«Public distrust in Ukraine is a catastrophe», – the interview with Roman Sheremeta

“Ukraine 139” is a project of VoxUkraine and LB.ua, in which we conduct interviews with the best Ukrainian economists. The purpose of this project is to find out the real and deep problems of the Ukrainian economy and understand what needs to be done to remedy the situation. Today’s guest is the best young economist in the world, according to the IDEAS rating, Roman Sheremeta, assistant professor of economics at the University of Management School of Wooderhead at the University of Keys Western Reserve (USA) and researcher at the Institute of Economic Science. With Roman we discussed what a modern experimental economy is and how it “pushes” to good things, how to raise the level of trust in society, how to start big privatization, how to weaken the influence of the oligarchs and what simple steps can accelerate the Ukrainian economy.

– According to the influential RePec ranking, you’re the most successful young economists in the world. And the good news doesn’t stop there. Yuriy Gorodnichenko, another Ukrainian economist, had topped this ranking before you. This is an encouraging trend – we already have a galaxy of world-class professional economists of Ukrainian origin. However, Yuriy Gorodnichenko, the head of our supervisory board, is engaged in applied macroeconomics, which looks like a very complicated math. And you are into experimental economics, without any formulas.

– That’s true, I stay on the microeconomic level. Yuriy is into all things macro, I’m into all things micro. However, even on the microeconomic level there’s a lot of math, formulas, and equations.

– Can you explain in one paragraph what does experimental economics mean?

– Experimental economics is a method of studying economic processes in the lab. Economic experiments can be conducted in computer centres, at universities, within companies, etc. The idea is to conduct experiments involving real people. As a rule, we have hypotheses based on economic theory. And we conduct these experiments by randomizing people into different treatments and tasks: we assign people to different treatments that are designed to test a theory.

– Tell us about the more specific things: where and how can we use it? For example, there’s a famous case involving your colleague Vernon Smith, who used experimental economics to create a model of privatization of energy sector in Australia and New Zealand. Is experimental economics used at such a level now?

– Today’s experiments are as vast as ever. Microeconomic experiments are even conducted at the macro level. The expression “The world is our lab” has become literal. For example, when you’re using Uber, you’re most likely taking part in an experiment conducted by our colleague John List, Uber’s Chief Economist. The World Bank tests a new approach to aid in Africa – it funds many projects under various conditions, analyzes what worked, and then scales these results to an entire industry, country, or continent under the same conditions.

– Does experimental economics research prove the economic theory, or is it rather contrary to the theory?

– It depends. That’s the point of the experimental method – you can test fundamental economic theories such as the competitive market model. According to the economic theory, market equilibrium occurs at the intersection of the demand and supply curve. And it’s just unbelievable how fast many people find this equilibrium in such experiments. But when it comes to trust, in real life people trust each other more than the economic theory suggests. Also, according to the economic theory and calculations, social cooperation should not happen, but then we conduct experiments and see that people actually cooperate.

– Trust as a topic is very important for Ukraine, where the level of trust is very low. In your lectures you said you would like to conduct an experiment to further explore this issue and find ways to improve the situation. What might speed up the restoration of truth in the society?

– Public distrust of Ukrainians is a catastrophe. Here’s a good example: the public trust in the government is so low that opposition has always been winning in Ukraine (except for the 1999 election). While in the US, if I’m not mistaken, 16 of the 42 presidents have served a second term.

I’ll give you an example of an experiment we conducted with Vernon Smith four years ago. We created a model of a complex financial market with a high degree of uncertainty, asymmetric information, etc. Person 1 provided Person 2 with funds, and in turn, Person 2 could provide funds to Person 3. There were incentives to give the money, but there was also a risk because the participants didn’t know who would use their funds and how. And then we gradually made the market more transparent and more predictable. And the more transparent the market became, the more trust the players had. When we completely lifted the curtain, we had the highest level of trust and the highest rate of efficiency of such a market.

Public distrust of Ukrainians is a catastrophe. Here’s a good example: the public trust in the government is so low that opposition has always been winning in Ukraine (except for the 1999 election). While in the US, if I’m not mistaken, 16 of the 42 presidents have served a second term.

This is a reason why it’s better to make all transactions as open as possible. In the US, anyone can have access to information on how public funds are used: all budgets are transparent.

– If openness of information is a way to raise trust, I feel quite optimistic. In the world rankings, Ukraine has made the biggest progress on the openness of data, budgets, and government.

– Indeed, this is a mechanism that will help raise trust. Of course, it’s not the only one, and other such mechanisms must be studied and translated into practice.

– And what kind of experiment could be conducted in Ukraine to find out more about trust and distrust?

