Ownership of reforms

No reform is ever successful unless people take ownership of how they change a country. In contrast to the Orange Revolution of 2004, the Euromaidan mass movement led to a burst of civic activity aimed at making the government more accountable and influencing the course of Ukraine’s future. While the majority of Ukrainians do not have a strong sense of ownership of the reforms, there is a critical mass of engaged citizens to push the reform agenda. The massive injection of new blood into the government created conditions for some radical changes in the country. Given the war and more than 10,000 lives lost in Eastern Ukraine, society has been more mobilized than ever.

However, the shadow of the Soviet past and the strong oligarchic system in Ukraine made even this powerful force rather insufficient to overcome corruption, incompetence and vested interests. In terms of governance indicators, Ukraine's starting point was tremendously weaker than that of Poland in mid-1990s. In 2013, Ukraine still belonged to 30% of countries with the lowest government effectiveness and rule of law indicators, while Poland was twice better on them back in 1996 (Figure 1). Fortunately, the grassroot movements were empowered by financial, technical, and political assistance from the West.

Figure 1. Governance Indicators: Ukraine in 2013 vs. Poland in 1996* (percentile rank**)

Notes: * the earliest available; **Indicates rank of country among all countries in the world. 0 corresponds to lowest rank and 100 corresponds to highest rank. Source: Worldwide Governance Indicators

A combination of improved public ownership and international support enabled Ukraine to make a visible progress in economic reforms. Index for Monitoring Reforms (iMoRe), an indicator compiled by VoxUkraine based on surveys of economic professionals, suggests that regulatory environment was changing in the right direction, though at a relatively slow pace. We estimate that international partners’ conditionalities provided for 23% of the cumulative iMoRe score since Index inception in 2015 (Figure 2).

Below we describe six economic reforms, which were successful not only in terms of putting necessary legislation in place, but also in terms of their proper implementation. We also identify the areas, which were reformed insufficiently or not at all and thus hinder Ukraine’s economic growth both in the short-term and over longer-term horizon.

Figure 2. Index for Monitoring Reforms*

Note: *index is based on expert assessment of changes in the regulatory environment which can be considered as reforms or anti-reforms and can take values from -5 to +5; index values above 2.0 is considered as an acceptable pace of reforms. Source: VoxUkraine

Gas sector reform

Low energy efficiency of the economy and considerable dependence on Russian supplies of gas were among key challenges for Ukraine for many years before the Revolution of Dignity. The country’s gas sector reform is viewed as one of the main success stories.

The first major achievement in this area was diversion of gas supply away from Russia. Before 2013, Russia was the only major supplier to Ukraine. In 2016, all imported gas was bought on the European market through reverse flows (Figure 3).

Figure 3. Ukraine’s Gas Imports (bcm)

Source: National authorities

The second major step was sharp adjustment in domestic gas prices. The gap between high import prices of gas and low household utilities’ tariffs was so large that Naftogaz’s (an energy monopoly) deficit in 2014 reached 5.4% of GDP, exceeding the general government deficit. The government hiked domestic gas tariffs paid by households 6.6 times in three years, as the underlying price for gas as a commodity was increased 10 times to match import price (Figure 4), and adjusted heating tariffs accordingly. Simultaneously, eligibility criteria for direct utility subsidies for poor households were loosened. The drastic gas tariff hike, even after accounting for generous subsidies, substantially improved Ukraine’s fiscal position and made the gas sector a net contributor to the state budget. According to company’s estimates, Naftogaz required UAH 91bn support from the state budget in 2014, while contributing UAH 40bn already in 2016 (accounting for direct and indirect subsidies and taxes).

Figure 4. Imported Gas Price and Domestic Gas Tariffs* ($/tcm)

Note: *price of gas as a commodity, e.g. net of VAT, transportation and mark-up. Sources: IMF, Naftogaz Ukrainy

The third major change was improvement in corporate governance of Naftogaz, which for years was under control of politicians and vested interests. Following appointment of a professional management team to run the company in early 2014, in 2015 the government approved a gas sector reform plan, which among other things aimed at bringing corporate governance in line with OECD standards. The new model of corporate governance was developed by a panel of international experts commissioned by the EBRD. In April 2016, an independent supervisory board including three foreign professionals and two government representatives was appointed and got enough authority to effectively supervise the company. Corporate governance reform was endorsed by the EBRD, which supplied loans to Naftogaz essential for buying gas. The threat of losing the loan is supposed to be one of the reasons that the reform was pushed through despite opposition from vested interests.

