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INDEX OF CONTENTS 1. INTRODUCTION ........................................................................................................................................................ 4 1.1. BACKGROUND ABOUT UKRAINE................................................................................................................................... 4 1.2. PRECONDITIONS FOR OUR PROBLEM AREA.................................................................................................................... 4 1.3. DEFINITION OF THE PROBLEM ....................................................................................................................................... 4 1.4. RESEARCH QUESTION ................................................................................................................................................... 5 1.5. PURPOSE....................................................................................................................................................................... 5 1.6. DELIMITATION ............................................................................................................................................................. 5 1.7. STRUCTURE OF THE THESIS........................................................................................................................................... 5 2. METHODOLOGY ....................................................................................................................................................... 7 2.1. A SCIENTIFIC VIEW POINT ............................................................................................................................................. 7 2.2. CHOICE OF METHODS.................................................................................................................................................... 8 2.3. CASE STUDIES .............................................................................................................................................................. 8 2.4. QUALITATIVE AND QUANTITATIVE DATA ..................................................................................................................... 9 2.5. PRIMARY AND SECONDARY DATA................................................................................................................................. 9 2.6. INTERVIEWS WITH ORGANISATIONS AND EMBASSIES .................................................................................................. 10 2.7. INTERVIEWS WITH FOREIGN COMPANIES OPERATING IN UKRAINE .............................................................................. 10 2.7.1. Making contact with foreign companies operating in Ukraine .......................................................................... 11 2.7.2. The population .................................................................................................................................................... 11 2.7.3. The development of the questionnaires............................................................................................................... 11 2.7.4. Distribution of the questionnaires ...................................................................................................................... 11 2.7.5. Decline in the population ................................................................................................................................... 11 2.8. VALIDITY AND RELIABILITY ...................................................................................................................................... 12 2.9. RESEARCHERS’ DIARY ................................................................................................................................................ 13 3. THEORETICAL FRAMEWORK ............................................................................................................................ 15 3.1. MARKET SCREENING .................................................................................................................................................. 15 3.1.1. Initial Screening ................................................................................................................................................. 16 3.1.2. Second Screening - Financial and Economic Forces ......................................................................................... 17 3.1.3. Third Screening - Political and Legal Forces .................................................................................................... 18 3.1.4. Fourth Screening - Sociocultural Forces ........................................................................................................... 20 3.1.5. Fifth Screening - Competitive Forces ................................................................................................................. 21 3.1.6. Final Selection of New Market ........................................................................................................................... 21 3.2. POLITICAL RISK - A DEEPER PERSPECTIVE ................................................................................................................... 22 3.2.1. Sources of political risk ...................................................................................................................................... 22 3.3. COUNTRY AND FIRM SPECIFIC POLITICAL RISKS ......................................................................................................... 22 3.3.1. Country specific risks ......................................................................................................................................... 23 3.3.2. Firm specific risk ................................................................................................................................................ 23 3.4. TRANSITION ECONOMIES ............................................................................................................................................ 24 3.4.1. Centrally planned economies and market economies ......................................................................................... 24 3.4.2. Basic elements of an economic reform program ................................................................................................ 25 4. A FURTHER DEVELOPMENT OF THE MARKET SCREENING MODEL ................................................... 27 5. UKRAINE ................................................................................................................................................................... 29 5.1. UKRAINE AND ITS HISTORY ........................................................................................................................................ 29 5.1.1. History ................................................................................................................................................................ 29 5.1.2. Geographic situation .......................................................................................................................................... 30 5.1.3. Population .......................................................................................................................................................... 31 5.1.4. Infrastructure...................................................................................................................................................... 31 5.2. ECONOMICAL AND FINANCIAL SITUATION ................................................................................................................. 32 5.2.1. Macroeconomic situation ................................................................................................................................... 32 5.2.2. Currency ............................................................................................................................................................. 34 5.2.3. Production .......................................................................................................................................................... 34 5.2.4. Financial system ................................................................................................................................................. 36 5.3. POLITICAL SITUATION ................................................................................................................................................ 37 5.3.1. Government ........................................................................................................................................................ 37 5.3.2. Political developments........................................................................................................................................ 38 1 5.3.3. Legal developments ............................................................................................................................................ 39 5.3.4. Trade barriers .................................................................................................................................................... 40 5.4. ECONOMIC REFORM .................................................................................................................................................... 41 5.4.1. Price liberalisation ............................................................................................................................................. 42 5.4.2. Macroeconomic stabilisation ............................................................................................................................. 42 5.4.3. Privatisation ....................................................................................................................................................... 43 5.4.4. Foreign direct investment ................................................................................................................................... 43 5.5. POLITICAL RISK .......................................................................................................................................................... 45 5.5.1. Ethnic risk .......................................................................................................................................................... 45 5.5.2. Corruption .......................................................................................................................................................... 45 5.5.3. Expropriation ..................................................................................................................................................... 46 5.6. SOCIOCULTURE SITUATION......................................................................................................................................... 46 5.6.1. Culture ................................................................................................................................................................ 46 5.6.2. Religion .............................................................................................................................................................. 46 5.6.3. Language ............................................................................................................................................................ 47 5.6.4. Education ........................................................................................................................................................... 47 5.6.5. Employment and wages ...................................................................................................................................... 48 5.6.6. Income and standard of living ............................................................................................................................ 49 5.6.7. Crime and safety situation .................................................................................................................................. 50 6. POLAND - THE ECONOMIC REFORM ............................................................................................................... 52 6.1. INTRODUCTION ........................................................................................................................................................... 52 6.2. HISTORY..................................................................................................................................................................... 52 6.3. THE ESTABLISHMENT OF A FREE MARKET ECONOMY .................................................................................................. 52 6.4. THE RESULTS OF ECONOMIC REFORMS........................................................................................................................ 54 6.5. POLAND’S SITUATION TODAY ..................................................................................................................................... 55 6.6. POLAND’S INTEGRATION INTO WESTERN STRUCTURES .............................................................................................. 56 7. ANALYSIS .................................................................................................................................................................. 58 7.1. INITIAL SCREENING - SPECIFIC NEEDS IN UKRAINE ..................................................................................................... 58 7.2. SECOND SCREENING - ECONOMIC AND FINANCIAL FORCES ........................................................................................ 59 7.3. THIRD SCREENING - POLITICAL AND LEGAL FORCES ................................................................................................... 60 7.3.1. Political forces ................................................................................................................................................... 60 7.3.2. Legal forces ........................................................................................................................................................ 61 7.4. BASIC ELEMENTS OF AN ECONOMIC REFORM PROGRAM ............................................................................................. 61 7.4.1. Preconditions for the reform work ..................................................................................................................... 61 7.4.2. Price liberalisation ............................................................................................................................................. 62 7.4.3. Privatisation ....................................................................................................................................................... 62 7.4.4. Development of a financial system ..................................................................................................................... 63 7.4.5. Macroeconomic stabilisation ............................................................................................................................. 63 7.4.6. Foreign sector liberalisation .............................................................................................................................. 63 7.4.7. Is Ukraine a market economy? ........................................................................................................................... 64 7.4.8. The effect of the reform work on foreign companies .......................................................................................... 64 7.5. POLITICAL RISKS ........................................................................................................................................................ 65 7.5.1. Ethnic risks ......................................................................................................................................................... 65 7.5.2. Corruption .......................................................................................................................................................... 65 7.5.3. Expropriation ..................................................................................................................................................... 66 7.5.4. Unstable government .......................................................................................................................................... 66 7.6. FOURTH SCREENING - SOCIOCULTURAL FORCES......................................................................................................... 66 8.CONCLUSION ............................................................................................................................................................ 68 8.1. CONCLUSION .............................................................................................................................................................. 68 8.2. A CRITICAL EVALUATION OF OUR RESEARCH ............................................................................................................. 70 8.3. SUGGESTIONS TO FURTHER RESEARCH ....................................................................................................................... 71 BIBLIOGRAPHY .......................................................................................................................................................... 72 COMPENDIUMS .................................................................................................................................................................. 73 PERIODICALS..................................................................................................................................................................... 73 WEBB PAGES ..................................................................................................................................................................... 73 RESPONDENTS ................................................................................................................................................................... 74 APPENDIX A ...................................................................................................................................................................... 75 2 APPENDIX B ...................................................................................................................................................................... 76 APPENDIX C ...................................................................................................................................................................... 78 3 1. INTRODUCTION 1.1. Background about Ukraine Ukraine is one of the largest untapped “emerging markets” in Europe. The country today is firmly on its course towards democracy and irreversible market-based economic reforms. It has been a struggle to get the country on the right course. Soon after Ukraine’s independence 1991, several half-hearted reform programs were attempted but then abandoned, mainly as a result of opposition in parliament and at local level. Since October 1994, Ukraine has broadly pursued macroeconomics stabilisation, price and trade liberalisation, and has implemented a new mass privatisation program. However, structural reform, including largescale privatisation, has until recently, proceeded slowly, while land and agricultural reform has been blocked by strong agrarian lobby in the parliament. 1996 was a breakthrough year for the country. First and foremost, a new Constitution was adopted. It guarantees all basic freedoms and human rights, private and other forms of ownership. Secondly a monetary reform was successfully implemented and the national currency, Hryvnia, introduced. Thirdly, inflation has been “tamed” and the country’s export potential has expanded. Small privatisation has been completed, whilst medium- and large-scale privatisation is on its way. Investors and bankers from many countries are considering Ukraine as an interesting investment. The country possesses pre-requisites to become an effective and competitive economy. It has rich natural endowments and fertile arable soils, a skilled population as well as a well-developed industry compared to the other countries of the former Soviet Union, and vast R&D potentials. 1.2. Preconditions for our problem area At present Ukraine attracts the attention of researchers because of the troublesome political and economical situation within the country. During our pre-trial investigation we learned that previous conducted research about the Ukrainian market mainly dealt in the sphere of economics. We have not been able to find any research that considered the Ukrainian business environment in the angle of business administration. This was an incentive for us to begin a pioneer investigation that deals with the Ukrainian business environment. Our notion was confirmed when we got in touch with several companies. Some of these companies were already established in Ukraine and the others were considering entering this market. The interest for our field of research was shared by all of the companies and they were looking forward to be informed of our result. 1.3. Definition of the problem As an object for foreign investment Ukraine is a country of potentials, but also of great complexity and uncertainty. In such an environment - characterised by potentially high returns but also relatively high risks, and where many investments break new ground - it is vital that investors have a good understanding of the opportunities and threats that exist. 4 The authors are of the opinion that an identification of the opportunities and threats would be a valuable contribution to the knowledge of the Ukrainian business environment. 1.4. Research question What kinds of opportunities and threats does the Ukrainian business environment hold for foreign companies? 1.5. Purpose The purpose with this research is to analyse the Ukrainian business environment with the aspiration to identify the opportunities and threats, which affects foreign companies in this market, using a model suited for market analysis. 1.6. Delimitation This research shall give a broad presentation over the Ukrainian business environment. We do not intend to focus too deeply on details due to limited time and resources. We intend to analyse the Ukrainian business environment from the perspective of foreign companies. In the analysis a comparison between Ukraine and Poland will be conducted within a limited part of the market screening model dealing with the economic reforms. The time period of this research will be focused on the period of transition from centrally planned economy to market economy, i.e. from 1991 and onwards. The research is primarily addressed towards all companies interested in Ukraine as a potential market as well as those already operating there. 1.7. Structure of the thesis To facilitate the reading of the thesis' outline we will briefly explain the basic structure and the thoughts behind it. The numbering in the text below corresponds to the chapter numbers in the present thesis: Chapter 2. Following this introduction is a description of the methodology used for our purpose. This part includes both a description of how our ideas emerged as well as the more practical parts, such as the accumulation of data and interviews. Chapter 3. This section contains a description of the theoretical framework behind our study. Chapter 4. This section consists of a further development of the market screening model, which is based on the theories in chapter 3. 5 Chapter 5. In this section we will provide a general view of Ukraine, focusing on factors concerning the business environment, which were identified in the further developed market screening model. This chapter is based on existing literature and the results from our interviews. Chapter 6. This chapter will consist of a brief presentation over the economic reforms in Poland. The results from this chapter will be analysed by the authors within a limited part of the market screening concerning the economic reforms. Chapter 7. The empirical data that we have accumulated will be analysed in this chapter according to the modified market screening model. Chapter 8. The final part of the thesis will consist of conclusions drawn from our analysis. Our research will be completed with a critical evaluation of our research and suggestions to further research. Figure 1: Structure of the thesis 2. Methodology 3. Theoretical framework 4. A further development of the market screening model 5. Ukraine - dealing with all the steps presented in the further developed market screening model 6. Poland - dealing with one step in the further developed market screening model, concerning economic reforms 7. Analysis 8. Conclusions - conclusions, critical evaluation and suggestions to further research 6 2. METHODOLOGY Following is a presentation of the methodology used to fulfil authors purpose. The chapter includes a motivation of the chosen method, a description of how authors ideas emerged as well as different techniques used to accumulate data and conduct interviews. 2.1. A scientific view point In the field of social science there are two main traditions on how to conduct a scientific research. They are called Positivism and Hermeneutics. Positivism has its roots in an empirical/natural scientific tradition, with physics as its role model. The scientists adhering to Positivism approach a social scientific research in the same manner as they do in a natural scientific research. They believe that “...since human beings and societies belong to the natural order, a single method, broadly defined, will serve for all sciences”. (Hollis, p 16) The underlying assumption here is that humans are rational beings. According to the positivists, scientists adhering to Positivism, the researchers should strive to build up knowledge consisting of general laws of causal nature, laws from which a cause-effect relationship can be described. Further on the positivists believe that the correct approach is to start with a theory which results into hypothesis. These hypotheses are then put to the test empirically through scientific methods. Positivists tend to favour quantitative methods before qualitative and seek to explain human activities in terms of cause and effect. Much like natural scientific research they avoid personal influence in order to reach objectivity, setting a distance between the scientist and the object. It is considered that the researcher as a person, as well as his/hers political, religious and emotional sentiments should not in any way influence the result. The ideal situation for a positivist would be when researchers are switched yet the result is the same. The aim of the positivists is to reach generalities. The hermeneutic tradition is different from the positivistic tradition. The hermeneutics explain their standpoint as following. Each phenomenon in the society is interpreted by humans, each phenomenon is given a meaning. To understand the phenomenon the researcher can not distance himself from the object, as suggested by the positivists. Instead the researcher should try to enter the phenomenon he/she is studying through the use of empathy. (Lundahl & Skärvad, 1992) The researcher is able to understand the studied phenomenon only if he/she understands the context in which it exists. The hermeneutics, scientist adhering to the hermeneutic tradition, therefore claims that the social world should be understood from within, rather than explained from without. Instead of seeking the causes of behaviour the Hermeneutics seeks the meaning of action (Hollis, 1994). The aim is to interpret and understand rather than to explain. As our research deals with a market, which is a social construct, we believe that we share the same scientific point of view as the hermeneutics. We do not believe that humans are rational and in order to explain the process we believe that an understanding of the human nature and behaviour is of consequence. 7 2.2. Choice of methods We have chosen to use qualitative case studies as the method for our research. We believe that it is the most appropriate method for us as the other methods did not really fit our purpose. The choice of method is dependent on the problem definition and the purpose of the study. We ruled out experimental research since it is a method that allows the researcher to make strong claims about causality, that one thing has an effect on something else (Bryman, 1989). That is not the purpose of our research. We want to study the Ukraine through a business point of view in order to create better understanding of this relatively new market. Our research is not an action research, as we do not intend to find a solution for a specific problem. We did not intend to make a fieldtrip to Ukraine either so we ruled out ethnographic research, which is a participating field research. The participating nature of this method is the main reason why it is not suited for our purpose since we can only observe but not influence our subject. Surveys came close to what we are doing but it still did not fit our purpose entirely. Our research includes interviews and questionnaires in order to gain greater validity as well as gather information. There have been articles and books written about Ukraine through the point of view of economics, which we have adapted to our research. Our research is therefore based on both primary and secondary data. The reason is to capture as many variables as possible for the identification of opportunities and threats. As such we had to eliminate survey as a method as it is a method which is limited on the amount of variables it can handle (Merriam, 1994). 