– This type of work should be systemic. First, you should conduct a poll to understand why people don’t trust politicians. We find out some reasons and events that are important to people. We analyze these case studies. Then we carry out a large-scale poll to define factors of distrust in more detail. Then we conduct a targeted experiment. For example, we found out that in people’s opinion, the reason why they distrust their mayor is a lack of communication and meetings in person. So we arrange weekly meetings between the mayor and the people to see if their attitude changes, if their level of trust increases or not. And in such a way we analyze each reason. This is how you can carry out such experiments. People don’t really know what they want. They say: “We would like to meet with our mayor every week to raise our level of trust.” But when we conduct an experiment and let them meet every week, nothing changes. So it’s very important to carry out experiments, not only to conduct opinion polls.

– As you probably know, no Ukrainian politician of a national scale can boast a level of trust of even 20%. But if you take regional scale politicians, such as mayors of Lviv, Dnipro, or Kharkiv, people’s level of trust in them is just crazy – more than 50%, sometimes even 70-80%.

– And that is why we need a decentralization reform. It’s a way to raise trust locally. It would be easier to keep under control, hold in check, and re-elect those in power. That’s why certain elements of decentralization shall be implemented.

– We’ve already discussed that the findings of the experimental economics were used for privatization. In Ukraine, the story of privatization is a very long and sad one. Privatization was among the priorities of the current authorities when they came into office. During these four years, nothing big, nothing significant has been sold, and we’re unlikely to see a big sale before the next election. There are both objective and subjective reasons for this lack of privatization. In my opinion, the most important is that neither the majority of the population nor the authorities (for various reasons) really want to sell anything. How should we solve this problem?

– Privatization is a difficult topic for any country. Everyone has to work a lot on it. I would start with the society. We’ll be able to start this conversation only when the society is in favor of privatization and nudges the political forces into action. How can we do this? I understand the skepticism coming from the society. People have been screwed over more than once with privatization. First vouchers, then strategic investors – Akhmetov and Kolomoyskyi; in the end, the people were left with nothing. We need to convey the message that privatization will take place in the best interests of the common people.

First of all, everything must be transparent, open, and available to anyone for free. If necessary, shown on TV. Another good idea I’ve heard in Ukraine is to distribute the money from privatization directly to the people, to every Ukrainian. We split up the amount received from the sale of state property by 42 million and distribute it to each and every Ukrainian.

That is, to promote the idea of privatization, we need to show the people that there will be no more “scams”. We need to work out the mechanisms that can change people’s attitude and nudge them to make the right decision. I advise everyone to read the book of another Nobel Prize winner, “Nudge” by Richard Thaler.

People have been screwed over more than once with privatization. First vouchers, then strategic investors – Akhmetov and Kolomoyskyi; in the end, the people were left with nothing. We need to convey the message that privatization will take place in the best interests of the common people.

– While reading this book, I wished that bad politicians would never read it, because they can nudge people to do many wrong things. You mentioned oligarchs in context of privatization. However, the problem is much bigger: a classic example of the iron law of oligarchy. Various clans have “captured” entire branches of economy and squeezed out competitors; they thrive on rent, they buy politicians, regulators, and local authorities; politicians adjust their rules of the game so these oligarchs get even more rent and even less competition. In my opinion, development of Ukraine is impossible without undermining oligarchic groups. But how can we do it when they are so influential and have the power? Can game theory and experimental economics answer these questions?

– Such big issues, big problems are usually tackled by institutions. If we want positive changes and sustainable growth, we must create inclusive institutions, which will undermine the oligarchic system. But you asked the right question: how can we create these institutions to undermine the oligarchs when these oligarchs have the power? In fact, Ukraine is a perfect example: there’s no more rent for gas production, the banking sector is clear and transparent. We do see some changes taking place: Kolomoyskyi is allegedly scared to return to Ukraine. We need a critical amount of such nudges.

An important role is played by the “external Western players”: the IMF, the World Bank, the US, and in the case of Ukraine, the EU. They can exert pressure on the government to ensure implementation of the reforms.

– Let’s imagine you became the Prime Minister of Ukraine and you have a full support of the parliament. Which top five challenges of Ukrainian economics would you tackle first? Which reforms would you implement?

– I would start with setting up the anti-corruption court and speeding up judicial reform. I would make it simpler, more comprehensible to people. For example, people would be able to elect judges locally; I would introduce a trial by jury, which would be randomly selected using an algorithm. These are quite real things that can be done thanks to judicial reform.

We need major changes in our education system. My heart aches for this. There’s not a single Ukrainian university in the list of the top 800 universities in the world. By the way, there are 13 Russian universities listed there. That’s why a higher education reform is a matter of competitiveness and survival of our country. Now, we have 2,5 times more universities per capita than in the UK, and the British education system is one of the world’s best. We need to sharply raise the bar and close down low-quality higher educational establishments. It would be nice if we switched to paid education, and if scholarships were granted to the smartest students who cannot afford the education.

Ukraine needs a radical change of its pension system. The current one is a disaster, 30% of the adult population are retired. In the US, where this number is 15%, and there are six employees per one retiree, there’s not enough money for a state pension. So how can Ukraine afford it?