However, these positive changes have stalled after the initial breakthrough. Three independent directors of the supervisory board announced in April 2017 that the Cabinet effectively blocked the corporate governance reform and hampered a solution of gas arrears’ crisis. One of the directors resigned from the board in August 2017 leaving it incapable to approve any decision. In late September 2017, two remaining independent Naftogaz supervisory board members resigned citing increased political meddling and lack of palpable changes in 2017 despite the assurances to the contrary by the authorities. In addition, the Cabinet of Ministers refused to implement its own resolution requiring further increase in domestic retail tariffs to keep them in line with the rising import prices.

This backtracking overshadows success in the gas sector reform, which stopped half way. Apart from defending the achievements, challenges lying ahead include unbundling Naftogaz in line with the third EU energy package, demonopolization of gas supplies to households, and investment in obsolete utilities infrastructure.

Banking System and NBU Transformation

The National Bank of Ukraine (NBU) has made several breakthrough reforms since 2014. Some of these reforms were painful because they had to be implemented in an environment with large accumulated imbalances and shrinking economy. Although the fruits of these changes may be not obvious immediately, Ukrainians will benefit from the reforms in the medium and long run considerably. For the sake of space, we focus on three key achievements.

First, the central bank adopted a new policy framework: inflation targeting. The experience of other countries (e.g., New Zealand, Israel, Poland) suggests that this new regime will bring macroeconomic stability as well as low and stable inflation and therefore stimulate economic growth. The effect of this reform is already evident in the rapid pace of disinflation, which is faster than disinflation after the major devaluation of the hryvnya in 2008-2009. As inflation continues to fall towards the declared target of 5% per year and economic agents adjust their expectations, we should observe a further decrease in interest rates, an increasing share of loans with long maturity, and gradual dedollarization of the economy. The flexible exchange rate regime will absorb external shocks thus reducing macroeconomic risks and making the economy more robust. Finally, the NBU dramatically enhanced its communication to create a predictable business environment.

Second, the NBU overhauled its supervisory function and put more oversights over banks and other financial institutions. Indeed, the banking sector in Ukraine was infamous for related-party lending which concentrated risks and made the whole country vulnerable to crises and panic. Banking system in 2015 was undercapitalized and many banks were de facto bankrupt---some were nothing more than Ponzi schemes---but continued operations thus destroying trust in the financial sector and sucking resources away from productive banks and firms. To address these enormous problems, the NBU implemented a series of measures to limit related-party lending, to raise capital, and to remove zombie banks from the system. For example, the NBU now requires banks to disclose its ultimate owners so that the central bank can monitor and enforce the quality of lending. Many banks had to be liquidated (see Figure 5) to restore trust and resume credit flows, a necessary condition for economic growth.

Figure 5. Number of Banks and Ownership Transparency

Note: *share of total assets attributable to banks with transparent ownership. Source: NBU

Third, perhaps most importantly, central bank independence was strengthened via legislative amendments and the NBU has been transforming over last few years into a Western-type central bank. In particular, decision-making processes has been overhauled with emphasis on collective decisions made by committees. Its quality has also been substantially improved. Internal structure is much more efficient now as many operations previously carried out in regions are moved to the central office. The staff was downsized from 11,800 in early 2014 to 5,300 in late 2015. The NBU now organizes regular research seminars and annual conferences. The first time in its history a Western trained scholar becomes a member of the NBU council. Furthermore, the central bank works hard to improve communication with businesses and media, in particular, through high-quality inflation reports, presentation materials and regular communiques.

The central bank has many challenges ahead, with, perhaps unsurprisingly, the main issues being of political nature. For example, while independence of the NBU was strengthened, the risk of appointing a political figure as the head of the central bank remains high. Building institutional capacity of the central bank as an independent authority with best-trained staff should be a priority.