2.3. Case studies After eliminating all the other methods we will here try to justify our choice of case studies as the method for our research. A case study is an investigation of a specific phenomenon, such as an event, a person, an institution or a social group (Merriam, 1994). This is very appropriate to our research as we are analysing a market. The qualitative case study that we have chosen does not exclude quantitative data. All kinds of data can be used in a case study. This suits our purpose very well. We have used both qualitative and quantitative data in our research to gain as much understanding of the Ukrainian business environment as possible, since not much has been written about it from the business administrative point of view. By using both types of information a form of triangulation is implemented and greater validity is achieved (Merriam, 1994). This kind of flexibility, the lack of any formal structure, which allows the combination of several different methods and different kind of data, is what makes case studies so appealing. Unfortunately there are drawbacks to case studies, as with all other methods. According to Guba & Lincoln, case studies can oversimplify or exaggerate facts in a situation, which can lead to readers drawing false conclusions. This is an inherit problem among all qualitative methods. The solution would be that the researcher is aware of this and points out this fact to the readers. Flexibility, which is the advantage of case studies, is also its drawback. The researcher is given a lot of freedom in the gathering and analysis of the information as well as the presentation of the result. Therefore great demand is put on the researcher’s ability and also his/hers integrity. An unethical researcher can choose among the accessible information to present the kind of result he/she wants. A detailed report concerning the gathering and analysis of the information can diffuse 8 the problem concerning the researcher’s ability in gathering, analysing and presenting the results. The readers are then given the opportunity to criticise the research. We will take these failings of the method into account and give the readers a detailed report of our gathering and analysis of the information. As for the problem of the unethical researcher, it usually arises when the research is financed or ordered by someone else. We do not have this problem and instead, as students writing a master level thesis, are encouraged to be as unbiased and truthful as possible. 2.4. Qualitative and Quantitative data Authors have included both qualitative and quantitative data in the research. First, we will define this two concepts and thereafter will explain their implementation in our research. According to Sharan B. Merriam, data, or information, conveyed through words is called qualitative. Qualitative data consist of detailed description of situations, events and people. They also consist of direct quotations from different people about their experiences, attitudes and thoughts. In contrast, information that is presented in the form of numbers is called quantitative data. The emphasis is put on measuring the extent of a certain opinion, attitude, event or a behaviour rather than to describe them. Our research is intended to be an analysis of the Ukrainian business environment with the purpose of identifying the opportunities and threats, which affects foreign companies operating in this market. Among our sources of qualitative data are different kinds of interviews that we have conducted, as well as information from literature, articles, databases and others. The sources for quantitative data came from statistical literature, concerning economic indicators in the investigated country. It has been difficult for us to find detailed statistical data concerning Ukraine. We believe that the reason is due to the economical turmoil that the country has experienced, which made the acquisition of statistical data an act of low priority. 2.5. Primary and secondary data Primary data are collected especially to address a specific research objective. They are timeconsuming to obtain. The advantage though is that the data are suited for the research and the researcher has some control over its accuracy. Methods to obtain primary data range from qualitative research to surveys to experiments ( Aaker, Kumar, Day, 1995). Secondary data are information that was collected for purposes other than solving the present problem/problems. The limitations, other than being collected for some other purpose, are that the researcher had no control over the data collection. They may therefore be not very accurate. They may also be outdated. The advantage though is that they require less time to obtain and needs less effort. In some instances they may also be the only source of information available, such as historical records. Examples of secondary data are information systems and data banks. (Aaker, Kumar, Day, 1995). The secondary data that authors have applied, after having it adapted to fit the purpose, are written sources such as literature, Webb-pages, periodicals and compendiums. The reason why we used these secondary sources is that it would be an inefficient use of our time to send questionnaires and to do interviews on subjects that others have already accumulated information about. 9 The primary data applied in the research consists of questionnaires and interviews. Authors intention was to find more recent data or data that have not been available through secondary data. Furthermore, we believe that obtaining information directly from the source is essential. Besides serving as a confirmation of the secondary information that we have accumulated, it allows the research to voice the opinions of the foreign companies operating in the Ukrainian business environment. This will give our research a higher level of validity. 2.6. Interviews with organisations and embassies Interviews with SIDA, the Swedish Trade Council and the Ukrainian Embassy were mainly conducted during our pre-trial investigation when we were accumulating facts concerning the problem area. The interviews were of an explorative nature. Before we go any further we shall explain the different kinds of interviews that can be conducted. Interviews can be divided into three different categories: structured, semi-structured and unstructured (Merriam, 1994). The structured interview is the oral equivalent of a survey: the questions and the order in which they are asked are confirmed in advance. This type of interview is especially useful when a large number of people are to be interviewed. The semi-structured interview is guided by a couple of questions, but the exact formulation and order are not determined. In this way the interviewer can adapt to the situation and take advantage of new ideas that may arise. The unstructured interview is explorative, and there are no pre-formulated questions. The unstructured interview is used in the initial stage of a case study in order to gain enough knowledge to be able to formulate the questions for future interviews. The questions directed towards SIDA, the Swedish Trade Council and the Ukrainian Embassy were unstructured, since they were asked in order to achieve a better knowledge concerning Ukraine. As mentioned earlier, they were conducted during our pre-trial investigation when we did not possess much knowledge of the Ukrainian business environment. As our research proceeded we were able to refer to the information obtained from these interviews. The majority of these interviews were conducted by telephone. The interview with Mr Marek Szczygiel, 2nd Secretary at the Polish embassy was a formally constructed interview, where we had a basic guideline concerning what questions to ask. The interview was conducted in the middle stage of our research and we knew what kind of questions to ask. Therefore, the interview was semi-structured since we wanted to give our respondent the opportunity to speak. In this way we could have a dialogue concerning essential aspects which might come up as the interview proceeded. The subject of the interview concerned the Polish reform process. 2.7. Interviews with foreign companies operating in Ukraine When conducting research, the nearness to the investigated object is of an essential importance. Therefore, the authors accomplished interviews with foreign companies operating in Ukraine. These companies are daily affected by the Ukrainian business environment, which we intend to analyse, and their experience is of great importance for our investigation. A complete summary of the interviews is to be found in Appendix C. 10 2.7.1. Making contact with foreign companies operating in Ukraine During our pre-investigation the Swedish Trade Council informed us about the 1996 state visit to Ukraine. The participants in the 1996 state visit were the Swedish Minister of Foreign Affairs and six Swedish companies interested in the Ukrainian market. We contacted the participants and from the following companies we received names of their contact persons in Ukraine: Alfa Laval, Atlas Copco, Electrolux, Scania, Tetra Pack. The sixth company that participated in the 1996 state visit, Esselte, did not conduct any business in Ukraine. Furthermore, we had a contact in Russia, Mr Reshetov Nikolay, Managing Director for Russian Maritime Register in St Petersburg, who introduced us to six further foreign companies operating in Ukraine. These companies were Kross (USA), Oditel-Siemens (Germany), Hi Tech (USA), Transas Marine (Denmark), Shevron (USA), and MacGregor (Sweden/Finland). 2.7.2. The population The purpose with the interviews was to achieve information about the Ukrainian business environment that would be applicable on foreign companies within different industries. Therefore, authors premises concerning potential respondents for the interviews were foreign companies operating within different lines of businesses. Based on our premises we contacted 11 foreign companies. 2.7.3. The development of the questionnaires The process of formulating the interview questions began when authors had achieved enough knowledge concerning the investigated market. The interviews were conducted in the form of a questionnaire containing 21 questions. The questions were formulated in such way that they could be categorised as being open-response questions. This means that they could not be answered by simply stating yes or no. The questions were general and dealt with the Ukrainian business environment. They were divided into categories such as economical situation, political and legal situation, cultural situation, and future prospects. 2.7.4. Distribution of the questionnaires The questionnaire was distributed mainly through the use of Internet. We chose this approach since we were not able to travel to Ukraine and conduct the interviews personally. The advantage with distributing the questionnaires in this fashion is the possibility for a quick reply. To companies that we had not received an e-mail address, we distributed the questionnaires by fax machine. 2.7.5. Decline in the population The drawbacks when using questionnaire is the low response rate (Aaker, Kumar, Day, 1995). In order to make sure that we achieved a high response rate we tried to address each respondent personally, explaining how we obtained their address and the purpose with our research. We informed them that their answers were essential to us and asked for a speedy reply, setting a deadline. Furthermore, they were informed that they could answer in Swedish, English or Russian, whichever language that they felt most comfortable using. 11 We received answers from 9 of the 11 contacted companies. The decline in the population was about 18 per cent. We believe that this small decline is explained by the companies’ interest for the research. The majority of the respondents were interested in receiving a copy of our research. At the headline Respondents at the end of this thesis we describe the appointments with the interviewed contact persons at the foreign companies. Several of our respondents wished to be anonymous. 2.8. Validity and Reliability In a scientific research, the issue of whether the results are valid and reliable is of great importance. Therefore a discussion about the validity and reliability of the research is often included in the research paper to justify the results. As mentioned earlier we share the hermeneutic point of view. This has a certain implication on the validity and reliability of our research. The validity concerns whether the result matches reality. Is the result a reflection of the reality or are there aspects that have not been captured by the research (Merriam, 1994)? To make sure that a research has high validity the researcher utilises several different methods and information sources. This is called triangulation. Validity is somewhat different in a qualitative case study. A qualitative case study is influenced by how the researcher interprets the data. Different people interpret the same thing differently. Therefore this might lead to issues concerning the validity of a research. We believe to have tackled the issue of validity by using information from different sources. They were primary sources such as different kinds of interviews conducted in Ukraine and in Sweden, as well as secondary sources such as literature, Webb-pages, periodicals etc. Authors have gathered opinions from many people and thereby avoided leaving things out and creating a distorted view of reality. Furthermore, we have allowed a few independent individuals read our thesis and confirm its validity (Merriam, 1994). Reliability concerns the extent to which the results can be repeated (Merriam, 1994). If the research is repeated again, the results should be the same as for the original research. The researcher often includes a detailed description on how the research was conducted in order to achieve greater reliability. The description enables other researchers to repeat the investigation. The idea that the same result should be achieved when repeating a research is based on the assumption that reality can not be changed. This is a positivistic point of view. Our statement earlier of sharing a hermeneutic point of view might lead to issues concerning the reliability of our research. This is because hermeneutic research is based on how the researcher interprets the data. Since the interpretation is highly subjective and based on personal values and sentiments, no researcher has been able to come to the exact same conclusions as the one before when repeating the investigation. Therefore, reliability as described above can not be obtained in a qualitative case study. It is more of a guideline, which should be followed rather than a goal that needs to be attained. We have attained reliability by using several sources for our research (Merriam, 1994). To make us familiar with the subject we conducted extensive reading and interviewed several persons possessing knowledge within the investigated field. The construction of questions and the documentation of the answers have been done thoroughly. The purpose of using a variety of 12 sources was to eliminate as many errors and biases as possible. Furthermore, we have described how we conducted our research so that it can be repeated. According to Guba & Lincoln reliability and validity are linked together. It is impossible to have validity without reliability. By strengthening the validity it also leads to the research acquiring greater reliability. The result is considered valid as long as no new information appears which contradicts it. 2.9. Researchers’ diary At the beginning of our research we all agreed upon the idea of analysing a transition economy. A transition economy means a country, which is transforming from a centrally planned to a market economy. Examples of such countries are Russia, Baltic States, Poland, Ukraine etc. Finally we decided to investigate Ukraine. Our interest in this market was deepened when we learned that there is lacking research concerning the Ukrainian business environment, conducted from the angle of business administration. In our research we aimed to analyse the Ukrainian business environment from the perspective of foreign investors. Due the lack of research concerning this market we decided to investigate the market as a whole. Our presented research will therefore be an interesting source for foreign companies operating in different and unspecified industries. We came up with the idea, that obtaining facts about threats and possibilities with the Ukrainian business environment would give foreign investors essential initial information about the country. Ukraine is on the way to become a market economy. The implementation of several reform programmes has already been settled in the country. The process of implementing those reforms is a determining factor for the future development of the country, and it plays an important role for the Ukrainian business environment as well. We had a wish to develop an understanding towards how efficient the reform work has been in Ukraine, and that is why we decided to compare the reform process in Ukraine with Poland, since Poland is also a former centrally planned economy that has succeeded with the reform work. The sources of our information were interviews with different types of organisations, literature, Webb-pages, periodical etc. Early in the writing process we decided to interview foreign companies operating in the Ukrainian business environment. We viewed it as important to achieve the information directly from Ukraine since we endeavoured to the nearness to the investigated market. We obtained the address to companies established in Ukraine in two different ways. First, the Swedish Trade Council informed us about the 1996 state visit to Ukraine. The participants in the 1996 state visit were the Swedish Minister of Foreign Affairs and six Swedish companies that were interested in the Ukrainian market. Further, while we contacted those six companies, we obtained names and addresses to contact persons at five of these. Through our contact in Russia, Mr Nikolay Reshetov, Managing Director of the Russian Maritime Register in St Petersburg, we could get in touch with another six foreign companies operating in Ukraine. Those companies had different countries of origin and are operating in different lines of businesses. 13 We received a quite high response rate on our questionnaire. 9 out of 11 companies answered. We interpret this as the companies having a high interest in our research. The majority of our respondents wished to receive a copy of our research report. Early in the process, while we were discussing the purpose of our research, we wanted to find a model that would help us through our analysis of the Ukrainian business environment. We went through several models and eventually chose the market screening model. Thereafter, we added two additional frameworks from the theory that would be useful in our analysis. In the end we had a model that was mostly based on the market screening model, but adapted in such way that it better suited our purpose. Having obtained a further developed market screening model and gathered the information needed we started with the analysis. The analysis follows the steps in the further developed market screening model. This helped us considerably in structuring the research. Based on the analysis we then drew conclusions about the opportunities and threats that affects foreign companies in the Ukrainian business environment. 14 3. THEORETICAL FRAMEWORK First in this section, authors will present a market screening model, which is suitable for analysing a new market. Further, we will briefly describe two additional theories concerning political risk and transition economies. These three theories will constitute the foundation for our research of the Ukrainian business environment. As a starting-point in the purpose of the research, which is to develop an understanding toward the Ukrainian business environment, we searched for a model that would be suitable as a tool when analysing this specific market. The models we found in the literature were similar in many ways, consisting of the same factors. Though some models were more thorough and detailed than others were as they were dealing with specific industries. We did not have the opportunity to make a too thorough analysis of Ukraine and, initially, we did not possess much knowledge concerning the market. Therefore, we believed that a general analysis of the Ukrainian business environment as a potential market for foreign companies would suffice. In accordance with our premises we chose the market screening model. The market screening model consists of different factors that are distinguish for a national market in specific as well as it is suitable and easy to apply on different enterprises. The model deals with six environmental components. To begin with the model aims for an investigation in order to locate the basic need potential for a specific product in a new country, as well as analyse the need for import in the country. The following steps in the model aim to investigate the economical, political and sociocultural factors in the country. The last step in the model treats the visit to the country in question and a direct investigation at place. 3.1. Market screening Market screening is a method of market analysis and assessment that permits management to identify a small number of desirable markets by eliminating those judged to be less attractive (Ball, 1993, p. 487). This is accomplished by subjecting the countries to a series of screenings based on the environment forces. 15 Figure 2: Market Screening model Market screening Initial screening Basic need potential and/or foreign trade and investor Second screening Economic and financial forces Third screening Political and legal forces Fourth screening Sociocultural forces Fifth screening Competitive forces Final selection Personal visits and, in some cases research in the local market Source: International Business, Ball et al, 1993, p 487 3.1.1. Initial Screening An initial screening based on the basic need potential is a logical first step, because if need is lacking, no reasonable expenditure of effort and money will enable the firm to market its goods or services. For example, the basic need potential of certain goods is dependent on various physical forces, such as climate, topography, or natural resources. When a basic need is clearly indicated, most experienced researchers will still investigate the trade flows to have an idea of the magnitude of present sales. Imports alone are rarely a measure of full market potential. Myriad reasons are responsible, among which are lack of foreign exchange, high prices, and political pressures. Import data indicate that a country has been buying certain products from abroad and are not guarantee that it will continue to do so. Management knows that a competitor may decide to produce locally, which in many markets will cause import to cease. Change in countries political structure may also stop imports. 16 The result from this step will be analysed by the authors to find out what specific needs there are in the investigated market. As an example, the geographic situation and climate in the market can result in different consequences for different enterprises. To develop a wider understanding of the investigated country we proceed to step number two. 3.1.2. Second Screening - Financial and Economic Forces After the initial screening, the analyst will have a more limited list of prospects. A second screening based on the financial and economic forces may further reduce this list. Financial data Trends in the rates of inflation, exchange rates, and interest rates are among the major financial points of concern. The analyst should consider other financial factors such as credit availability, paying habits of customers, and rates of return on similar investments. Economic data Economic data may be employed in a number of ways, but two measures of market demand based on them are especially useful. These are market indicators and market factors. Other methods for estimating demand that depend on economic data are regression analysis, trend analysis, and cluster analysis. 1. Market indicators Market indicators are economic data that serve as yardsticks for measuring the relative market strength of various geographic areas. The indicators include population, GDP, various categories of private consumption expenditures, and the production or consumption of steel, cement, electricity, and energy. These indicators are weighted and combined to form composite indexes of (a) market size, (b) market intensity, and market growth (c). a). Market size shows the relative size of each market as a percentage of the total world market. The percentages for each market are obtained by averaging data on population (given double weight), urban population, private consumption expenditures, steel consumption, cement and electricity production, and ownership of telephones, cars, and television sets. b). Market intensity measures ”the richness of the market” or the degree of concentrated purchasing power as compared to the world intensity of 1.00. The intensity for each market is calculated by averaging per capita consumption of energy, ownership of passenger cars, and telephone access lines. Double weight is given to overall private consumption expenditures. The proportion of urban population is also included and double-weighted because in many developing countries, much of the rural population does not actually participate in the money economy. c). Market growth is an average of percentage growth of the following indicators over the past five years: population; steel consumption; electricity production; ownership of cars, trucks, buses, and television sets; private consumption expenditure; and real GNP. An analysis of these three indexes will show which major regions and major markets were the fastest growing, what their growth rates were, and which have a highest degree of concentrated 17 purchasing power. By comparing the values of the indexes with the sales results of the company’s subsidiaries, management can quickly judge their performance. 2. Market factors Market factors are similar to markets indicators, except they tend to correlate highly with the market demand for a given product. If the analyst of foreign market has no factor for that market, he or she can usually use one from the domestic market to get a reasonable approximation. Moreover, an analyst who works for a multinational firm may be able to obtain market factors developed by comparable subsidiaries. To be able to transfer this relationships to the country under the study, the analyst must assume that the underlying conditions affecting demands are similar in that market. In this step we shall take a closer look at the country specific conditions typical for the country investigated, as well as the financial factors typical for the country. Financial data will show us how the financial system in the country works. It might as well be interesting for us to look at the development of financial indicators during the recent years. Indicators such as: inflation, exchange rate, interest rate, credit availability and paying habits of customers might be of common importance for all foreign investors. Rates on return are more company specific and therefore not in our interest to investigate. Based on market indicators, that is economic data, we intend study the country specific indicators in the country. To study such indicators from the latest years might clarify the development in the country. Market factors are more company specific, since they correlate with a demand for a specific product. Therefore, we will not further investigate these factors at this stage. 3.1.3. Third Screening - Political and Legal Forces Political forces The political climate within the country a company operates, is as essential as the topography, and meteorological climate of the country. Many of the political forces with which business must cope have ideological sources. Such names as socialism, capitalism, liberal, conservative, left, and right wing are used to describe governments, political parties, and people. These names indicate ideological beliefs. But there are also a large number of other sources. These include nationalism, terrorism, traditional hostilities, unstable governments, international organisations and so forth. Legal forces International business is affected by many thousands of laws and regulations on hundreds of subjects that have been issued by states, nations, and international organisations. Some of these forces concern every business, whereas others involve fewer firms. 