Strategies for enhancing the political sustainability of reform in Ukraine

31102 50 ESP Discussion Paper Series Strategies for Enhancing the Political Sustainability of Reform in Ukraine Carol Graham January 1995 Education and Social Policy Department Human Resources Development and Operations Policy The World Bank   Strategies for Enhancing the Political Sustainability of Reform in Ukraine' Stabilization and related macroeconomic reforms are usually implemented in contexts where economic crisis and political stalemate have become reinforcing factors. In addition to the adoption of appropriate macroeconomic policies, successful reform usually requires a strong political - and public - consensus in favor of change. This usually entails a regime change or election which brings in leadership capable of expending the political capital necessary to sustain reforms until they yield positive results. The development of consensus for change and of the necessary leadership to carry it out are far more likely if there is a relatively widespread public understanding of the extent and severity of the economic crisis, and of the high social costs of prolonging it. An additional factor determining the political viability of reform in the short term and its sustainability in the longer term is the manner in which reforms are presented and explained to the public. Good government communication and public relations, as well as an explicit government commitment to addressing the social costs of reforms, are critical elements of any strategy for enhancing political sustainability. Until recently, the political context in Ukraine was such that none of these factors were present, for a variety of reasons which include the novel and tenuous nature of democratic political institutions, weak leadership, and low public understanding of the causes of the economic crisis and of market economics more generally. The result was a damaging cycle of stop-and-go reform, which exacerbated the negative social welfare effects of the ongoing deterio- ration of the nation's economy. Yet the public - and most politicians - attributed these costs to "reform" rather than to unsustainable distortions in the economy and successive failures to implement coherent corrective measures. This is not surprising as Ukraine only became independent in 1991, and there was not the related rejection of Communism and state-led economics that occurred in several other countries in the region.2 Market-oriented reforms are understood and supported by a relatively small group of politicians and policymakers. Yet there are few places in the world where reform is more necessary and where the social costs associated with prolonged economic crisis are more evident: hyperinflation, electricity and fuel shortages, major erosion of living standards, and increasing poverty. Widespread public anxiety about declining social welfare, and the association of these trends with reform rather than with the failure to implement it, provides a political platform for the opponents of reform ' I would like to thank Alan Angell, Jeanine Braithwaite, Tom Hoopengardner, and Oey Meesook for helpful comments. 2 Indeed, Ukraine and Belarus stand out as unique among former Communist countries in that public opinion surveys show that a majority look more favorably at the old Soviet regime than at the present system. In all other countries surveyed, while Communism was the dominant political experience for most of the public, and there was public anxiety about the uncertainties under transition regimes, the majority clearly rejected a return to the previous system. For detail see Richard Rose and Christian Haerpfer, 'Mass Response to Transformation in Post-Communist Societies', Europe-Asia Studies, Vol.46, No.1, 1994, pp.3-28.  -2 - as well as for more extreme political positions.3 A coherent central level commitment to reform only recently emerged. Elections for president were held in July 1994, and in October the new President, Leonid Kuchma, announced a comprehensive package to stabilize hyperinflation and begin a process of market-oriented structural reforms, a program which has the support of the IMF and World Bank. The nation seems on the point of departure to significant change. The prospects for sustained implementation of the necessary reforms, however, remain uncertain at best. The political obstacles to implementing reform are the subject of the first section of this note; the second section draws from international experience and suggests strategies for making reform more politically sustainable. Due to the high political salience of social welfare issues, they are a particular focus. A central theme throughout is that educating the public about the need for and the benefits of reform in general and of the social welfare system in particular will be critical to the political sustainability of reform. A related theme is the need for a visible safety net program. The existing social assistance and insurance systems are ill-equipped to cope with the challenges posed by a decline of living standards of the order of those of recent years, much less with the additional transitional costs that sustained structural reforms would entail. The current reforms include targeting and increasing allowances to the most vulnerable groups. This is technically correct from poverty alleviation and budgetary perspectives, but the political perspective requires convincing the public and the Parliament that a reduction in social welfare benefits for the majority are necessary in order to protect the needy. Many politicians are already warning that the lack of a comprehensive social safety net will lead to social unrest. Cross-country experience suggests that visible government efforts (in the form of safety net programs) which demonstrate concern for the social costs of reforms can generate important public support for the government - if not for reform per se - at a critical political time (this is discussed in detail below).4 Given the particularly critical political moment for reform in Ukraine, a more visible safety net program could play a major role. There is a host of international experience in this arena, and the final section of this note details some examples which could be useful for policymakers in Ukraine. 