Public Procurement

The system of public purchases was considered one of the major sources of corruption and waste in the pre-Euromaidan Ukraine. Public procurement reform started in 2014 and encompassed a set of legislative and institutional changes, as well as technical overhaul of the system of public purchasing into new electronic system, called ProZorro.

This reform stands out by the fact that it was initiated, conceptualized, and carried out by the activists from business and civil society, who managed to build a wide coalition of support among the policymakers, international community, and other stakeholders, for the legitimate implementation of reform at the national level. The reform had five objectives, most of which were achieved.

First, the new system reduced opportunities for corruption on the side of the government. Second, businesses obtained better access to public tenders: the number of suppliers for large tenders grew approx. 74%. Third, the reform provided tools for civil society and businesses to keep accountable authorities doing public procurement. ProZorro was supplemented with the business intelligence module which provides access to data and visualizes major procurement metrics. Fourth, the legislation harmonized public procurement with the EU and WTO standards, giving Ukrainian producers access to public procurement abroad. Finally, the new system cut red-tape and waste in public procurement. According to some estimates, the new auction system generated approx 3.5% savings.

Ukraine’s public procurement reform in this area gained plaudits internationally and was approved by the EBRD as a model for other countries.

Decentralization

The Ukrainian governance system has several fundamental flaws embedded into the Constitution. One of them is unclear distribution of responsibilities between popularly elected local councils and state administrations which belong to the executive power representation at regional and district levels. An elected mayor or head gets a complete executive power only in cities, villages and - since 2015 - united territorial communities (a new administrative unit). Moreover, the local authorities were financially dependent on the resources allocated by the national government. The central government used to [partly] cover the gap between projected revenues and expenditures of local governments, which were obliged to provide certain minimal amount of public services. This resulted in an extremely centralized state where regional elites exchanged their loyalty for higher subsidies from the centre (e.g. prior to 2015 about 45% of Ukrainian communities received 70% of their budget as a subsidy from the central level).

Decentralization reform aims to change this political system by providing local authorities with higher financial autonomy and more responsibility over the everyday issues of their communities. As a result, accountability of governing bodies to general public should increase. For example, people vote more carefully if they know that their elected mayor together with the city council or the community head is directly responsible for schools, roads and hospitals. Additionally, such delegation of power should result in the emergence of ‘grassroot’ politicians, i.e. those who paved their way to politics by hard work and good results at the local level, rather than by ‘bribing’ higher-level politicians.

Decentralization reform started in early 2015 with amendments to the Budget Code and adoption of the law "On voluntary merger of communities". These two laws lay the ground for two key elements of decentralization – greater financial autonomy of local governments and formation of larger, self-sustainable, communities (prior to the reform, there were 12 thousand territorial communities in Ukraine, over a half of them with less than 3 thousand people).

Today, while the share of local budgets in the total public finances remains rather stable, local governments have more freedom in spending this money. Since education and healthcare are the largest expenditure items at the local level, local governments receive educational and medical subventions and can spend this money freely based on the needs of these sectors. For instance, small schools can be closed, with bus services to larger schools organized instead, which could result in a higher quality of education and more efficient spending. In addition, local authorities are now responsible for most administrative services, such as property and enterprises registration, construction permits issuance, etc.

The mechanism of leveling-off local government revenues is adjusted in such a way that a community/city now retains a higher share of its revenues which provides local governments with more incentives to create business-friendly environment.

The process of amalgamating cities, towns and villages into new administrative units - United Territorial Communities (UTCs) is on the way. During 2015-2017, over 500 UTCs were formed from over 2,500 smaller communities, covering 18% of Ukraine’s territory. 414 of them held local elections by the end of 2016 (see map). To encourage the process, UTCs are allowed to apply for funding of infrastructure projects to the Regional Development Fund financed from the central budget. Many of them have already launched investment projects such as renovation of schools, kindergartens, roads etc.

The decentralisation has already changed the spending pattern of local authorities. As Figure 6 shows, local budgets now invest more into roads, communication systems, construction and transport.

