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Contents Preface iii Figures vii Summary ix Barriers to Trade and Foreign Direct Investment in Ukraine ix Recommendations for Improving the Climate for Trade and FDI in Ukraine xi Acknowledgments xv 1. Introduction 1 Missed Opportunities 2 Organization of the Report 5 Research Approach 5 2. Foreign Trade, FDI, and the Ukrainian Economy 6 Ukrainian Economic Growth: The Record 6 Ukraine's Foreign Trade 9 Foreign Direct Investment in Ukraine 13 3. Barriers to Trade and Foreign Direct Investment in Ukraine 16 Corruption 16 Barriers to Trade 18 Barriers to Foreign Direct Investment 22 4. Recommendations for Improving the Climate for Trade and FDI in Ukraine 28 Reducing Corruption 28 Fostering Trade 29 Attracting Foreign Direct Investment 32 Setting Priorities and Sequencing 35 Figures Figure 1 -- Ukraine's GDP 1989-2007 6 Figure 2 -- Per Capita GDP in 2006 for Selected Former Soviet Republics at Market and Purchasing Power Parity Exchange Rates 8 Figure 3 -- Ukrainian Exports: 1994-2006 10 Figure 4 -- Ukrainian Exports by Region or Country in 2006 11 Figure 5 -- Ukraine's Imports by Region and Country in 2006 11 Figure 6 -- Ukraine's Trade with the United States: 1996-2006 12 Figure 7 -- Cumulative FDI in Ukraine and Hungary 13 Figure 8 - Cumulative Foreign Direct Investment in Ukraine by Country of Origin in 2006 14 Figure 9 -- Foreign Direct Investment in Ukraine from 2001 to 2006 by Country of Origin 15 Summary Ukrainian governments have found it singularly difficult to implement policies to liberalize trade and improve the climate for foreign direct investment (FDI), ostensibly economic policy priorities. Trade and FDI have contributed heavily to economic growth and increases in standards of living throughout the world, especially in Central Europe. In contrast to Central Europe, Ukrainian governments have been slow to open Ukraine's borders to trade and have had difficulty in attracting sizeable inflows of FDI. Ukraine has suffered economically for this failure: Ukrainian standards of living are currently far below those in Central Europe, Russia, and Kazakhstan. Barriers to Trade and Foreign Direct Investment in Ukraine Corruption Corruption, petty and grand, constitutes the single greatest barrier to expanding trade and investment in Ukraine. Grand corruption involves high-level officials with discretionary authority over government policy, the sale of government assets, or large government contracts. Petty corruption involves lower-level officials who make decisions about enforcing regulations (or not). Foreign businesses complain most vociferously about Ukrainian regulatory and legal hurdles designed to elicit bribes. As in most countries afflicted by corruption, Ukrainian government employees deliberately design licensing and registration procedures to be so complex that they may credibly threaten to halt or slow trade or a foreign investment in hopes of eliciting a bribe. As a consequence, the time and expense of obtaining the requisite permits and licenses to trade or set up and open a business add substantially to costs, reducing both trade and investment. Rigged privatizations also impede foreign investment. Ukraine's contradictory laws and corrupt judges discourage investment as businesses find it hard to enforce contracts. Barriers to Trade The most immediate problem facing Ukraine is that it is not yet a member of the World Trade Organization (WTO) despite support from all major political parties for this step. Because it is not yet a member, Ukrainian firms face discriminatory treatment in most of their export markets. Exporters and importers in Ukraine confront arbitrary changes in domestic policies, as the Ukrainian government is unconstrained by treaty obligations. The most severe impediment to exports in Ukraine is the corruption embedded in the system for providing rebates to exporters for value-added tax (VAT). Government employees encourage companies seeking VAT refunds to hire local law firms or consulting companies that charge a "fee" of 25 to 30 percent of the refund to expedite reimbursements. If the designated firms are hired and paid, VAT is reimbursed promptly. Companies that do not make these payments wait 3 to 18 months; smaller companies sometimes receive no refunds at all. Ukraine's complex, corrupt system of certifying imports imposes the greatest barrier to importers. Accepted international practice recognizes products that have been certified by accredited bodies in partner states as acceptable in the importing country. In Ukraine, products that are subject to mandatory certification--a very long list--have to be recertified, substantially increasing costs to importers. Nothing has served to undermine Ukraine's reputation as a responsible trading partner more than the embargoes imposed on grain exports in 2006 and 2007. The embargoes were instigated by Ukrainian commercial