnot managed to eliminate some of its worst

drawbacks. Despite the fact that theConsumer Confidence Index has beensteadily rising and reached . in Q,it has not yet broken the record set inDecember , when the CCI was .points. Economic expectations have tended to improve the most among poorer


Improving the business climateas a government policy priority

UkraineRussiaHungary()

Poland()

SlovakiaCzech

,

,

, ,,

,

Chart . Per capita GDP (PPP),

Sources: National statistical agencies; calculations: ICPS.


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Ukrainians, who generally do not anticipate starting up their own businesses.Negative economic expectations have actually been growing among rural residentsand those with higherthanaverageincomes.

It is well known that obstacles to doingbusiness are most keenly felt by small andmedium enterprises (SMEs). This meansthat the state of development of this business sector is a good illustration of the stateof health of a countrys business environment. In Ukraine, SMEs have an extremelysmall share of GDP. In , it was %,whereas in some other countries this indicator ranges as high as %. These kinds of

figures clearly point to significant problems that interfere in doing business.

The acceleration of Ukraines economyover the last few years has set the basis foran economic breakthrough for Ukraineand established positive conditions for theliberalization of the business environment.

The drivers behind further economicgrowth should be domestic and foreign

investment. Given that internal investmentresources are fairly limited right now,Ukraine needs to provide the necessary

conditions for attracting external investment into its economy. The example ofUkraines neighbors shows persuasivelythat this can contribute fundamentally tothe improvement of the domestic economyand of the wellbeing of the countrys citi

zens.

Results for show that Ukraine attracted a cumulative US $.bn in foreign directinvestment (FDI). By comparison,Ukraines neighbor, Poland, had attractedthat much by . As a result, the annualaverage per capita GDP for Poland at current exchange rate is US $,, whereas inUkraine it is barely US $, although thetwo countries started at about the same

level (US $, per capita). (See CHART )

A look at the experience of Ukraines moresuccessful neighbors makes it possible toconclude that attracting the necessary capital investment to raise the countrys economy further can be done provided thatinvestor rights are guaranteed and there isa positive investment climate for both foreign and domestic businesses.

For this reason, it is important to activelytackle the problems facing businesses inUkraine.

consumer confidence report #, July , prepared by GfKUSM and ICPS.

UkraineCroatiaKazakhstanRussiaHungaryCzechPoland

Chart . FDI in selected Eurasian countries, as of end, bn USD

Sources: National statistical agencies; calculations: ICPS.


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And such problems are plenty. Multilateralconsultations with both businesses and thegeneral public have made it possible tonumerate more than serious obstacles tothose who are trying to do business inUkraine. These obstacles can be grouped

into five key areas where the Governmentneeds to start more actively working toresolve problems:

regulatory and administrative barriers tomarket entry and the introduction ofnew products;

complicated access to resources andinfrastructure, which hampers thegrowth of business by lowering produc

tivity and competitiveness;

the absence of guarantees for ownershiprights, which greatly increases investment risk in Ukraine;

the lack of clear and fair rules of the game,which is one of the main reasons for thehigh level of corruption in Ukraine;

unfair distribution of incomes throughthe system of taxation and mandatorycontributions, which lowers the profitability of business in Ukraine. This, inturn, reduces its attractiveness for potential investors.

The presence of such problems causes considerable damage to Ukraines economyand leads to many negative consequences.The main one is corruption.

The Index of Perceived Corruption for placed Ukraine th among countries.(See TABLE )

A business survey showed that more than

% were forced to pay bribes of one kind oranother in the course of the previous year. According to business owners themselves,corruption is the second biggest burden aftertaxes that puts pressure on businesses andhampers their development. Corruptionforces businesses to launder huge sums ofmoney, which stimulates the shadow economy. By the most pessimistic counts, the cost of

Table . The Index of Perceived Corruption in Ukraine and elsewhere

ountry

FinlandSloveniaHungaryChinaRussiaUkraineLibya

Nigeria

Rank among countries

Index of PerceivedCorruption

.......

.

Transparency International, http://www.transparency.org, .

The higher the index, the lower the level of corruption in the country (maximum points).

Excerpted from a speech by President Kuchma at an AllUkrainian Council on problems in combat

ing organized crime and corruption and the protection of human rights, January .


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corruption is about US $.bn annually forUkraine, which is about % of all Budgetrevenues planned for . This is moneythat could otherwise have been invested inUkraines economyand which the economydesperately needs. And these are the num

bers that scare off potential investors, especially foreign ones.

The link between corruption and its rootcauses is twoway. On one hand, an imperfect regulatory environment provides incentives for corruption and bribery by making itpossible to resolve problems and obstacleshampering business activity on the spot. On

the other, corruption encourages evendeeper inefficiency in both administrativeregulation and market mechanisms. Thus,corruption fails to resolve the evident problems and fails to remove barriers to doingbusiness. All it does is ease them temporari

ly. In the long run, corruption leads to amore extensive shadow economy, lowquality public services, and a situation where itbecomes impossible to predict the impact ofspecific government policies.

In tackling the task of improving the business environment, Ukraine will also facilitate a lowering in corruption levels.


Data from the AllUkrainian conference October called How to ensure transparency in

the regulation of SMEs.


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Improving the business environment mostlymeans putting effort into eliminating thoseobstacles that most effect businesses today.Still, these kinds of problems were, are, and will continue to be for the foreseeablefuture. All that can be done is to reducetheir negative impact on business and society over time. For this reason, it is critical tounderstand that a society can never resolveall these problems, nor is this the main purpose of reforms launched by the

Government.

Yet, its important not to get caught up inpatching holes but to direct all efforts atbuilding an effective, transparent businessenvironment and resolving the worst problems. For this, the most important point is tounderstand to what kind of environment isdesirable for businesses to operate effectively and to determine indicators of a healthybusiness environment.

With the help of such indicators, it becomespossible to assess to how close the businessenvironment in Ukraine is to the desiredstate and to understand what specificactions need to be taken to make this environment more attractive to potentialinvestors. In this way, it becomes possible toclearly define those issues in doing businesswhose resolution is essential to reaching theultimate goal. Moreover, if it is understood what the business environment in Ukraineshould look like, it becomes possible toclearly determine the approach of government policy, to steadily move in a constantdirection, and to resolve old problems without giving birth to new ones.

The basis for determining the indicatorsinherent in a healthy business environment was a series of public hearings on government policy directed at improving the business environment in Ukraine. Based on theresearch carried out and public opinion,there are five elements that are the most critical to doing business in Ukraine.

Easy market entry and exit

This means that it is easy to start up a business,easy and not prohibitively costly to enter newmarketsboth goods markets in terms oflaunching new products and regional markets, and easy to shut down a particular commercial enterprise and keep earned profits.

Easy access to resources andbusiness infrastructure

After deciding to start a new business or toexpand an existing one, entrepreneurs runinto the problem of accessing necessaryresources. This primarily means financialresources to organize startup capital, infrastructure necessary to operate and communicate (transport, communications, water,electricity and so on), to launch productionand organize its sale. In addition, of course,there are human resources and information.