3 Indeed, Ukraine's economic performance since independence is often compared to that of its neighbors at war, such as Georgia, Armenia, and Azerbaijan. For detail see Marek Dabrowski, 'The Ukrainian Way to Hyperinflation', Communist Economies and Econornic Transformation, Vol.6, No.2, 1994. For detail on wage and GDP trnds, see The Ukrainian Challenge: Reforming Labour Market and Social Policy (Kiev: International Labour Organization and United Nations, 1994). ' For detail in several different country contexts, see C. Graham, Safety Nets. Politics, and the Poor: Transitions to Market Economies (Washington, D.C.: Brookings, 1994).  -3. Overcoming Political Obstacles to Reform in Ukraine: A Point of Departure? Kuchma's package was hardly the first attempt to reform Ukraine's economy. Kuchma himself served as prime minister during the most serious but still unsuccessful prior attempt at reform, from October 1992 to September 1993. Yet this package of reforms may have greater chances of success than previous attempts, due to its association with a new govemment committed to reform, and to the manner in which it was presented to the public. President Kuchma presented the package to the Parliament in a powerful public address, in which he stressed the absence of an alternative to rapid and far-reaching reform, and the high costs of the stop-and-go approach to reform. The President stressed that he was not just introducing economic policy measures, but indeed a new economic ideology, and several times noted the importance of individuals providing for themselves. He also stressed the need to build consensus in society on reform, and to solicit the participation of unions and business organizations in the policy dialogue. He was straightforward in saying the process would entail difficult and unpopular measures, and at the same time called for safety net programs to protect the poorest and most vulnerable groups, who he correctly identified as families with large numbers of children, non-working pensioners, and invalids.5 His speech was comparable to many of those given by strong leaders that have implemented successful reforms in other countries. In addition, shortly after the presentation of the reforms, Kuchma issued an additional strong signal about reform with his appointment of a committed reformer, Victor Pynzenyk, as Deputy Prime Minister for Economics. Pyzenyk is a committed reformer, and had served as Deputy Prime Minister in the previous Kuchma-led effort at reform.' Yet the political obstacles to implementing sustainable reform in Ukraine remain more formidable than in most countries. The first set of obstacles stems from the novel nature of political institutions and democratic government. Not only are politicians inexperienced with democratic politics, but the lines of authority between the different branches of government are not clear cut, most critically between the executive and the legislature. The second set stems from the very low level of public understanding of the causes and longterm implications of the economic crisis, and of market economics more generally. Political Institutions The unstable nature of political institutions in Ukraine results from their novelty, from the unclear lines of authority between the executive and the legislature, and from the ethnic and regional divisions that they reflect. Central level political institutions are less than four years old, and there was no real tradition of democratic government prior to their introduction. As in most 5 "Ukraine: Good Intentions", The Economist, 15 October 1994, p.44. 6 He resigned from that post in protest of the conservative's stalling of reform shortly before Kuchmna resigned as Prime Minister. Intelnews, Kiev, 1 November 1994.  -4 - formerly Communist countries, most people's dominant political experience has been authoritarian regime.7 In Ukraine the difficulties of the transition were exacerbated by its physical and administrative proximity to Russia: not only were decisions made in Moscow, but so were the most attractive public sector career options were also located there, resulting in significant human capital flight. Secondly, the division of power between executive and legislature is unclear, and there is no established line of authority between them. The Kuchma government is proposing to reform the constitution to strengthen the executive vis-a-vis the legislature, which is bound to meet substantial opposition from the Parliament. The proposal is likely to be submitted to a popular referendum. The outcome will be critical to the fate of reform, but is as yet impossible to predict. Finally, there are ethnic and regional differences which were the root of substantial divisions even prior to independence. The east of the country is largely of Polish origin and ties, while the west has much closer links to Russia and favors stronger formal ties. There are also strong regional secession movements, such as in the Crimea, which make the formulation and implementation of central level political decisions even more difficult. All of these factors pose significant obstacles to the implementation of government policy, and in large part explain the failure to implement sustained reform prior to the Kuchma government's ongoing effort. The subordination of macroeconomic policy to the political whims of an inexperienced and fragmented Parliament is at the root of the current economic crisis, and has led to uncontrolled monetary expansion and a huge budget deficit.' While there have been sporadic attempts at tight monetary policy by the semi-independent central bank, the NBU,9 these attempts have been insufficient to contain inflation in the face of a spiralling fiscal deficit. And given the role of parliament and unions in channeling resources to enterprises, the ability of the NBU to carry out a coherent policy is limited. In addition, a tendency to blame external events rather than internal distortions contributed to a de facto devolution of responsibility for fiscal policy by the Ukrainian authorities. There is no doubt that Ukraine's poor economic record is in part due to extemal shocks, and in particular to its high level of dependence on trade with and subsidies from Russia at a time that the Russian economy also experienced a severe decline. Yet inadequate domestic policy response to external shocks severely exacerbated their negative effects. In Poland in contrast, advanced liberalization and tight monetary policy helped to mitigate the effects of CMEA shock on GDP and on the balance of payments. Given the uncertain nature of the country's political institutions and the lack of policy coordination between them, it is not surprising that there has been a strong correlation between 9 Rose and Haerpfer (1994).