A short mythological guide to Ukrainian economic animals (02/20/94)

A short mythological guide to Ukrainian economic animals

by Dr. Oleh Havrylyshyn

CONCLUSION

Equal conditions: making an aquarium from fish soup

The previous article suggested that today one might not have equal conditions for private and state enterprises, because the latter begin the competition with a much bigger amount of, and access to, resources. The starting situation is therefore no more equal than would be a race between a bicycle and a Volga. What then could be done to equalize the conditions? How can we achieve the apparently impossible as stated in the well-known "perestroika" metaphor, that it is easy to make fish soup from an aquarium, but much more difficult to make an aquarium from fish soup?

Let's consider the case of privatizing land now in collective farms. Let's do it scientifically (po nautsi), asking how we got to this position in the first place. In other words, how did the aquarium of private lands become the fish soup of kolhosp farms? If we remember a little bit of history, we will remember that this was not achieved by declaring "equal conditions for all forms of ownership," followed by a large voluntary move by farmers into collective groups. And one suspects it would not have been achieved by such statements because the initial starting point in 1929 favored private ownership very strongly and to achieve collectivization it was necessary for government to take three compensating measures:

prohibit land ownership beyond a small size;
undertake a massive propaganda effort on the nature of collective farming;
send down from Moscow to every rural region of the USSR a brigade of "collectivizers" to, shall we say, "help" farmers collectivize.

Is it possible one could simply reverse the process today? This might comprise the following:

pass a law making full ownership possible (not just 100-year leases);
undertake a massive propaganda effort on the nature of private farming;
send from Kyyiv ("Slava Bohu" not Moscow) down to every rural region brigades of "privatizers" to "help" kolhosp directors distribute the land to individuals or groups that desire this.

A valid counter-argument to this proposal may be that today we should not use the unfair methods of the Stalinist Communist program of collectivization. Undoubtedly it would be wrong to use force to drive individuals into private farming, or to remove in advance kolhosp directors simply on the argument that under private farming they are not needed. The reverse measures proposed are intended to create equal conditions for the free choice by individuals.

As long as laws on land ownership restrict the right to resell the land, and provide only lifetime lease rights, potential farmers are not sure what the long-term intentions of the government are, and fear the possibility of forceful recollectivization in the future. The signal to people on the land must be clear: the government gives you and your heirs full assured control of your land. Only when we have this situation will it be possible to judge whether people do or do not wish to be private farmers. This signal would be given by the first two measures: laws on ownership of land and propaganda of government in assistance to potential farmers.

The third measure proposed - creating special groups of "privatizers" to implement land-distribution requests - is also simply a measure to create presently non-existent equal conditions. Kolhosp directors are not to be faulted for being only human like the rest of us. It is unfair to ask them to rise above this state and behave against what they understand as their own interests, their accumulated perceptions and values. They, too, of course, are members of the collective and must be given the same full rights to become private owners of farming land.

Exchange rate measures temperature of economy

It is widely accepted in Ukraine and outside that the large devaluation of the karbovanets (the rate to the dollar rose from 1,000 in January 1993 to more than 30,000 in December 1993) is a reflection of the general deterioration in the economic conditions of Ukraine and of Ukrainians. But there is a lot of confusion and misunderstanding about the causes and cures for this deterioration. No analogy is perfect, but a useful analogy in this case may be the temperature of a sick person: the higher the rate for a dollar, the sicker the economy.

The present illness of the economic body of Ukraine consists of several diseases at the same time: declining productivity of the labor force, declining production in both industry and agriculture, the shock of high energy prices, and of course hyperinflation. Any of these by itself would be enough to cause some rise in the temperature, that is a decline in the value of the karbovanets. When several diseases are simultaneously affecting the body it is of course not easy to determine how much of the rise in temperature is caused by each one. But a few generalities are possible.

It is often said our inflation is imported from Russia. During 1992, until the karbovanets became the legal currency of operations for all transactions - cash plus non-cash - it was still possible to argue Ukraine could not have an inflation rate lower than Russia's. But for this past year, this argument is not possible.

It is correct that substantial increases in prices of petroleum imports caused some of the inflation in 1993. But how much? At the start of 1993 these prices were, in dollar equivalents, about 20 percent of world prices, and by the end of the year they have reached 80 percent approximately, or four times higher in real terms. Even if energy-intensity in Ukraine is three times higher than in Western economies (and the typical expert's assessment is about two times), this means energy accounts for 20 percent of value of production. A fourfold increase in price of energy (400 percent) should mean a direct increase of final prices of about 80 percent - let s say 100 percent. Indirect effects exist, of course, but each round of such effects should be much less than the previous one if no other inflation factors exist. Therefore, at the maximum one could accept that energy prices would cause inflation of perhaps 200-300 percent, and a corresponding devaluation of the karbovanets of the same amount to a level of, say, 3,000 kbv/$1, or let's even say 5,000 kbv/$1.