interests tied to the government. They hoped to benefit from obtaining and reselling export quotas to legitimate grain exporters, pocketing substantial sums. This policy resulted in the loss of upwards of $200 million by the larger grain exporters. It will have a lasting, depressing effect on the incomes of Ukrainian farmers, as international grain trading companies now shun the Ukrainian market because of the risks of export embargoes and quotas. Barriers to Foreign Direct Investment Potential investors in Ukraine find it very difficult to obtain satisfactory sites. Potential investors are unable to build distribution centers and factories because they cannot obtain land. Retailers and restaurateurs complain that municipal governments sell or lease all the best commercial sites to favored individuals. Problems in obtaining titles, construction permits, and operating permits add to costs and complexity. A number of provisions in the 2004 Commercial (or Economic) Code contradict existing provisions in the more market-oriented Civil Code. Businesses find that some activities are mandated by one code, while violating provisions of the other. Some Ukrainian businesses exploit these legal discrepancies to select those laws they find preferable for their current operations. If disputes arise, they choose courts that favor their choice of applicable law or judges who are willing to be bribed to do so. Because of deficiencies in the laws pertaining to joint stock companies, shareholders lack key rights of ownership. Majority shareholders can use the legal system and a friendly court to issue new shares and steal assets. Minority shareholders ("raiders") have used current laws to deprive majority shareholders of their rights and in a few instances of control of their company. In contrast to Central Europe, Ukrainian governments have not extensively used privatization to attract foreign capital and business expertise to Ukraine. With the exception of a very few transparent sales of major assets, privatization has usually resulted in the acquisition of formerly state-owned enterprises by Ukrainian businessmen or foreign companies controlled by Ukrainians. In most instances, Ukrainian businessmen have effectively excluded foreign investors by usurping the privatization process. Current laws and policies, although ostensibly designed to make it possible for foreigners to invest in Ukraine's energy sector, effectively discourage most potential investors. Those companies that have invested in Ukraine's energy sector have had difficulties with Ukrainian regulators. Some decisions have been in violation of the law or based on extraordinarily narrow interpretations of regulations. Recommendations for Improving the Climate for Trade and FDI in Ukraine The Ukrainian government should adopt a two-pronged strategy to remove the worst of these impediments to trade and investment. The first prong should focus on making a few, highly visible policy changes that promise results within one hundred days. The second prong should set in motion changes in Ukraine's institutions necessary to reduce corruption and other impediments to trade and investment, which would take longer to bear fruit. Below, we provide several recommendations that if adopted would reduce the most egregious barriers. We have classified them according to whether they would bring results within 100 days or longer. Corruption Within the next 100 days, the Ukrainian government should reduce opportunities for government employees to manipulate the regulatory system to solicit bribes in the following ways: - Set up a network of regional boards to which businesses and citizens can appeal administrative decisions. The boards should be composed of civil servants, businessmen, and citizens. They should have the authority to stay decisions taken by lower level civil servants until reviewed by higher level administrators or administrative courts. All meetings should be open to the public. - Give Inspector Generals the authority to immediately put government employees facing credible accusations of soliciting bribes on administrative leave and then quickly bring cases to court for resolution. - Reprimand or dismiss supervisors whose employees have been convicted of corruption. Fostering Trade Joining the WTO is the most important near-term step that the Ukrainian government can take to spur trade. If bilateral negotiations fail to resolve issues with current WTO members that threaten to block entry, the Ukrainian government should turn to the secretariat of the WTO, the United States government, or the European Commission to assist in resolving these issues. The Ukrainian government will need to maintain an inter-ministerial working group with the clout to prevent the issuance of laws or regulations that violate Ukraine's agreements with the WTO. The Ukrainian government should give the Department on Cooperation with the WTO full