Figure 6. Shares of Local Budgets in Spending on Economic Activities

Note: X axis shows the shares of local budget spending in 2013, Y axis - in 2016. Dots above the unit line show items for which the share of local budget spending increased in 2016 compared to 2013.

The decentralization reform faces several challenges. First, some of the incumbent raion officials oppose formation of united communities, as this means less resources to manage. Second, negotiations about mergers into UTCs are sometimes tough since some “rich” towns/villages do not want to merge with their “poor” neighbours, despite all the synergies that mergers could provide. Third, there is a lack of human capital and other capacity constraints at the local level which prevents local communities from pursuing all the opportunities that decentralization process offers (e.g. apply for the infrastructure projects financed by the Regional Development Fund). As a result, local government accounts accumulated large amounts of unused funds (UAH 34 bn at the end of 2015, UAH 57 bn at the end of 2016, of them UAH 16 bn at bank deposits). Hence, there are over 20 international projects (e.g. PULSE or U-Lead) to develop capacity of local governments and local civil society organizations.

The decentralization reform cannot not be completed without amendments to the Constitution and without forced merger of those communities which fail to do that voluntarily by a certain deadline. These legislative changes are still to be adopted by the parliament, but exact distribution of responsibilities between central and local governments has to be carefully scrutinized.

Business Environment

Just before the 2014 Revolution, Ukraine ranked 112th out of 189 countries in the World Bank Doing Business (DB) survey. Since then Ukraine’s rank rose to 76th in Doing Business 2018 and the country has further potential to climb the ranks. The European Business Association’s Investment Attractiveness Index reached 3.15 points in the first half of 2017, the highest value since 2011.

Figure 7. Business Climate Indicators

Note: Doing Business ranks are provided with a one-year backward shift to reflect the period of the evaluation. Source: European Business Association, World Bank

The growing business optimism positively affects the changes important for business environment.

In terms of tax burden, Ukraine's paying taxes rank (a component of Doing Business rank) rose from 164th in DB 2014 to 43rd in DB 2018. Since 2016, the payroll tax rate was cut almost twofold - from over 40% to 22% which resulted in lowering labour costs. This decision brought the overall level of taxation in Ukraine in line with comparable countries in Central and Eastern Europe. In 2017, the long-standing issue of delays in VAT refund to exporters was resolved via introduction of the single electronic online registry, which keeps track of each VAT refund claim. According to the follow-up monitoring, VAT refund became more transparent and faster. The special Large Taxpayers Office was established for businesses paying over UAH 20mln taxes annually ($0.7 mln at current exchange rate), and since 2018, electronic cabinets have to be set for all taxpayers to keep records and communicate with tax inspectors. Over 2015-2017, the system of tax administration has been gradually simplified by removing inconsistencies and streamlining existing practices.

The Government made considerable efforts to deregulate business practices. The number of licensed activities dropped by 40% - from 56 to 33. Similarly, the number of activities requiring permits was reduced by 40% - from 143 to 85 (according to the estimates of the Office of Reforms of the MEDT). It is now also easier to get permits, which is demonstrated by an improved position of Ukraine in “dealing with construction permits” component of Doing Business: the country moved from 140th to 35th place over two years. Stamps as a mandatory attribute of the legal entity were eliminated.

The introduction of e-services intensified: it is possible to register business, obtain licenses and many other official documents online. In addition, a network of administrative service centres has been established with 701 operating centers as of July 2017.

In international trade, the launch of the Deep and Comprehensive Free Trade Agreement (DCFTA) with the EU since January 2016 opened the largest world market for the Ukrainian exporters, as well as facilitated access for EU goods to Ukraine. Apart from ‘classical’ duty-free trade regime, the DCFTA aims to reduce non-tariff barriers, including the administrative costs associated with moving goods across the border. In 2016, the Government introduced an electronic ‘single window’ at customs; but this measure was only moderately efficient as paper documents are still mandatory in many cases. More systematic changes in the legislation regulating the controls of goods moving across the border are still needed.

In the process of harmonising the Ukrainian product safety legislation of the EU acquis, the Government abolished the obsolete system of mandatory certification of products as well as over 14 thousand Soviet-era GOST standards dated before 1992, as well as multiple Soviet sanitary norms. At the same time, key cross-sectoral product safety legislation was adopted or amended to align with the EU norms.