18 Taxation Multinational companies, unlike a domestic firm, which is based in one country, come under the jurisdiction of more then one tax authority. Each country has its own taxation rules and regulations and as such the MNC’s are subjected to various taxation treatments concurrently. Countries differ in their position towards foreign companies. Some would like to encourage incoming foreign direct investment, and use tax incentives to this end while others use high taxes in order to discourage the repatriation of foreign firms’ profits. Entry barriers Entry barriers vary for the company, depending on whether management is considering exporting or setting up a foreign plant. In certain lines of business where the host country tries to defend domestic companies those barriers can be very large. In other lines of business that are under growth and development those barriers are less bothering. Profit remittance barriers When there are no objectionable requisites for entry, a nation may still be excluded if there are what management believes to be undue restrictions on the repatriation of earnings. Limits linked to the amount of foreign investment or other criteria may be set, or the nation may have a history of inability to provide foreign exchange for profit remittances. Tariffs, Quotas, and other trade obstacles The purposes of tariffs are to raise revenue for the government and to protect domestic producers. Tariffs are either ad valorem, which means they are a percentage of the value of the imports, or they are specific. The specific tariff is based on the weight or number of items imported. Quotas, which limit the number or amount of imports, are for protection. There are many other forms of protection or obstacles to trade in national laws. Some are health and packaging requirements. Other concerns language. Price and wage controls Price and wage controls are prohibitions or limits on upward movements of prices or wages that are imposed by governments to combat inflation when the government has been unable or unwilling to slow or halt it by fiscal or monetary measures. This step is very important for us since we are investigating a country that is in an economic transition. Political forces might be strong in former communistic countries. The countries that are now transforming to market economies can still in some extension be bonded to the communistic ideology. New political parties might also affect the political thinking in the country. We are interested to see the impact of those ideologies on the business environment in Ukraine. Legal forces might affect all the foreign enterprises and they can be more specific depending on the line of business. We want to investigate the legal forces that affect all different types of foreign investors. 19 3.1.4. Fourth Screening - Sociocultural Forces Culture is defined as historically involved values attitudes and meanings which are learnt and shared by the members of a given community, and which influence their material and non-material way of life. People that live in the same culture learn these shared characteristics through different stages of the socialisation process of their lives in institutions such as family, religion, formal education and the society as a whole. A culture in a certain country has an implication for business environment and foreign companies acting there. It is important for foreign investors to know the culture, customs and what is and what is not accepted in the country. Knowledge about those factors will help enterprises to act adequately in the new market. A screening of the country on basis of sociocultural factors is difficult because these are highly subjective. The analyst, unless he is a specialist in the country, must rely on the opinions of others. It is possible to hire consultants, but they are expensive. Reading Overseas Business Reports (US Department of Commerce), international business publications (Business International and The Economist), and specialised books will improve the analysts sociocultural knowledge. The use of the checklist of the principal sociocultural components will serve as a reminder of the many factors the analyst must consider in this screening. Checklist of the principal sociocultural components 1. Aesthetics Aesthetics is a culture’s sense of beauty and good taste. Aesthetics is expressed in the culture’s art, drama, music, folklore, and dances. 2. Attitudes and beliefs Every culture has a set of attitudes and beliefs that influence nearly all aspects of human behaviour and help bring order to a society and its individuals. Among the wide variety of subjects covered by attitudes and beliefs, some are of prime importance to the businessperson. These include attitudes toward time, toward achievement and work, and toward change. 3. Religion Religion, an important component of culture, is responsible for many of the attitudes and beliefs affecting human behaviour. A knowledge of the basic tenets of some of the more popular religions will contribute to a better understanding of why people’s attitudes vary so greatly from country to country. 4. Material culture Material culture refers to all manmade objects and is concerned with how people make things and who makes what and why. 5. Education Formal education, especially in those societies where there is a well-developed educational system, contributes to the formation of culture, both through the value system and the priorities on which it is based on as well as the teaching practices and styles. 6. Language Communication or language is probably the most apparent cultural distinction that the newcomer to international business perceives. Differences in the spoken language are readily discernible, and after a short period in the new culture it becomes apparent that there are variations in the unspoken language (manners and customs) as well. 20 7. Societal organisation Every society has a structure or an organisation that is the patterned arrangement of relationships defining and regulating the manner by which its members interface with one another. In this step we will try to get an understanding of the culture in the investigated country. Having done that we shall see how it affects business environment and foreign companies operating there. After the fourth screening, the analyst should have a list of industries for which a demand appears to exist. The two following steps that are described will not be taken into consideration in our analysis. In step five a company shall investigate competitors and their strategies on the new market. This implies that the outcome depends on the type of company and how the results differ between companies and lines of business. We want to reach conclusions that could be essential for all the foreign investors. Thereby we will not go further into this step. In step six the company is recommended to make a visit to the country and get all the information needed on the very market itself. This visit is the last thing the company is advised to carry through before it decides whether to establish in the new market or not. This step is also company specific and we therefore chose not to go further into this step. Since these steps are included in the model we will give them a brief description. 3.1.5. Fifth Screening - Competitive Forces In this screening, the analyst examines markets on the basis of such elements of the competitive forces as the number, size, and financial strength of the competitors, their market shares and marketing strategies, their pricing policies and so forth. Countries, in which management believes strong competitors make a profitable operation difficult to attain, are eliminated. This will occur unless: the management follow a strategy of being present wherever its global competitors are, or believes a reason for foreign investment to be the entrance of a competitors home market to distract the competitors attention from its home market, 3.1.6. Final Selection of New Market An executive of the firm should visit those countries that still appear to be good prospects. Before leaving, this person will review the data from the various screening along with any new information that the researcher can supply. Based on this review and on experience in making similar domestic decisions, the executive will prepare a list of points in which information must be obtained on arrival. Management wants the facts uncovered by the desk study (the five screenings) to be corroborated. Furthermore, the management will expect a firsthand report on the market, which will include information on competitive activity and appraisal of the suitability of the firms present marketing mix and the availability of ancillary facilities (warehousing, service agencies, media, credit, and so forth). The field trip should not be hurried, since as much time should be allotted to this part of the study that would have been spent on a similar domestic field trip. Often time can be saved if the executive can join the government-sponsored trade mission or visit a trade fair, because such events attract the kinds of people this person will want to interview. 21 3.2. Political risk - a deeper perspective As we have already mentioned in step three in the Market screening model the political forces are of essential meaning for foreign companies doing business in former communistic countries. The risk from eventual political events can affect the business activity in a negative way. Our chosen market, Ukraine, is in the middle of a complicated process of transforming the country into market economy. As such we believe that further explanation of political risks than what has been discussed in the market screening model would be appropriate. This because the transition requires a lot of political support in orders to succeed. In these transition economies there are strong forces that wants things to be returned to the “good old days”. This will result into disagreement between the political leaders and greater turbulence and risks in the market. Political risk can be defined as “...probability of domestic or foreign firms activities being adversely affected by the actions taken by the state” (Tayeb, 1992, p. 28). 3.2.1. Sources of political risk Political risk can occur at three levels: national, industry and firm. At the national level, some countries seem to be more risk prone than others. Although it is difficult to generalise, nations that experience a greater degree of political instability are more likely to cause problems for foreign firms. A change in government through revolution or elections or just change of leadership can lead to changes in the policies affecting foreign firms. These policies can be related to such areas as foreign exchange controls, foreign investment inside the country, taxation, price controls and profit remittances regulations, and shift of emphasis in foreign policy towards certain countries. At the industry level, the potential for political risk is greater for strategic industries, such as oil, steel, power stations, arms and weaponry, and high technology, than for non strategic ones. At the firm level, political risk is potentially great if, for instance, the company produces a large amount of the host countries GNP; or if it is a subsidiary of a powerful multinational which can or does exert political and economic pressure on the host country. 3.3. Country and firm specific political risks Stephen Kobrin has classified contemporary political risks along two dimensions. The first dimensions distinguishes between country-specific risks that affect all foreign firms in the country, without regard to what they do, and the firm-specific risks that are specific to an industry, a firm, or a project (Eiteman, 1998, p. 513). 22 Figure 3: Country and firm specific political risks Political risk Firm specific risks Country specific risks Expropriation (Directed toward ownership of foreign firms) Ethnic strife (Foreign firms are only bystanders, but get hurt Goal conflict (Responsible goals of governments and firms diverge) Corruption (A ”way of life” in many countries) Source: Multinational business finance, Eiteman et al., 1998, p 513 3.3.1. Country specific risks Expropriation risk Expropriation is defined as official government seizure of private property. It is recognised by international law as the right of any sovereign state, provided the expropriated owners are given prompt compensation at fair market value in convertible currencies. Fair market value is in the eyes of the beholder, with firms usually arguing for a ”going concern” value tied to the present value of lost future cash flows. Risk from ethnic, racial, religious, tribal conflicts , or civil strife The decade of the 1990s has seen the rise of a second type of country specific political risk, caused by ethnic, religious, tribal, or civil strife within a country. Strife from these causes appears at this time in history because of, among others, the sudden end of the overarching tension that had previously existed between the Soviet Union and the Euro-American alliance, which had as a byproduct the supervision of ”minor” conflicts (Eiteman, 1998, p. 514). A recent example of these new types of strife is a civil war in Yugoslavia. 3.3.2. Firm specific risk Goal conflict The most important type of firm specific risk arises from a conflict between objectives of government and private firms. Major areas of conflict may be economic and/or non-economic in nature. 23 Economic conflict may arise including the following: monetary policy, fiscal policy, balance of payments and exchange rate policy, economic protectionism, economic development policies. Two common non-economic arguments against multinational firms are: 1. Economic imperialism. In many countries, for example in ex-colonial countries, a widespread suspicion exists that multinational firms represent a new and insidious form of imperialism. 2. National security and foreign policy. Host countries sometimes become alarmed that foreign control of key industry sectors will impair national security or an independent foreign policy. Corruption The administrative machinery in the host country might be bedevilled with corruption and incompetence. This can force foreign firms, in their efforts to obtain a license to operate in or deal with a country, to be caught in a complicated web of bureaucratic procedures and paperwork. They may also have to deal with corrupt officials who would manipulate the situation in order to extract commissions from the firms before granting them permission to trade. Once the permission is granted the firms have to co-exist with these people and procedures for as long as it intends to continue its operations in that country. Not knowing the rules of the game is likely to jeopardise the foreign firms successful operation and therefore be a source of risk and threat. 3.4. Transition economies Ukraine is a former centrally planned economy, which is in transition toward market economy. If it succeeds then it will become an important market due to its geopolitical situation, size and the natural resources that it posses. But if it fails in its reforms and returns to being centrally planned, the market will then be closed to foreigners. The government will then, most likely, expropriate the foreign companies established there. There are serious risks involved here and we therefore believe that it would be important to examine Ukraine’s transition towards market economy. Besides assessing Ukraine’s commitment towards becoming a market economy, the examination will also serve another purpose. It will give an indication as to how far Ukraine has changed from being a centrally planned economy. This is important as transition economies usually experience a turbulent period in the beginning when the old system is dismantled while the new one is still not in place. This means greater risks involved for the foreign companies investing in the country. In order to better understand the kind of changes that Ukraine has gone through a comparison will be made with another former centrally planned economy which is in transition like Ukraine. What follows here is some theoretical background of what market and centrally planned economies are and the changes that needs to be implemented by a centrally planned economy to become a market economy. The basic elements of an economic reform program are taken from several different books written by Isachsen et al, Bosworth and Ofer, and Gros and Steinherr. 3.4.1. Centrally planned economies and market economies Centrally planned economies are characterised by the centralisation of decision making. (Lipsey et al., 1993). Central authorities, which decide what to produce and the procedure in producing, determines economic behaviour. This involves an elaborate plan that encompasses every stage in 24 the supply chain. Each level of the supply chain must receive enough material to be able to produce just the right amount ordered by the central authority for the next level of the supply chain. The sheer quantity of data needed is enormous and the effort to analyse these data in order to produce a fully integrated plan is staggering. Add to this the fact that the plan needs to be continually changed and it is perhaps not so hard to understand the problems inherited in this kind of economy. Centrally planned economies are also characterised by the issue of ownership. Most assets are public-owned i.e. owned by the state. In market economies the decision about resource allocation are made without any central direction. (Lipsey et al., 1993). Instead they result from innumerable independent decisions made by individual producers and consumers. This leads to better flexibility towards change. Even though the decisions are decentralised they are still co-ordinated and the main co-ordinating device is the set of market-determined prices. In market economies, most assets are privately owned. So far there have not been any economies that are purely centrally planned or market economies. Instead every economy is a mixture with different degree of the mix. The United States are often considered as the prime example of a market economy but even there some principals from centrally planned economies do exist. Minimum wages, rules and regulation for environmental protection, restrictions on the import and such are prime examples. This proves that not everybody believes that a pure market economy is the answer to abolishing inequalities. Though market economies has proven to lead to a much better growth than centrally planned economy, which has led to many former centrally planned economies implementing reform programmes in order to switch to market economy. These economies are called transition economies. 3.4.2. Basic elements of an economic reform program There is an agreement among the experts that a reform program should consist of these basic elements: Price liberalisation, Privatisation, Development of a financial system, Macroeconomic stabilisation, and Foreign sector liberalisation. Price liberalisation: An efficient market requires a rational set of prices that can signal the appropriate allocation of resources. Prices must be freely determined in line with underlying resource costs before world market will open up to the products of the transitional economies. In the old system, the price was determined by a central agency and did not necessarily reflect the real value of the product. Privatisation: The issue is not about private ownership but how to introduce an effective system of governing and controlling the enterprises. One way is to have foreigners invest in the country, bringing with them their expertise and technology. Unfortunately there are drawbacks to this approach. The foreigners usually seek to limit competition as a condition of their entry. There is also domestic resistance to giving away national resources. The advocates of privatisation consider this as an important way of dismantling the old organisation and ensuring that the reform process will not be reversed. Development of a financial system: Under the old system of bureaucratic control, the financial system played no allocating role in distributing savings to the most efficient investment projects. Worse, it had no means to discipline firms to ensure that scarce capital was used efficiently. The investment decisions were made and financed through the government ministries and thus the financial system played no part in the evaluation of projects. 25 The new financial system will have two roles to play. On one hand they must finance the enterprises. On the other hand they must discipline the enterprises and force them to conserve scarce capital, as these enterprises did not have the problem of capital before. Macroeconomic stabilisation: Macroeconomic stability involves a balance between public expenditures and tax revenues (p 225). It sounds simple but it entails a lot of elements. Economic reform brings with it a sharp decline in government revenues. The old fiscal system relied heavily on the surpluses of state enterprises and turnover taxes to finance the state budget. The reform led to a collapse of the state enterprise profits and the government has no effective mechanism for collecting taxes from the newly emerging private sector. On the expenditure side they did not have to subsidise the state-owned enterprises but a new social safety net program needed to be developed. Also some responsibilities held by the state-owned enterprises, such as health care, education, and housing, was transferred to the government. In order to achieve price stability the increase of wages must be restrained. But this is hard to accomplish, as the management of the enterprises is weak and do not have any incentives to do so. Tax is on profit and not on the value added on goods or service. Foreign sector liberalisation: An early opening of the external sector has generally been viewed as critical to the reform process. The global market provides a most relevant guide to a rational price structure. Foreign competition is considered the simplest way to introduce competition into the domestic market. A convertible currency and free trade would assist in evaluating the competitiveness of state enterprises. Although Western advisers encouraged this rapid opening it is sometimes forgotten that the western countries have had several decades to evolve into its present state. Liberalisation in the foreign sector involves changing the trade policy and the exchange rate policy and convertibility. A change in the trade policy entails allowing individual firms to engage in foreign trade. The changes in the exchange rate policy entails establishing an exchange rate and deciding on whether or not it should be a fixed rate, a floating rate, or a crawling peg (floating within a set interval). Convertibility refers to the freedom to convert between national and foreign currencies. There are degrees of convertibility. Current account convertibility allows foreign exchange for the purpose of settling transactions involving the purchase of goods and services, the payment of interest, and repatriation of profits. Full convertibility, also called capital account convertibility, extends this principle to the purchase and sale of assets. All of these elements are not separate issue but interrelated. In the beginning when the enterprises still had a good supply of capital, the liberalisation of price led to a sharp rise in inflation and threatened the country specific stability. Foreign sector liberalisation with increased competition as a result led to bankruptcy and high unemployment. Privatisation of the financial institutions would bring expertise and technology from abroad but might threaten the existing state owned banks. 26 4. A FURTHER DEVELOPMENT OF THE MARKET SCREENING MODEL In this section we will modify the market screening model as well as adding further steps which will consist of important aspects presented in our theoretical framework. The chapter will be concluded with a presentation of The further developed market screening model, which will constitute as a structure throughout the thesis. Earlier we have stated that we will to limit our research to give a broad presentation over the Ukrainian business environment. We do not intend to focus too deeply on details, which applies to specific industries.We will rather deal with the business environment as a whole. Therefore we do not intend to follow all the steps in the Market screening model. Instead we will use the first four steps of the Market screening model and exclude the last two as they are aimed towards specific companies. As Ukraine is a relatively new market for foreign investors and is experiencing major political changes in its transformation towards market economy, we intend to give more focus on the political aspects compared to the Market screening model. As a result of this we have incorporated some elements from Kobrin’s model, concerning political risks, into step three in the Market screening model. In accordance to our purpose and delimitation we have incorporated Kobrin’s country specific risks in our model. We have also incorporated corruption into the model, even though it is classified as a firm specific risk. The reason behind this is that we believe that corruption is a factor that affects all the foreign companies established in Ukraine. Corruption is an aspect that is common in transition economies. Most people will have it worse off in the beginning of the transition and some will seek alternative ways to make a living. This will lead to corrupt government officials and strong criminal elements, such as the Mafia, targeting the better off foreigners. Earlier we have discussed that one important element which makes Ukraine interesting is that it is striving to become a market economy. If it is successful then it will become a major market in Europe. As such we thought that it would be important to look into how much they have done in order to become a market economy. The reasons are twofold. First, it will give an indication to the Ukrainian people’s commitment towards market economy as a reversal back to planned economy would be a catastrophe for those foreign companies that have established themselves there. They might then risk expropriation, as the government owns all assets in centrally planned economy. Second, the analysis, when compared to another former centrally planned economy, which has succeeded in its transition, will give an indication as to how far Ukraine has left in their development before fulfilling its potentials. Entering early in the market can allow the company to dominate the market towards other foreign companies but there are considerable risks involved. Therefore it might be wise to wait until the country has developed more so that the risks involved are minimised. Due to this, we have decided to add another step into the model, entitled Basic elements of an economic reform program. The reason for this is that all of the elements in the reform program are political in nature. We chose not to incorporate it into the third step because we believe that the topic of transition deserved its own attention. In our analysis we will take the results we have acquired from the Basic elements of an economic reform program step and compare it with another former centrally planned economy. We have chosen Poland, as we believe that they have succeeded in their transition. They are considered a candidate for EU membership and many companies have already invested in this country. Therefore, Poland is no longer considered as a “new market”. 27 The comparison is not about finding out which country is better to invest. We do not intend to analyse the Polish business environment as we have the Ukrainian. The aim of the comparison is to see whether or not we can determine how far behind Ukraine is in their reform program. As such we will compare these two countries in those elements described in step alpha and no other. After Basic elements of an economic reform program step we will return to the original Market screening model and go through step four. We will then complete our analysis and draw a general conclusion concerning the Ukrainian business environment, based on the results that we have achieved. The further developed market screening model will therefore, as well, serve as a guidance to the structure of our analysis. Initial screening Specific needs in the market, geographic situation, imports Second screening Economic forces (market indicators) and financial forces Basic elements of an economic reform program. Third screening Political and legal forces Fourth screening Sociocultural forces Political risks 1. Ethnic, Racial, Religious risks 2. Corruption 3. Expropriatio n risk Conclusions about the investigated market Figure 4: The further developed market screening model 28 5. UKRAINE The disposition in this chapter is structured according to the further developed market screening model. The authors will focus on essential factors concerning the Ukrainian business environment. The chapter consists of secondary data from different sources as well as primary data based on interviews conducted with foreign companies in Ukraine. A complete summary of the interviews is to be found in Appendix C. 5.1. Ukraine and its history 5.1.1. History Recorded Ukrainian history is usually dated back to the Kyivan Rus in the seventh century. Kyiv Rus was a powerful state in the 9th to the 12th centuries; its rulers introduced Christianity and established Ukraine as a sovereign state. The collapse of the Kyivan Rus in the 13th century was followed by centuries of instability until a treaty signed in 1654, which effectively divided the territory between Poland and Russia. Ukraine remained under foreign rule until 1917, when it enjoyed three years of independence in the wake of the Bolshevik revolution. In 1920, Ukraine came back under Russian dominance. Industry and commerce were nationalised, private property outlawed and in the 1930s agriculture was collectivised, which took place at great human cost. As part of the Soviet Union, Ukraine was supplying for much of its agriculture needs. Ukraine was also one of the Soviet Unions main production centres, supplying much of the heavy industry. It expanded geographically, western Ukraine was attached to the main state in 1939, and Ruthenia after 1945. Crimea was part of the Russian Federation until 1954 when Khrushchev transferred it to Ukraine to mark 300 years union between the two countries (Coopers & Lybrand, 1997). Kyiv gradually became the focus for the independence movement that started in the west of the country in mid 1980s. The cover-up following the Chernobyl disaster in 1986 together with the activism of the independence group Rukh fuelled the demand for political mobilisation. National awareness grew rapidly. Ukraine’s Prime Soviet, which was dominated by the communist party, requested independence on the 16th of June 1990. They claimed that Ukrainian laws should be in prior to Russian laws. Following the failed coup against President Gorbachev on the 19th to the 21st of August 1991, Ukraine, in common with the other republics, declared independence on the 24th of August the same year (Coopers & Lybrand, 1997). The December 1991 referendum found 95% of Ukrainians in favour and former communist party Leonid Kravchuk became independent Ukraine’s first president. After the statement of Ukraine’s independence, many believed that the economical situation automatically would get better. Instead, the overlapping period has been very difficult for the majority of the population. The economy was still managed by the government, centrally planned economy. The economical situation was a catastrophe, for example, during 1993 there was an inflation with 10 000%. The dissatisfaction with Leonid Kravchuk was great. Under President Kuchma, who became state president after winning the July 1994 presidential elections, economic reform and boosting Ukraine’s appeal to foreign investors have become an issue of high priority. 