A Chicken And Egg Problem: How Can Ukrainians Have A Good Government If They Don’t Trust The Government?

What is a good government?

An essential feature of a good government for the economy is predictability because many decisions depend on what we think will happen in the future. For example, investment decisions are long term – especially if you think of investment into human capital as opposed to investment into physical capital. Constructing a plant is much faster than educating a person to become a good specialist. This means that the government should not suddenly change the rules of the game. 

Predictability also implies inclusiveness. In other words, the government should take into account the opinions and interests of many people. If we constantly ignore or exploit minorities, sooner or later we will have a revolution and social unrest. Most importantly, people (even the majority) will not feel that their government is fair, and fairness is an essential feature of good government policies.

Another feature of good governance is accountability that goes hand in hand with transparency and turnover of the ruling parties. These features are essential for limiting corruption and vested interests. If some party misbehaves, citizens should know it and there should be another party around to take over. The prospect of losing power is a very strong incentive for good behavior.

Perhaps most importantly, good governance is about trust. You cannot simply set a KPI for a government. The world is highly complex and you can’t write a contract for every contingency. But citizens should be sure that in an ever-changing environment the government will act in the best interest of its people. Without trust even the best government will not be effective. Think of COVID19 vaccination in Ukraine: although vaccines are widely available today, many people are reluctant to get a jab because they do not trust the government.

All of these features – accountability, predictability, transparency, trust and fairness – are intertwined and reinforce each other. 

However, in a society with low trust, like Ukraine, how does one move from a ‘bad equilibrium’ when tax evasion is high and the amount and quality of government services is low to a ‘good equilibrium’ when everyone pays taxes and gets good quality government services? 

In some sense, this is a chicken and egg problem but obviously someone should make the first step. This cannot be one person who will honestly pay taxes – from a private perspective, it is irrational and will not change things. I see several viable alternatives. First, someone can show leadership. For example, a new president or a new party will show that it is honest with a personal example. Then the leader will have the moral right to demand honesty from everyone else. I think this was one reason behind the high support of ‘Servant of People’ party – many people hoped that “new” politicians would “reboot” the state. It is abundantly clear that Ukrainian society has this need for a new social contract. However, it turned out that ‘Servant of People’ was a more complicated story. Although it is not illegal, having offshore companies was a bad idea for Zelenskiy as it undermines trust and moral right to ask other people to contribute a fair share to the society and specifically pay taxes in full.

Second, one can encourage decentralization so that more local leaders can demonstrate commitment to good governance. Indeed, since the beginning of time, people have always voted with their feet. If one government is not treating people well, people migrate to another place with a better government. We see it most clearly with DNR/LNR: a lot of people (up to ⅔ by some estimates) leave or have left these gray areas to have a better life and future for themselves and their children. You also see how people migrate from Ukraine to other countries in search of better options.    

This brings me to the third alternative. One could also have an external incentive for development of a new social arrangement. For example, consider the Eastern Europe after the collapse of the Soviet Union. The EU accession accompanied by large subsidies was a big stimulus to overcome distrust and start building a good government. I think Ukraine definitely has a chance to enter the EU some day, but we need not only count on the EU help. We should also offer to the EU some value, solution to some of its problems. For example, now people are worried about food insecurity because of global warming. Ukraine could become a solution to this problem for the EU. Another competitive advantage is Ukraine’s IT industry where the EU lags behind the US and China. Ukraine can offer unique experience in cyber security and fighting cyber wars. There should be other things on the table. 

Is there an alternative to the European future of Ukraine?

Ukrainians have made their choice for the EU. As I said, people vote with their feet. More people try to find a job in the EU than, for example, in Russia or CIS countries. The young Ukrainians try to get their education in Europe and not in Russia. The choice is clear. In fact, it is so clear that the migration to EU countries is a major concern for the Ukrainian economy. We have to move fast to get Ukraine closer to the EU in terms of rules and institutions to slow down this outmigration. We should be doing this not because we want to please the EU but because we want to improve lives for millions of Ukrainians.   

More generally, the EU accession is a hard but achievable goal. There were times when no one would believe that Romania or Bulgaria or parts of former Yugoslavia would join the EU. But now it is the reality. Some EU countries, such as Hungary, express “Euro skepticism”. However, I am a ‘Euro optimist’. I think the EU has a bright future, and when the new EU members overcome their Soviet legacy, they will be a part of this bright future.

The slowdown of China is making headlines. Is this a problem for Ukraine?

We have a big uncertainty about further developments in China and some historical lessons are useful here. One can remember that until the early 1990s Japan was growing very fast – everyone was thinking that it would outgrow the US. However, after its housing bubble burst, it fell into stagnation for 30 years. The recession in Japan did not have a large impact on the global economy. But it allowed China to emerge as a leader of the developing world. A stagnation in China may trigger the emergence of another leader – India could be a good candidate.

We should not however underestimate the role of the Communist Party in China. It may well solve today’s problem with the housing crisis. However, in the long run, if the party continues to dominate the market, they will lead the country to stagnation, similar to the USSR. When the extensive growth exhausts, i.e. when there are no more people willing to move from villages to cities to work in the manufacturing, China will stagnate unless it switches to intensive development. And the Party very much limits the stimuli for intensive development.

Today China is Ukraine’s largest trading partner. How will a possible crisis there impact Ukraine? Again, there is a useful lesson in history. The USSR was the largest trading partner for Finland, a well-functioning democracy. Finland supplied nuclear icebreakers and other specialized equipment to the Soviet Union. So when the USSR collapsed, Finland had the worst recession in a century because it was very hard for Finland to redirect its trade to other markets. Ukraine today is in a better situation: if China does not buy Ukraine’s grain or steel, it can be sold elsewhere. However, problems in China may cause a fall in commodity prices, which will negatively affect Ukraine. The Ukrainian government should recognize this challenge and make a country resilient to it. How to do this? 

There are several dimensions to this. First, we do not need one ‘commander in chief’ who decides what to do in every instance. Today, a “big idea” is to plant one billion trees. Tomorrow, it could be building large firms. Instead, we need institutions that take a long perspective and do not have to respond to daily impulses of politicians. For example, the NBU is responsible for price stability. It should employ people who understand the challenges for the country and are able to develop policies in response to these challenges. It should not depend on politicians so that the people in charge of macroeconomic policy are shielded from daily political polls. The exodus of professionals from the NBU is a big concern.  

Second, we need to build reserves. The government should develop a system that would be resilient to external shocks. For example, the IMF unconditional tranche of $2.7 billion received in August could be put into reserves and used in case there is a full-scale crisis in China. Having a program with the IMF is another line of defense as it gives us a credit line not only with the IMF but also with the global capital market. 

Third, Ukraine should focus on developing trade and other relations with the EU to have more friends there. Together with the EU, Ukraine would be able to more easily cope with challenges. It is not only an economic anchor in turbulent times, it is also a good investment in building a predictable, accountable, transparent and trusted government. In this sphere, the EU has been both leading by example and providing practical help to Ukraine. Whether Ukraine is genuinely willing to accept this help remains to be seen.