Protection of private propertyrights

For investors to put their capital into a business, they need to be certain that their prop


Consultations with the general public have shown that properly defining a problem is a very difficultchallenge. The number of problems raised by people was in the dozens. Of course, many of them overlap or repeat each other, and some of them are actually consequences rather than root causes. See

APPENDICES and .

Indicators of a healthybusiness climate


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erty rights are secure. Owners need to beconfident that no one will be able to illegally take their business away from them, thattheir rights to utilize their property in thepursuit of profits will not be restricted, andthat they will be able to use the profits that

are returned in whatever way they deemappropriate. Finally, for business owners it isparticularly important that the state guarantees that any property disputes will be handled in a timely manner and reviewed in anunbiased manner, that violations of property rights will be resolved or rights restored inthe case of illegal restrictions, and that theowner will have the possibility to ask forcompensation for losses resulting from anyviolation of property rights.

This is all firstly requires the necessary guarantees and enforcement mechanisms to beenshrined in law and, secondly, that aneffective system be established for protecting property rights against violations.

Clear and fair rules of the game

Everybody understands that business is agame with certain rules that are set by the

state. Entrepreneurs agree to play the game when they are certain that these rules areclear, that they are fair, that is, that the statedoesnt hand advantages to other players.

An important element for any business isplanning, so entrepreneurs need to be con

fident that the rules under which they choseto enter the market will not change for theworse down the line, that they will change ina transparent manner, and that the government will make clear, consistent and predictable moves. This requires that the

Government clearly define its policies in different areas and act within the limits of thesepolicies.

A fair distribution of revenuesthrough taxes and mandatorycontributions

Business is an activity aimed at gaining profits. Part of this profit should be redistributed

to the benefit of the state, in the form oftaxes and mandatory contributions. This is akind of payment to the state for carrying outits functions, including providing a numberof administrative and social services.

Its understood that commercial activitiesbecome attractive only when this distribution is fair and does not seriously reduce theprofitability of businesses. In addition, itsimportant that tax rates and other mandato

ry contributions be reflected in the qualityof the services provided by the state.

When all these elements can be seen in acountry, it is possible to say that that countryhas established a positive business environment.



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An analysis of the current situation inUkraine and discussions with the generalpublic have led to the conclusion that thebusiness environment does not, in fact,

reflect the elements discussed earlier. Those who are engaged in commercial activitiesrun in to numberless problems.

Regulatory and bureaucratic barriers can beseen in:

complicated registration procedures;

a poorly regulated system of licenses andpermits;

ineffective regulation of rates.

Evidence of the difficulty of enteringUkrainian markets can be seen in a slew ofsymptoms.

To start up a business, today entrepreneurs

in Ukraine need to go through registrationand postregistration processes involvingno less than six government agencies.

Because these various agencies do not havean effective system of sharing informationamong them, the fact that the onestopshop registration system has not yet beenimplemented means that business have tothemselves visit each of these bureaucracies with virtually the same set of documents, which takes up enormous amountsof time.

On average, a business will spend an estimated days in order to go through allthe necessary red tape to get the company

up and running from the moment theyapply to register with the state to when theyhave a bank account and company stamp.

In most developed countries, this indicator

is from to times lower. (See CHART )

That the process of registering a business istoo protracted and bureaucratized can alsobe seen in the fact that most entrepreneurstry to speed up the process by using unofficial voluntary contributions to businessdevelopment. According to data collectedby BIZPRO, a USAID project, in ,nearly % of all individuals and % oflegal entities did so.

Still, even having gone through the registration process, businesses typically cannotstart their commercial activities right away.Now they have to overcome a number ofbarriers created by a burdensome licensing and permits system, collecting a largenumber of documents without which theiractivities will be considered illegal. Thisincludes:

permits to start operations from suchbodies as the Fire, Health and SanitationDepartments, permits to set up points ofsale, approval from antimonopoly bodies, and so on;


The business climate in Ukrainetoday: a diagnosis

Regulatory and bureaucratic barriers to market entry

Registration procedures for the most part mean state registration of business entities and postregistration processes such as: registering with the Tax Administration, the Pension Fund, the three mandatory universal social insurance funds, and state statistics bodies.

World Bank Doing Business Indicators, . See http://rru.worldbank.org/DoingBusiness/TopicReports/.


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operating licenses, which are requiredfor more than kinds of activities;

certifications in order to be able tolegally use or sell a variety of productsand services;

licenses to confirm that the companyhas the right to engage in retail sales,personal services, and running gamingestablishments.

There are an estimated , differentapprovals required in Ukraine.

A single example of how burdensome andwrapped in red tape the system of approvalsis in Ukraine is the process of gettingapproval to set up a small booth or kiosk.Based on surveys carried out among businesses in various regions of Ukraine, this

kind of approval requires signatures,which take on average six weeks to obtain.

Another example is getting approval forextraction. Because licensing is so poorlyregulated, today the granting of extractionlicenses and extensions of such licenses has,for all intents and purposes, ground to ahalt. The queue for such licenses is morethan applications long, and the cost tothe state has reached UAH bn at this

point.

The system of approvals is a major barrierfor those who would like to invest their capital in new markets and new products, as it:

Absorbs considerable financial resources (most approvals have to be paidfor). Solely from handing out licensesin , the Government expects to col


UkraineUKItalyFranceUSCanada RussiaPoland

Henceforth, the word approval is used in the broad sense to include licenses, operating licenses,certificates and so on.

Materials from an internet conference on the topic, Ways to reform the system of getting approvalsin Ukraine. See http://www.vlasnasprava.info.

Excerpted from a speech by President Kuchma, op. cit.

This can include payments to both government agencies (such as for licensing fees) and nongovern

ment agencies (such as laboratory testing to have a product certified).

Chart . Number of days needed to start up a business in differentcountries

Source: World Bank Doing Business Indicators, . See http://rru.worldbank.org/DoingBusiness/TopicReports/


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lect nearly UAH mn. Getting backto the example of the kiosk, the cost forplacing such an architectural objectranges from UAH to ,.

Costs companies a time penalty. This

is the time that is wasted to deal with thered tape necessary to get approvals. Thispenalty amounted to .% of worktime in and grew to % in .

Strengthens the administrative leverage of various overseeing agencies overbusinesses. The more approvals a company needs, the more the government controls it. Today in Ukraine, the averagecompany is inspected times a year.

A regional survey has shown that the mostaggravation (%) comes from inspections arising in the process of gainingapproval (such as inspections to makesure the terms of a license are being maintained, fire inspections and so on).

Regulatory restrictions include regulationof rates. The current regulatory system for

rates and prices is simultaneously aimed atsocial objectives, at ensuring fair competition, and at ensuring administrativeorder; as a result, it reaches none of theseaims. Actual rates are a compromisebetween approximations of the production

cost (value) and current political restrictions.