1996 was an extremely important year for the independent Ukraine: the passing in June of a new constitution guaranteeing private property and the freedom of speech, 29 coupled with the introduction of a new national currency in September. Unfortunately, Kuchma´s reform-approach is not in line with the communist-dominated parliament. Therefore, the conflicts between the presidential and the parliament have had a restrained effect on the development (SIDA, Ukraine, 1997). Ukrainian is the official language although Russian is very widely spoken, particularly in the east, and in Crimea. English and German are increasingly common, especially amongst the emerging entrepreneurial class in the main cities. 5.1.2. Geographic situation Area: 603 700 km sq. Neighbouring countries: Russia, White Russia, Poland, Slovak republic, Hungary, Rumania, Moldavia. Capital City: Kyiv. Other major cities: Charkiv, Dnipropetrovsk, Donetsk, Odessa Most important rivers: Dnjepr, Danube, Dnjestr, Southern Bug, Northern Donets. Biggest lakes: Dnjestrovskij liman, several artificial lakes along Dnjepr and Dnjestr. Source: European Community, EU/Ukraine relations, 1998 Ukraine's area is 603,700 sq. km. The country is slightly larger than France. Ukraine is mainly a vast plain with no natural boundaries except the Carpathian Mountains in the south-west and the Black Sea in the south. The Dnipro River with its many tributaries unifies central Ukraine economically, connecting the Baltic coast countries with the Black Sea and the Mediterranean Sea. The mouth of the Danube River provides an outlet for Ukrainian trade with the Balkans, Austria, and Germany. Ukraine has extremely fertile black-earth soils in the central and southern portions exceptionally well-suited for agriculture. In the east is the industrial heartland containing large reserves of mineral deposits known as the Greater Donbas or Donetsk Basin. Northern and western Ukraine is hilly forested areas with many mountain resorts. Enhancing the topography of Ukraine are two mountain ranges, the Carpathian on its western border with winter sports attracting visitors; and the Crimean range, which divides the Crimean peninsular, creating a semitropical area on its southernmost tip. The Crimea is a favourite destination not only for Ukrainian tourists, but also for citizens of other states of the former Soviet Union, as well as the eastern and the western Europe. 30 5.1.3. Population Population: 50.8 million (July 1996 est) Population per km sq.: 84.5 Urban population: 36.5 million (71.6%) Increase of population: -0,2% Life expectancy: Men 64.2 yrs, Women 74.2 yrs. Adult literacy: 98.4% Ethnical groups: Ukrainians 73%, Russians 22%, Jews 0.7%, White Russians 0.9%, Romanians, Moldavians, Bulgarians, Polish, Hungarians, Greeks, Germans etc. Source: The World Economic Factbook Ukraine’s population of about 51 million people consists mostly of Ukrainians and almost one fifth of Russians. In Crimea the majority of the population are Russians and almost half of the populations in the industrial area of eastern Ukraine consists of Russians. The minority of the population consists of Polish, Hungarians, Romans, living in the west, and Bulgarians, Greeks and Germans in the south. The official language of Ukraine is Ukraine, which is closely related to Russian. Until 1991, before the declaration of independence, Russian was the language spoken by the government officials. At the same time there were few schools that spoke Ukraine. This lead to a majority of the population, even those identifying themselves as Ukrainian, are only able to speak Russian (Länder I Fick format). 5.1.4. Infrastructure Transport Ukraine’s principal international airport is Borispol, which serves Kyiv and the Kyiv region. Refurbishment work was concluded in 1995. Irish partners supported the refurbishment with credit from the European Bank for Reconstruction and Development (EBRD) and through the EU-Tacis scheme (SIDA, Ukraine, 1997). There are regular flights from Kyiv to a number of western capitals run by Ukrainian International Airlines (UIA) LOT, MALEV, Lufthansa, British Airways and Austrian Airlines. Ukraine’s second and third airports are Odessa and Lviv to which Austrian and Lufthansa fly. In September 1995 international flights began to run from Khakiv airport, in eastern Ukraine. The airport serves numerous destinations in the Commonwealth of Independent states (CIS) and is connected to Kyiv and other Ukrainian cities by regular flights. UIA recently introduced regular flights between the capital and Kharkiv linking on to its international flights. State-owned Air Ukraine remains the country’s national carrier with a fleet of 240 mostly Soviet planes. Air-Ukraine serves a number of cities in Russia and elsewhere in the CIS. It has problems concerning the safety standards – between one third and a half of its fleet is grounded – and is expected to purchase a number of western aircraft to replace its ageing fleet. Over 1996 Air Ukraine entered into a joint venture with an Israeli company to form AeroSweet; the airline flies to destinations in the near east and Levant. 31 Ukraine’s surface transport infrastructure is extensive – there is 22 630 km of railroad and 247 300 km of road. Though the actual quality of the roads are not very good and in need of modernisation (SIDA, Ukraine, 1997). The rail system, on which around 20% of the transportation of food and other cargoes are dependent, is bankrupt. The government is committed to improve the surfacing of Ukraine’s roads. Currently some 45% are unpaved but shortage of money has made progress very slow. Telecommunication With around 18 telephone lines per 100 inhabitants and a waiting time of around 7 years for a phone, Ukraine’s telecommunication system is in critical need of modernisation and development. The situation looks more promising if focused on the largest cities where there are around 40 telephone lines per 100 inhabitants. Though demand is far in excess of foreseeable supply, especially in the cities but also to a growing extent in rural areas (SIDA, Ukraine, 1997). Ukrtelekom, the state-owned national telecommunication operator, has launched a US$ 20 billion programme to lay new lines and install digital exchanges. The goal is 35 telephone lines per 100 people by the year of 2005. It has also established a joint stock company, Telekominvest, to help attract investment into the network. A number of western firms have already contracts to modernise elements of the system and are working with local telecommunication authorities to improve service and lay more lines. These include AT&T (US), Siemens (Germany), Northern Telecom (Canada), Alcatel (France), Ericsson (Sweden) and LG Group (South Korea). The EBRD has completed two of the telecommunication projects. Given the time-frame for the building up of surface telecommunication and the strong demand, it is no wonder that mobile telecommunication firms have entered the Ukrainian market with enthusiasm. Many of the above companies are directing their efforts to improve the availability of mobile phones in Ukraine. In addition Ukrainian Mobile Communications (51% owned by Ukrtelekom, 16.33% by Koninklijke PTT Nederland, 16.33% by TeleDanmark and 16.33% by DBP Telekom of Germany) is committed to investing up to US$ 1 billion in a GSM 900 cellular network (SIDA, Ukraine, 1997). The majority of our respondents consider the transport system to be relatively undeveloped. Though, they consider the main transport directions to be in a relatively sufficient condition. The general opinion among our interviewees is that during the last years there has been some progress in the development of the telecommunication system. They believe that Ukraine is approaching to the standards of the southern European countries (Summary of interviews conducted in Ukraine 1998, see Appendix C). 5.2. Economical and Financial Situation 5.2.1. Macroeconomic situation As a result of a combination of policy mistakes and a particularly unfavourable inheritance from the Soviet era, Ukraine has experienced severe country specific instability over the past years. GDP, industrial output and agricultural production have fallen steeply, and inflation has been exceptionally high because of lax monetary and fiscal policies. Although the situation began to 32 improve during the second half of 1995, Ukraine failed to meet the targets agreed with the international agencies in respect of stabilisation and the privatisation of large enterprises and those with Russia and Turkmenistan in respect of payment debt on deliveries of oil and gas. Consequently, in January 1996 the International Monetary Fund (IMF) postponed disbursement of the two final tranches of 1995´s US$ 1.5 billion stand-by loan. However, the economic situation improved markedly during 1996, inflation fell sharply, nominal depreciation of the exchange rate slowed and foreign currency reserves increased. The improvement in the economic situation, coupled with additional financial support from the IMF, provided favourable conditions for the successful introduction of the country’s new currency, the Hryvnia, on the 2nd of September 1996 (Exportrådet, Kiev, 1997). To reinforce the progress achieved towards country specific stability, the government will need to maintain tight fiscal and budgetary policies. It will also need to finance the budget deficit through non-inflationary means, which in turn will require foreign financial assistance. In terms of the wider market reforms, it will be essential that deregulation of the economy continues. Furthermore, the legal and regulatory environment needs to be simplified and made more consistent in its affects on different sectors and companies. Finally, the enterprises have to be subject to greater financial discipline in their dealings with their suppliers, employees and the government (Coopers & Lybrand, 1997, p. 5). The majority of our respondents claimed that the current economical situation in Ukraine obstructs their business activity. The unstable economical situation makes it impossible to provide long-term crediting for investment projects. The companies are limited to short-term crediting, which inhibits their ability for strategically planning. Furthermore, the companies interviewed stated that the most recent financial crisis in Ukraine, which was a consequence of Russia’s default, implied reduced sales, difficulties to buy hard currency, violation of contracts, and increased control by the state. Companies operating in the gas and oil industry were hardest hit by the crisis (Summary of interviews conducted in Ukraine 1998, see Appendix C). Figure 5: Economic Indicators ECONOMIC FIGURES 1993 1994 1995 1996 1997 Inflation (%, end of year) 10155 401 182 40 25%* Exchange rate (per US$) 25,000 60,750 1.47 1.83 1.86 X X 122.7 79.9 49.1 Interest rate (% per annum, lending rate) GDP (US million) GDP per capita (US$ million) GDP (% real growth) Consumption (US$ million) Consumption per capita (US$) 132,271.0 128,013.0 37,010.4 44,006.6 49,666.5 2,533.9 2,451.4 716.7 861.4 973.7 -14.1 -23.0 -11.0 -10.0 -3.0 97,483.7 1,867.5 94,345.6 25,246.1 30,598.5 34,679.6 1,806.7 488.9 598.9 679.9 Source: SIDA, Ukraine, 1997, and The World Economic Factbook, Euromonitor, 1998, *estimation 33 5.2.2. Currency On the 2nd of September 1996 Ukraine introduced the long-delayed new currency, the Hryvnia. The Hryvnia replaced the interim currency, the karbovnets at a rate of 1:100,000 and an exchange rate of 1.76 to the dollar. The karbovnets was trading at 176,000 to the dollar at the time of the conversion. The currency, which is the sole legal tender of Ukraine, has since held steady against leading western currencies. In mid March 1997 the Hryvnia was trading at around 1.84 to the dollar (SIDA, Ukraine, 1997). 5.2.3. Production According to data from the Ministry of Statistics, foreign trade turnover increased by 17% during 1995 to reach US$ 23.0 billion. Export increased faster than imports, 20% compared to 14%, and the balance of trade was slightly positive. Raw materials and energy account for a very large proportion of the country’s foreign trade. In 1995, for example, petroleum products accounted for more than 50% of imports, while mineral products and ferrous and non-ferrous metals accounted for more than 50% of exports. Ukraine is highly dependent on Russia for all oil products and on Russia and Turkmenistan for natural gas. Although higher prices resulted in a sharp fall in energy imports, Ukraine is still having difficulty paying for them. However, the structure of foreign trade is improving as exports of manufactured goods grow strongly and imports of food and non-food consumer goods decline. Another positive development during 1995 was the decline of barter trade. In 1994 barter accounted for almost half of all foreign trade but in the first half of 1996 it had fallen to less than 25% (Exportrådet, Kiev, 1997). During the years of independence the total production in the state sector has declined with more than 50%. The production of consumer goods and agriculture products has suffered the most. Only a few of the state industries have increased their production, i.e. sugar- and alcohol manufacture and fishing. An important task for the government to deal with is to decide what parts of the giant state sector that can be saved and improved. The reasons for the decline in Ukraine’s production are the following (Bekkers, 1993): Ukraine uses obsolete machines from the 1960s. The hidden unemployment is about 30% with a consequence of a low level of production/worker. During the central planned economy the government decided what and how much each company should produce. Therefore, the companies lack knowledge when it comes to identifying the demand for the products for example. Ukraine has paid the market price for oil, which has resulted in increased energy debts. Due to the great debt to Russia there has been a contraction of oil deliveries. Russia delivered 60 millions of oil at 1990 compared to 15 millions at 1993. Nevertheless Ukraine has some production advantages. One advantage is that the country has a skilled workforce. This is a consequence of a well-developed industry that Ukraine has possessed for a long time, unlike the other former Soviet republics. There are a considerable number of specialists among the workforce that are able to organise current production, solve complicated 34 tasks and master new processes and equipment (Doing business in Ukraine). Other examples are the low cost for workforce due to the low wages and the great natural resources. Industry Compared to the other former Soviet republics. Ukraine has a well-developed industry with a high level of industrialisation. Their industry covers fields such as mining, iron and steel, oil and gas, chemical and petrochemical, manufacturing, building, textile and food. The manufacturing industry used to account for about half of Ukraine’s total industrial production. The reason is mainly Ukraine’s important position in the defence of the former Soviet Union (FSU) concerning military electronic and shipbuilding. An important part of the Ukrainian industry is owned by the military complex, which provides 20% of the labour with work. The manufacturing part of the total industry has declined dramatically since the collapse of the former Soviet Union (FSU) – from 30% in 1990 to 14% at the end of 1995. (Exportrådet, Kiev, 1997). Ukrainian industry is heavily energy-intensive: after the United States and Russia, the country is the third largest consumer of gas in the world. The reason for this is that it enjoyed heavy subsidies when it was part of the FSU. At present, Ukraine’s energy debts, mainly owed to Russia and Turkmenistan, topped US$ 6 billion by the end of 1996. As a consequence the dependence of Russia and Turkmenistan increases. Ukraine has been trying to reduce its dependence on these two suppliers through increasing exports from other sources, such as Uzbekistan. However to reduce its overall dependence on foreign energy sources, which some estimates suggest could reach an annual US$ 10 billion by the year 2005, Ukraine has to prioritise developing its own oil and natural gas resources (SIDA, Ukraine, 1997). A large part of the companies are at present dependent on government subventions. Ukraine lacks established manufacturing of consumer goods. The production of consumer goods has been neglected which implies that a giant structural rationalisation towards these industries is to be expected, with a higher level of unemployment as a consequence. The production has declined in practically all lines of business during the 1990s. A few signs of improvement have been recognised since the implementation of the economical reform started in the end of 1994. The industry production declined with 9% during 1995, but the electricity consumption declined with only 3%, which can be seen as a sign of increased economical activity. Agriculture Ukraine has long and rich agricultural traditions. The country is famous for its extremely fertile black earth, chernozern, which is unique to this part of Europe. Historically Ukraine was a major exporter of agricultural products to most countries of the FSU, Russia and Belarus in particular. Today agriculture accounts for an estimated 13% of GDP, though the figure used to be higher (almost 25% in 1991). There is export potential in sugar, vegetable oil, meat, dairy products, and fruit and vegetable products and sunflower oil. The growth for the agriculture production has declined since 1989. This can be explained by the fact that the soviet regime put priority in developing the heavy industry on the expense of the agriculture sector. Other reasons are environmental pollution, poor watering systems, and ineffective cultivation methods, lacking packing and stocking possibilities (Exportrådet, Kiev, 1997). Furthermore, many of the agricultural machines are unusable due to the increased cost for energy. A major bottleneck in the system is food processing which uses outdated technology and has low capacity. 35 Due to high prices for agricultural land and to continuing legal difficulties surrounding the sale or purchase, private farms are only 3.2% of the total. State farms are 60.2% while the collective share of the total is 36.6%. Some 60% of agricultural enterprises are now join-stock companies. To date, the state has sustained soft subsidies to the sector. The Ministry of Agriculture has been attempting to improve yields through western investments but this has not had much success due to a failure to reform the land law. Privatisation of the agricultural sector has been hardest to implement due to heavy resistance in the Parliament for “selling out the land”. Natural resources Ukraine completely satisfies its needs and has a considerable export potential when it comes to natural resources. Ukraine contains about 5% of the world’s total mineral resources. There are about 8,000 deposits of more than 80 types of mineral including iron core, coal, manganese, salt, sulphur, graphite, uranium, titanium, magnesium, kaolin, nickel, zirconium, lithium, and mercury. There is also a joint-stock company, created in late 1996 to co-ordinate exploitation of the country’s gold deposits, called Ukrzoloto (SIDA, Ukraine, 1997). However, fuel resources are lacking, although there are large coal, oil and gas deposits. Almost 60 per cent of agricultural arable land are covered by highly productive black soil (Doing business in Ukraine). There are various recreation resources throughout the country, including forests, mineral waters, therapeutic slush, lakes, and seashores. 5.2.4. Financial system Ukraine’s financial sector is at an early stage of development and an effective regulatory system is only gradually being created. A two-tier banking system was introduced in 1991. At the beginning of 1997 there were 229 banks registered in Ukraine, of which 14 have foreign capital. The banking sector remains dominated by the five former state-owned specialised banks, two of which remain state-owned although their share of assets has declined from 90% in 1994 to around 70% by early 1996. The largest banks have been subject to western style accounting procedures. A number of banks ceased operations in 1996, including one of the larger banks, Credobank, which was placed under administration by the NBU. Credit to the private sector is still scarce as commercial banks are risk-averse; the spread between lending and deposit is high and loans are mainly short-term. Regulation and bank supervision are being tightened: the NBU is planning to introduce capital adequacy rations of 8%, while the minimum capital requirement was raised to ECU 1 million (ECU 100,000 by July 1996 rising to ECU 1 million by January 1998) according to a law adopted in February 1996. The minimum capital requirement for banks with foreign participation is ECU 3 million and for wholly foreignowned banks ECU 5 million. A resolution of the NBU at the beginning of 1996 provided for the establishment of a private deposit insurance fund. The authorities have also introduced prudential ratios for banks, introduced a loan classification scheme, set exposure limits and introduced legislation that prohibits insider lending. Non-bank financial institutions in Ukraine include trust companies, investment funds, insurance companies, and credit unions and pension funds. There are about 600 insurance companies, 265 investment funds, investment companies and trust funds and a large number of brokers, with some 36 overlap between these groups. The minimum capital requirement for investment funds is US$ 20.000. A comprehensive regulatory framework is still lacking. Activities of investment funds are regulated by a February 1994 decree “On Investment Funds and Investment Companies”, amended in March 1995. Present supervisory functions are fragmented between various government agencies. In an attempt to tighten supervision, the State Property Fund has revoked the licenses of some investment funds. The Law on Securities and Stock Exchange has been in effect since January 1992. In July 1996 new securities regulations were adopted by Parliament, establishing the State Committee for Securities and Stock Market. The Committee has administrative and disciplinary powers over brokers and trading activities. Most trade still takes place in Kyiv in an unregulated over-thecounter market. The more centralised trading systems include the Ukrainian Stock Exchange, which was established in 1991 and presently has 67 brokerage houses registered as its members, and the Central Depository system. At present only a small number of companies are officially quoted on the stock exchange and weekly trading volumes are very small. As a result the exchange suffers from low liquidity. Furthermore, there are no independent share registration and minority shareholders rights are not protected. Auctions for Treasury Bills were first introduced in March 1995. The auctions are now held on a regular basis and sales, which were originally only to institutions, have now been extended to individuals. Until the introduction of the Hryvnia, Ukraine was very much a cash economy where credit, debit and charge cards were used almost exclusively by foreign visitors. The situation is set to change. Ukrayina Bank and Perkombank are negotiating with MasterCard and Aval Bank and Privatbank with Visa to issue their respective credit cards to customers with good credit references. Progress in introducing point-of-sales machinery is expected to be slow and expensive. Although the national banking system is well prepared with an electronic payment system that should facilitate speedy, paperless cash transfers, the new Ukrcard system comprising 22 banks, lacks the estimated US$ 500m needed to introduce the state of the art equipment needed to make the system run smoothly (SIDA, Ukraine, 1997). The opinion among our respondents concerning the financial system is that the system is undeveloped and ineffective. Due to financial instability credit rates are too high. Further experienced drawbacks are restrictions on purchase of hard currency, slow money transfers, no reliable credit regulation, and a complex accounting system (Summary of interviews conducted in Ukraine 1998, see Appendix C). 5.3. Political situation 5.3.1. Government Ukraine is a parliamentary democracy with separate executive, judicial, and legislative branches. The president nominates the Prime Minister and members of the cabinet, who must be confirmed by the parliament. The 450-member parliament (Supreme Rada) initiates legislation, ratifies international agreements, and approves the budget. Its members were elected to five-year terms in 1994. Following free elections held on December 1, 1991, Leonid M. Kravchuk, former Chairman 37 of the Ukrainian Supreme Soviet, was elected president for a five-year term (Canadian Institute of Ukrainian Studies, Ukraine in 1996). At the same time, a referendum on independence was approved by more than 90% of the voters. Political groupings in Ukraine include former communists, Rukh nationalists, the Congress of National Democratic Forces, "New Ukraine" (combining economic reformers and environmentalists), and the Civic Congress, which supports a federated structure and closer ties to Russia within the CIS (Ukraine HRD, 1998). Since becoming independent, Ukraine has named a parliamentary commission to prepare a new constitution, which was adopted on the 28th of June 1996; has adopted a multi-party system; and has adopted legislative guarantees of civil and political rights for national minorities. New parliamentary elections were scheduled to take place following ratification of the new constitution, but criticism of the draft constitution's allocation of presidential authority resulted in its being referred to the parliament's constitutional committee. A coalition of parties, including the Rukh and New Ukraine parties, failed to obtain sufficient support for a referendum to force parliamentary elections in early 1993 (Ukraine HRD, 1998). 5.3.2. Political developments After re-gaining independence Ukraine was initially slow to implement market reforms. This was largely due to the conservative attitudes of members of the soviet era parliament and the country’s former communist president, Leonid Kravchuk. Although some pro-reform policies were adopted, they were often not put into practice because of political differences between the government and parliament or because they conflicted with the interests of powerful groups such as the directors and managers of large state-owned enterprises. As a result, policies changed frequently and legislation was often contradictory or distorted to favour certain interest groups (SIDA, Ukraine, 1997). The Communist party was forbidden immediately after the failed coup in August, and has therefore changed name to the Socialist party. Former communists are still dominating the parliament. The general opinion is that it is still the “old” communists that are running the country (Bekkers A, 1993, Taming the wild East – a business study of Ukraine). However, parliament became more reform-oriented after the elections in spring 1994. Although left-wings parties obtained a majority of seats, the pro-reform forces gained in strength. This process continued with the election of Leonid Kuchma in the second round of the presidential elections in July 1994. President Kuchma, who is a former director of one of Ukraine’s most advanced military-industrial enterprises, had previously served as Prime Minister, and was known both for his commitment to market reform and managerial skill. However, despite being granted stronger presidential powers, President Kuchma still found it difficult to persuade parliament to approve measures to stabilise and reform the economy. For example, in November 1995 parliament effectively blocked a major part of the “rapid privatisation” program and other legislation (Coopers & Lybrand, 1997). Most of the new political parties are issued from the Rukh, the national movement that during 1990-91 carried on the demand for independence. There are also important regional political differences. The national parties have their strongest support in the west of Ukraine, while the Socialist party finds it support in the Russian spoken industrial areas in the east of Ukraine. Several communistic and strongly Russia-nationalistic parties have developed in these areas as well. (Canadian Institute of Ukrainian Studies, Ukraine in 1996). 