Of course, it’s necessary to develop capital markets, to set up stock exchanges. People hide their money under their mattress and keep their business offshore instead of investing these money into the economy. These are the first simple steps to cure the economy.

Ukraine needs a radical change of its pension system. The current one is a disaster, 30% of the adult population are retired. In the US, where this number is 15%, and there are six employees per one retiree, there’s not enough money for a state pension. So how can Ukraine afford it?

– I don’t think they are easy. Recently I saw a stats that really surprised me. In Ukraine, 22 million people receive some kind of social assistance for more than UAH 870 billion – this is one third of all revenues. Let’s be frank: Ukrainian society is quite paternalistic. In an interview, you said that Ukrainians should change their mentality. How will we change it?

– Yesterday I was on Radio NV with Pavlo Sheremeta, and there was one particular thing that struck me. The callers who reached us by phone live on air had a Soviet mentality (not everyone, though): “decadence of capitalism”, “we will set American dollars on fire”, “It’s none of my business”. And who is to blame for everything? The state!

– I want to stand up for Radio NV. They started several months ago, and before that, a very “Soviet” radio had been broadcasted on their wave. But you’re right, calls to Radio NV are a window into the real Ukraine, which is not very progressive. We must face up to reality: a very large part of Ukrainians lean toward left-wing sentiments, they are disappointed with market reforms. There’s a demand for a strong political figure. So here’s the question: can we admit that at this stage of development Ukraine isn’t capable of building an effective democracy, and we should really look for a hetman leader with great powers?

– I’m an optimist, so I believe we’ll manage to get through this populist cycle. This challenge isn’t purely Ukrainian: similar sentiments exist in the US, in Italy, and in the UK (Brexit).

However, I don’t believe that we need a hardliner who will come and change everything. The risks are too high. Moreover, historically Ukrainians have always been against one-man rule, we’ve got this spirit of rebellion. Historically, the Hetmanate fought for its freedom against the kings and tsars, so why shall we need a tsar in the 21st century? Did we oust Yanukovych just to look for a hardliner? Ukrainians don’t need a hardliner, they need proper institutions and a well-functioning economy – and everything will be OK.

– It’s quite uncommon for Ukraine to be in the mainstream with the US in terms of economic policy. However, these days protectionist ideas are gaining momentum in Ukraine and in the US. What’s your opinion towards ideas such as import tariffs or “Buy Ukrainian”?

– My opinion is based on scientific research, which shows a pattern that protectionism, as a rule, plays against the end user. That is, in the case of the “Buy Ukrainian” draft law, Ukrainian consumers will definitely suffer. Moreover, it contributes to the rise of corruption. And I don’t quite understand what other preferences Ukrainian producers need. They are protected now, we have rather high tariffs on a range of goods, such as cars. My Lexus RX 350 costs $40,000 in the US. Here, it would cost me $70,000-80,000. Do you really need more protection?

Moreover, labor is much cheaper in Ukraine. For someone who produces goods, especially for export, the labor is quite cheap. I don’t have to compete with Italy or France for salaries, where they are N times higher. We have natural elements of protectionism in our economy. So protecting national manufacturers from competition is a very bad and harmful idea.

Many studies show that the Great Depression in America in the 1930s was caused not by the English, but by the American protectionism.

I don’t have to compete with Italy or France for salaries, where they are N times higher. We have natural elements of protectionism in our economy. So protecting national manufacturers from competition is a very bad and harmful idea.

– Let’s get back to the economic science. Tell us a few words about your latest job, where you’ve been studying the correlation between a person’s status and charitable behavior.

– In the US, charity funds from individuals and corporations make a huge part of funding for schools and universities. We’ve been studying how to get more money from them. It was a field experiment. At the first stage, parents who came to pick up their children at the kindergarten were given envelopes with the following words written on them: “Would you like to donate to the Red Cross? By the way, we will write down the amount you give at a board”. People donated $3-5 on average.

We offered the same thing to another group of parents, and we said we would write down their names next to the amount of money they donated. People love recognition, so they donated more: on average, $6 instead of $5. This is a well-known effect – educational institutions have long been named after their largest donors.

The next step was to say to a new group of parents that the board would list only the top 3 largest donors. Now they could let themselves go. Everyone wanted to make it to the top 3, so they donated $7,5 instead of $5.

But it turned out there was another very effective design. We said that only the names of those people who had donated the least amount of money would be written on the board. A so-called “group of shame”. And it worked best. We understand that in real life it won’t always work. For example, if I decide to donate to Vox Ukraine and I know that I can get into such a “group of shame”, it’s unlikely Vox will get anything from me at all.

Long story short, when recognising our donors, we should differentiate them. It’s worth saying, for example, that we have golden and silver donors – it will encourage patronship. Behavioral experiments show us which system works better.