In fact inflation was far higher than 300 percent (about 2,000 percent) and the exchange rate jumped over 30,000 kbv/$1, leaving a lot to explain. There remains only one explanation, which is not surprisingly the same as every historical episode of hyperinflation from Weimar Germany to corrupt Zaire: the policy of printing large amounts of paper called "money," in the form of karbovantsi to pay workers and credits to enterprises to buy from each other. There is no escaping the fact that the excessive issue of credit and money is the principal disease that has contributed to inflation and thereby to devaluation of the karbovanets.

But why did the "temperature" increase 30 times (from 1,000 to 30,000) if inflation increased "only" 20 times (2,000 percent inflation)? Because when inflation becomes so high, all confidence in the economy is lost, and everyone - including the factory-worker, the kiosk operator, the racketeer who "guards" kiosks, the new commercial capitalists - attempts to run away from the devaluating currency into things that store wealth safely. Goods are one possibility, so increased demand for these drives prices higher in a vicious circle. But as hyperinflation experiences in Bolivia, Israel, Brazil, etc. also show, the safest store of economic wealth is: dollars. Therefore, demand for dollars rises even faster than inflation and the temperature or exchange rate reaches unimaginable, crisis, levels.

Lowering the economy's temperature: a gift for the new year

Our previous article described the movement of the exchange rate (kbv/$1) as the "temperature" of an economy. It concluded by noting that growing inflation results in a lack of confidence, and as a consequence a flight from karbovantsi into dollars, which causes the exchange rate temperature to rise to unreal, crisis levels. There is, however, a paradox here, as one can speak of a rate that is at the same time "realistic but unreal."

An exchange rate of 30,000 kbv/$1 is very real in the sense that demand and supply for dollars are what they are, and no artificial administrative measure of government can much affect this, anymore than can a doctor lower a patient's 40 degree temperature by saying it is unrealistic and declaring it must fall to a more reasonable 38 degree. It is on the other hand correct to say such a rate is unreal and unreflective of the real state of the economy.

At 30,000 kbv/$1, average wages in Ukraine for most people can buy only $10 to $20 in hard currency, an amount unimaginable for physical survival anywhere in the world. While people's consumption standards have no doubt fallen over the past two years, they are still consuming enough basic goods to survive. Indeed, if the goods people consumed were to be evaluated in dollar prices of world markets, the value of their consumption would be closer to $100 to 200 per month, not $10 to $20. An exchange rate of about 3,000 kbv/$1 would perhaps more realistically reflect the purchasing power of individuals in the economy. The question is how to get to the position of stability where the market exchange rate reflects the more reasonable underlying purchasing power exchange rate.

There is in this paradox of a "realistic but unreal" exchange rate a potential New Year's gift for Ukrainians, if the right economic policy measures are taken. As stated already, administrative "forcing" of the exchange rate will not change the underlying economic forces of people's demand for dollars, which reflects their lack of confidence. This lack of confidence comes primarily and in the immediate sense from hyperinflation and people's expectations that it will continue.

This vicious circle must be reversed and transformed into a virtuous circle. A sharp restriction of the cheap and large bank credits to various producers in the economy as well to government, by reducing the supply of the monetary mass, will quickly reduce the inflation spiral. The sooner this happens, and the more forcefully it happens, the sooner will people's expectations of inflation change, and confidence begin to be restored. With restored confidence, the urge to run to dollars will be reduced, and the exchange rate temperature can fall, or at least, as happened in the Baltic states and Poland, rise less quickly than inflation and wages. This, of course, means that wages calculated in dollars will begin to rise.

The experience of Poland and the Baltics shows that an effective inflation-stabilization policy of this kind means dollar-calculated wages increase four or five times within one year. Thus, in Poland, early 1990 average wages were about $20/month - by early 1991 they were over $80, and are now well over $100. In the Baltics, stabilization in 1993 gave similar results, with Estonia's average wages rising from about $15 to about $70 by the end of the year.

Even in Russia, some of this same effect is visible in the second half of 1993. Although inflation of about 20-25 percent per month was not very much reduced since credit emissions continued, these emissions did not grow more - as they did in Ukraine - hence the expected hyperinflation did not occur. This was enough of a surprise to Russian people to make them believe things would not get worse, and therefore the urge to buy dollars was calmed down. Consequently, the exchange rate of rubles moved up very little, staying around 1,000-1,200, while inflation of 15-25 percent per month raised wages to an average of about 80,000 rubles by year's end. In dollar terms wages therefore rose from about $20 to $25 in January 1992 to about $70 to $80 by December 1993.

Is it possible a similar policy of stabilization of credits in Ukraine could achieve a similar reduction in inflation? This would be a nice New Year's gift for a courageous Ukrainian government to give its people in 1994.

Dr. Oleh Havrylyshyn is alternate executive director of the International Monetary Fund and represents Ukraine's interests on the IMF board of directors. The views expressed here are those of the author and do not necessarily reflect the position of the IMF or Ukrainian authorities.

| Home Page |