38 The foreign companies that we interviewed believe that the communistic regime still exists in Ukraine and that it characterises the common sense and thinking in Ukraine. Even the people in the present government, are more or less the same as before (Summary of interviews conducted in Ukraine 1998, see Appendix C). According to our respondents, Leonid Kuchma is not considered to be the best reformer possible. None of the companies interviewed believes that the present government with Kuchma will be able to turn the country into a market economy in a near future. Still Kuchma is considered as a better alternative than the communist and socialist leaders who will also run for the Presidential post in 1999 (Summary of interviews conducted in Ukraine 1998, see Appendix C). International organisations that give economic aid to Ukraine, in the form of loans and grants, also pose as a great political force. These organisations are, for instance, International Monetary Fund (IMF), World Bank and EU. The purpose with the aid is to support the economic reforms implemented by the Ukrainian Government. Each loan is subject to monthly monitoring concerning the performance of the Ukrainian government. In case the government should fail in their obligations set by these organisations, the support and aid from them would then cease. Ukraine recently received a new three-year loan package of more than 2,2 billion U.S. $ from IMF. Of this amount, about 257 million U.S. dollars were available for Ukraine immediately. This money is to support Ukraine’s economy during 1998-2001. IMF believes that lately Ukraine has made considerable progress in its economy and in the first half of this year, for the first time since the country regained independence, there was economical growth (Itar - Tass News Wire, Sep 6, 1998). The main objectives of the Ukrainian medium-term programme are the strengthening of state finances and carrying out major structural reforms in order to ensure economic growth and improve the quality of life in the country. The programme sets GDP growth at 4 % by 2001 compared to minus 3 percent in 1997 and inflation should drop from 10 percent to 7 percent. Due to unfavourable developments in Russia in august 1998, the economic situation in Ukraine grew worse. Ukraine is strongly dependent on Russia due to import of Russian oil and gas. Representatives from the Ukrainian government believe that IMF should reformulate the targets of its last economical aid to Ukraine. ”The loan is very generous, but many of the conditions IMF set do not correspond to our situation,” said V.Chernyak, an economist from the Rukh Party (Financial Times, Sep 23, 1998). On 14 of June 1994, the European Union and Ukraine signed a partnership and Co-operation Agreement (PCA) replacing the trade co-operation agreement signed in 1989 between the EC and the Soviet Union. The PCA entered into force on March 1, 1998. The Agreement establishes a political relationship with Ukraine grounded in democratic values and with provision for political dialogue. It grants trade concessions such as most-favoured-nation status and access to the generalised system of preferences, all of which should help develop trade and pave the way for a possible free-trade area after 1998 (EU/Ukraine relations, 1998). 5.3.3. Legal developments The greatest weakness in the Ukrainian legal framework is that it is unstable. New legislation and norms are changing all the time. According to our respondents the situation with the Ukrainian legal system is a major frustration. The laws have a short life span but during that time the companies must abide by them. This leads to a constant adaptation to the new legal environment (Summary of interviews conducted in Ukraine 1998, see Appendix C). 39 Lately there have been a lot of changes in the Ukrainian taxation system. During the early years of Ukraine’s independence, taxes were based largely on gross revenues as in Soviet times, rather than on net profits. Consequently, the tax system artificially favoured firms with low turnover and high margins and generally discouraged investment. Cumulative rates for all taxes on gross income could exceed 100 per cent of net profit, which encouraged false accounting and corruption. The general profits rate applicable to residents and the Ukrainian permanent establishment of nonresidents is 30 per cent. Since adoption of the income and corporate tax laws of 1995 and subsequent tax laws and amendments, particularly those in 1997, tax rates have been substantially reduced. Taxes are now are based on profits after expenses (Doing business in Ukraine, 1998, p. 25). Under another Ukrainian law all employees, except subcontractors or consultants are required to pay payroll tax to the various Social Security funds. For instance, 32 per cent of an employee’s monthly salary is paid to the Pension Fund, 4 per cent is paid to the Social Security Fund, and 10 per cent is paid to the Chernobyl Fund; a further 1,5 per cent is paid to the Unemployment Fund. These rates have been lowered from earlier levels and reflect the government’s stated intention to reduce tax on wages (Doing business in Ukraine, 1998, p. 224). These payments are made by the employers in addition to the salary and therefore pose as another tax that the employers have to pay. During 1997 the government worked a package of reforms that would lead to further improvements in the tax system. One of the intentions with these reforms is to reduce or eliminate some tax rates (among others a payroll tax) to increase business activity in the country. According to our respondents, the tax system in Ukraine is believed to be one of the greatest problems faced by the companies since there is no possibility of working legally without suffering sufficient losses. That is why tax evasion is very common resulting in shadow economy (Summary of interviews conducted in Ukraine 1998, see Appendix C). 5.3.4. Trade barriers Companies, which are interested in trade with Ukraine, should report themselves to the Ukrainian ministry for foreign economical relations. They issue export and import licenses (Exportrådet, Focus east, 1994, p. 8). The fees for export and import have been decreased. The fees vary depending on the type of the goods. The import tax for luxury goods, such as cars and wine, is about 30% and for tobacco and liquor it can get as high as 300%. The import fees also vary depending on if the goods are raw materials or a finished product. All interviewed enterprises are more or less affected by trade barriers in Ukraine. Some barriers differ depending on what kind of company it concerns, and some are common for all companies. It is interesting to point out that the larger the company; the more these barriers will affect it. The most common trade barrier for all our respondents is the exorbitant custom taxes, since it makes the final price incompetitive. Other trade barriers are imperfection of custom laws, custom procedures, bureaucracy, the need to obtain certificates for selling products, and the very frequent change in legislation. A summary of the respondents’ point of view is that ”everything takes 10 times longer compared to normal Western countries” (Summary of interviews conducted in Ukraine 1998, see Appendix C). 40 The largest threat for the interviewed foreign companies connected to the current political and legal situation is presumed to be the possibility of bankruptcy of the main domestic clients, and - as a result - a decrease in the business activity in the country. Another threat is a high probability of an economical crisis - as in Russia. All our respondents agreed upon the fact that the instability of the current legal and political situations is a threat to the business activity as a whole (Summary of interviews conducted in Ukraine 1998, see Appendix C). 5.4. Economic reform Since independence many basic changes have been accomplished: the institutions and practice of central planning have been dissolved, many prices have been deregulated and the process of charging for many hitherto free services initiated. An ambitious programme of privatisation has been undertaken. However, much remains to be done, and even where the reform legislation has been put in place, implementation often lags. Since he came to power in July 1994, President Leonid Kuchma has demonstrated a firm commitment to reform. Most importantly, he has sought to slowly build a consensus behind the changes, both in government and in Parliament. Consequently, those placed in charges of implementing the reform process have also followed a slow and steady path, rather than attempting a rapid and radical restructuring. The approach is almost certainly a better guarantee of sustainable change. However, progress is sometimes too slow and invites frustration. The President's first important reform blueprint was delivered to Parliament in October 1994. He made a further very important address to Parliament on 5 February 1996, in which he drew attention to the poor legislative record of the reform process: of 62 draft laws submitted by the Cabinet of Ministers only three had been adopted as of January 1996, while only another eleven had been through their second reading (Ukraine HDR, 1998). Many of the remaining 48 - including those dealing with taxation, banking, foreign investment and the privatisation process - were crucial to the reform process. Taxation reform is particularly urgent, as citizens and enterprises are often required to pay more than thirty different kinds of taxes and payments to the government, which places undue burdens on the economy and hampers collection. Privatisation is at the heart of the reform program. The process was officially launched in the second half of 1992, when Parliament adopted the State Privatisation Program with a set of laws stipulating the different conditions for privatising small, medium and large state enterprises. Citizens' participation is based on the right to receive one free certificate of privatisation issued by the National Bank of Ukraine and distributed by the State Savings Bank. From August 1993, people were invited to open "privatisation deposit accounts" and within a year more than five million, or 10% of the population, had done so. Employees in enterprises designated for privatisation have certain privileges in acquiring the property rights of their enterprises. By the end of 1995, 28 million citizens had received certificates, and five million had become owners of shares, entitlements or portions of private property. Privatisation certificates will be given out until July 1996, and must be used by the end of the year. By the beginning of 1996 approximately 26,000 enterprises had been privatised, most of them in 1995. However, the targets for the year were not reached: 13,093 were small businesses (58% of the target); 3,121 medium and large-scale enterprises (39%) were corporatised and began selling their shares. Only 25% of the targeted industrial enterprises had been privatised and only 4% of unfinished construction projects (Ukraine HDR, 1998). In January 1996, President Kuchma gave a major speech at a conference on accelerating privatisation in which he reiterated the goals of 41 privatisation in Ukraine and spelled out a 12 point program to speed up privatisation, stressing "the extraordinary socio-economic and political importance of completion of primary privatisation in 1996". For our interviewees the economical reform has so far implied constantly changing conditions in the business environment such as the continually introduction of new laws and norms. They claim that the bureaucracy and the imperfection of the legal framework are strangling any form of businesses and hence obstruct the activities of the foreign companies (Summary of interviews conducted in Ukraine 1998, see Appendix C). 5.4.1. Price liberalisation The government lifted most price controls along with most ceilings on profit margins in October 1994 – except for September 1996 when prices were frozen to accompany the introduction of the new currency. Since 1993, administered prices have been raised for energy, agricultural products and communal services with the aim of moving towards cost/border prices (SIDA, Ukraine, 1998). The only goods and services which remain subject to price controls are bread, utilities (gas, electricity, central heating, water supply and sewerage), public transport and rents. Rents and the price for some utilities (including gas and electricity) were raised twice in 1996 to reduce the subsidy share of the national budget and lower price-cost disequilibrium in the economy. Industrial users of gas have been charged border-prices since March 1995, with adjustment of the local currency price being made regularly to reflect depreciation of the exchange rate (SIDA, Ukraine, 1998). The prices paid by residential consumers of gas and electricity are subsidised, but the subsidy element fell substantially during the course of 1995 and following the aforementioned rounds of price increases in 1996. 5.4.2. Macroeconomic stabilisation Because of lax monetary policy, consumer price inflation was exceptionally high between 1992 and 1994. A t 1992 the annual inflation was about 2,500% and during 1993 the monthly inflation fluctuated between 50-100% (inflation reached the level of 10155 % during 1993). The situation improved in 1995 and 1996. The annual inflation fell from almost 400% in 1994 to just under 180% in 1995. The 1996 figure of 39.7% was well below the target of 60%. In the middle months of the year, monthly inflation reached a post-1991 low level of around 0.3%, enabling the introduction of the new currency, and in the closing months of the year the averaged inflation rate was around 1.2% a month (Exportrådet, Kiev, 1997). A salary and price spiral can, among others, explain the extremely high inflation rate. The spiral is caused by factors such as: the market reform has not yet been very successful, a heavy tax burden, increased prices on imported energy resources, uncontrolled wage raises and increased governmental expenses (Paris Organisation, 1993, p. 39). Already in 1994 Ukraine managed to get a better control over the inflation, compared to their neighbouring countries. This can be explained by the implementation of a tight monetary and financial policy, under the supervision of the International Monetary Found (IMF). The new 42 currency Hryvnia, which replaced the karbovnets in the beginning of September 1996, has against some expectations remained stable. 5.4.3. Privatisation In 1992, the government of Ukraine formally launched privatisation, establishing a responsible body, the State Property Fund, to handle asset sales. Over the first two years the pace was slow, due to excessive bureaucracy but also to strong parliamentary opposition, particularly from the agroindustrial lobby. Privatisation was suspended in July 1994 pending an official review. A Presidential Decree in November 1994 introduced a new voucher-based mass privatisation program (MPP) where every Ukrainian citizen receives a privatisation-voucher, which can be changed for shares in the companies that are being privatised (Exportrådet, Ukraina-Seminarium, 1997, p. 68ff). President Kuchma has taken action for the privatisation reform to be implemented. Furthermore, the World Bank demands a privatisation reform within the country; otherwise Ukraine will not receive the loans offered. In the implementation of the privatisation reform, the majority of sales have taken the form of preferential sales, share transfers and buyouts by management and employees. Aside from continued opposition from parliament, a further source of slowdown in the pace of privatisation has been the setting of minimum prices in voucher-based auctions. Steps have been taken to accelerate the privatisation reform. These include the decision to reduce the time required to prepare enterprises for privatisation (SIDA, Ukraine, 1997). Furthermore, the people of Ukraine fear that the privatisation reform will lead to higher unemployment and a worse social situation. The unemployed, which will be affected by the privatisation, will receive a minimum remuneration as compensation. In response to criticism from foreign investors and, in early 1997, from the World Bank, President Kuchma has indicated that greater transparency in privatisation, particularly where it involves acquisition by strategic and foreign investors, will remain a priority. Privatisation in agriculture has had less success, mainly because of opposition from parliament to allow sales of agricultural land. The new constitution guarantees private property rights including land ownership, but there is a six-year moratorium on land sales. State and collective farms still account for some 85% of the total arable land area, although private farms provide a disproportionately large share of the output of certain products (SIDA, Ukraine, 1997). 5.4.4. Foreign direct investment Ukraine’s parliament, the Rada, passed the new law on foreign investment on the 19 th of March 1995. This replaced all previous legislation. Among the protections is to be find the guarantee against the state confiscating property, compensation for incorrect interference by the government, repatriate profits after tax and a 10-years protection against changes in the legislation concerning expropriation and government confiscation. Ukraine has also signed several bilateral investment treaties, including eight OECD members (OECD, 1997, Foreign direct investment in Ukraine). Under the law, there are no restrictions on foreigners owing shares in Ukrainian companies. Foreigners are prohibited from owning, although they may lease land for a maximum of 49 years (Exportrådet, Ukraina-Seminarium, 1997, p. 69). A foreign investment is defined as an enterprise in 43 which at least 10% of the initial capital are of foreign origin. Capital assets imported into Ukraine that are to be part of the founding capital are duty-exempt, while corporation taxes on foreignowned enterprises are left at 30%, the same as that payable by Ukrainian enterprises. Other taxes are also payable – notably a payroll tax, currently 52%, and a 45% tax in intermediary and wholesale businesses – but are also being reviewed. Profits may be converted into hard currency and repatriated once all relevant taxes have been paid (SIDA, Ukraine, 1997). Successful reform of Ukraine’s economy depends not only upon equalling the trade balance but also on the active involvement of foreign investments. The implementation of the reform requires substantial financial backing. Investment and credit resources of foreign investments could play an important role in the renewal of Ukraine’s economy. According to data from the Ministry of Economy of Ukraine the economies need for foreign investment now amounts to over US$ 49 b. As of 30 June 1997, the total volume of foreign direct investment in Ukraine amounted to US$ 1.690 bn (at the end of 1996, a cumulative amount of US$ 1.4 billion had been invested), of which US$ 335 m was transferred into Ukraine in the first half of 1997 (Jolly. A & Kettaneh. N, Doing business in Ukraine, 1998, p. 6ff). The United States remains the largest investor in Ukraine, accounting for about a quarter of the total investment. Other important investors include Germany 10%, the Netherlands 9.7%, Great Britain 7.9%, Cyprus 7.0%, the Russian Federation 6.9%, and Liechtenstein 6.2%. As of June 1997 5,858 businesses with foreign investments were registered. It is clear that foreign investments made so far are very limited, considering Ukraine’s size and population. Engineering and metal processing have attracted the most investment, followed by the food industry (Exportrådet, Ukraina-Seminarium, 1997, p. 70). Figure 6: Central Europe: annual inflow of Foreign Direct Investment (US$ million) 1990 1991 1992 1993 1994 1995 Czech Republic 112 494 1,004 654 569 2,562 Hungary 900 1,700 1,700 2,550 1,300 4,570 Poland X 247 900 1,479 1,342 2,511 Russia X 300 800 1,100 549 1,500 Ukraine X X X 50 90 200 Source: Austrian Ministry of Economic Affairs and Vienna Institute for Comparative Economic Studies, Foreign Direct Investment in Central and East European Countries and the Former Soviet Union, June 1996. 44 5.5. Political risk 5.5.1. Ethnic risk The population in Ukraine consists of 73 % Ukrainians, 22% Russians, 0.7% Jews, 0.9 % White Russians, 0.5% Bulgarians, 3.2% Polacks and other ethnic groups. There are no serious tensions or conflicts between ethnic groups. 1997 witnessed a number of explosions and contract killings in Ukraine (1998 Crime and Safety Report). Although Ukraine refers to these incidents as terrorist acts, there is no evidence that either domestic or international terrorist groups were involved. Rather, the incidents appear to be a manifestation of ongoing struggles between informal political and financial groupings over oil and gas distribution and other commercial interests (Ibid.) Furthermore, there is a struggle between the three most important churches: the Russian Orthodox Church, the Ukrainian Church and the GreekCatholic Church. The struggle for power is present mostly in the higher ranks of the church hierarchy. Despite the country’s difficult economic straits, Ukraine is largely free of significant civil unrest or disorders. As in most democratic countries, political demonstrations and gatherings to mark significant anniversaries and holidays, as well as to address specific political issues, are normal parts of life in Ukraine and these have been largely peaceful. Ukraine is considered to be a relatively stable country, with no risk for a civil war or a coup, but the result from the last election for the parliament, Verchovna Rada, was not optimistic. The communists are dominating with 113 seats of 450 possible. This expects to complicate the cooperation between the president, the government and the parliament; the economical reform in Ukraine will be retarded and the dissatisfaction among the population in the west will increase. 5.5.2. Corruption During the past years there has been a number of reports of business or investment disputes involving incidents of harassment and intimidation directed against businesspersons and interests. Physical threats have been recorded against foreigner investors or facilities, with the apparent goal of restraining foreign business development, or excluding entrance to the Ukrainian market, or even eliminating competition (1998 Crime and Safety Report). In some cases, it appears that local commercial interests, who may have links to organised crime groups, are behind these incidents. In other cases, local government entities have engaged in practices such as termination or amendment of foreign investors license or contractual rights without warning or legal basis, arbitrary dilution of corporate stockholding in order to diminish foreign investors shareholdings, random implementation of unfavourable legislation, and delay of payment or delivery of goods owed to foreign investors (1998 Crime and Safety Report). This has led to allegations that the private sector, including foreign and local investment, is being manipulated at the impulse of some government officials and their favoured business interests for personal gain. In some instances, local judicial or law enforcement authorities may be unduly influenced in order to justify or ignore illegal acts. Even in those cases where foreign investors have received favourable judgement from Ukrainian courts, there is at present a lack of a reliable mechanism to enforce legal judgements (1998 Crime and Safety Report). 45 At a question concerning the high criminality level in Ukraine non of the companies interviewed claimed to neither have been in direct contact with the Mafia or that the Mafia has had a negative effect on their activity. Most of the respondents though believe that the Mafia together with other criminals practically controls the economical situation in the country (Summary of interviews conducted in Ukraine 1998, see Appendix C). 5.5.3. Expropriation In the past the legislation indicated that foreign investors occupied a special, privileged position in the Ukrainian market. Thus the original draft of the Law provided qualified investors with certain protections. Among the protections in the Ukrainian legislation, is to be find: the guarantee against the state confiscating property (expropriation), except in cases of natural disasters; compensation for incorrect interference by the government; repatriate profits after tax and a 10-years protection against changes in the legislation concerning expropriation and government confiscation. 5.6. Socioculture situation 5.6.1. Culture During Ukraine’s history, the country has been independent for very short periods, which has restrained its cultural life. The cultural life of Ukraine, and especially theatre and literature, had its glorious days at the turn of the century. The Ukrainian culture was depressed during the government of Josef Stalin. During the history of the country, authors have used the literature as a tool to indicate the demands for Ukraine’s independence. To day the country has a need to reestablish the cultural heritage of Ukraine (Exportrådet, Focus east, 1994, p. 13). The companies interviewed had different opinions concerning how the cultural differences affect their business activity in Ukraine. Some considered it as a problem, and others did not. Overall, the general opinion among the respondents was that the Ukrainian culture is not experienced as very different compared to the western culture (Summary of interviews conducted in Ukraine 1998, refer to Appendix C). 5.6.2. Religion Law guarantees freedom of religion, although religious organisations are required to register with local authorities and with the government's Council of Religious Affairs. The dominant religions are the Ukrainian Greek Catholic Church and the Ukrainian Orthodox Church, which retains its links to the Russian Orthodox Church. The Ukrainian Autocephalous Orthodox Church is nationalist oriented and independent of Moscow. 46 5.6.3. Language It is important to know that the official language in the country is Ukrainian although one can manage with Russian, tendencies differ in different regions. For example, in West Ukraine, which traditionally is of Ukrainian tongue you will be better received if you know at least a few words of Ukrainian. This is because of the strong national sentiments since they were not able to express their culture while being part of the former Soviet Union. The knowledge in English and German is not very well developed in Ukraine. Therefore, companies are dependent on an interpreter who can speak Russian or Ukrainian when doing business with Ukraine. The current language barrier that exists between Ukraine and the western countries is under processing. English has been given higher priority in the schools and there are language courses for adults. Many claims that the situation has improved already. All companies though agreed, and naturally so, upon the fact that the language barriers obstruct their business activity. The problem concerns foreigners unable to speak the local language as well as Ukrainian people with limited knowledge in English (Summary of interviews conducted in Ukraine 1998, refer to Appendix C). 5.6.4. Education Ukraine has inherited a developed and comprehensive educational system, which starts at early ages. The three-tiered state education system remains in place, consisting of pre-school centres, combined primary-secondary schools for grade one through to eleven and higher education establishments. Currently, there are 50 508 educational institutions, of which more than half are pre-schools. According to official figures, in 1995, 857 out of every 1000 Ukrainians had a generalsecondary or higher education as compared to 794 in 1989 (Ukraine HRD, 1998). In quantitative terms, the current system is comparable to those found in most developed countries. Whereas the number of institutions has remained stable or increased, the number of pupils has decreased. The most significant decreases are the pre-school level. This drop in number can be explained in part by the falling birth-rate; increasing unemployment among women, which is keeping more pre-schoolers at home; and the development of private day care centres which are not included in statistics (Ukraine HRD, 1998). Primary-secondary institutions are also facing a serious drop in attendance rates. The general worsening of socio-economic conditions and decrease in public expenditure on education have had a negative impact in societal attitudes towards education. The growing number of the educated under- or unemployed and the deterioration of teaching facilities through inadequate maintenance have decreased the perceived value of education. There has been a steady drop in numbers of pupils graduating with secondary level education (Ukraine HRD, 1998). The falling number of attending pupils is accompanied by the problem of decreasing numbers of teachers. Again, economics is largely to blame. Approximately one third of the payments arrears in the public sector are owned to teachers (Ukraine HRD, 1998). Higher education is experiencing the most wide-ranging transformations. Since 1991 numerous new higher education establishments have opened, and the number of non-state run institutions of higher education are increasing. Another innovation has been the opening of seven state-run centres for retraining military officers throughout the country. 