However, more efforts are required to push Ukraine up in the Doing Business ranking. The most problematic areas are cross-border trade, access to electricity, and insolvency settlement. Moreover, the rule of law and the protection of property rights remain fundamental for the establishment of the attractive business climate in the country.

Patrol Police

Ukraine’s police force was notoriously corrupt and is perhaps best known for its officers soliciting petty bribes during routine traffic stops.

On July 2015, the new Law “On the National Police of Ukraine” replaced the Soviet-style Law “On Militia” (of 1990). Its main goal was to depoliticize the police force by providing it more autonomy and creating a service-oriented organization. The National Police, employing around 119,000 police officers, consists of six units: Criminal Police, Patrol Police, Security Police, Special Police, Rapid Operational Response Unit, and Pre-trial Investigative Services.

Patrol Police stands out separately as it was the only newly-created unit, while other units were reorganized from the old militia. Patrol policemen were selected via rigorous process including a battery of tests and a three-month training program conducted with the help of the American police officers. New police officers received decent salaries along with new uniform and cars. In July 2015, new patrol police took to the streets of Kyiv, replacing the much-disliked and corrupt traffic police.

Shortly after its launch, new Patrol Police, which has since spread to all Ukraine’s regions, became one of the few state agencies enjoying public support. According to opinion polls, 44% of Ukrainians trusted Patrol Police in April 2016, while the National police in general enjoyed support of only 22% of people. Though around one third of population still distrusted patrol police officers, this percentage of distrust was much lower than for other institutions, which resulted in positive confidence balance of 11 % vs -41% for the National Police.

The Patrol Police reform offers an example of how a new strong institution can be successfully built from scratch. Heavy engagement of former Georgian reformers and strong support from Ukraine's international partners contributed to the success. However, the success was limited only to Patrol Police unit including around 11,600 policemen out of 119,000 total, while other units of the National Police remained largely unreformed. In particular, renewal of staff did not take place. For instance, in Criminal Police only 8% of policemen were fired after repeated test and some of them were able to return to service later on. In November 2016, Khatia Dekanoidze, the head of the National Police resigned, hinting to increased political interference. Not surprisingly, the popular trust in Patrol Police turned on a downward trend.

Figure 8. Confidence Balance: share of people who trust an institution minus share of the people who don’t

Prosecution for Corruption

Fighting endemic corruption along with moving towards the EU was one of the key demands of the Euromaidan. However, corruption still remains a major obstacle for foreign investment, according to a recent survey (Figure 9), and is seen by the citizens as one of the major problems.

Figure 9. Key obstacles to foreign investors (10= the biggest obstacle)

Source: Dragon Capital/EBA/CES survey, August 2017

Successful anti-corruption approach includes two major components: narrowing opportunities for corruption and ensuring proper prosecution for corrupt activities. Ukraine made a noticeable progress in reducing corruption opportunities. In fact, successful reforms described above, including creation of the online public procurements system, business deregulation, banking system clean-up, were conducive to reducing corruption. Among other important achievements, Ukraine opened a number of state registries and databases for public access and launched detailed electronic income and asset declaration system for state officials. However, increased transparency has a limited impact on the level of corruption without effective (but not selectively repressive) punishment system.

To combat high-level corruption, Ukraine’s authorities, supported by international partners, set up new independent institutions, such as the National Anti-Corruption Bureau (NABU) and the Specialized Anti-Corruption Prosecutor’s Office. These organizations shortly became operational and opened hundreds of criminal cases, including the one against the head of the State Fiscal Service. However, the effectiveness of prosecuting corrupt officials charged by NABU has been limited: for 2016 - June 2017, only three cases (out of 171 high-ranking official charged) resulted in jail sentences.

Given weakness of the overall judicial system (see next section), international community and local activists repeatedly call for creation of a specialized Anti-Corruption Court. While existence of such court has been envisaged in the recently adopted judicial reform legislation, there has been no visible progress for its creation.