This ineffective regulation is a significantobstacle for the development of business inspecific markets. Distorted rates removeincentives for market players to improveand expand.

One example of this is the telecommunications branch. Ineffective ratesetting is one

of the main factors that hampers the development of local land lines. Because ratesare not optimized, revenues from a localland line were only US $ in , compared to nearly US $ in . As a result,the share of local telephone communications in overall telecoms services continuesto decline, dropping from % in to.% in .

Certain key aspects of this problem standout in Ukraine:

not enough government support forbusiness startups;

inadequate informational support forbusinesses;

limited access to financial resources;

underdeveloped industrial infrastructure.

Its worth taking a closer look at the symptoms that testify to the existence of theseproblems.


Law IV on the State Budget, dated November .

Results of a quarterly enterprise survey in Ukraine by the Institute of Economic Research and PoliticalConsulting. See http://www.ier.kiev.ua/English/qeseng.cgi.

Certain rates (for instance, residential services rates and transit fares) reflect political aims rather thaneconomic realities.

By industrial infrastructure is meant the interlinkage of companies and organizations that providebusinesses with basic resources and services: telecommunications, transportation, electricity, water sup

plies, and so on.

Difficult access to resources and businessinfrastructure


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The lack of serious support for business startups can be seen in the tiny amount of funding set aside for this purpose by the government. Despite the fact that the developmentand support of the business environmenthave been declared priorities in state policy

priorities for a number of years now, financing for the Business Support Fund in was a mere .% of Budget revenues. Bycomparison, the state plans to collect tentimes more in fines than it intends to directat fostering business startups.

This kind of approach is illconsidered. Farmore resources and funding need to bedirected at supporting business. Accordingto the Business Support Fund, every hryvnia

invested in a business project makes it possible to bring in UAH of product andUAH in sales, and increases Budget revenues at all levels by UAH ..

Yet, even this low level of state support is veryineffectively applied. The main reason forthis is the result of poorly devised informational support for the business environmenton the part of both national and local government agencies. The lack of necessary

information leads to a situation where businesses cannot turn anywhere for support.Thus, in some regions, financing that hadbeen allocated for SME development purposes (for instance in ), was never evenused. As a result, such funding was actuallycut back in .

Inadequate informational support has otherimplications as well. In particular, local government agencies do not disseminate information about idle production facilities thatare communal property and could easily beused for business purposes. Nor do they promote the priority business developmentareas that are being supported by localfunds or changes in the simplified tax rate.

Today it is clear that the level of educationamong entrepreneurs, particularly legal deg

rees, is at a very low levelespecially amongsmall businesses. The lack of information andknowledge about legal requirements, established procedures and restrictions leads tounwitting violations of various regulations. Asa result, the number of fines that are collected

from businesses every year is on the rise. In, businesses paid out UAH mn,UAH mn in , and in theGovernment expects to collect UAH mn.

Lack of state funding for business development would be acceptable if conditions werelaid down that would enable these businesses to have access to cheap and longtermcommercial financial resources. However, todate the Government has not done anything

to make this possible. This can be seen in thehigh interest rates for loans for investing intoproduction and for starting up a business.Thus, the average rate for micro credits froma commercial bank in was, dependingon the source of the money, from a minimum of % to as high as .% in hard currency (usually USD). By comparison, in EUcountries, businesses can borrow at %.

Yet, even at such high interest rates, its fair

ly hard to borrow money. Borrowers areexpected to provide collateral worth% the value of any loan. Suchrestrictions on access to financial resourcesare one of the main barriers to greaterinvestment in the Ukrainian economy. In, the weighted value of borrowedmoney in overall investment by companiesinto their fixed assets was only %, whereasin leading developed countries, this indicator is around %.

In addition to problems with borrowingmoney, opportunities to attract additionalinvestment capital are limited by the underdevelopment of the securities market andmortgage lending, the low level of development and use of financial instruments thatare needed to hedge risks and simplify theprocess of borrowing money.


Statistical Pocket Guide of the European Central Bank, http://www.ecb.int/stats.


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Research and consultations with the publichave made it possible to say that businessactivity in Ukraine continues to be a highly

risky affair, one whose outcomes are hard topredict. This is primarily tied into the factthat there is an absence of clearly definedand fair rules of play. This can be seen in:

inconsistency, opacity and lack of coordination in government policy in differentareas of business regulation;

flawed legislation and regulation;

unequal conditions on many marketsand for many businesses;

unregulated relations between businessand the state, especially with oversightbodies.

Today, government policy aims change asthe external situation changes. Decisionsare made without the input of public dialog.Only % of draft regulatory bills are publi

cized for the purpose of getting feedbackand propositions from the general publicand private business. The process of developing government policy remains ineffective because state bodies ignore the requirements and principles of regulatory policy.This can be seen, among others, in the factthat only % of regulatory bills drafted bygovernment organs are accompanied byappropriate analyses of the impact of theregulations, and the little analysis that is pro vided is unacceptably poor in quality: only% of authors bothered to review alternativeoptions to dealing with the given problem;% calculated the benefits and losses of theproposed alternative; and only % attempted to predict the consequences of the pro

posed reform using socioeconomic indicators.

All of these have a negative impact on thequality of the legislative and regulatoryenvironment. When norms and regulationsare frequently changed, businesses have topay constant attention to them and adjusttheir activities accordingly. The survey ofbusinesses indicated that, compared to, legislative unpredictability as anobstacle to the production process grew in. The portion of entrepreneurs whothought the regulatory climate was the

main hurdle to doing business grew from.% in to .% in . This indicator grew mostly as a result of componentsthat reflect growing unpredictability andinconsistency in legislative changes. Thenumber of respondents who thought thatlegislation was unpredictable doubled in over .

An additional complication is the fact thatthe consistency of new norms in relation to

the norms established by existing legislationis not always checked, leading to conflictsand divergent interpretations. This conclusion is confirmed by the huge number ofconflictsmore than between such fundamental business laws as the Civil andCommercial Codes.

In addition, business people note that legaldirectives are far too generalized: whenreading the law, entrepreneurs are unable toextract a template for running a business inpractice. Between the Civil and CommercialCodes, a business person will find some, provisions that make reference tonorms in other current legislation. Thisforces them to turn to lawyers for consulta


Absence of clear and fair rules of the game

Data from the State Entrepreneurship Committee.

Quarterly Enterprise Survey of the Institute of Economic Research and Political Consultations, ,

February . See http://pigra.kiev.ua/ier/qes/qes_eng.pdf.


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The tax regime and mandatory contributions system should reflect a balance ofinterests between the state and the privatesector. On one hand, social needs need to

be financed in the appropriate measureand, on the other, the ongoing developmentof business should not be stifled by cuttingdeeply into profits.

tions and commentary, which distractsentrepreneurs from their business.

No less painful an issue for businesses is theabsence of fair (even) conditions for all players in a specific market, especially the lack

of de facto protection of competitiveness,and unfair (distorted) distribution of various breaks.