authority to ensure that Ukrainian legislation and regulations remain in compliance with the WTO. The Ukrainian government should promptly reimburse exporters for VAT payments. Regulations should be issued stipulating that VAT reimbursement requests be processed in accordance with the law (60 days). Supervisors should be penalized if these time periods fail to be observed. Ukraine should immediately accept all products that conform to EU standards. Once a product is certified by the EU, no further certification should be necessary in Ukraine. The Ukrainian government should immediately eliminate all remaining embargoes on grains. It should pass legislation conforming to WTO practices that strictly defines when export quotas on agricultural products may be imposed and how they will be allocated. Attracting Foreign Direct Investment The Ukrainian government should set legal limits on the ability of government employees to impede the establishment of businesses in Ukraine. It should: - Set fixed deadlines for action on permits. - Set a yearly limit on the total number of inspections to which a business is subject. - Ensure that initiatives for one-stop registrations and permits be operating by January 1, 2008. The Ukrainian government should also ensure that its decision to repeal the ban on agricultural land sales goes into effect on January 1, 2008. The Ukrainian government should immediately abolish the Commercial Code and appoint a task force to revise the Civil Code. The task force should be composed of representatives from the judiciary, government agencies, the legal profession, businesses, and consumer groups. It should provide draft legislation or regulations to fix problems in laws affecting Ukrainian businesses that are contradictory, poorly written, or lacking. It should also appoint a small team of senior government officials to spearhead efforts to make the necessary legislative changes. The Ukrainian government should replace its current privatization strategy with a new one geared towards the rapid, transparent privatization of almost all of the remaining commercial assets owned by the government. The government should draw up a revised list of companies to be privatized, including an accelerated time schedule for privatization. The government should establish clear procedures for issuing tenders for trade sales, permit all interested parties to bid, and publish the terms of all bids and the winning bid. The highest bid should win. To ensure adequate, competitive supplies of energy, the Ukrainian government should actively seek FDI in the energy sector. It should lengthen production-sharing agreements from the current 5 years to international standards of 10 to 20 years to encourage foreign investment in domestic production of oil and gas. The government should increase wholesale prices of Ukrainian natural gas to those of imported gas. It should also encourage foreign investors to participate in the construction and ownership of new gas or oil transit pipelines. Acknowledgments This report benefited greatly from the insights and suggestions of a large number of investors, managers, government officials, and analysts both in Ukraine and outside the country. We would likely to express our deep appreciation for the assistance of the following individuals: Dr. Irina Akimova, Bureau of Economic and Social Technologies; Dr. Anders Aslund, Peterson Institute of International Economics; Edward Chow, Center for Strategic and International Studies (CSIS); Dr. Elisabetta Falcetti, European Bank for Reconstruction and Development; Alexander Gorodetsky, Interpipe Corporation; Mark Iwashko, Western NIS Enterprise Fund; Gary Litman, Vice President, Europe and Eurasia, U.S. Chamber of Commerce; Douglas Kramer, Economic Counselor, U.S. Embassy in Ukraine; Jock Mendoza-Wilson, System Capital Management; Lidiya Melnyk, Deputy Director, Ministry of Economy of Ukraine; former U.S. Ambassador to Ukraine William Miller; Lauri Molnar, Office of the United States Trade Representative; Pavel Moyseychenko, Ministry of Economy of Ukraine; Olga Oliker, RAND Corporation; Ambassador Steven Pifer, Center for Strategic and International Studies; Andrea Raffaseder, Siemens Ukraine; Andreas Rickmers, Cargill; Dr. Farooq Siddiqui, International Steel and Tube Industries; Ihor Shevliakov, International Centre for Policy Studies; Ambassador William Taylor, U.S. Embassy in Ukraine; Serheii Teriokhin; Member of the Verkovna Rada; Morgan Williams, Sigma-Bleyzer; Ihor Petrovich Zahlada, Director, Ukrainian Center for Promotion of Foreign Investment; Svetlana Petrivna Zaitseva, Ministry of Economy of Ukraine; and Jorge Zukoski, American Chamber of Commerce in Ukraine.
Library of Congress Subject Headings for this publication:
Ukraine -- Commerce.
Investments, Foreign -- Ukraine.
Ukraine -- Commerce -- United States.
United States -- Commerce -- Ukraine.
Investments, American -- Ukraine.