Judicial System and Law Enforcement

The court system in Ukraine remains largely dysfunctional, corrupt and politically dependent. Unreformed judicial system is a stumbling block for many other reforms - the most progressive legislation makes no difference if laws are not properly enforced. Ukraine ranks 78th among 113 countries in the 2016 Global Rule of Law Index largely due to weak regulatory enforcement and widespread corruption, in particular, in civil and criminal justice. Not surprisingly, Ukrainians deeply distrust the judicial system. The difference between those who trust courts and those who distrust them reached whopping 72%, one of the lowest figures among social institutions surveyed.

Judicial system reform is one of the most difficult and time-consuming. Judges in office cannot be substituted quickly with newcomers similar to police officers, as judges require much more extensive knowledge and training. Effective system of checks and balances should be introduced without jeopardising independence of the judicial branch of power.

Figure 10. Balance of Trust to Institutions

Source: Razumkov Centre opinion poll, October, 2017

Ukraine chose the latter - all subsequently adopted laws strengthened independence of the judiciary. In the long run, this is a preferable option but right now this causes dissatisfaction within civil society, as it sees that the judges who made clearly unlawful decisions or who have unjustified assets in their declarations keep their offices.

Not surprisingly, one of the first major laws approved after the 2014 Revolution was “On renewal of trust to judicial system”, which essentially prescribed lustration of judges. In a sign of entrenchment, 75 percent of court chairpersons fired by this law were re-elected by their peers.

Judicial reforms focused on gradual upgrades to achieve greater trust and independence in the system. For example, new legislation granted an imperative power to Supreme Court decisions, introduced open competition for all positions in the system, considerably raised salaries of judges, and set up the Higher Council of Justice (a self-governing body for the judicial branch) to make all decisions regarding recruitment, promotion, and punishment of judges. At the same time, to minimize corruption, judges were obliged to submit e-declarations which are now available online. So far, Higher Council of Justice was reluctant to reject judges shown to be corrupt or dishonest by the integrity commission comprised of civil activists.

In a rare reform of prosecution, amendments to the Constitution removed prosecution’s universal oversight function, a Soviet remnant. Unfortunately, prosecution remains opaque and repressive. For example, the business ombudsman office reports that prosecution is in the third place by the number of filed complaints.

Although the new patrol police was a success, the rest of the police (namely, the investigative police) remains unreformed. During 2016, all 80 thousand of police officers were screened for integrity, but surprisingly only 6% were dismissed (and manywere reinstated in their jobs on the basis of court rulings). There is a high risk that the frontline of the reform - the new patrol police - will become as corrupt as former militia used to be, which will discredit the very idea of the police reform. According to a recent poll, over the last year 11% of Ukrainians gave bribes to policemen.

Land Market Reform

With 41 million hectares of agricultural land covering 70% of the country, Ukraine accounts for one third of all black soil in the world. At the same time, Ukraine along with Belarus remain the only two European countries where agricultural land cannot be bought and sold. A ban for sale of farmland (Moratorium) was introduced in 2001 as a temporary measure, but then was prolonged eight times and remains in place today. About 40 m ha or 93% of agricultural land cannot be traded and used as a collateral (including 10.5 m ha of state and communal land). Almost 7 m of agricultural land owners (or 16% of Ukraine’s population) cannot freely use their property. The majority of these owners live in rural areas and are of old age. The moratorium severely hurts farmers’ capacity to borrow capital and consequently sector’s productivity (see Figure below) because land cannot be used as a collateral. In addition, agricultural land in state and communal ownership [a quarter of total agricultural land] is poorly managed and misused, generating fiscal losses.

Although since 2014 some preconditions for market opening have been met, the lifting of the moratorium remains heavily politicized and unpopular. This is unfortunate because a successful land market reform will improve property rights of landowners, enhance public benefits from using state and communal land and facilitate much-needed investment in productivity and socio-economic infrastructure in rural areas. In addition, the reform will generate capital inflows and fiscal revenue thus strengthening Ukraine’s macroeconomic position. Depending on the market design, the lifting of the moratorium could boost GDP by at least 2 to 3% p.a. over the next 3-5 years assuming a liberal market design, and by meager 0.2-0.3% p.a. assuming a very restricted market design (e.g. restriction on land trade for foreigners, legal entities and a cap on maximum land plot that can be purchased).