The latter is confirmed by the high level ofconcentration on certain markets: startupsand small businesses who are already marketplayers are being either taken over or drivenout. AntiMonopoly Committee data showsthat the GDP share of the monopolist sectoris almost %, which leads to high con

sumer prices.

This tendency towards monopolization canbe seen in many sectors of the domesticeconomy, even in such areas as retail trade.Half of the countrys wholesale turnover iscurrently controlled by only businessentities.

The problem with distorted privileges andtax breaks is that manufacturers who dont

have such breaks become unable to compete with those who do. Moreover, largecompanies are able to reduce their tax burden through such breaks, which increases itfor SMEs, since the state then tries to compensate its revenue losses through them. Forexample, three large oil refiners who weregranted illconsidered breaks were able,between them, to reduce their tax obligations by nearly UAH mn.

The last aspect of the problem worth examining is the unregulated state of relationsbetween businesses and the state, especiallyoversight bodies. Without doubt, a government needs to carry out a certain amount ofoversight, as this is one way of ensuring the

law is upheld. However, this kind of controlshouldnt become a burden to business orincrease the risk factor in undertaking commercial activities. Today, these conditionsare not being met. Existing legislation doesnot provide entrepreneurs with a clearanswer to the question, Who has the rightto carry out inspections; when and how, andwhat are the restrictions on and obligationsof inspectors and those whom theyinspect?

These conclusions are supported by the factthat the costs to business of undergoingstate inspections rises with every year. Thetotal number of inspecting agencies inUkraine has grown to more than , whilethe Budget anticipates picking up revenues from planned violations of legislationthat is, income from fines and financial penaltiesto the tune of UAH mn.This is % more than in .

Based on figures, the most money isexpected to come from fullscale inspectionsof the energos, domestic power utilities( businesses to pay UAH .mn, makingthe average price for such a review overUAH mn) and the heavy machinery sector(, companies to bring in UAH .mn,for an average of UAH , per company).


Excerpted from President Kuchmas speech, op. cit.

Unfair distribution of incomes through taxation andmandatory social payments


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Today, it is possible to state that this kind ofbalance does not yet exist in Ukraine. Theredistribution of corporate revenues isquite unfair. The extent of payments thatthe state collects in the form of taxes andmandatory contributions does not corre

spond to either the quantity or the qualityof public services provided (administrative,social and so on).

The main harm to business in terms of taxation continues to be:

social payment pressure;

multiple taxes;

unstable tax regulations.

The current system of social security inUkraine is too burdensome for businesses.The extent of the contributions that companies have to make based on wages andsalaries and transfer to the basic SocialFunds, is at least .% of payroll. Inaddition to these mandatory social contributions, employers are obliged to withholdfrom their employees salaries about .%

to the payroll fund.

When personal income taxes are added(% as of ), it becomes clear that, forevery hryvnia paid into the hands of anemployee, a company has to pay out an additional approximate UAH . in the form oftaxes and social contributions.

As a result, either the production cost of thegoods (services) rises or the shadow economy grows. Obviously, in order to minimizetheir payroll costs, employers are forced topay at least part of their salaries and wagesunder the table. This increases the risk of

social insecurity for hired workers, becausethe tiny official income they receive makesthem ineligible for significant social services(pensions, unemployment or maternity benefits, and so on).

In addition to the burden of social paymentsfor businesses, there is the tax burden itself.Tax reforms made it possible to reduce thecorporate burden somewhat. Still, althoughthe current tax rate and number of taxes are

comparable to those in other Europeancountries, discussions with the communityhave shown that entrepreneurs still find themtoo high. The problem seems to be not thenumber or size of the taxes, but such pointsas:

) When the demand for financial assets ishigh, paying taxes means a reduction inliquidity of circulating capital for companies;

) When the tax administration system is indisorder, businesses spend a lot of extratime dealing with it. This means thatcompanies show losses on paper. In practice, nearly , enterprises reportedlosses last year. According to the Accounting Chamber, these (mostly artificial)


In this paper, the word taxes is used to mean the combination of all taxes, fees and universal mandatory contributions.

These include the Pension Fund, the Social Welfare Fund for those who are temporarily unable to work, the Universal Unemployment Fund for those who are out of work, and the WorkersCompensation Fund to cover those who have been in an accident.

Contributions to the various funds are: % for pensions, .% for welfare, .% unemploymentinsurance rate and .% (minimum) for universal workers compensation insurance without countingdiscounted rates.

Of this, % goes to the Pension Fund (the most common rate), % to insurance against temporary

inability to work, and .% to the Unemployment Insurance Fund.


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losses mean that, in , the Budgetlost UAH .bn.

At the same time, the tax system still does notensure a stable level of Budget revenues, which leads to endless shortterm adjust

ments and changes to tax laws. As a result,

tax legislation is unsystematic and unstable.This can easily be seen in the fact that from to , the Law on the VAT wasamended more than times, the Law onCorporate Profit Tax more than times,and the Law on Personal Incomes, more

than times.


Biznesnewspaper , May .


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The problems with Ukraines business environment require consistent and wellthoughtout decisions, as they have a negative impact on business activities and thushamper economic growth.

The lack of transparency of the businessenvironment makes it difficult to carry outcommercial activity at all stages of a businessinitiativefrom the conditions for registering and finding capital to the earning of

profitsand is one of the main sources ofcorruption. To lower the level of corruptionis an urgent task, as corruption is both theconsequence of an imperfect regulatoryenvironment and a condition for its continuing growth. Corruption gets in the way ofcarrying out a commercial initiative on thebasis of fair and equal terms. It also leads toa slew of economic, social and political consequences, including:

failure to take advantage of investmentopportunities;

baselessly high costs for doing business;

the movement of commercial activityinto the shadow economy.

Ukraine was th among countries inthe Corruption Perception Index.

This high level of corruption leads to anopaque business environment and thus tohigher risk for doing business. This slows theflow of investment into the Ukrainian economy. In fact, the main investors in Ukrainetoday are businesses themselves and the levelof lending remains low, while foreign

investors lack confidence in the protection ofproperty rights and thus do not bring theircapital to Ukraine. Ukraine had accumulatedonly US $.bn in FDI by the end of , while its neighbor Poland had alreadyreceived that much in .

The business survey showed that more than% felt forced to give bribes during theprevious year. Entrepreneurs themselvesestimated that corruption was the second

key factorafter taxesthat puts pressure onbusinesses and hampers their development. The very existence of corruptionforces business people to launder enormous sums of money, which stimulates theshadow economy. Losses from bribes alone,according to the most pessimistic estimates,amount to US $.bn annually, which isnearly % of Budget revenues planned for. This kind of illegal payment reducesthe operating capital of a company, which

could otherwise go to the expansion of thecompanys activities.

According to official statements by the countrys leaders, the share of the shadow economy is just about as big as the official economy in Ukraine, nearing %. For this reason, despite record postindependencegrowth in the current year, , the country still has a monthly GDP of only UAH per person, less than US $.

