What kind of economy are we building?

Julia Svyridenko - First Vice Prime Minister of Ukraine and Minister of Economic Development and Trade of Ukraine

Source - https://www.pravda.com.ua/columns/2022/07/8/7357131/

FRIDAY, JULY 08, 2022, 11:15 p.m

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The Recovery and Development Plan of Ukraine continues to be a key topic among the business community. But in order to correctly plan our way to the desired goal, we must give a clear answer to the question: what kind of economy are we building?

I'll start from the end. Our main task is to make a triple jump from a transitional economy ($4,000 per capita GDP per year) to a developing economy ($12,000 per capita GDP per year). And, most importantly, to get there in about 10 years, that is, in half a generation. In practice, this means the creation of a Ukrainian economic miracle - growth at the level of 7% of GDP annually over a long period of time.

Why is this important? Because only economic growth enables the state to fulfill its social mission - to create equal opportunities for development for all Ukrainians, to provide modern education, quality medicine, developed infrastructure and absolute security for citizens.

And where does economic growth come from? Of course, from economic freedom.

Economic freedom begins where the state ends. The example of the Soviet Union proves that the state and business are at opposite ends of the economic axis. A large state displaces business, makes it small, and vice versa: the smaller the state, the more the private sector occupies a larger part of the economy.

Achieving optimal size for the state

The first step to economic growth is to achieve optimal size for the state.

Who determines the optimal level? We find the answer in modern economic history: in the 20th century, states that redistributed no more than 20-25% of GDP through the budget "grew" the fastest.

GDP - gross domestic product - is the sum of all goods and services created by the economy per unit of time (calendar year). Accordingly, everything that the state collects in taxes and fees (and then spends) can be measured as a percentage of GDP. This is called the fiscal percentage of GDP. In Ukraine before the war, it was 40-45% throughout the years, in the USA - 25-30%, in China - generally only 10-11% during the years of frantic economic growth.

It is a scientifically proven fact: the lower the fiscal percentage of GDP, the higher the economic growth.

I believe that, despite the war, already from January 1, 2023, we should reduce the fiscal percentage of GDP in Ukraine from 45% to 30%, and then, within 10 years, confidently move towards its further reduction and reach 20% in 2032.

I will say to all supporters of Marxism-Leninism: a reduction in the size of the state inevitably generates growth. Therefore, not surprisingly, lower tax rates ultimately lead to higher government revenues.

To achieve the optimal size of the state, we must start with a liberal tax reform, adopt a liberal labor code (we have already introduced some of its elements during the war), and also carry out a major reform of social benefits based on a single digital register.

Economic diversification through small and medium-sized businesses

The second step is economic diversification through small and medium-sized businesses.

The Soviet legacy for Ukraine is industrial giants, each of which employed tens of thousands of people. But during the war, these companies were the most vulnerable. They are easier to target with missiles, aerial bombs and targeted strikes. The ‘Ilyich’ Mariupol Metallurgical Plant, "Azovstal", Avdiivka Coke Plant, Kremenchug Oil Refinery, "Antonov" - these names are heard in the news along with reports of destruction due to the war.

What is the alternative? An economic structure where the main contribution to GDP is made by small and medium-sized businesses (SMEs). Poland, the Czech Republic, the United Kingdom, and the United States are following this path.

In poor countries, the contribution of SMEs to GDP is 18-20% (30-35% of all employed in the economy). And in wealthy countries, SMEs account for more than 60% of GDP and more than 70-75% of all employment.

What do we have in Ukraine? In our country, too, the contribution of SMEs to the economy is more than 50%. But, firstly, it is mostly due to "creeping" deindustrialization during 30 years of independence. Secondly, almost all of this volume is made up of medium-sized enterprises. Microenterprises account for only 6-7% of GDP, and small enterprises account for 17-19% of GDP.

What is needed from the state for mass development of entrepreneurship? The next six steps are about this.

Free regulatory environment

The third step is a free regulatory environment.

In order for Ukraine to become a real place of economic opportunities, we must carry out a further revolution in the collective consciousness regarding the role of the state.

For 70 years, we lived under totalitarianism, where the state had a monopoly on entrepreneurship. Business was possible only if it was allowed by officials. But this contradicts the entire history of our civilizational development.

Free people in our lands are used to working, earning a living by their own labor. So let's abandon the practice of total permits, licenses, and approvals.

We offer a philosophy of the Free Steppe, when an entrepreneur can do everything that does not violate the freedom of other people and does not endanger society.

The government launched a large-scale deregulation even in wartime conditions. We have converted more than 500 permit procedures into a declarative principle - the entrepreneur simply states that he meets all the existing requirements and can start working.

In fact, we should move on and continue liberalizing. The current law provides for only 5 types of permit documents, but in reality there are 14 of them. We should cancel most of these permits and licenses as such. To return common sense to the relationship between the state and business. Unfortunately, most of these licenses and permits do not fulfill their main role - they do not make people's lives in Ukraine safer and more secure.

