CASE UkraineCASE Ukraine

www.case-ukraine.kiev.ua

Driving Forces for the Driving Forces for the UnUnwanted Reforms: wanted Reforms: Can the rent seekers curb the rent seeking?Can the rent seekers curb the rent seeking?

Vladimir DubrovskiyVladimir Dubrovskiyjoint work with joint work with Janusz SzyrmerJanusz Szyrmer, and , and William Graves IIIWilliam Graves III

as a part of the country study within the Global Research Project of as a part of the country study within the Global Research Project of Understanding Reforms Understanding Reforms

arranged and funded by GDNarranged and funded by GDNwww.gdnet.orgwww.gdnet.org

Prepared for the Ronald Coase Institute's Workshop in Institutional Analysis

Barcelona, Spain, September 2005amended with use of the comments and feedback from faculty and participants

The The case of UKRAINEcase of UKRAINE

“Standard” approach: “mandated” reforms, based on the political support of a resulting political force

CASE Ukraine

Reforms in transition

There may be a “bad” There may be a “bad” equilibrium, in which equilibrium, in which prevailing rent-seeking prevailing rent-seeking becomes self-supportingbecomes self-supporting

Sonin (2003), Hoff and Stiglitz (2002, Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and Savvateev 2004), Polishchuk and Savvateev (2002); (2002);

Initial (naïve) approach: benevolent government SHOULD pursue the reforms

How to minimize the cost of reforms?

How to get a political support for the reforms (make them popular)?

A state “captured” with rent-A state “captured” with rent-seeking vested interests is seeking vested interests is not supposed to complete the not supposed to complete the reforms at allreforms at all

Hellman (1998), Hellman, Jones, Hellman (1998), Hellman, Jones, and Kaufmann (2000)and Kaufmann (2000)

A majority was always against privatization of the large enterprises, and so were their directors that dominated in politics those times

Monetary stabilization was started without any mandate and continued despite the political defeat of its initiators.

Paternalism towards the enterprises was contracted despite the growing public sentiment in its support, and against vested interests of all major players

CASE Ukraine

Understanding reforms in Ukraine

No program of reforms has ever got a public mandate

and often even against the dominating vested interests

The major reforms were undertaken irrelevant to the position of the population,

Collective actions were rare and unimportant

The reforms (passive or reactive) occurred nonetheless the state was “captured”, and the rent seeking dominated

Stylized facts:Stylized facts:

CASE Ukraine

The model-based analytical narrative

Going to explain:

Why did the reforms (particularly the ones of Why did the reforms (particularly the ones of 2000-2001) NEVERTHELESS happen?2000-2001) NEVERTHELESS happen?

Why did not these reforms happen earlier?Why did not these reforms happen earlier?

How did they eventually lead to the How did they eventually lead to the Orange Orange Revolution?Revolution?

How a rent-seeking society can How a rent-seeking society can transform itself?transform itself?

UKRAINEUKRAINE

CASE Ukraine

Tornell (1998): a “reform from within”, when the rent seekers themselves restrain the rent seeking, can occur under the threat of a crisis, if such a reform is a “second best” for at least one of the interest groups.

Escaping from a “capture” trap

Requires a collective action at least within this interest group

HistoricallyHistorically was was notnot the case in Ukraine the case in Ukraine

CASE Ukraine

Dixit, Grossman, and Helpman (1997):

a government can have sufficient political choice, if:

•The pool of rent is fixed

•A norm for sharing of the rent between principals and agent is uniform and strictly defined (e.g. by a competitive market)

Escaping from a “capture” trap

•It is a common agent of many diverse lobbyists acting as principals

Olson (1980); Olson and McGuire (1997):

a rational encompassing rent seeking ruler (or group) has vested interest in efficient institutions, hence curbing the rent seeking

CASE Ukraine

Main questions:

Why, despite theseWhy, despite these convincing convincing reasons, the reasons, the rent-seeking societies existrent-seeking societies exist at all at all??

Why and how they finally Why and how they finally transform themselves?transform themselves?

CASE Ukraine

•Explaining in which way the evolution of societal norms and Explaining in which way the evolution of societal norms and technologies eventually can break a “bad” equilibrium, thus technologies eventually can break a “bad” equilibrium, thus

•drive a country out of the “capture trap” drive a country out of the “capture trap”

•through altering the balance between rent seeking and through altering the balance between rent seeking and profit-seeking activities. profit-seeking activities.

•The rent seeking requires control and coordination to The rent seeking requires control and coordination to prevent from “the tragedy of the commons”prevent from “the tragedy of the commons”

•Increase in transaction costs of control and coordination Increase in transaction costs of control and coordination brought about by technological and societal evolution brought about by technological and societal evolution eventually drives the contraction in rent seeking – regardless eventually drives the contraction in rent seeking – regardless to the special interests!to the special interests!

Our contribution:

Main ideas:

In many cases players fail to establish the efficient institutions.