Under such conditions, even the most ideallegislative initiative wont make any difference, since it is being ignored by both thosein power and those in business. It hasbecome inconvenient to work legally, since a


The consequences of currentproblems

By comparison, Russia was th. See http://www.transparency.org.

Excerpted from President Kuchmas speech, op. cit.

AllUkrainian conference, op. cit.


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companys shadowsector competitors getaway with paying no taxes and ignoring regulatory restrictions and are thus more competitive, while the entire tax burden fallssquarely on the shoulders of legal businesses.

Analysis of the business environment inUkraine shows that, although quantitativelyUkraine is drawing closer to European standards, qualitatively it is not. This is particularly true of the SME structure, which showsa number of discouraging features:

) Number of SMEs per , residents.In , Ukraine had registered SMEsfor every , citizens. This indicator isclose to EU levels (:,), but the

structure of SMEs is such that smallenterprises amount to only % of thisfigure. The remaining % are sole proprietors, that is, physical entitiesengaged in commercial activities. Theineffectiveness of such a structure ofbusiness testifies to the fact that sole proprietors are mostly engaged in trade,and hence do not generate any added value. As a result, the level of GDP perperson in Ukraine is extremely low.

) Weighted value of SMEs in the GDP. According to the Tax Administration,

most small businesses report gross revenues below UAH , per annum,while data from the business survey indicates that only % of businesses in retailtrade (about % of all registered SMEs) who started operations years ago

have been able to accumulate capitalworth US $,. As a consequence, the GDP share of SMEs in wasonly %, whereas in OECD countries,this indicator is as high as %.

) Share of workers employed at SMEs. According to BIZPRO estimates,

% of Ukraines population are ableto engage in commercial activities, orabout ,, people. Employment in

small businesses has stayed largely flat inrecent years and in it was, on average, . workers for one registered business physical entity (payers of the flattax). In this way, Ukraines SME sectorcurrently engages three times fewerentrepreneurs than the potential that isthere. Globally, SMEs are traditionallythe backbone of the middle class in asociety, whose existence lowers incomegaps and poverty. This means that if the

number of people working in SMEs canbe increased, this will improve the wellbeing and stability of Ukrainian society.


Official site of the State Tax Administration of Ukraine at http://www.sta.gov.ua/english/index.php.

Data from the Akademia thinktank at http://www.academia.org.ua.

Explanatory brief to the Bill on amending certain Laws of Ukraine regulating commercial activities.See http://www.parliament.org.ua.

Ukraine and Russia: State policy regarding SMEs, Institute of Competitive Society, .

Akademia, op. cit.


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Analysis and public opinion both point to anumber of reasons for barriers to entry onUkrainian markets:

Low level of cooperation between business and the government. Lines of communication between the private sector,the general public and the governmentare not effectively established to takebusiness interests into account when therules of registration are worked out andto prevent procedures from being solong and tangled.

Lack of effective informational support on the part of the government tosupport businesses. Government agencies do little to disseminate informationabout the proper pre and postregistra

tion procedures that are needed to startup a business, including approvals andthe tax regimes governing specific forms

of commercial activity in differentregions (such as in a SEZ or a PriorityDevelopment Territory). Governmentofficials are uninterested in providinghighquality public services.

Unregulated procedural issues withregard to administrative services.Many issues related to administrativeservices, in particular in terms ofapprovals, are not appropriately regulat

ed. This creates points where theprocess of issuing documents can bedelayed, groundlessly increasing company costs and allowing for abuse by civilservants.

For entrepreneurs who have already startedup their business, an urgent issue is findingcapital and access to a developed infrastructure. A number of factors get in the way ofaccess to financial resources:

Limited supplies of longterm loans.Because of the high level of risk and theneed to create huge reserves, the collateral demanded by Ukrainian banks for

longterm loans is too high for mostbusinesses. Moreover, the lack of adequate resources in the commercial banking system (low capitalization of banks)means Ukrainian banks and nonbankfinancial institutions are unable toensure the provision of enough longterm credits. All this reduces the possibilities for acquiring and updating production facilities.

In order to make Ukraines business climatea healthier one, the reasons for the problems listed here need to be understood andexamined. That will make clear where treatment needs to start. An analysis of the rea

sons for so many obstacles to business activity in Ukraine has been prepared for each ofthe main criteria necessary for a healthybusiness environment.


Why is Ukrainesbusiness climate sick?

What causes barriers to business startups?

What prevents access to resources?


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Inadequate level of mortgage lending.Legal initiatives in this area need sometime to become effective. Regulatingmortgages has been hampered by anumber of issues that have not been regulated legally in terms of mortgaged

securities and nongovernment pensionfunds.

In addition to financial and informationalresources, businesses also need access toproduction infrastructure. But the ineffective regulation of natural monopolies getsin the way.

Services in the infrastructure sectors are generally in the hands of monopolists that arestateowned. For businesses, its important tobe certain that infrastructural services will begiven at predictable rates, since they have alarge weighted value in the production cost

of any manufactured goods. Yet ratesettingin the infrastructure sectors is often determined on the basis of political expediencyand the interests of specific enterprises.

Another aspect that hampers business activity is the unevenness and low quality ofinfrastructure development, especially inrural areas.

Once business owners have invested somecapital, they want to be assured that theirrights to assets and to any profit they makeon those assets will remain theirs to dispose.But such guarantees are not adequate inUkraine for a number of reasons:

Flawed court system. Businesses haveno guarantees that their rights will beupheld in an unregulated court system.

Decisions at various levels in the samecase can be quite different and dependmore than anything on the effectivenessof the lobbying and bribes provided bythe parties involved in the case. In addition, the enforcement of court decisionsis uncontrolled or avoided altogether.

Ineffective extrajudicial protection ofproperty rights. Mechanisms for theextrajudicial protection of propertyrights are not widely spread, since theyremain inadequately regulated today onthe legislative level.

Lack of corporate culture in businessdealings and effective legislation in thisarea. Company shareholders remainunprotected, which holds people frominvesting in commercial ventures in anopaque business environment whereproperty rights are not guaranteed effectively. Stock companies only came intobeing in Ukraine after independence andthus standards of corporate governance

are still not fully formed. This means thatrelations among shareholders and company management remain unregulated.Because corporate culture has not beeningrained yet, it becomes particularlyimportant that existing rules of corporategovernance be upheld. But the low levelof legal culture among entrepreneurs andthe lack of strict control over compliancemean that standards of corporate governance are largely ignored.


Why are property rights not adequately protected?

The Law on Mortgages has already been approved and a State Registry of Mortgages has been set upto protect creditors. One and the same mortgaged property can be used as collateral for several credi

tors, so the highest priority is given to the creditor who first registered the loan contract.