For most enterprises, a choice can be made - continue to endure the visits of fire inspectors and State Labor inspectors, or replace them with appropriate insurance and work with the control services of private insurance companies. Under capitalism, the most serious responsibility is money.

Rule of Law

The fourth step is the rule of law.

Job security in the country has two components: external and internal. External security is provided by the Armed Forces, we bow to them for the opportunity to live and work in Ukraine. And this is the public consensus.

We must do everything to ensure that the same consensus is reached regarding the Ukrainian judicial and law enforcement system as soon as possible. So that entrepreneurs believe in the possibility of honestly protecting their rights.

What can we do? In the long term, the continuation of judicial reform and reform of law enforcement agencies.

From June 24, we have a powerful reference point - EU membership requirements.

In fact, the status of a candidate for EU membership means a lot for Ukraine: we no longer need to invent a Ukrainian model of the work of courts and law enforcement agencies - we can take the European model and implement it without hesitation. Not everyone likes it, but our European future is impossible without it.

There is another, shorter way - to use Kazakhstan's experience and allow Ukrainian entrepreneurs to use British law in relations between themselves and the state of Ukraine. This requires changes to the Constitution, but they are worth it. Opponents of investments in Ukraine will have one less valid argument, and we will also give more confidence to businesses that already work here. The British are our friends and, I think, would be happy to help us.

Export-led growth model

The fifth step is the export-led growth model.

Before the war, exports accounted for 35% of GDP. It can be increased further - up to approximately 50%. But our exports have one big drawback - 75% are raw materials. It's a pity, but for a number of more developed countries, we are a raw material appendage. We sell them wheat at $350 per ton, and they sell us iPhones at the same price, but for just one of them.

It is up to us to change this trend, develop industrial processing and change the shares so that they are exactly the opposite of what exists now: to for 75% of our exports to be finished products and services and only 25% of our exports to be raw materials.

I will add a couple more figures: Ukraine and Canada exported approximately the same number of tons of agricultural products in 2020 - 74-75 million tons each. However, exports from Canada were worth 55 billion US dollars, and from Ukraine - only 22 billion US dollars, or 2.5 times less.

Blocking sea ports inevitably pushes us to reduce the physical volume of exports. However, we have a chance not to lose in money or even to gain - it is to export processed products.

For example, if only one ton of any cargo can cross the border, then a ton of iron ore will give us 150-200 US dollars in revenue, a ton of metal from this ore - 1.8-2 thousand US dollars, and a ton of machine-building equipment from the same metal – 10-12 thousand US dollars.

There is only one way for the mass development of industrial processing - intensive capital investments.

Intensive capital investment in industry

The sixth step is intensive capital investment in industry.

There are several theories of economic growth. The most contemporary – the modernist theory. Its author is Harvard economist Robert Solow. He received the Nobel Prize for this work.

The beauty of the Solow model lies in its simplicity. He proved that economic growth has 3 components: the amount of capital, the amount of labor and the general factor of productivity (the level of technology, innovation and the quality of governance).

For economies with low fixed asset accumulation, capital is crucial. This is absolutely logical. To increase the volume of production, more modern equipment is needed.

Since the 2000s, the annual level of capital investment in Ukraine has been 11-20% of GDP. In China at the time of its tremendous growth - 50% of GDP. For the jump, Ukraine must maintain capital investment at the level of 35% of GDP for at least 5 consecutive years. In terms of money, this is 70-80 billion dollars every year.

Traditionally, there are three sources of capital investment: domestic funds of national enterprises, loans and foreign direct investment. Domestic funds and loans mainly ensured the capital investments that Ukraine had in the past. Therefore, it is almost impossible to accomplish this task without direct foreign investment. Moreover, we need investment now, without waiting for the end of the war, but it is held back by military and political risks.

We offer two solutions.

The first is an increase in lending by Ukrainian banks on the basis of state guarantees. We are preparing a decision to provide Ukrainian state guarantees to destroyed enterprises to attract bank loans for reconstruction. This will give a maximum effect. The people, experience, and sales skills are already here – restore production facilities, and you can get to work.

The second solution is state guarantees by the G7 countries and the EU for investments in Ukraine.

For example, French companies could receive French state guarantees against military and political risk for opening enterprises in Ukraine. Partners for French investors could be Ukrainian companies with a 20-25% stake, providing local coordination. The guarantees must cover military and political risk (the French government pays the investor compensation in case of loss of the asset). For its part, if the French government is forced to pay money under the guarantee, it gets a first priority right to offset this payment with assets confiscated from the Russian Federation.

Our team took this proposal regarding state guarantees to the conference in Lugano. We agreed with the EBRD and the International Finance Corporation to jointly develop a specific mechanism and open negotiations with partner governments.

Our ambitious goal is state guarantees to the amount of 0.2% of the GDP of each G7 and EU country over 5 years, which is roughly $100 billion annually. In fact, this is the main idea of the economic part of the Marshall Plan for Ukraine, which was proposed by the Ministry of Economy.

Development of land logistics to Europe

The seventh step is the development of land logistics to Europe.

We need to create export logistics capacity - approximately 200 million tons by road and rail transport.