Civil Service Reform

A modern, successful country requires efficient and competent bureaucracy to formulate economic policies, allocate government resources, design reforms and ensure their speedy implementation. Unfortunately, the effectiveness of civil service in Ukraine is the second lowest in Europe after Moldova, according to the World Bank Governance Indicators.

A successful civil service reform should include three key elements: (1) bring new, competent people to the civil service, (2) minimize the political impact on appointments and (3) redesign the processes inside the government to make it efficient and transparent.

The first attempt to launch civil service reform was made at the end of 2015 with the approval of the new Law On Civil Service. The law envisaged that all top appointments should be made with a special selection committee, created new positions of state secretaries in the ministries to be selected through the open competitive process, and changed the salary structure of civil servants. The senior level officials were banned from having membership in any political party. Since 2016, civil servants and candidates for high-level civil service positions have to submit an e-declaration. Despite high expectations, the law did not lead to major improvements. Approved changes were not sufficient to rejuvenate civil service, as internal processes remained cumbersome and the introduced salary structure failed to motivate professional newcomers.

To correct some of these mistakes, the government (with the EU support) intends to hire 1,000 new civil servants (vs. 202 thousand total) to newly-created directorates in selected ministries, offering them higher salaries. Directorates will be responsible for strategic policy-making and restructuring of ministries. It is expected that the ministries will be transformed into compact analytical structures and released from their extra functions, such as management of state enterprises, inspections, provision of services, issuing licenses etc.

Privatization/SOEs Reform

Ukraine has over 3,300 state-owned enterprises (SOEs). Their oversight by the government is so poor that different agencies provide different numbers of SOEs ranging from 3,350 (the Ministry of economy) to 4,500 (the State Property Fund). For the last three years, the goal for privatization revenues in the state budget was set to UAH 17 bn, but this plan has never been fulfilled by more than 5 per cent. Privatization revenue in 2016 was only UAH 0.2 bn. This means that in 2016) stemming from incompetence and corruption schemes continue to be covered by taxpayers.

Although reforming and privatizing of SOEs has proven to be challenging, there are both success stories and failures. Perhaps, the largest success is the reform of Naftogaz, which holds 48.5% of all assets in the top-100 SOE list. Indeed, as we described above, Naftogaz has new independent management, conducted and published audit and improved its financial results. On the other side of the spectrum is Ukrspirt (a state alcohol producer). Estimates suggest that up to 40% of all vodka and other alcoholic beverages production uses ‘grey’ (i.e. unaccounted) spirits from Ukrspirt. Just in August 2017 the State Fiscal Service arrested UAH 540 mn worth of supposedly illegal spirit produced by Ukrspirt.

The government has recently introduced to the parliament the legislation streamlining privatization procedures and identified SOEs to be privatized, liquidated or left in state ownership, but corporate governance reform in strategic SOEs stalled.

Figure 11. Privatization Reсeipts ($bn)

Note: January-August figure for 2017 is shown. Average annual UAH/USD rate is used for conversion. Source: State Treasury reports

Healthcare

Inherited from the Soviet Union, Ukraine’s healthcare system is still unable to ensure good health of population. Life expectancy in Ukraine is substantially lower than in the EU (72 years in Ukraine vs. 81 years in the EU), while mortality rates are higher. One of the major causes of mortality in Ukraine are cardiovascular diseases: 67.3% of Ukrainians die due to these diseases vs. 38.3% in the EU.

Though Ukraine’s Constitution guarantees free healthcare provision to its citizens, in reality public healthcare financing accounts for only a half of total health care expenses of population, with the other half funded by out-of-pocket, often informal, payments. Many households report large difficulties in financing their medicines and healthcare services in case of health problems. Another major problem is inefficiency of public healthcare financing, which covers the needs of healthcare facilities (clinics, hospitals) rather than services they provide.

As a result, Ukraine is ranked among ten worst-performing countries in terms of equal access to healthcare and is second worst among Central and Eastern European countries in the Health Care Access and Quality Index, ceding only to Russia.