47 5.6.5. Employment and wages During the communism regime the government decided how to manage the companies. The employees were given directives concerning work procedures and how much to produce. To day in accordance with the privatisation process, the employees have to make their own decisions. In general they lack the knowledge and experience needed to manage a company. This causes confusion and affects the success of the company. In many companies the implementation of the market economy approach has been slowed down since several of the managers are former members of the communist party (Bekkers A, 1993). All the respondents agreed upon the fact that the old communistic regime stills influences the Ukrainian people in their way of performing work. The interviewed companies claimed that ”there is a tendency of Ukrainian people trying to work less but still earn much”. People have difficulties with taking responsibility and working independently (Summary of interviews conducted in Ukraine 1998, refer to Appendix C). The labour market has been characterised by a low productivity/employee. The reason for this is an unmotivated workforce as a consequence of the communism regime during the centrally planned economy and the development of extremely low wages (Bekkers A, 1993). Under the centrally planned economy of the Soviet Union, people were guaranteed jobs with state regulated wages, a comprehensive and universal system of social protection for those who could not work, and a wide variety of services and goods available at little or no cost through the enterprises for which they worked. With the transition to a market economy, many of the benefits have been substantially reduced, many people face unemployment for the first time in their lives, and all the old certainties have been swept away. Although officially employment has not fallen as much as production, many workers have been placed on "administrative leave", usually without pay, and many others are being paid only irregularly. Most try to avoid the tax collector, with the result that many transactions are conducted in cash or barter. The employed include all those who are in registered employment, plus entrepreneurs and some of the self-employed. It does not include those who work solely in the informal economy. It can be seen that while total labour resources have remained constant just below thirty million, the number employed has fallen by almost two and a half million since independence. It is very hard to assess its importance, and hence to know what has been the true impact of the transition on employment, wages and living standards (Ukraine HRD, 1998). Disguised unemployment The problem of keeping people on the payroll but putting them on administrative leave, thus disguising the real extent of unemployment, has arisen from the laws on severance pay and the desire of workers to stay attached to their workplace for the non-remunerated benefits. Currently the law in Ukraine requires enterprises to pay three months of severance pay. But for companies facing declining output and demand this is often impossible, and they resort to administrative and maternity leave, which also reduces the wages fund on which employers must pay social security taxes. From the workers' perspective it may be preferable to becoming officially unemployed, particularly as unemployment benefits are so low; there is always the hope of being recalled and meanwhile they have access to such amenities as health clinics, sports clubs and the like. 48 Wages As of June 1997, the average monthly wage in Ukraine was US$ 98. By far the highest wages were registered in the finance, banking and insurance sector, and the lowest in personal and household services. The main problem with these wage measure is that they represent the wages that should have been paid, not what were paid; in other words, they are measures of wage rates, not of earnings. In fact, many people are not paid their wages promptly, and sometimes have had to wait several months to receive some, not necessarily all that they are owed. Figure 7: Socio-economical indicators SOCIO-ECONOMICAL FIGURES Population 1993 1994 1995 1996 1997 52,200.0 52,219.9 51,640.0 51,090.0 51,008.3 Employment (1,000 persons) X X 23,726 23,232 22,500 Unemployment rate, reg. (%) X X 0.6 1.5 X Average gross monthly wage (US$) 35 48 55 75 X X X 31.7 X X Poverty (% below the national poverty line, 1995) Source: The World Economic Factbook, Euromonitor, 1998, Countries in transition, WIIW Handbook of Statistics, 1998, World development indicators, The World Bank, 1998. 5.6.6. Income and standard of living Hyperinflation and the collapse of productive activity associated with the transition to a market economy have had an immediate and serious impact on the incomes of Ukrainians. Their earning capacity has been undermined at the workplace and their cash assets have virtually disappeared. Furthermore, social benefits and services, often at little or no direct cost to the individual, have been reduced. Apart from money wages, the wealth of Ukrainians has largely been in the form of collective ownership. Although the privatisation program will eventually transfer ownership to individuals, these assets will have little meaning as a form of wealth until the necessary market institutions are in place, which enable trading to establish their value. Income from the informal sector is not included in the estimates of income and wages, thus to this extent official statistics underestimate income level in Ukraine. Estimates of the value of earnings in the shadow economy vary enormously. Conservatively their value is put in the range of 30-40% of legal incomes; but others believe that the combination of illegal and unreported incomes is as much as the legal earnings, in other words actual incomes are twice reported levels. Before independence Ukrainians shared in the collective wealth of the nation. As citizens of the Soviet Union, this wealth was realised in the form of: rights to a comprehensive set of universal 49 social services and pensions; in the form of access to housing, transportation and many social, recreational and cultural activities, which were provided at little or no cost to individuals and families; in the form of privileges and services available to workers through the enterprises for which they worked; and in the form of special rewards and dispensations awarded to certain groups and individuals. In addition, many families had access to land plots on which they could grow food for themselves and their friends, and some were able to build up their cash assets. The hyperinflation associated with the transition has virtually wiped out the value of the cash assets accumulated by the Ukrainian population. It has also caused serious erosion of the value of the various pension programs set up by the new state beginning in 1992. Despite frequent increases in the basic pension allowance, its purchasing power has fallen significantly. At the same time the government has been introducing charges for many of the services which Ukrainians are used to receiving free. For instance, in the last few years, some charges have been levied for medical care, education, and holiday retreats; transportation costs have been raised in many localities. Rents, utilities and maintenance have all increased substantially. A new housing subsidy program has been introduced to mitigate the effects of these charges on those least able to afford them, old age pensioners, the unemployed and families with a single female head. Eventually the privatisation program will lead to the accumulation of wealth, both in the form of the ownership of shares in privatised businesses and in the form of ownership of homes and apartments. But at the moment it is very difficult for Ukrainians to realise the value of these significant assets, as the market mechanisms are either not in place, or are at a very initial stage. Almost no one has a current account at a bank, and most bills are paid in cash and in person. In addition to the inconvenience of the lack of financial markets and credit systems, their absence means that individuals and families cannot realise their assets as cash, nor even know the value of what they own. In short, for the new forms of wealth to have any practical use, Ukraine needs a stock exchange, a housing market, an insurance market and all the other financial mechanisms upon which modern market mechanisms rely. 5.6.7. Crime and safety situation The problem of crime remains an item of serious concern for Ukraine’s growing community, which is continuing to be targeted by various manifestations of street crime, property crime, and organised crime and corruption, which we have mentioned above. The country’s problems with drugs have increased greatly in recent years. According to preliminary estimates, 35 000 criminal cases involving narcotics were brought to court this year. The number of registered drug addicts is expected to surpass 55 00 in 1998, up from only 8 000 in 1992. The number of unregistered is estimated at close to half a million (1998, Crime and Safety Report). Russian officials claim to have confiscated two ton of narcotics on the Ukrainian border over a ten-month period, and believe that Ukraine is the main source of narcotics for the St. Petersburg region. Ukrainian efforts to combat these trends continue to be plagued by low pay among law enforcement personnel, and by the lack of resources available for the fight against drugs. Ukrainian drug enforcement units remain inexperienced and understaffed. In addition, lack of co-ordination between law enforcement agencies continues to put a damper on enforcement efforts. The Chernobyl nuclear power station located ninety kilometres north-west of Kiev experienced an explosion and fire, followed by an uncontrolled release of nuclear material, in 1986. The accident resulted in the largest short-term release of radioactive materials to the atmosphere ever recorded. The Ukrainian government has a program of monitoring fresh foods and meats sold in local 50 markets. Food that exceeds European norms for radiation is confiscated and destroyed (1998, Crime and Safety Report). 51 6. POLAND - THE ECONOMIC REFORM Following is a presentation of the economical and political developments in Poland during the 90s. The chapter will focus on the economic reform making it possible for Poland to break free from their economical crisis. The investigation is founded on secondary data from several sources as well as primary data based on interview conducted with the European Commission Department and the Polish Embassy. The result from this chapter will in our analysis be treated merely in one section of the modified market screening model; the step entitled Basic elements of an economic reform program. 6.1. Introduction Poland was the first country to break free of the former Soviet block and from the command economy. Poland today is the first Central Eastern European economy to show strong growth - the fastest in Europe - after emerging from deep recession following economic restructuring. Gross national product has been growing during last years and private sector is developing rapidly. Poland’s economic development programme makes the assumption that exports and direct foreign capital investment will act as the main driving forces for growth (Doing Business in Poland, 1994, p. 19). The ultimate goal for Poland is full EU membership and integrating into the very bloodstream of Europe’s economy. With this aim in mind, Poland is creating within its own economy a comparable business environment, harmonising with Europe on issues like competition law, intellectual property rights and other such aspects. 6.2. History Modern Polish history starts around the ninth century when the country began gradually to form its own identity. By the fourteenth century, Poland had become a European superpower, stretching from the Baltic States to Hungary and all the way east past Kiev. Unfortunately, due to Poland’s geographic location, the country was subject to many successive invasions. It was not until 1918 that Poland finally managed to reclaim its sovereignty. After the Second World War Poland transformed into a Communist regime. In comparison to elsewhere in Eastern Europe, Polish communism was relatively mild. The general population always kept a cynical and suspicious attitude towards their communist leaders, and this led to public demonstrations in 1956, 1968, and 1970 (Weclawowicz, 1996, p. 52). In 1980 there was the rise of the Solidarity movement which united workers with intellectual dissidents, again demonstrating the lack of public support for the government. By 1989 the combination of a swell in popular dissatisfaction with the government, miserable economic conditions and the onset of perestrojka in Russia led to the bloodless fall of Communism in Poland. 6.3. The establishment of a free market economy The rejection in Poland began in the early 70:s. After labour protests 1970 the current regime tried to modernise the industrial technique without economic reforms. Poland lent about 20 million dollars from different states and banks (Sachs, 1994, p. 40). Due to an unchanged economic structure the country did not raise its export, in spite the large loan from the western markets. 52 According to this the loans could not be paid back. Poland became one of the first countries in the world that sank down in a loan crisis due to heavy loaning in the 1970:s. The crisis in Poland and the economic rejection caused the protest, which in turn gave the country a new political movement in the 1980:s, called Solidarity. The popularity of this new party grew among the polish population during the entire 80:s, and the party later won a great victory in the parliament election 1989. The Communists formed a Coalition Government together with Solidarity. The Communists kept the governmental control and Solidarity got important economical appointments. In the late 1980s, after more than forty years of central planning, Poland’s economy was in severe crisis. Especially in 1988 and 1989, it was in deep disequilibrium with regard to both goods and factors markets, and suffered the beginnings of hyperinflation, widespread shortages, serious distortions in prices, interest and exchange rates, subsidies, and tariffs. In 1989, just before the macroeconomic reforms, basic economic indicators were deteriorating very rapidly. Prices was rising at an accelerating rate - from 8,5% per month in the first half of the year to more than 30 percent per month in the second half (Kulig, 1994, p. 15). Decisions made by previous communist governments to partially liberalise prices and fully index wages had triggered a typical wage-price spiral. The budget deficit was increasing very rapidly. One of the major problems was the deficit in the balance of payments; the import was bigger than the export and emptied the reserves in the central bank. The severe situation in the country lead to a new radical planning on how to get a successful state economy and how to strengthen the communistic control in Poland, which was worked out by Solidarity. This was called the Shocktherapy. The 24th of August 1989 Tadeusz Mazowiecki became the first non-communistic Head of Government in Poland since the 2nd World War. The Coalition Government consisted representatives from Solidarity and the Communists. Vice Head of Government became the brilliant economist Leszek Barcelowicz. And it was Barcelowicz who took the initiative to the radical economic reform. The cornerstones in the reform were as follows: Macro economical stability, which means tight monetary and fiscal policy to lower the flow of credits from polish banks. Liberalisation, abolition of the central planning and the setting of free prices. Privatisation, transformation of governmental assets to the private sector. Establishment of a safety net in order to defend potential victims during the transition to a market economy. Mobilisation of international fiscal support for the transition. The polish program for stabilisation and liberalisation was put in work at January the 1st 1990. The fundamental goal was to move from a situation with an extreme shortage on commodities and hyperinflation toward an equilibrium between demand and supply as well as stable prices. Another goal was the achievement of positive real interest rate (current nominal rate minus inflation) through a restrictive monetary policy. One of the steps in the as to keep the wages down. Wages could be raised only as a set proportion of the previous month’s retail price index. The Government introduced special tax on wages to reinforce transgressing defined norms. It implied that a company for every 100 zloty of raised salary would have to pay 500 zloty to the Government. This wage-tax, known as ”popiwek” gave the Government control over the wages during the period of transition and slowed down the speed of inflation. Small wages and high prices made the population exchange their foreign savings back for zloty, which raised the government’s currency reserves markedly. 53 6.4. The results of economic reforms As a result of the shock-therapy there was an initial burst of price rise, but already in March 1990 they began to fall. Nearly all the prices were freeing. In the beginning of 1990 the real wages sank with an impact of 30% and the standard of living was changed for the worse. A lot of new enterprises were established as a result of deregulation made for private activity. Export and import raised markedly. One of the fundamental conditions for the market economical stabilisation was the sharpness in the budget discipline and that the subsidiary credits to the industry ceased to exist. Parallel to this the corporate taxes were raised. In 1989 there was a 7,1% deficit in the state budget, but 1990 there was a surplus on 1,7% (Sachs, 1994, p. 84). Due to the reform negative changes temporarily occurred in the standard of living, the unemployment and production. The standard of livings momentary changed for the worse soon after the beginning of the reform. However it improved by time. An example is the statistics regarding possessing of durable goods (TV, radio, stereo, car etc.) in Poland in 1989 and 1991. The part of households that was in hold of durable goods raised considerable between those years in as near as every product category (Sachs, 1994, p. 82). The unemployment has certainly risen and reached western measures, especially in the countryside. It has risen from 1,5% during 1989 up to 14% during 1993. Though polish experts claims that there is a large number of workers which states to be unemployed, nearly a third of the workers who holds unemployment compensation, that are actually working black and, or get grants to complete incomes (Ibid.). To lower the unemployment rate government tries to create positive conditions for the entrepreneurship as well as tempting foreign investors to make investments in Poland, aiming at their ability to supply the polish inhabitants with work. A more long-term policy is the investment in vocational training courses for the unemployed. In special economical zones with extremely high unemployment rates companies that employ more staff received a tax-reduction between 5 and 10 % (interview with M. Szczygiel). The industrial rejection as well had also a temporary character. In 1990 the production sank with a fourth in comparison with the former year. 1991 the production was 10% lower than in 1990. But in 1992 it began to rise with 3,5%. The largest reason to this rejection is the structural change in the economy. All communistic countries have had a well developed industrial sector. During the transition to a market economy the industrial production starts to sink and the non-industrial production is raised, especially in the trade, fiscal and service sector. As a matter of fact: all east European countries have had a deep rejection in the industrial production, independent of whether they have been introducing their reforms rapidly, slowly or not at all. Poland shows the least rejection in production in comparison with those other east European countries (Sachs, 1994, p. 97). The Privatisation Law came into force in August 1990. It has led to a number of stock exchange floating, trade sales to domestic and foreign buyers, joint ventures, and ”liquidation” of small and medium-sized enterprises often resulting in the sale or lease of the assets of the enterprise to employees and/or the management (Myant, 1993, p. 49). An important part of the process of privatisation in Poland was the mass privatisation programme (MPP) which was enacted in May 1993. It involved a scheme for share ownership in which all adults are eligible. A large number of state enterprises became part of this scheme. 54 Privatisation means not just sale of state assets but also the creation of private sector in Poland. There are many indicators that suggest the private sector was developing increasingly actively. According to polish official statistics in 1989 the number of private firms was 11 639 and this number increased to approximately 41 450 by September 1991. The number of individual establishments increased over the same period from 813 000 to approximately 1,4 million (Doing business in Poland, 1994, p. 25). At 1991 the private sector employed 54 per cent of the labour force, at 1997 this increased to 69 per cent (Country Profile, Poland, 1998). Here it is important to mention that Poland had positive preconditions to develop the private sector. Even during the centrally planned economy polish government encouraged people to build their own businesses, and especially in the agricultural sector. By this follows that the polish people had an idea about having their own businesses before the reform work. Those experiences enlightened the privatisation process. (Interview with M. Szczygiel). The following changes have occurred in the financial system. The system with one single bank was left behind and its functions as both a central- and a business-bank were separated. A large number of business-banks became active in Poland. The governmental politic has a purpose to support foreign investments in the bank sector. Since this is believed to be supportive for the privatisation in the bank sector as well as to strengthen the capital in the bank sectors. The bank activity has no wide range and the transactions in the private sector are still done according to the contactprinciple, but the banking ability has clearly improved during the recent years. The Warsaw Stock Exchange was opened in 1991 and there is a market for treasury bills and bonds as well. The wage differences in the communistic Poland were minimal and many social services as health care and education were free. Poland’s transition to a market economy led to high rates of unemployment and poverty. A lot of corporate activities were settled and due to this, Poland confronted high levels of unemployment. The introduction of job-centres and unemployment subsidies were fundamental steps in the polish social safety net. A key long-term policy issue thus is improving the quality of education as well as the coverage of basic education. Social assistance transfers are available to households below the minimum pension level and where the family or individual belongs to one of several eligible groups (Country Profile, Poland, 1998). The support from western countries has been and still is of fundamental value for Poland. Within implementation of market reforms, the country was in need of the chance to get a new financial platform. The western countries began their economic support to Poland already in 1989 by giving Poland two large loans. And apart from that the western banks withdrew parts of the polish state loan. Those measures played an important part for the future of the country, since they helped the economists to implement their reforms. Ever since the 80:s Poland has been aware of the need to repay their loans. Poland tried to take as few loans as possible, as well as to pay the interest and instalment on time. Those measures played an important role for Poland, since it lead to a greater understanding and a greater confidence from west, as well as created positive expectations on the future economy of Poland. As a result to this, foreign direct investments have made great improvements in Poland (interview with M. Szczygiel). 6.5. Poland’s situation today The polish economy has performed strongly since the transition process began. In 1997, real GDP increased by an estimated 6,9% (up from 6% in 1996) and for the sixth consecutive year the country experienced strong economic growth. Inflation (average 14,9% in 1997) and unemployment (10,5% end 1997) remain high but are falling. GDP per capita now amounts to 37% 55 of the EU average (31% in 1995). Foreign direct investment (FDI) increased from 0,3 billion dollars in 1991 to 6,6 billion dollars in 1997. More than half of total accumulated FDI now comes from European Union Member States (Country Profile, Poland, 1998). The greatest problem in the current polish economy is believed to be the agricultural and the industrial sector. In connection to the entry into the EU Poland has to make sure that all the companies in the country are able to compete with foreign competitors. Today companies in the heavy-, steel- and mining industries, developed during the communistic era, are the ones least adapted to the market economy. The agriculture is also badly prepared for competition of such a degree. Today only a third of the agricultural activity has ability to compete with foreign countries. (Interview with M. Szczygiel). The privatisation is another reform process that is not fully accomplished in Poland. About 70 percent of the inhabitants are working in the private sector today (the average measure for Europe is about 65 percent). All governmental companies that are left are now conversed into an independent subsidiary company, and they will be privatised in the near future. Foreign investors can participate in the privatisation process without emerging any limits for the amount of stocks in the company, with exception for some certain industries, such as national defence. (Interview with M. Szczygiel). In September 1997 there was also a parliamentary election in Poland. It resulted in a new Government composed of former Solidarity parties AWS (Solidarity Election Platform) and UW (Freedom Union). The most important priorities for the new Government, outlined by the Prime Minister himself, is as follows: lower tax rates; higher expenditure for health, education judiciary and public safety; completion of privatisation; decentralisation of the budget deficit; combating unemployment; and rural development. Since 1990 the President is elected directly by the people. The Presidential elections are held every five years and the president is only allowed to run the office for two mandate term. Alexander Kwasniewski has been the President of Poland since 1995. 6.6. Poland’s integration into Western structures Integration into Western political and security structures has been the main goal of successive Polish governments since 1989. Membership of EU remains the overdriving strategic objective for polish government. The present contractual relationship between the Republic of Poland and the EU is regulated by the European Agreement, which was signed on December 1991 and entered into force on February 1994. The EA is a preferential agreement, of which the trade parts aims to establish a free trade area over a maximum period of 10 years. It recovers all subjects of common interest and some of them among others are: political dialogue, trade in industrial and agricultural products, liberalisation of payments and movement of capital, protection of intellectual, industrial and commercial property, economic, cultural and financial co-operation (Country Profile, Poland, 1998). The EA takes the objective of future membership of Poland into account and provides a framework for Poland’s gradual integration into the EU. According to the Commissions approach of the European Council in Copenhagen June 1993, the candidate countries of Central and Eastern Europe in preparations for membership in EU have to fill the following conditions (Report from EU commission, Poland, 1998): 56 The candidate country has reached an institutional stability serving as a guarantee for democracy, legal safety, human rights and respect for protection of minorities. There is a functional market economy as well as an ability to handle competition and market forces within the union. The country is able to undertake the obligations that follow with a membership and to join the missions for the political, economical and the monetary union. Regulations made at the EU meeting in Copenhagen gave Poland the opportunity to officially apply for an EU membership. Poland applied for membership to EU on 5 April 1994. In the beginning of 1997 Poland announced a national integration strategy containing general outlines for the preparations undertaken to join the EU. In the strategy several political areas of central value for the association are mentioned. The investigation made by EU in the year of 1997 came up with the following conclusions on the Polish preparations toward an entry into the EU. Poland shows the characteristics that are distinguishing for a democracy. Poland can be viewed as a durable economy and ought to be capable of managing the pressure of competition and market forces in the union in a middle-term perspective. Strengthened strategies in such areas as the legal system, agriculture, environment and transport will help Poland to quicken the preparation work connected with the membership. Today Poland is restructuring the legislative system in the country. The legislative system is compared to the EU directives to locate which parts of the legislation system that are already adapted, which adjusting that has to be made and which additional parts that has to be worked through (interview with M. Szczygiel). 57 7. ANALYSIS In this chapter an analyse of the Ukrainian business environment will be conducted through the use of the further developed market screening model. To facilitate the reading, the structure of the analysis will follow the structure of the model. The analysis consists of the authors’ findings from the empirical section and the interviews. 