CASE Ukraine

1
Prepared for the Ronald Coase Institute's
Workshop in Institutional Analysis Barcelona,
Spain, September 2005 amended with use of the
comments and feedback from faculty and
participants
Driving Forces for the Unwanted Reforms Can the
rent seekers curb the rent seeking?
The case of UKRAINE
Vladimir Dubrovskiy
joint work with Janusz Szyrmer, and William
Graves III as a part of the country study within
the Global Research Project of Understanding
Reforms arranged and funded by GDN www.gdnet.org
CASE Ukraine www.case-ukraine.kiev.u
a
2
Reforms in transition
Initial (naïve) approach benevolent government
SHOULD pursue the reforms
How to minimize the cost of reforms?
Standard approach mandated reforms, based on
the political support of a resulting political
force
How to get a political support for the reforms
(make them popular)?
There may be a bad equilibrium, in which
prevailing rent-seeking becomes
self-supporting Sonin (2003), Hoff and Stiglitz
(2002, 2004), Polishchuk and Savvateev (2002)
A state captured with rent-seeking vested
interests is not supposed to complete the reforms
at all Hellman (1998), Hellman, Jones, and
Kaufmann (2000)
3
Understanding reforms in Ukraine
The reforms (passive or reactive) occurred
nonetheless the state was captured, and the
rent seeking dominated
Stylized facts
The major reforms were undertaken irrelevant to
the position of the population,
and often even against the dominating vested
interests
No program of reforms has ever got a public
mandate
Collective actions were rare and unimportant
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
4
The model-based analytical narrative
Going to explain
How a rent-seeking society can transform itself?
UKRAINE
Why did the reforms (particularly the ones of
2000-2001) NEVERTHELESS happen?
Why did not these reforms happen earlier?
How did they eventually lead to the Orange
Revolution?
5
Escaping from a capture trap
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.
Requires a collective action at least within this
interest group
Historically was not the case in Ukraine
6
Escaping from a capture trap
Dixit, Grossman, and Helpman (1997) a
government can have sufficient political choice,
if

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

• 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)

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
7
Main questions
Why, despite these convincing reasons, the
rent-seeking societies exist at all?
Why and how they finally transform themselves?
8
Our contribution

• Explaining in which way the evolution of societal
  norms and technologies eventually can break a
  bad equilibrium, thus
• drive a country out of the capture trap
• through altering the balance between rent seeking
  and profit-seeking activities.

Main ideas

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

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

9
Rent seeking vs. profit seeking
Profit seeking
Rent seeking
Creation 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
Players can establish certain efficient
institutions, primarily, the property rights by a
voluntary agreement
In many cases players fail to establish the
efficient institutions.
Sonin (2003), Hoff and Stiglitz (2002, 2004),
Polishchuk and Savvateev (2002)
A coercive force is required to arrange
appropriation while preventing the
overappropriation
Rent seeking requires FORCED coordination and
control that can only be arranged by
AUTHORITARIAN POWER
10
A model of the rent-seeking society of Ukraine
Departures from Dixit, Grossman, and Helpman
(1997)

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

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

• Multi-agent instead of multi-principal

Abilities of extracting the rent from its source
Coercive force
Arbiter
Abilities of extracting the rent from its source
Coercive force
Clients

• Proportion of rent sharing is subject to
  bargaining

11
Arbiter-clients model how it works
Authoritarian arbiter
Distributes the quotas for rent appropriation
arbitrarily, and enforces them in order to
restrain the devastating competition
Rent source
Rent source
client
player
player
client
player
player
client
client
but instead extorts the rent himself, or trades
it for loyalty
12
An arbiter
Has an incentive to extract the rent (share the
players rents)
In effect, owns a source of rent
Looks as captured with vested interests
Crowds out and suppresses any other ways of
preventing the overappropriation
Asymmetry The players can motivate their arbiter
with a carrot, but not threaten to him ?
irresponsibility
players are clients of their arbiter
Interested in using his discretionary power for
further weakening the clients residual rights of
control
Rent-maximizing
authoritarian, plutocratic

Arbiters
Power-maximizing
totalitarian

Arbiters and clients form a hierarchy
13
Effects of authoritarian rule
Profit seeking (competitive) sector
Rent seeking sector
Monopoly rent
player
player
client
client
client
client
player
player
Increase in the social wealth
Decrease in the social wealth
Firms earn their incomes mostly as rents
depending primarily on the arbiters discretion
Paternalism (clietnelism) and corruption
14
Problem of an authoritarian arbiter
Rent seeking CONTRACTS!
Profit-seeking sector
Rent-seeking sector
Similarly to Ronald Coases theory of a firm
The rent seeking proliferates
Systemic reform
A residual remains!
MORE EFFICIENT
UNSUSTAINABLE!
EQUILIBRIUM
CRISIS
Marginal cost of control and coordination
Marginal rent
A long-term process preceding to reforms
Technology SOCIETAL NORMS
15
Problem of a totalitarian arbiter
TOTALitarian arbiter
Profit-seeking sector
Rent-seeking sector
SMALLER residual
TOTAL cost of control and coordination
TOTAL rent
Technology SOCIETAL NORMS
EQUILIBRIUM
16
Transition from a rent-seeking society
Evolution and REvolution?
Rent-seeking sector
Profit-seeking sector
Politically responsible government
REVOLUTION?
Profit-seeking sector
Rent-seeking sector
Technology SOCIETAL NORMS
Standard approach applies
17
In the case of Ukraine
Totalitarian power based on societal norms
determined by Communist ideology have been
eroding during several decades after Stalins
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 (???)
18
Implications
Only valid in a long run!
Testable hypotheses

• Democracy should be negatively correlated with
  rent seeking

• 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)

UKRAINE

• 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

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

19
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
20
Thanks for your attention!