While various public opinion polls suggest the healthcare reform to be one of the top priorities for population, government’s attempts to transform the system have been halted by a mix of political and economic vested interests, including sizable informal cash flows in the industry.

Until recently, progress in the healthcare reform was limited to several small steps, which nevertheless faced huge resistance. In 2015, the government temporarily (until 2019) outsourced centralised procurement of medicines to international organisations (UNICEF, UNDP, and Crown Agents) and permanently simplified registration of medicines. This helped to eliminate a large source of corruption at the Ministry of Health, though transition to the new procurement regime was bumpy. Since April 2017, the Government introduced a reimbursement program for the most essential drugs needed for the treatment of cardiovascular diseases, bronchial asthma, and type II diabetes. This program aims at early treatment thus increasing success rate and reducing cost for the system.

In October 2017, a broader healthcare reform was finally launched. The changes are intended to raise competition in the healthcare sector, improve quality of services, increase efficiency of healthcare spending and reduce corruption. This will be achieved via the following changes:

1. Introduction of “money follows the patient” principle, i.e. financing will be based on the payment for service (as compared to the current approach of financing infrastructure);

2. Establishment of the National Health Service - a state agency that will control quality of services provided and make payments to healthcare providers on the basis of contracts (i.e. act as a quasi-insurance company). In this way, the Ministry of Health as a policy-maker will not have control and payment functions, which eliminates conflict of interest within it;

3. Introduction of a “State Guaranteed Service Package”, i.e. the list of healthcare services completely covered by the state. Other services will be either partially financed by the state or fully financed by patients. The State Guaranteed Service Package will be approved every year by the State Budget law.

The approved law is only a beginning. The Government will have to approve a substantial package of secondary legislation and put in a lot of efforts to the ensure smooth implementation of changes. Moreover, the Parliament rejected the Government's suggestion to introduce co-payments for the healthcare services, which puts under question financial sustainability and thus an ultimate success of the reform.

Education

Official statistics suggests that Ukraine is one of the most educated countries in the world: the literacy rate is almost 100%, secondary and tertiary enrolment rates are 99.2 and 82.3%, respectively. While these figures are impressive, the education system in Ukraine shows troubling signs of inefficiency and wasteful activities.

First, the overall quality of the education system ranks only 56th in the world (the quality of math and science education ranks 27th according to the WEF ranking). Second, according to the World University Ranking, the best Ukrainian university is ranked 800-1,000, while another four are included in the ranking just because they applied. Third, while education is relatively cheap (the government financially supports 60% of university students), 40% of the workforce is overeducated, and the education-job mismatches are high and persistent. Finally, despite strong academic credentials, Ukrainians have low productivity. The mismatch is growing partially due to increased participation in higher education. With over 80% of the relevant age population studying at universities, there is simply not enough people left to take up vocational education due to the low prestige of these professions, and also because of the hugely outdated curriculum in most of the vocational schools.

There is a growing concern on the quality of higher education as well: 39% of Ukrainians believe that research activity of the faculty needs to be stimulated (compared to 32% in 2015). Surveys show that corruption remains one of the main issues of Ukraine’s higher education: 44% believe that corruption is the biggest challenge (though the number is lower compared to 59% who believed so in 2015).

The government made a few steps to enhance the quality of education. New legislation on tertiary education introduced autonomy for universities, transparency in the distribution of government-funded seats between universities and faculties, and a new list of majors in line with the international classifications. To fight pervasive plagiarism, the government obliged PhD candidates to publish their dissertations online and initiated an electronic database of publications which allows to monitor plagiarism.

The government also tightened the requirements for obtaining ‘assistant professor’ or ‘professor’ positions - now a candidate must have publications in the internationally recognised academic journals. This step was not much welcomed by the academic community.

The new law on education passed in September 2017 addresses the quality of secondary education. It extends secondary school from 11 to 12 years with the last three years of academic or professional specialization and foresees teachers’ salary increase by more than 3 times by 2023.

The new legislation defines the new framework for the education system development. Yet, many things need to be accomplished to implement it. As for now, the system of funding of public universities and scientific research remains inadequate, keeping Ukraine on the sidelines of international science.