CASE Ukraine

Rent seeking vs. profit seeking

Profit seekingCreation of the value voluntary apprised by competitive market

Appropriation of already existing value, e.g. created by others

A positive-sum game (“cooking a pie”) increases the public wealth

A zero- or negative-sum game (“cutting a pie”) usually decreases the public wealth

Rent seeking

Players can establish certain efficient institutions, primarily, the property rights by a voluntary agreement

A coercive force is required to arrange appropriation while preventing the overappropriation

Rent seeking requires FORCED coordination and Rent seeking requires FORCED coordination and control that can only be arranged by control that can only be arranged by

AUTHORITARIAN POWERAUTHORITARIAN POWER

Sonin (2003), Hoff and Stiglitz (2002, 2004), Polishchuk and

Savvateev (2002):

Departures from Dixit, Grossman, and Helpman (1997):

CASE Ukraine

•Multi-agent instead of multi-principal

Abilities of extracting the rent from it’s source

Coercive forceClients

Abilities of extracting the rent from it’s sourceCoercive forceArbiter

• Pool of rent: no more fixed, but a common resource vulnerable to overappropriation

•Proportion of rent sharing is subject to bargaining

State budget, renewable natural resources, poorly controlled state-owned enterprises, monopoly rent

A model of the rent-seeking society of Ukraine

playerclient Rent source

CASE Ukraine

player

playerplayer

Arbiter-clients model: how it works

Authoritarian arbiter

Distributes the quotas for rent appropriation arbitrarily,arbitrarily, and enforces

them in order to restrain the devastating competition

client

clientclient

… … but instead extorts the rent himself, or trades it for loyaltybut instead extorts the rent himself, or trades it for loyalty

Rent source

CASE Ukraine

An arbiter:CASE Ukraine

Has an incentive to extract the rent (share the players’ rents)

Looks as “captured” with vested interests

Asymmetry: The players can motivate their arbiter with a “carrot”, but not threaten to him irresponsibility

players are clients of their arbiter

In effect, “owns” a source of rent

Interested in using his discretionary power for further weakening the clients’ residual rights of control

Arbiters and clients form a hierarchy

Crowds out and suppresses any other ways of preventing the overappropriation

Rent-maximizing

Power-maximizing totalitarian

authoritarian, plutocraticArbiters: Arbiters:

≡≡

Profit seeking (competitive) sector

Rent seeking sector

Monopoly rent

CASE Ukraine

player player

playerplayer

InIncrease in the social wealth

DeDecrease in the social wealth

Effects of authoritarian rule

Paternalism (clietnelism) and corruptionPaternalism (clietnelism) and corruption

Firms earn their incomes mostly as rents depending primarily on the arbiter’s discretion

client

client client

client

Technology Technology

SOCIETAL NORMSSOCIETAL NORMS

CASE Ukraine

The rent seeking The rent seeking proliferatesproliferates

EQUILIBRIUMEQUILIBRIUM

Profit-seeking sectorRent-seeking sector

A residual remains!

Marginal rent

Marginal cost of control and

coordination

Rent seeking Rent seeking CONTRACTS!CONTRACTS!

MORE EFFICIENT

Similarly to Ronald Coase’s theory of

Similarly to Ronald Coase’s theory of

a firma firm

Problem of an authoritarian arbiter

Systemic Systemic reformreform

A long-term

process

preceding to

reforms

CRISIS

UNSUSTAINABLE!UNSUSTAINABLE!

CASE Ukraine

TOTALTOTAL cost of control and

coordination

Problem of a totalitarian arbiter

Profit-seeking sectorRent-seeking sector

SMALLER residual

TOTALitarian arbiter

TOTAL rent

Technology Technology

SOCIETAL NORMSSOCIETAL NORMS

EQUILIBRIUMEQUILIBRIUM

Profit-seeking sectorRent-seeking sector

Technology Technology

SOCIETAL NORMSSOCIETAL NORMS

CASE Ukraine

REVOLUTION?REVOLUTION?

Rent-seeking sector

Profit-seeking sector

“Standard” approach applies

Transition from a rent-seeking society: Evolution and REvolution?

Politically responsible government

CASE Ukraine

In the case of Ukraine:

Totalitarian power based on societal norms determined by Communist ideology have been eroding during several decades after Stalin’s death

The systemic crisis hit in the end of 1980th, because the whole system of control and coordination became unaffordable and crashed

Adjustments were done by authoritarian arbiter (President Kuchma) in two main waves of reforms (1995-96 and 2000-2001), each brought about by a crisis

As a result, the rent-seeking sector has been contracted so much that made the Orange Revolution possible (???)

CASE Ukraine

Implications Only valid in a long run!Only valid in a long run!

Testable hypotheses:

•Long-term reversals in modernization should be rarely observable, unless induced by increase in the rent flows

•Reforms are often brought about by crises of overappropriation (Drazen and Easterly, 2001)

•As a result of Orange Revolution, the rent seeking sector should contract further

•The Orange Revolution was mostly driven by the interest groups representing the profit-seeking sector•Political support of Kuchma/Yanukovich stem mostly from the rent-seeking sector

•Democracy should be negatively correlated with rent seeking

UKRAINEUKRAINE

CASE Ukraine

Prescriptions:

Standard approach and respective policy prescriptions are productive when the profit sector already dominates and a politically responsible government is in place. Otherwise they can be counterproductive!

Before this moment, the aid strategy should be focused on educating of the population and stimulating of profit-seeking sector. Assistance in improving of control and coordination rather harms than helps.

In any case, abstain from providing the potentially rent seeking authoritarian and quasi-authoritarian regimes with rents, even for the sake of preventing of crises

Thanks for Thanks for your attention!your attention!