7.1. Initial screening - Specific needs in Ukraine There are two specific needs that are easy to discern from the empirical chapter. As part of the former Soviet Union (FSU) Ukraine was a major producer of heavy industrial products and agricultural products. The reason for this is simple. Ukraine is rich on natural resources and a large part of its area is arable, consisting of extremely fertile black soil. Therefore it specialised in these two areas of production and has most of its needs of consumer products and energy supplied by other parts of the FSU. Ukraine played an important role in the FSU’s defence programme by supplying vital goods. As such, it enjoyed heavy subsidy of the energy that it needed for its productions. This lead to a very intensive production system, which became the country’s legacy after the independence. The country is in need of more energy for its productions than it is able to produce and therefore imports a lot from Russia and Turkmenistan. This is a business opportunity for foreign companies as the country itself has large deposits of coal, oil and gas. The Ukrainian government has also shown that they are interested in decreasing the country’s dependency of imported energy. Besides energy, consumer goods are an further area where there is a great need. The country lacks manufacturing of consumer goods such as household appliances, consumer electronics etc. as the majority part of its industry consist of heavy industry. Even though attempts are being made in restructuring the industry the results are far from certain. Agriculture is a major opportunity for foreign companies, which have shown interest in this area. There are major obstacles though, in the form of the government’s uninterested in privatising the lands and the huge state owned companies, which subsequently dominates the market as a result of this. One positive note is that international organisations such as the IMF and the World Bank have stated privatisation as a condition for their continuing support in loans and such. As Ukraine is in need of the help from these organisations, the authors believe a change in this sector is inevitable. The question is when it will come to pass. Telecommunication is further area where Ukraine has a great need to develop. With an average phone line of 18 per hundred people and a waiting time of 7 years this is surely a sector with opportunities for foreign companies. The same thing can be said about the infrastructure. Though extensive it is of bad quality and therefore hampers business and the growth of the economy. Consulting is another sector that needs to be developed. The transition from centrally planned economies to market economies creates a new legal system and among others, new fiscal systems. New competencies are needed. 58 To sum things up the major needs of Ukraine is to decrease its dependency of energy import and to have more consumer products. The other sectors such as agriculture, telecommunication, infrastructure, development of the financial sector etc. also offers business opportunities. 7.2. Second screening - Economic and financial forces In this step authors will analyse the financial and economical forces of Ukraine. The forces include GDP, inflation, population, consumption, distribution of income etc. Unfortunately it has not been possible for us to acquire very detailed statistical data in the libraries as well as on the Internet. We believe that the reason for this is that most countries do not prioritise acquiring statistical data when they are experiencing economical turmoil. Ukraine has experienced hyperinflation and economical turbulence. The priorities have then been set on battling the inflation and establishing macroeconomic stability. Spending money on exactly how much money the inhabitants spend on each product category is therefore not on the top of the list of things to do. The inflation rate and the exchange rate has been stabilised and remained stable during 1996 and 1997 (refer to figure 5). This is a positive sign as it smoothes the business operation considerably. Rational prices can now be set and plans can be made without fear of raging inflation rate and fluctuating exchange rate eating up the profits. The interest rate for 1997 was 49.1% for lending (refer to figure 5). Though inflation was around 25% it still meant that the real interest rate was around 24%. This shows that the Ukrainian market is more risky than others are. This leads to banks and financial institutions dealing with short-term loans as the risks are otherwise too great. The long-term strategic plans of the companies are then upset, as they can not find the financial resources needed. GDP/capita and, more importantly, consumption/capita show a low purchasing power. These figures are a bit misleading though and do not say anything by themselves about the distribution of income in Ukraine. Compared to the neighbouring countries Poland, Russia and Hungary, the figures do show a considerable lower purchasing power (refer to Appendix A). The real rate of GDP growth has been negative since independence, reaching its worst stage in 1994 of -23%. The trend seems to have been reversed and in 1997 it experienced its best result of -3%. This is a good sign, which shows that the economy might be on its way to recovery. As mentioned above GDP/capita and consumption/capita can be misleading and the figures need to be compared with statistics over the distribution of income in the country. The latest figures available was from 92 and we do not believe it to be relevant as the economy has gone through a lot of changes. We did find another figure that might give us an indication of the distribution of income though. According to statistics from 1995 31,7% of the population lived below the national poverty line. This shifts a considerable amount of the purchasing power to the rest of the population. We interpret this as such that there is a group in Ukraine, which has a considerable purchasing power, a higher than consumption/capita has indicated. This group is not small either, as the total population of Ukraine is 51 million people. Life expectancy and adult literacy do not differ too much with western standards (refer to headline 5.1.3. Population), which shows a quite high level of development. The official unemployment rate is low but the real unemployment rate is estimated to be quite high. The average monthly wage is quite low, which results in an educated and cheap workforce that foreign companies can take advantage of. 59 From this analysis it has been shown that the purchasing power is not as bad as it seems from just analysing consumption/capita. The lending rate is high but the stable condition of the interest rate and the exchange rate, coupled with the positive development in the GDP foretells a possible recovery of the economy and eventually even growth. Considering that Ukraine has a population of 51 million, should this scenario come true then Ukraine will become an important market in Europe. Despite the already given facts, the authors would like to point out one further aspect. In 1998 the Asian crisis swept to other parts of the world and Russia and Ukraine was severely affected by it. So far it is too soon to receive any figures of the damages the crisis have caused. It might be that the positive signs that Ukraine has managed to accomplish might have been mitigated by the crisis. Though we still believe that the inherit factors of Ukraine is a force to be reckoned with. This is a view that our respondents seem to share too as all of them have stated that they plan to expand their business activities in Ukraine. This even though they have stated that it is very difficult to operate in Ukraine and that there are a several issues that hampers their activities. 7.3. Third screening - Political and legal forces 7.3.1. Political forces The main political force in Ukraine consists of a disagreement between the leaders in the Ukrainian government, leading to governmental instability. The reform work in the country has become more complex since the government; the parliament and other powerful groups seem unable to cooperate. As a result of the conflicts between these parties, policies and legislation have frequently changed to favour certain interest groups. We believe that this political force is very important since the development of the entire country is extremely dependent on the interplay between political groups of interest and political leaders. The business environment in Ukraine is also dependent on this interplay. Each new outcome of this interplay affects the legislation in the country and changes the ground rules for the business community. This is why all companies we interviewed have claimed they are bound to continuously adapt themselves to the changes in the Ukrainian legislation. It is our opinion that foreign companies should be aware of this instability in the government, which is a political risk that greatly affects them. Communism is another part of the political forces we count as important. The communist regime was well established and held a strong position in Ukraine before independence. Even though the Communist party was prohibited following the declaration of independence it did not mean that communism ceased to exist. Former communist, which has joined other parties, is still a dominating force within the Parliament. Those companies that we have interviewed do not believe that the country will return to the communistic regime. But they are also of the opinion that it will take a generation before the communistic thinking cease to be such an influence in politics. At present, the presence of communism is slowing down the reform process and as a result hampers the business activities of the foreign companies as they are used to perform in market economic conditions. We also consider international organisations such as the IMF and others to be a political force. The IMF, the World Bank and EU finance the reform process of Ukraine and can stop lending money to the country if they believe that it is handling the reform in a bad fashion. Unlike the previous political forces discussed earlier, this one has a positive effect on the country’s business 60 environment. The international organisations strive to improve the legislation and the macroeconomic conditions of the country. These efforts improve the business environment in Ukraine for foreign companies. 7.3.2. Legal forces Ukraine is a country, which have had an inefficient tax system all the way to the 1990’s. They were set in such a fashion that they did not encourage the companies to show profit. As Ukraine started its transition to market economy, a new tax system was developed. Due to the difficult situation of the country’s economy, it was considered important to collect as much tax revenues as possible. No thought was given to the human incitement in this. The high tax rates lead to the creation of shadow economy (people evading taxes) and a decrease of the population’s entrepreneurial ambitions. The tax revenues became slight as a result. Our respondents consider the exorbitant taxes to be the greatest trade barrier as it made the final price look much too high. Since 1997 efforts have been made to lower the rate on some of the taxes. This process will keep on continuing as the IMF has set lower pressure of taxation as one of their conditions for their support. We believe that the tax rate will be lowered in the near future and that it will keep on continuing until it reaches a more reasonable rate. Besides high tax rates, it is hard for us to point out any other specific trade barriers such as quotas and tariffs. This is because they are specific for different industries. We can however distinguish factors, which pose as indirect trade barriers. Such factors are a complicated fiscal framework, frequent changes in the legislation, bureaucracy in such form as the necessity to obtain certificates to be able to sell products, and other factors. They all make it hard for foreign companies to do business in Ukraine, whether this is intentional or not. 7.4. Basic elements of an economic reform program Ukraine is striving for a market economy; the recent reforms strengthen that fact. In this issue we will analyse the economical reforms in Ukraine. A comparison will be made with Poland, a country that could realise a rapid transformation and become a market economy. This will serve as an instrument that enables us to determine how far beyond the actual state of development Ukraine is compared to Poland. It is important to add that today the reforms in Poland are considered as historical facts, that is they are accomplished and believed to have been successfully implemented. The reform work in Ukraine is a continuo process and it is not always easy to see direct results linked to it. We have done our best in order to discern and interpret the results of the Ukrainian reform work, as well as to identify how the reform work affect the Ukrainian business environment and thereby foreign companies. 7.4.1. Preconditions for the reform work Starting with the material we have gone through, we find that Poland had better preconditions concerning reform work. According to us the communistic regime was milder in Poland than in Ukraine. Poland has had a well-developed democratic movement. The Solidarity was strong before the reforms; the people relied on and had confidence with the political movement while they hated the communists. Within the movement Poland had experienced economists as Barcelowicz, who developed and implemented the reform program. In Ukraine we believe that the communistic regime was stronger and it posed as a heavy break on the reform work. Another important point of 61 view is that private activity was allowed in Poland long before the proceeding of the reform work. This made the privatisation process easier to implement. In Ukraine private activity is a new phenomenon and we believe that this is one of the reasons why it is taking longer time than in Poland to adapt to a market economy. 7.4.2. Price liberalisation The politicians in Poland understood at an early stage that one of the preconditions in order to enable transformation into market economy is to have a price mechanism at the market, that is prices, which are set according to the law of supply and demand. This results in a demand driven market where bad products and inefficient companies will have to leave. Poland set the prices free from 1 January 1990. This was followed by an initial burst in price rise, but already after a three months period of time prices began to fall. This is because the demand on some goods fell and people had a buying-force allowing them to purchase the most essential goods only. In the case of Ukraine, no radical reforms have been put into work following the declaration of independence. Dominating parts of the economy continued to be centrally planned, that is the politicians decided what and in which quantity different goods were to be produced and made available to the market. The supply did not cover the demand and it eventually lead to staggering inflation rates - 10 000% during 1993. The price liberalisation was put into practice only during 1994, when Leonid Kuchma became president of Ukraine. Having to wait for such a long time for the liberalisation of prices have affected Ukraine negatively. The standard of living grew worse and worse due to the inflation and governmental expenditures were still high, since it continued to give subsidies to state-owned enterprises producing goods where there is no demand. Prices were eventually set free. We believe that the losses for the Ukrainian society would have been much smaller if price liberalisation was implemented at an earlier stage. 7.4.3. Privatisation The privatisation process is quite similar in Poland as in Ukraine. One difference would be that foreign investors were allowed greater transparency in the Ukrainian privatisation process only in 1997. The privatisation was realised much earlier in Poland than in Ukraine. Another difference is that Ukraine does not seem to handle the privatisation by its own. Instead the World Bank is keeping an eye on the privatisation process in Ukraine. In case of a badly implemented and lacking privatisation process Ukraine would not receive any loans from the World Bank. The agricultural privatisation was less successful in Ukraine than in Poland. We see two main reasons for this. First, the Ukrainian agriculture has always been governmentally owned while Poland have had private farms long before the time of agricultural reforms, coupled with a common positive attitude work and private property. Second, the privatisation of the agricultural sector drew forth an opposition within the Parliament with the opinion that one should not sell out the land. As a consequence to this there are only 15% private owned firms in the present Ukraine. Some further negative aspects are that the Government has to give large subventions to state farms, which lowers the governmental income, as well as creating bad preconditions for competition in this sector. 62 7.4.4. Development of a financial system The development of a financial system means, among other things, that the banks shall be the ones that handle the giving of loans to companies. Poland has succeeded to transform into a seemingly well-developed financial system. A great part in this is played by the foreign banks, which were given permission to establish in Poland. Foreign banks contributed to an increased cash-flow into the country as well as to an improved competition within the entire financial system. In Ukraine the development of the financial system has been slowed down by some reasons. First, the country continued to persist as being centrally planned since after the implementation of the reforms. Second, there were still many activities owned by the Government, especially in the agricultural sector where these companies were receiving governmental subsidies and were therefore in no need of loans. Third, as a result of a severe macroeconomic situation, especially high inflation rates and saving risks, the Ukrainian population does not put their money in the bank. In situations where people do not save their money in the bank, the bank can not give companies large loans. The interest rate is therefore high and the enterprises mainly commit themselves to short loans, which obstructs their activity and strategic planning. Besides this it can be seen that Ukraine is slowly but surely adapting to the global financial system. Among other things a stock exchange, a market for treasury bills and securities and a credit card system has recently been implemented in Ukraine. But the entire financial system is still believed to be inefficient. The companies we have interviewed claim that the loaning process, payments and currency exchange is connected to different problems creating obstacles for their activity in Ukraine. 7.4.5. Macroeconomic stabilisation We believe that the Ukrainian government was less strict than the Polish government concerning the implementation of economical reforms and consequently had to pay a larger price connected to that. There has not been any shock therapy taking place in Ukraine. The reforms have been implemented in sequences with sufficient breaks between the different stages. A macroeconomic stabilisation means that there is a wish to keep the inflation rate down with strict monetary and fiscal policy. Between 1991 and 1994 Ukraine has been hit by a salary-price spiral which later lead to steering inflation rates. In Poland this spiral-development was broken by a raise in income taxes. The fiscal policy was slack in Ukraine as well. The Ukrainian Government continued to give large subsidies to companies not able to compete on their own. Together with a long-term decline in domestic production, the badly performing fiscal policy resulted in a negative development of the Ukrainian GDP. Only until 1997’s forecast was there a positive change in the development of the GDP. 7.4.6. Foreign sector liberalisation In Poland government realised at an early stage that foreign companies would give a sufficient cash-flow to the Polish economy to support underdeveloped sectors in Poland as well as contributing in making the domestic companies competitive. In Ukraine one was late with the foreign sector liberalisation. Before Kuchma became the president of Ukraine, in 1994, foreign investments were not viewed as important for the country. Not until 1995 did the new government introduce the Law on foreign investment which among others guaranteed protection expropriation. Authors believe that before 1995 the Ukrainian government did not consider foreign investment as a high priority. One can identify the impact of this law in the FDI statistics in Ukraine. In 1995 FDI 63 consisted of 200 US $ million and was many times smaller than in other eastern European countries (refer to headline 5.4.4. Foreign direct investment and figure 6). In 1996 the FDI grew up to 1400 US $ million. The statistics in the figure 5 ”Economic indicators” shows that since 1995 the inflation rate, exchange rate and the real GDP have improved. It is hard to claim that the raise in the FDI is the sole factor, which lead to a better macroeconomic situation in Ukraine. But we do believe that it has contributed to the improvement of the situation together with other reform implementations. By that we can draw the conclusion that if Ukraine had liberalised the foreign sector at an earlier stage, as in the case of Poland, the country would have avoided many economical problems. 7.4.7. Is Ukraine a market economy? We believe that Poland and Ukraine have had different preconditions and incentives to become market economy. Poland was already strongly interested in becoming a part of Europe. They did not use passive help in terms of loans, but actively helped by liberalising the foreign sector and letting foreign companies compete with domestic companies. Poland had a strict way of carrying through their reforms which has given the western countries confidence in Poland. Ukraine on the other hand does not seem to have enough will or strength on its own to enable a transformation into a market economy. The country is instead being pushed by different international organisations encouraging it on its reform work. Ukraine is committed to large loans upholding the economy and it took a great while before the liberalisation of the foreign sector. Ukraine has left the price liberalisation reform and the privatisation in the industrial sector behind. With the help from loans Ukraine has managed to stabilise the macroeconomic conditions in the country as well. Unfortunately the crisis in Russia 1998 has lead to a deterioration of the Ukrainian economy and showed that it is too early to claim that Ukraine is a country with a stable economy. The majority of the companies we have interviewed mean that Ukraine is not a market economy and that it will take quite a while before it will become one. We agree with the interviewees, but we still believe that Ukraine has managed to fulfil a part of the preconditions needed to become a market economy. The most important precondition is still left, consisting of Governmental agreements concerning the reform work, tight monetary and fiscal policy, a continuous liberalisation of the foreign sector, development of a financial system and privatisation of the agriculture. The last loan from IMF is believed to give Ukraine favourable conditions concerning future reforms and an eventual stabilisation of the domestic economy. 7.4.8. The effect of the reform work on foreign companies By analysing the reforms in Ukraine we have found that the reform work makes the Ukrainian business environment more complicated. All the companies that we have interviewed confirmed our opinion and pointed out that the reforms have a negative influence on their activity. The largest threat for them is the unstable condition of the Ukrainian economy. Norms, laws and regulations changes rapidly and the companies have been forced to adapt to them over and over again. Inefficient financial systems and staggering inflation rates obstruct the financing process and strategically planning of the business community. The companies that we have interviewed also believe that the reforms are carried out in a slack manner, hardly improving the economical development in Ukraine. 64 In spite of all the problems Ukraine might face connected to the adaptation process becoming a market economy, the companies interviewed did not believe that the reform work will cease, as well as that Ukraine will not return to a centrally planned economy. We believe that one can identify a positive tendency concerning the influence reform work has had on foreign companies. As for example: The liberalisation of the foreign sector has facilitated the establishment for foreign companies in Ukraine; foreign investors may join the privatisation process, and the inflation rate has sunk to a reasonable level. The loan from IMF will serve as guarantee for foreign companies that the reform work in Ukraine will proceed. Since all of our interviewed companies are planning for a future expansion this tells us that the companies have a long-term confidence with Ukraine, which overshadows the present difficulties they confront within the business environment. 7.5. Political risks 7.5.1. Ethnic risks During the last years there has not been any severe ethnic struggles in Ukraine. Neither is there any tendency for such ethnic conflicts to occur in the nearest future since there is no hostility between the existing ethnic groups. The current disorders are not more significant than in any other western democratic country. Therefore, we do not believe the ethnic risk to be of great importance for the business environment. 7.5.2. Corruption Corruption seems to be widespread in Ukraine. The companies that we have interviewed confirmed the high level of corruption in the business environment but claimed that they were not affected by it. We do not wish to draw a general conclusion stating that corruption does not affect all other foreign companies in Ukraine, based only on our respondents’ answers. According to other sources that we investigated, there have been a number of reports concerning incidents of harassment and intimidation directed against foreign businesspersons and companies. We consider one of the reasons for corruption to be disputes between central and local government forces. Local government has shown a tendency to act outside of legal framework. The central government establishes the laws. Unfortunately the local, regional, government do not follow them explicitly. The corruption leads to the regional government following, or discarding the laws depending on which is more profitable for them. Therefore, foreign companies are not always protected by the legal system since the regional government has such power that they can entangle the business in heavy bureaucracy. The legal system is not yet well developed. Laws are constantly changing making the system complicated and ineffective. It is not an unusual situation when one law is contrary to another. As a whole the insufficient legal system facilitates corrupted activities. The authors believe that another reason for the high corruption level to be the existence of commercial and governmental interest groups. These groups supervise and control certain sectors in the Ukrainian economy for their personal gain. The interference of these interest groups makes the business environment complicated and unstable, which affects foreign companies in a negative way such as delay of payment, delay of delivery of goods owed to foreign investors, and prevention of the distribution of the foreign companies products on the domestic market. 65 7.5.3. Expropriation Foreign companies are by law protected against government expropriation, which means that companies have a guarantee against confiscation of private property. Authors do not believe that this is a completely safe protection due to the insufficient Ukrainian legal system. Recently, according to our sources, the government has shown a tendency to tear up old laws. One such example is the tax haven created for foreign companies in order to attract foreign direct investment. This was abolished later in 1997. We therefore consider expropriation as a potential political risk even though the law against such does exist. 