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Since the state fulfills a social function aswell as ensuring the stability of the regulatory environment, businesses agree to pay forthese services. Still, given the low quality ofpublic services and ineffective Budget allocations, businesses have additional incentives to consider even the lowest tax ratesburdensome. The main obstacles that the

current system of mandatory contributionsplaces before businesses are:

Responsibility for social servicespassed onto businesses and social welfare ineffectively managed. Since theGovernment is supposed to guarantee theprovision of social benefits but uses the

The effectiveness of a business depends agood deal on certainty about the rules ofthe game. But in Ukraine many obstacles

get in the way of this:

Norms and regulations are seen as atool for promoting business and political interests rather than as a broadbased policy. Ukraines financialindustrial groups (FIGs), which have enormous advantages of scale because ofboth vertical and horizontal integration,have both economic and political clout.Because of their solid financial support,

they are able to lobby government policies. Many entrepreneurs in fact becomepoliticians, only nominally leaving theirbusinesses but in fact promoting publicpolicy that benefits those branches andinterests that are theirs.

Lack of analysis of the impact of introducing specific legislative changes.Regulatory restrictions are necessary forboth society and business, but in

Ukraine they can sometimes be excessive. Before introducing or changingthe rules of the game in business, government bodies do not bother to thoroughly analyze the impact of suchchanges or to adapt the experience ofother countries to Ukrainian businessrealities.

Lack of accountability on the part ofthe Government. The rules for developing Government policy are acknowl

edged, but not enforced, as there is nomechanism that would hold politiciansaccountable for this. As a result, legislative changes and additions appear almostat the same time as the main law. Then, inthe midterm, what is worked on is notthe mechanism for introducing the law athand but the development of a new andentirely unworkable law. Governmentbodies take little responsibility for theiruncontrolled interference in business

activities. As to oversight bodies, thereare no legislative norms at all to regulate which particular oversight bodies caninspect specific kinds of businesses, with what frequency, and to what extent.There are also no mechanisms that wouldgive businesses the chance to take anoversight body to court when necessary.

A poorly regulated environment suitsgovernment officials. When the busi

ness environment is complicated andopaque, illegal payments become moreconvenient than the official ones. Forthis reason, the lack of regulating procedural issues tied with providing publicservices and their deliberately low quality spurs business owners to simply paybribes to cut through the red tape.


Whats missing in the regulatory environment?

Why is the system of mandatory contributions so

unbalanced?


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revenues it collects ineffectively, thefinancing of these services is throughSocial Funds that collect money by increasingly pressuring businesses for contributions.

Inconsistent and unsystematic regulation of the tax system. Shortterm policyaims outweigh longterm strategy in thetax system. In focusing on filling theBudget, fiscal policy fails to take intoaccount the cost to business of continually adapting to changes in tax rules andadministrative procedures.

Ineffective Budget allocation policy.Unrationalized allocations of Budget

funds lead to a situation where the state isunable to fully finance spending on social

services. This means that the state has tofind additional financial resources, whichmeans more tax pressure on businesses. Inaddition, the illplanned policy of distribution of revenues between Kyiv and localbudgets fails to provide local governments

enough incentive to support business.

Tax breaks. Excessive interference by thestate leads to distortion of market conditions for running businesses not just insubsidized branches, but throughout theeconomy. In fostering one sector or market, the state destabilizes others. For theBudget to collect the necessary revenues,the tax burden is shifted to profitable sectors, which end up unable to fully take

advantage of positive investment opportunities.



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The business environment is a complex system containing many components. Its effec

tive functioning depends on many factorsand is hampered by many problems.Moreover, the problems affecting the business environment and the reasons why theyarise are diverse.

Today, its critical to define the main aimsthat will ensure an improvement inUkraines business climate and to concentrate government efforts and existingresources on reaching them.

Given the key problems of the business environment in Ukraine, four main objectivescan be formulated for its improvement:

. Improve the regulatoryenvironment

Regulations are one of the main instruments that the government uses to influ

ence the business environment. For thisreason, improving the regulatory environment, that is, the legislative base inUkraine, could ensure:

the elimination (or at least reduction) ofregulatory and bureaucratic barriers;

the establishment clear, understandable and fair rules of the game for business.

. Reform the tax and socialcontributions systems

Its critical to continue with reforming thetax system and the system of mandatory uni versal social contributions in order toensure:

a fair distribution of the tax burdenamong different players in the business

environmentbusiness and individuals;

the lowering of tax pressures to a levelthat reflects a balance between the interests of the state and business andresponds to the quality of administrativeand social services provided by the state.

. Reform the system of publicgovernance

The government bureaucracy which is themain regulator is also the main source of themost obvious obstacles to business inUkraine. Bureaucratic and regulatory barriers to doing business as well as complicatedaccess to resources and infrastructure arethe consequences of ineffective actions andlack of accountability on the part of government bodies.

Thus, reforming the system of governmentadministration must be one of the main priorities in order to improve the business climate. Reaching this goal should ensure:

an expansion in opportunities for business to have access to resources andinfrastructure;

a reduction in administrative and regulatory costs.

. Protect property rights

By guaranteeing property rights, the risks topotential investors are reduced and the business environment becomes much moreattractive. In addition, effective protection ofthe rights of owners reduces unproductivebusiness costs while increasing trust in thegovernment and in the measures that it takes.


The main aims of reform


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Each of the main goals for improving thebusiness climate listed in this paper can bereached by more than one road. And eachof these paths has its strengths and weaknesses, requiring the definition and institution of a different set of instruments andmechanisms. In a situation where resourcesare limited, it is obvious that any attempt togo down all the roads at once will only lead

to none of them being followed to the end.This means the choices have to be prioritized.

Based on a series of public hearings, a number of tasks have been defined whose resolution is a top priority, and a number of instruments and mechanisms that need to beintroduced in the shortest order.

One of the main headaches of the businessenvironment in Ukraine is the lack of clearand fair rules of the game for business, particularly the flawed set of norms and laws.According to participants in the public hearings, complaints about current legislationboil down to two main aspects:

lack of effectiveness;

poor quality.

The effectiveness of legislation meansthat state interference is purposeful, adequate (the minimum necessary) and the

positive effect on society is greater than thecosts of introducing or enforcing it.Ineffective legislation leads to the creationof many regulatory barriers (restrictions) forbusinesses.

The quality of legislation means that theirwording is understandable, mutually agreed,free of contradictions, consistent, and stable.This kind of quality ensures simplicity in car

rying out the law and reduces the riskattached to enforcing/not enforcing different prescriptions in the law. This kind of riskarises when it is possible to interpret the provisions of a regulation in more than one way.


Priorities: The first steps to fixingthe business climate

Improving the regulatory environment (legislation)

Henceforth, this text uses the term norms and regulations synonymously as legislation and regula

tions.

Given the reported responses of the general public, it is possible to note four reasons whycurrent legislation is flawed:

norms and regulations are seen as instruments for satisfying specific business or politcalinterests and not as a way to effectuate government policy;

no effective informational support is given to businesses by the government;

there is no analysis of the effectiveness of introducing changes to legislation;

government bureaucracies find it convenient to operate in a flawed legal environment.