Before the war, Ukraine exported 170 million tons of goods, of which 117 million tons were shipped by sea. Obviously, the ports are now blocked and an alternative is needed. But given our strategic focus on export-led growth, the new logistics capacity will boost trade with the EU even after the ports open, once we win Russia's war against us.

Financing of such projects along the Ukrainian border was agreed upon in Lugano with leading international financial institutions.

For every open economy, the price of logistics is of great importance. Before the war, Ukrainian enterprises paid an average of up to 1 euro per kilometer for road transport to Europe. The price has now doubled due to shocking demand.

Increasing the capacity of border and customs control points, the speed of customs procedures, and the supply of means of transport reduces the price of transportation. Accordingly, these are our priorities.

The government is negotiating with our European neighbors about new checkpoints and a greater number of customs officials on their side (on the Ukrainian side, we have reached the maximum possible speed, so the only limitation is the passage of motor vehicles and wagons by our European partners).

Reducing the size of the state in the economy through mass privatization

The eighth step is the further reduction of the size of the state in the economy through mass privatization.

Ukraine still owns 3,500 state-owned enterprises. Moreover, more than 1,800 of them have not been active for years. Another part worked more or less normally before the war, but now they have significant difficulties.

The transfer of state-owned enterprises to private ownership through privatization is another impetus for economic growth.

Each object is a potential site for creating new production capacity or preserving what exists (if there is something to save).

It is quite difficult to hope that the state will be able to independently overcome the problems of these enterprises. A private owner has more flexibility and can ensure the necessary speed of decision-making and their implementation, which is the most important thing in these conditions.

In the end, we should end up with a small number of large, powerful state-owned enterprises that are either monopolies (such as the Ukrainian Seaports Administration, which owns the ports, Ukrzaliznytsia, which controls rail transport), or perform a social function (such as Ukrposhta, which delivers pensions in all corners of Ukraine).

Development of the social sphere through public-private partnership

The ninth step is the development of the social sphere through public-private partnership.

The state will continue to manage tens of thousands of objects of the social sphere - for example, educational and medical institutions.

Considering the extent of the destruction of social infrastructure objects as a result of the war, their restoration at the expense of the state may take a long time. PPP is a much faster method.

Under the terms of a public-private partnership, the private partner receives state or communal property in an "as is" condition, carries out repairs and modernizes the object at its own expense, uses it for its intended purpose to return its investment, and then hands the object back in high condition to the state.

Despite the significant improvement of legislation in the field of PPP in recent years, the number of objects actually transferred under PPP conditions to private partners is insignificant. One of the reasons is the very long term of project preparation, according to the existing law - up to 2 years.

In view of the war going on in our territory, it is necessary to move very quickly. Corresponding changes to the Law on PPPs have already been prepared, and a qualitatively new draft of the law has been registered in the Verkhovna Rada. I think it will be approved soon.

Our colleagues from the Office of the President, the Ministry of Regions and regional administrations are already creating an electronic catalog of objects in need of restoration - it will serve as a kind of source of proposals for investors to participate in PPPs.

Military-tech and military technologies

The tenth step is an innovative breakthrough thanks to military-tech and military technologies.

We must admit that we do not yet know the date of the end of the war. We all hope for victory as soon as possible, but the enemy does not slow down and continues to attack us. Therefore, it is possible that the security situation in Ukraine will resemble Israel's for some time. Therefore, for self-defense, we should borrow the Israeli experience in the development of military technologies and military startups.

Israel has the highest level of R&D (Research and Development) spending in the world – 4.5% of GDP. And it is precisely such venture investments that are the key to its strength.

Small in size, Israel has become the #1 military power in the Middle East. Its success factors, in addition to investments in R&D, include a bet on private defense companies that work in close cooperation with state defense giants, the transfer of defense technologies from powerful foreign partners, and a bet on dual-purpose goods that can also be exported.

We can do all this in Ukraine. After all, it is obvious that the main task of our defense-industrial complex is to provide us with sufficiently powerful weapons.

Results

Let's summarize. The war is the greatest grief that has befallen Ukraine in recent decades. But our future depends only on ourselves. The heroism of the Armed Forces of Ukraine gives us an opportunity to think about the future. What will it be like?

I see Ukraine as a fast and flexible entrepreneurial economy, which is preparing to make a major leap in all its recent history. A jump from a country with a transitional economy to a country with a developing economy (from 4 thousand to 12 thousand dollars in GDP per capita).

We call this a triple jump. Why? The first jump is to the optimal size of the state (from 45% to 30% of GDP). The second leap is to rapid entrepreneurial development based on SMEs. The third jump is to capital investments (from 15-20% to 35% of GDP for at least 5 years).

This triple jump can provide us with growth of at least 7% of GDP annually for 10 years.

At first, this is easy to do due to the low base of the current year. But everything will depend on how much we push away from our status quo. However, if it succeeds, then the whole world will recognize that a new economic miracle has happened in Ukraine. And then economic growth will spiral upward. And no one can stop it.

In recent weeks, our new motto: "Bravery" has appeared all over the world. So let's find the courage to take that leap!