7.5.4. Unstable government We have analysed three types of political risks in accordance with our model. After our investigation of the Ukrainian business environment we came to the conclusion that there is one more type of political risk that is worth mentioning. This is the current unstable government. At present there is political instability with disagreement between the different forces within the central government. The political force that is currently dominating in the government affects the business environment. Due to the disagreement within the government there is a constant shift in power, which implies regularly new conditions for the business activity in the country. Our respondents agreed upon the fact that the instability of the current political situation is a great threat to their business activity in Ukraine. Based on these facts it is important for foreign companies to be aware of this political risk. 7.6. Fourth screening - Sociocultural forces During the former Soviet Union era, Stalin and the other communist leaders suppressed the Ukrainian culture. After independence the Ukrainian was given the opportunity to express their cultural heritage and a strong nationalistic sentiments was developed where they were proud to be Ukrainian. Today Ukrainian is the official language and in the business environment it is preferred before Russian. Though from our respondents we have been informed that it is greatly appreciated when foreigners use Russian instead of English or German as a sign of good will. As for the question of whether or not language poses as a barrier in the business environment, our respondents have informed us that it does. Foreign companies seldom know Russian and even fewer know Ukrainian. As for the Ukrainian themselves, their knowledge of English and German are not extensive, though they do possess some knowledge of the foreign languages. The authors have been able to discern a tendency from the Ukrainians to be more interested in knowing the great business languages such as English and German. The general attitudes among the population concerning work, achievement and other cultural aspects are coloured by the communistic thinking. Our respondents have confirmed this fact. According to them there is a tendency of the Ukrainian people in trying to work less but still earn much. Even the governmental forces are considered to be communistic though they do not call themselves communists. We believe that this attitude is common throughout the Ukrainian society and a generation needs to pass before the society will change their attitudes. In our opinion this communistic thinking affects the business climate greatly and the foreign companies needs to take this in account when doing business in Ukraine. An example of this is the Ukrainian people’s attitude towards taking responsibility. Taking responsibility is nothing new in the western countries, 66 but for the Ukrainian people this is something new. During the Soviet era all the decisions were made in a higher administrational level. The lower levels in the administration only needed to make sure that the directives were followed. Therefore, the foreign companies can not expect people to volunteer in assignments and even if they do they might not take responsibility for it. In Ukraine the inhabitants are free to practice any religions they wish. The authors do not think that religion affects the Ukrainian in their behaviour and conduct of business activities. We believe instead that it is similar to any west European countries in that the religions are respected but do not affect the business life much. The material culture in Ukraine used to be the same as the western countries, even though they did not enjoy the same level of sophistication. The prices were subsidised by the state and therefore a lot of people were able to live under good conditions. This made them used to a certain kind of standard of living. After the independence the material standard was reduced for a lot of people. This created a group of people that were very poor and another group that was very rich. In the authors opinion a new social structure has been developed that the foreign companies need to take into account. Even though there are many people who are poor there are also many that are very rich and have both the ability and the willingness to pay in order to receive foreign products. Although the statistics shows that 31,7% of the population lives below the poverty line, all of our respondents have plans to expand their business which shows that there are business opportunities now and even more when the economy has recovered. The educational level in Ukraine is high, though the number of students seeking higher education has fallen. One of the reasons for this decrease in student enrolment is that there are many highly educated people that are unemployed. In our opinion, the impact this has on the foreign companies is that they can hire highly educated people at low cost. This concludes our analysis of the Ukrainian business environment through the use of our model. What follows here is the authors’ conclusion of the Ukrainian business environment based on the facts uncovered in the analysis. As to how we have come to these conclusions we believe that it has already been explained in the analysis. 67 8.CONCLUSION This chapter contains of the conclusions that the authors have drawn from the analysis. The thesis will be completed with a critical evaluation of the investigation and suggestions to topics for further research. 8.1. Conclusion In our problem formulation we have stated that we want to identify the kinds of threats and opportunities that the Ukrainian business environment holds for foreign companies. From our research we have been able to draw the following conclusions. Threats in the Ukrainian business environment: The main political threats in Ukraine consist of a disagreement between the leaders in the Ukrainian government, leading to governmental instability. This instability has resulted into frequent changes in the legal framework. As a result, the business environment has become very confusing. The foreign companies constantly have to adapt their business activities to the current legislation. The legal framework is still on the process of being adapted to market economy. Old and new laws co-exist and often they contradict each other, which makes it difficult for the foreign companies to know which is applicable. Another example of the insufficient legal framework is the tax system, which is currently being modernised to suit market economy. The initial tax rate was set unrealistically high and inhibits business activities. High tax rates are considered as a trade barrier to foreign companies and affects their activities negatively. Laws have been established to protect foreign companies from expropriation. Though the threat of expropriation can not be excluded due to the constantly changing legal system. As a whole the confusing political situation has facilitated corrupted activities. The corruption may be a threat to foreign companies. It can result into restriction on their business or hindrance of their entrance on the Ukrainian market. The extensive bureaucracy in the country is also a threat to the daily business as it slows down the business operations considerably. The infrastructure can create problem with transportation due to its bad quality. The telecommunication is underdeveloped and hampers business operations. The underdeveloped financial system creates difficulties in payments and obtaining of loans. The implementation of the economical reform has so far been conducted in an insufficient way. The disagreement within the government has led to that different reform programmes are being delayed. Once they have been commenced the implementation takes unnecessarily long time. Since the economy is neither market economy or centrally planned, the foreign companies are forced to conduct their business in a grey zone where the conditions changes constantly. This instability is a threat to the foreign companies as no one can foresee what will happen next. 68 Another threat is the communistic thinking which affects the workforce in their way of performing. Ukrainian workers are not used to taking responsibility on their own, in contrast to western workers. A cultural misunderstanding can be created in the work process, which can lead to lower productivity. The Ukrainians do not possess enough knowledge in foreign languages, which complicates communications. Misunderstandings can easily arise. This makes the conducting of business more troublesome. Opportunities in the Ukrainian business environment: Despite the threats that have been presented we still believe that the business environment has a lot to offer foreign companies. The initial reason as to why Ukraine attracts the attention of foreign companies is that the country is a large untapped consumer market of 51 million people, making it one of the largest national markets in Europe. The country is also richly endowed with natural resources. This creates opportunities for foreign companies, which operates within the heavy industry as well as those requiring these resources for their production. Ukraine has an important strategically position as a bridge connecting the East with the West. Its infrastructure, though undeveloped, is extensive which creates opportunities for foreign companies concerning the transportation of goods to the East as well as the West. There is no risk for ethnic strife and the religions do not affect the business climate in Ukraine. The Ukrainian culture is not much different compared to western cultures. This simplifies the business activities for foreign companies. During the communist regime the priority was put on the development of the heavy industry, at the expense of all other industries. Due to this industrial structure the country is in need of help to develop the other sectors such as: the consumer industry, the telecommunication sector, infrastructure, financial sector etc. These pose as opportunities for foreign companies operating in these sectors. The privatisation of the agricultural sector is still in its initial phase. So far only 15% of the total arable lands has been privatised. Eventually, when the government proceeds with the privatisation process, this sector will offer great opportunities for foreign investors. Even though a large part of the population is considered to be poor, more than half is considered to have enough purchasing power to make the market interesting for foreign investors. The workforce in Ukraine is highly skilled and educated. Compared to western standard the Ukrainian wages are low. This gives the foreign companies access to a low cost workforce of high quality. Future perspective: At present the reforms are at an early stage though they have been initiated. We believe that Ukraine will continue with its reform programme. The country relies heavily on the support of international organisations such as IMF and the World Bank. A condition for their support is the continuation of Ukraine’s reform work. Ukraine also understands that in order to have economical 69 growth it needs foreign investment. For the foreign companies to invest in Ukraine, the country must make itself attractive by for instance lowering the tax rate. This is also one of the conditions set by the international organisations. We have also noticed a tendency in the country of giving foreign languages higher priorities in general. This will simplify the business activities with the foreign companies and can most probably lead to increase dealings with the rest of the world. The latest figures have shown that the country has been able to stabilise its economical situation. Inflation rate and exchange rate has been stable. The negative growth of GDP has reduced and growth of the economy seems possible in the near future. This will most certainly increase the consumption in the country, which is beneficial to foreign companies. We believe in the potentials that Ukraine holds for foreign companies and that once the economy has recovered, these potentials will be realised. According to all of our respondents they intend to expand their business activities, despite the negative critique they have had on the current business environment. This indicates that they also believe in the future potentials that the market holds. 8.2. A critical evaluation of our research The authors of this thesis believe that critique concerning our research could be directed towards the following three areas: the model developed in this thesis, the research procedure, and the conducted interviews. It is possible that there might be factors that authors have overseen while modifying the market screening model. Though, the authors opinion is that all the important aspects needed in order to fulfil the purpose of this research has been covered. Another object of critique is the chosen research procedure. Authors could have made a field trip to Ukraine to raise the validity and reliability of our research. Though, we believe the information we received was enough for us to enable an identification the opportunities and threats in the Ukrainian business environment. Readers might consider the results of the interviews to be based on too few respondents. Authors are of the opinion though, that the results were valid despite the number of respondents. The respondents came from different industries and originated from different countries. As such we were able to cover a large part of the business environment. In addition we were able to discern similar tendencies in their answers. Therefore, we believe we have achieved a sufficient level of reliability and validity in our research. Readers might criticise, why authors did not analyse a specific industry or even a single company operating in Ukraine. The reason for our choice of research is that we wanted to analyse the Ukrainian business environment as a whole. We would not have been able to draw generalised conclusion concerning the entire business environment based on an analyse of a specific company or line of business. Furthermore, the choice of our problem area is motivated by the lack of existing research in this investigated field. Finally, we want to defend ourselves against arguments claiming that the perspective of our problem area is close to economics. We maintain that we have dealt with the problem from a business administration point of view. Authors have chosen to analyse the problem area in the angle of foreign companies. Throughout the whole research we have made sure to connect the 70 investigated market with the foreign companies. Furthermore, our empirical chapter, analysis and conclusions are based on interviews conducted with foreign companies operating in Ukraine. The research is focused on the concept the Ukrainian business environment, which is repeated in the title, research question, purpose and throughout our reasoning. The Ukrainian business environment includes all aspects affecting companies conducting business in this market, which firmly establishes this research in business administration. . 8.3. Suggestions to further research These are the suggestions authors have concerning topics for further research. In what way do these threats and opportunities that we have identified, within the Ukrainian business environment, affect the foreign companies within a specific sector? Considering the role that the political situation has on the Ukrainian business environment, a further research could be done focusing on the political risks affecting the foreign companies. 71 BIBLIOGRAPHY Aaker, David A., Kumar, V., Day, George S., (1995, Fifth Edition) Marketing Research, John Wiley & Sons Inc. Ball, Donald A., McCulloch, Wendell H., (1993), “International business”, Irwing, USA. Bekkers A, (1993), Taming the wild East – a business study of Ukraine, Erasmus Universiteit Rotterdam Fackulty of Business Administration Bosworth, Barry P. and Ofer, Gur, (1995), “Reforming Planned Economies in an Integrating World Economy”, The Brookings institution. Bryman, Alan, (1989), “Research methods and organization studies”, Unwin Hyman Ltd. WIIW Handbook of Statistics, “Countries in transition”, (1998). Eiteman, David K., Stonehill, Arthur I., Moffett, Michael H., (1998) “Multinational business finance”, Addison-Wesley, USA. 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Svenska Dagbladet, 1993-01-16 Webb pages Coopers & Lybrand, 1997 Crime and Safety Report, 1998, Kyiv, Ukraine – US Embassy in Kyiv Itar - Tass News Wire, Sep 6, 1998. The new Ukraine law on foreign investments: Overview of major provisions and comparison to previous foreign investment legislation - Matthias, Rebecca A. and Jennifer J. Saxe, East/West Executive Guide, 1998 Ukraine, Human Development Report (HRD), 1998 http://www.brama.com 73 http://europa.eu.int/ http://www.transparency.>. Respondents Following are companies operating in Ukraine. The interviews were received from Ukraine during November and December 1998. Several of our respondents wished to be anonymous: The Director of MacGregor, (Sweden/Finland) The Director of Kross, Motorola distributor in Ukraine, (USA) The Commercial Director of Oditel-Siemens, (Germany) The Director of Hi Tech (USA) The Technical Director of Transas Marine (Denmark) The Director of Electrolux, Peder Westerlund, (Sweden) The Managing Director of Scania Ukraine, (Sweden) The General Manager of Atlas Copco Compressor Division, Antoine Santiago, (Sweden) The General Manager of Shevron (USA) This interview was conducted in Sweden at the Polish Embassy: Marek Szczygiel, 2nd Secretary of the Polish Embassy in Stockholm, Karlavägen 35, 2 December 1998 Following interviews were conducted by telephone in Sweden: Sigrid Johansson, Europeiska kommisionen in Stockholm, 25 November 1998. Pontus Förberg, Area Manager, Department for Central and Eastern Europe, SIDA, 20 October 1998. The department of Information, Exportrådet, 15 October 1998. The Ukrainian Embassy, 23 October 1998. 74 Appendix A Figure: Economic indicators, GDP per capita and consumption per capita, in four transition economies ECONOMIC FIGURES 1993 1994 1995 1996 1997 GDP per capita Ukraine (US$ million) 2,533.9 2,451.4 716.7 861.4 973.7 GDP per capita Poland (US$ million) 2,236.0 2,431.8 3,062.8 4,076.0 4,097.9 GDP per capita Russia (US$ million) 4,615.5 4,805.6 2,372.8 2,746.6 3,389.1 GDP per capita Hungary (US$ million) 3,508.3 3,727.6 4,419.6 4,383.6 4,438.5 Consumption per capita Ukraine (US$) 1,867.5 1,806.7 488.9 598.9 679.9 Consumption per capita Poland (US$) 1,409.5 1,457.7 1,949.8 2,594.8 2,608.7 Consumption per capita Russia (US$) 2,197.0 2,287.4 1,276.8 1,616.7 1,625.5 Consumption per capita Hungary (US$) 2,182.7 2,201.6 2,900.0 2,875.9 2,912.0 Source: The World Economic Factbook, Euromonitor, 1998, Countries in transition, WIIW Handbook of Statistics, 1998, World development index. 75 Appendix B Interview guide for foreign companies operating in Ukraine: Company description and establishment in Ukraine Name your rank/position in the company. Describe your business in short terms. (For example: country of origin, size, year of establishment and products.) What kind of experience do you have from the eastern market? What was the reason for establishing in Ukraine? Economical situation In what way has your company been affected by the current economical situation within the country? Has the implementation of the economical reform led to any changes for your company and the business environment in general? (Regarding for example legislation and the privatisation program.) What effects have the past years high inflation rate had on your activities and what actions have you taken against these effects? What do you think about the Ukrainian banking-system? In what way are the Mafia and the high level of criminality affecting the market and business environment in general? Have your company been affected and what actions have you taken against it? How well developed is the transportation- and telecommunication-system in Ukraine? Political and legal situation In what way has the Law of Foreign Investment affected the company? What kind of trade barriers exist and do you consider them as a great problem? What threats and possibilities have the current political and legal situation imposed on you company and the market in general? 76 Cultural situation Do you consider the language and the culture differences as a barrier when doing business with foreigners? In what way has the old communist regime influenced the Ukrainian people in their way of performing work and doing business? What do you consider to be the main problem at present? Future prospects Do you believe that Ukraine will keep its present course towards market economy and what changes in the business environment do you believe that the economical reform will lead to? What actions do you believe has to be taken to improve the business environment? What are your expectations on the president Leonid Kuchma and the government? Have you considered expanding your business in Ukraine? 77 Appendix C A summary of interviews conducted with foreign companies in Ukraine We were interested in achieving information from foreign companies in different lines of business represented in Ukraine. We aimed to achieve an overall apprehension of how the foreign companies understand and interpret the Ukrainian business environment. Following is a summary of the interviews conducted by the authors, by e-mail and fax, during November-December in 1998. Company description and establishment in Ukraine The responding companies operating in Ukraine are established in different forms - foreign-owned subsidiaries, joint ventures and representative offices. The enterprises are operating in different lines of business as for example telecommunication, sea-transport, white goods, cars and mining. The number of employees in Ukraine varies from 3 to 22 persons, foreign as well as Ukrainian personnel included. The earliest and most employee-intense foreign establishment in Ukraine took place in 1991. Other companies were established later during the 90’s. According to the respondents, a reason for establishing in Ukraine is the fact that the country is the second largest in Europe after Russia, and is number four concerning inhabitants. Above that, educated workforce is much cheaper in Ukraine compared to the foreign company’s home-markets. These are the characteristics that underlie whether or not foreign companies choose to establish in the Ukrainian market. More concrete reasons for establishing in Ukraine were of varying importance to the enterprises: ”A wish to try a new interesting market”, ”Following company’s customers overseas”, ”Contribute to some sector’s development in Ukraine” and even ”The necessity to survive physically”. Economical situation The majority of the interviewed companies claimed that the current economical situation in Ukraine obstructs their business activity. The unstable economical situation makes it impossible to provide long-term crediting for investment projects - which normally is the utmost effective way from an income point of view. The companies are limited to short-term crediting, which inhibits their ability for strategically planning. Furthermore, the respondents stated that the most recent financial crisis in Ukraine, which was a consequence of Russia’s default, implied reduced sales, difficulties to buy hard currency, violation on contracts, and increased control by the state for foreign companies. Companies operating in the gas and oil industry were hardest hit by the crisis. The implementation of the economic reforms in Ukraine has so far implied constantly changing conditions in the business environment such as the continually introduction of new laws and norms. The respondents claim that the bureaucracy and the imperfection of the legal framework are strangling any form of businesses and hence obstruct the activities of the foreign companies. During the last two years the inflation in Ukraine has been reasonably stabilised. Hence, as a consequence of the Russian financial crisis in August the inflation fuelled. This rise in inflation has made the current business activities more difficult for the foreign enterprises interviewed. The respondents claimed that due to the Russian default the rise in inflation and other difficulties 78 virtually reduced their efforts to ''zero''. Furthermore, their clients’ ability to pay has decreased as a result of the inflation, whereby the interviewed companies has been forced to suspend contracts regarding payment periods lasting longer than 6 months. Despite the rise in inflation due to the Russian default, the majority of the respondents shared the opinion that the inflation has been stabilised during the last few years. According to the respondents the tax system is insufficient and causes great problems. The problem is founded in the situation that it is not possible to work legally without suffering sufficient losses. Lately most lines of businesses have been affected by the realisation of increasing import taxes. The situation affects any kind of imported goods as well as laws concerning international relations forced in the present Ukraine. Recently the Ukrainian Government supported sectors in development by releasing goods on the market, which were produced in VAT. This privilege was cancelled at the 22nd of September 1998. The opinion among the respondents concerning the financial system is that the system is undeveloped and ineffective. Due to financial instability credit rates are too high. Further experienced drawbacks are restrictions on purchase of hard currency, slow money transfers, no reliable credit regulation and a complex accounting system. One definite point of view was that the banking system stays under the government. The majority of the interviewed companies consider the transport system to be relatively underdeveloped. Though they consider the main transport directions to be in a relatively sufficient condition. The general opinion among the interviewees is that during the last years there has been some progress in the development of the telecommunication system. They believe that Ukraine is approaching to the standards of the southern European countries. At a question concerning the high criminality level in Ukraine none of the companies interviewed claimed to neither have been in direct contact with the Mafia or that the Mafia has had a negative effect on their activity. Most of the respondents though believe that the Mafia together with other criminals practically controls the economical situation in the country. Above this it should be mentioned that all the companies interviewed agreed upon one important thing that they have learned on the new market - to continuously adjust their activity to the unstable and constantly changing environment. Political and legal situation Law of Foreign Investment has had no affect on any of the companies interviewed. The respondents claim that all new legislation and norms have short-time effect on the foreign companies’ business activities. This is a consequence of the constantly changing legal system. All enterprises are more or less effected by trade barriers in Ukraine. It is interesting to point out that the larger the company; the more these barriers will affect it. The most common trade barrier for all our respondents is the exorbitant custom taxes, since it makes the final price incompetitive. Other trade barriers are imperfection of custom laws, custom procedures, bureaucracy, the need to obtain certificates for selling products, and the very frequent changes in legislation. A conclusive point of view was that ”everything takes 10 times longer compared to Western countries”. The largest threat for foreign companies in Ukraine connected to the current political and legal situation is presumed to be the possibility of bankruptcy of the main domestic clients, and - as a 79 result - a decrease in the business activity within the country. A further threat is a high probability toward an economical crisis - as in Russia. All our respondents agreed upon the fact that the instability of the current legal and political situations is a threat to the whole business activity in the country. Cultural situation The companies interviewed had different opinions concerning how the cultural differences affect their business activity in Ukraine. Some considered it as a problem, and others did not. All companies though agreed, and naturally so, upon the fact that the language barriers obstruct their business activity. The problem concerns foreigners unable to speak the local language as well as Ukrainian people with limited knowledge in English. Overall, the general opinion among the respondents was that the Ukrainian culture is not experienced as very different compared to the western culture. All the respondents agreed upon the fact that the old communistic regime stills influences the Ukrainian people in their way of performing work. The interviewed companies claimed that ”there is a tendency of Ukrainian people trying to work less but still earn much”. People have difficulties with taking responsibility and working independently. During the communistic system there was no need to concern about private property since everything at the place of work belonged to the government. It is this particular feeling of private property that is missing among the Ukrainian people today when the country is transforming into a market economy. The responding companies believe that the communistic regime still exists and that it characterises the common sense and thinking in Ukraine. Even the present government is considered to consist of - more or less – the same communist members as before. Future prospects Leonid Kuchma is not believed to be the best reformer possible. None of the companies interviewed believe that the present government, with Kuchma, will enable the country to transform into a market economy within a near future. However, Kuchma is a good alternative to communist and socialist leaders who will fight for the President seat in 1999. None of the companies believe that Ukraine is a market economy, nor do they consider that the reform process is proceeding well. However, the interviewed companies believe that there is no way back to communism. The country still needs heavy economic reforming in almost all the existing business sectors. The respondents believed that it is impossible to predict what will occur in Ukraine in the future and even what will happen in a week time from now. It is all about being alert and to adjust oneself to the changing environment. The permission of a second trance of the International Monetary Fund (IMF) loan to Ukraine, as well as a loan from the World Bank and EU, commits the Ukrainian Government to fulfil agreed targets regarding economical reforms. The majority of the interviewed companies believed that the most important thing for their business activity in the future would be that the following events occurred: decreasing of the tax pressure, hindrance of foreign investments, continuos development of private business, an upgrading of the legislation system and organising of new working places. 80 However, despite the negative aspects given by the respondents, their plans for future are positive. Most of the companies interviewed have a long-term strategy in the Ukrainian market and they are planning to expand their activity in a near future. 81