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In determining ways of improving the regulatory environment, the orientation has tobe on improving both the effectiveness andthe quality of regulations, since both aspectsare equally important. The related problemscan be removed and this goal achieved by

moving in two directions:

. Introducing regulatory policywhile involving the general

public as an equalparticipant in the process

This option means that part of the burden ofintroducing regulatory policy is shared by

the community. Engaging the general publicin the process of developing public policyshould become a mandatory requirement ofgovernment bodies at all levels. It is criticalto also concretize and enshrine the mechanisms for involving the public, for twowayfeedback, and so on, in legislation.

In addition, this option means creation oftransparent system of access to the information about government bodies regulatory

activities. The public can be an equal participant of regulatory policy implementationprocess only when it has access to the complete regulatory information.

This would make it possible to raise theeffectiveness of legislation. But this does notguarantee the quality of such legislation, inthe sense noted here. This is largely connected to the fact that the Law establishingthe basis for regulatory policy in commercialactivities largely does not define the necessary instruments for this purpose. In addition, the requirements of state policy do notinclude all types of regulations and all sub jects of regulatory activity, such as electeddeputies.

To improve the regulatory process, it is necessary to take some steps in a different direction:

. Providing incentives forregulatory bodies to improvethe quality of regulation

Earlier it was noted that regulatory bodies

find it convenient to work in a flawed regulatory environment, as any weaknesses inlegislation can be used to their advantage.For this reason, they have no incentive whatsoever to put together regulatory provisionsin such a way that would be accessible andunambiguous for those who are supposed tointroduce or apply the provisions of suchregulations.

Another approach to the situation would be

to interpret all ambiguities in the law in favorof the private sector, which would protectbusinesses from the abuse of governmentbodies in the application of specific provisions of their regulations. In this situation,government bodies will have an incentive toimprove the quality of their regulations.Given this, it makes sense to concentrateefforts on protecting subjects of commercial activity from the negative impact ofany inherent flaws in legislation.

This option makes it possible to set up a system whereby any flaws in legislation do notcreate additional risk for business and,more importantly, will be interpreted to thebenefit of entrepreneurs, not governmentbodies at the central or local level. Toachieve this, it is necessary to:

establish clear rules to determine effective norms in legislation (indicatingwhich piece of legislation, among several, takes precedence) in terms of determining approvals, sphere of regulationand so on, depending on the body thatapproved or passed that legislation;

set clear rules for applying legislation(particularly by the courts) when different pieces are in conflict with each other,overstep their legitimate authority, or do



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not conform to overall government policy in a particular sphere, and so on;

extend the notion of conflict of interests to all legal areas, so that when acommercial entity protests any wrongdo

ing, penalties cannot be applied untilsuch time as the conflict between thegovernment agency and the businessentity are resolved either administratively or judicially.

On one hand, taxes and mandatory universal contributions to Social Funds create aconsiderable burden for businesses, but onthe other they are a source of financinggovernment expenditures. Given this, theissue of reforming the tax system and thesystem of social insurance contributionsneed to be examined comprehensively in a

unified manner. For this reason, taxes andmandatory universal contributions to so

cial Funds will be collectively be referred toas mandatory contributions in this discussion.

Despite significant movement in terms ofreforming the tax system and the system ofmandatory social insurance contributions,flaws in this sphere remain one of the main

obstacles to the further development ofbusiness, according to those surveyed.


For instance, today, changes to tax legislation are often in violation of the Law on the tax system andthe Budget Code. It is critical to determine that, when such conflicts arise, business entities have a rightto refuse to comply with new requirements as long as these conflicts have not been resolved.

Based on this principle, when a legal norm or other regulatory act or the norms of different pieces oflegislation or different regulations allow for ambiguous or multiple interpretations of the rights andresponsibilities of business entities or government agencies, allowing for a decision to be taken in favorof both the business entity and the government agency, then the decision shall be made in favor of thebusiness entity.

This means the Pension Fund, the Social Welfare Fund (temporary incapacity to work), theUnemployment Fund (loss of work), and Workers Compensation Fund (loss of work through onthe

job accidents).

Reforming the tax and social contributions systems

Further improvements in quality will have to be connected to eliminating reasons otherthan high mandatory contributions that cause problems in the business environment:

tax breaks that lead to an uneven distribution of tax pressure and reduces opportunitiesfor reducing tax rates across the board;

ineffective Budget allocation policy, which leads to unrationalized use of governmentfunds, limits the opportunities to reduce tax pressure, and fails to stimulate government

officials to support business, especially at the local level; inconsistent and unsystematic regulation of the tax system, which makes it opaque,

increases business risk, and raises the unproductive costs of doing business;

passing on the burden for the states social function to business, and ineffective management in this area.


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Unfortunately, the reduction of mandatorycontribution rates is not accompanied bythe elimination of the deeper reasons forexisting problems. Moreover, this resourceis fairly limited, that is, reducing mandatorypayments, since it has to ultimately ensure at

least a minimal level of government expenditures. Thus, it is important to look forother options to reforming the system of taxand social contributions.

In order to resolve the issue of lowering taxpressure, the state also needs to keep inmind the need to collect enough revenuesin the Budget to adequately finance all itsexpenditures. In the first phase of reducingtax rates, the main source of compensation

of Budget losses has to be the legitimizationof the shadow economy and the resultingexpansion of the tax base as a result of growing reported revenues among commercialentities. But this resource is also limited. Tofurther reduce tax rates will require usingproactive measures to increase the countrysfinancial options. Among such steps, onetakes priority:

. Reviewing and reducing taxbreaks

The system of tax breaks means that the burden of paying taxes is not evenly distributedacross all businesses. Most existing taxbreaks are groundless, economically ineffective, and only satisfy specific interests amonginfluential business groups. These holidaysneed to be immediately eliminated.

In some instances, tax breaks can bereplaced by direct, targeted subsidies.

Eliminating tax breaks will make it possibleto increase revenues to the Budget and atthe same time set up a reserve that will eventually allow tax rates to be further reduced.

In addition to lowering tax pressure on business, the pressure of having to pay into

Social Funds also needs to be altered byredistributing the social burden amongthree groups: business, the state and individual citizens. This has to be done in such away so that, on one hand, social spending isfully covered and, on the other, conditions

are established to increase business revenues and draw salaries out of the shadoweconomy, which will expand the base for collecting social payments.

The Ukrainian Government finances itssocial commitments through the social contributions of businesses. Another source offunding is the Budget itself. The simplestway to reduce the burden on businesses is toincrease the share of financing of social

spending that comes directly from theBudget. However, this step cannot be takenat the same time as tax reforms.

Thus, the current task facing the Government is to concentrate efforts on other,alternative options, among which key is:

. Consolidating Social Fundsto minimize unproductivecosts to business

A large portion of the funding that finds its way into the various Social Funds is spentnot on social benefits but on administeringthese funds. In addition, the complicatedbureaucratic system increases unproductivecosts for businesses (for reporting, accounting, paying fines and bribes, and so on).Consolidating all the Social Funds wouldmake it possible to:

firstly, reduce administrative costs in thebudgets of the Social Funds and thusincrease the level of actual social spending;

secondly, reduce the rates of contributions and thus lower pressure on businesses. The reduction in receipts frombusinesses would be partly compensat



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ed by a reduction in administrative overheads;

thirdly, indirectly reduce the pressure ofsocial payments on businesses by reducing their unproductive costs.

In terms of developing the business environment, the main purpose of reforming thesystem of public administration has to be tobuild a system of mutuality between government agencies and business that would:

minimize unproductive costs to businesses;

minimize the opportunities for government officials to look for rents, that is,

to use their office to satisfy personalinterests rather than the interests of business or Ukrainian society.

There are four criteria that the system ofgovernment administration should fully satisfy. Specifically, the system of public governance should adhere to these principles:

Efficiency, that is, to provide the necessary public services in the fastest and

best way, involving the minimum oftime and costs. This will allow businesses to more easily and less expensively

get their approvals, permits, licensesand so on.

Accessibility and transparency, that is,the mechanisms of government workshould be transparent and clearly defined. It will help to avoid corruption,make decisionmaking process moreaccountable and decisions more predictable.

Relegation, that is, the governmentshould perform only those functionsthat absolutely cannot be handled at alower level (regional/local government,NGOs, business). Government servicesshould be maximally oriented on theneeds of business.

Responsibility, that is, the governmentshould be answerable for any violationsof the law and for any damage that results

from its ineffective or illegal actions. Theresponsibility of government and business should be even (symmetrical).


Reforming the system of public administration

This primarily refers to costs related to obtaining government services such as licenses and permits,certification, registration and so on. And among these costs, of course, time has to be included, such as

how long it takes a company to go through a particular process.

Reforming the system of government administration should ensure that certain key obstacles in the business environment are removed:

lack of accountability on the part of the government;

unregulated procedural issues around the services that the government provides;

inadequate level of cooperation among business, the government and NGOs.


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Doing business means to undertake something at your own risk in order to earn a profit. That is why the owner who starts up a business or invests in one begins by assessing thepotential risks and benefits. In Ukrainetoday, the risk of losing control of assets isalltoooften greater than the profits that canbe made by investing in a business.

Establishing an effectiveextrajudicial system to protect

property rights

The main instrument to ensure an improvement in this situation with property rights isan effective extrajudical system. It is critical

Ensuring informationaltransparency and openness At this stage, the main instrument ofreforming public governance should beensuring informational transparency and

topenness. Informational openness on thepart of the Government means setting upconditions for business to have easy accessto the process of approving governmentdecisions, especially regulatory ones.

If this alternative is brought into play, business will be assured real access to information about the activities of governmentagencies, their right to interfere in theactivities of commercial entities, the form

that any kind of interference should take,and so on, as well as information aboutwhat kinds of decisions government bodiescan take, in what timeframe and in whatorder.

Moreover, informational openness is impossible unless the Government continuallyreports about its activities. The Government has to show the consequences of itsinterference and its effectiveness. To achieve

this stage, four steps are needed:

Introduce regulatory monitoring,assessing and reporting on the part ofgovernment bodies about their activitiesand plans. It is important to clearly determine who reports about what, when, andhow the Government and the communi

ty can make use of these reports. Freepublic access to this information needs tobe ensured, as well as the level and mechanisms of legal leverage in those situations when this condition is not met.

Establish and enshrine in law simplified procedures for providing government services and approving decisionsthat affect the business community.

Oblige government bodies to regularlydisseminate information about theirfunctions, rights and obligations, and therights and obligations of citizens and business. It also makes sense to obligate suchbodies to explain the procedures for pro viding public services and to ensure thenecessary financing.

Clearly assess the value of governmentservices, indicating the methods used to

calculate this, and ensure the dissemination of this information.


An example of such openness might be national bodies regulating the power sector and telecoms.The procedures for approving key decisions by these two bodies allow businesses the right to expresstheir positions, to present their arguments, and to suggest other options.

Here the issue is not only control of assets, but also the right to dispose or utilize assets in order toearn a profit. The problem today is not only a matter that owners are illegally (groundlessly) deprivedof their property, but that government bodies use their position to set obstacles that make it impossible

for business owners to effectively use their assets to earn those profits.

Protecting property rights


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to ensure the option of handling somekinds of disputes in the business community on a nonjudiciary basis, that is, directlyamong the disputing parties withoutrecourse to government institutions. This

requires effective procedures for arbitrating disputes outside the court system as wellas new institutions that would review business disputes.

The main advantage such a system has overthe judiciary is that decisions are taken morequickly and are less costly, especially interms of cash outlays. To achieve this goal,the government needs to:

Develop community institutions thatcan take on themselves some part ofdisputes that are currently undertaken

by state institutions. This means basicallya system of arbitration panels. However,key to their effective functioning is thattheir decisions must be binding.Another important task is to inform the

general public and businesses of the benefits of this form of dispute settlement.

Expand the system of administrativesuits (challenges to the decisions of government bodies) and pretrial settlements (disputes among commercialentities). Along with this, the objectivityof such mechanisms has to be very high, which means, among others, ensuringthat there is broader representation of

stakeholders (business, NGOs, and soon) in such dispute settlement commissions.


Thus, reducing the risk to owners is one of the main conditions that would make Ukraineseconomy more attractive to investors. Based on public opinion, four reasons appear tounderlie the lack of protection of property rights in Ukraine:

the absence of accountability on the part of the government and guaranteed rights forcommercial entities;

the ineffectiveness of the noncourt system in protecting property rights;

a flawed court system;

the lack of corporate culture in doing business and effective legislation in this area.


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The law on regulatory policy with regard tocommercial activities and subsidiary legislation clearly describe the instruments thatare intended to be used to institute regulatory policy. However, the law is not workingin full force today. Government bodies lackthe necessary resources, and they dontknowand sometimes dont want to knowhow to carry out its provisions.

The next steps to ensure that regulatory pol

icy is properly carried out include:

. Eliminating the possibilityof ignoring or not followingthe law

Firstly, this means that all existing regulations that contradict this law need to beautomatically declared void. This requiresa procedure for canceling an existing regu

lation administratively, that is, canceling thestate registration of the given act at theMinistry of Justice and sending it back to beimproved, as it has definite flaws.

In addition, it is necessary to introduce asimplified system for recognizing regulatoryacts as invalid through the courts. Violationsor the avoidance of mandatory proceduresrequired according to regulatory policyshould become sufficient grounds fordeclaring a regulatory act invalid.

At the same time, this option anticipatesdetermining the responsibility (fromadministrative to criminal) of governmentofficials who failed to ensure the fulfillmentof all mandatory procedures provided by theabove

improving the business climate in ukraine 2004

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