Reducing Market Distortions for a More Prosperous Ukraine Proposals for Market Regulation, Competition Policy, and Institutional Reform ACKNOWLEDGEMENTS This report was authored by: Georgiana Pop (Senior Economist, Markets and Competition Policy Team; Macroeconomics, Trade and Investment), Martha Martinez Licetti (Practice Manager, Markets and Technology; Finance, Competitiveness and Innovation), Soulange Gramegna (Consultant, Markets and Competition Policy Team; Macroeconomics, Trade and Investment) and Seidu Dauda (Analyst, Markets and Competition Policy Team; Macroeconomics, Trade and Investment). Valuable inputs were provided by Mariana Iootty de Paiva (Senior Economist, Markets and Competition Policy Team; Macroeconomics, Trade and Investment) and Tanja Goodwin (Senior Economist, Markets and Competition Policy Team; Macroeconomics, Trade and Investment). The report builds on and summarizes the findings of the 2018 World Bank analysis “Ukraine: A New Vision for Competition Policy to Boost Competitiveness and Growth,” which was prepared under the guidance of Satu Kähkönen (Country Director for Ukraine, Belarus, and Moldova). Sean Lothrop (Consultant) provided editorial support. The team is grateful to Yuriy Terentyev, President of the Antimonopoly Committee of Ukraine, and his team for their valuable contributions and insights. ACRONYMS AND ABBREVIATIONS AMCU Antimonopoly Committee of Ukraine CMU Council of Ministers of Ukraine FDI Foreign Direct Investment GDP Gross Domestic Product HHI Herfindahl-Hirschman Index ICT Information and Communications Technologies MEDT Ministry of Economic Development and Trade of Ukraine OECD Organisation for Economic Co-operation and Development PMR Product Market Regulation TFP Total Factor Productivity WBG World Bank Group WDI World Development Indicators i CONTENTS EXECUTIVE SUMMARY 1 FROM MICROECONOMIC CHAPTER 1 FUNDAMENTALS TO MACROECONOMIC OUTCOMES   5 CHAPTER 2 SOURCES OF COMPETITION AND MARKET CONSTRAINTS   11 PROPOSALS TO STRENGTHEN CHAPTER 3 MARKET INSTITUTIONS, REGULATION, AND COMPETITION   37 REFERENCES   41 ANNEX   43 iii iv REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE List of Figures FIGURE 1 Total Factor Productivity Growth, Ukraine, 2002–2016 (%) . . . . . . . . . . . . . . . 7 FIGURE 2 Total Factor Productivity Growth, Ukraine and Comparators, 2010–2016 (%) . . . 7 FIGURE 3 Contributors to GDP Growth (percentage points) . . . . . . . . . . . . . . . . . . . . . 7 FIGURE 4 International Trade as a Share of GDP, Ukraine and Comparators, 2006–2017 (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 FIGURE 5 Net FDI Inflows as a Share of GDP, Ukraine and Comparators, 2006–2017 (%) . . . 8 FIGURE 6 Contribution to the Growth of Value Addition by Major Sector, 1991–2015 (percentage points) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 FIGURE 7 Contribution to the Growth of Value addition and Gross Employment, 1991–2016 (percentage points) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 FIGURE 8 Supply-Side GDP Decomposition by Subsector, 2010 and 2015 (%) . . . . . . . . . 9 FIGURE 9 The Extent of Market Dominance in Ukraine . . . . . . . . . . . . . . . . . . . . . . . 11 FIGURE 10 Market Structures in the Manufacturing Sector, Ukraine and Comparators . . 12 FIGURE 11 Number of Markets with at Least One SOE, Ukraine and Comparator Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 FIGURE 12 Distribution of Ukraine’s 100 Largest SOEs by Sector . . . . . . . . . . . . . . . . 13 FIGURE 13 Distribution Ukraine’s 100 Largest SOEs by Subsector . . . . . . . . . . . . . . . . 14 FIGURE 14 Ukrainian SOEs across Sectors by Commercial Viability and Rationale for Government Intervention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 FIGURE 15 Market Shares of Politically Connected Firms by Subsector, 2015 (%) . . . . . . 16 FIGURE 16 Multimarket Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 FIGURE 17 Market Concentration in Key Sectors with SOE and Oligarch Participation . . . 18 FIGURE 18 Does One SOE Hold More Than 50% of the Market? . . . . . . . . . . . . . . . . . 19 FIGURE 19 Does One Politically Connected Firm Hold More Than 50% of the Market? . . . 19 FIGURE 20 Does One SOE or Politically Connected Firm Hold More than 50% of the Market? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 FIGURE 21 Has a New Producer Entered the Market in the Last Three Years? . . . . . . . . . 19 FIGURE 22 New Business Entry Density (average 2006–2016) . . . . . . . . . . . . . . . . . . 21 FIGURE 23 New Business Entry Density Gap Among Comparator Economies (2006–2016) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE v FIGURE 24 ICT Development Index 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 FIGURE 25 Port Infrastructure Quality, Ukraine and Comparator Countries (% of respondents reporting “poor” or “very poor” quality) . . . . . . . . . . . . . . . . . . . . . 23 FIGURE 26 Port Charges, Ukraine and Comparator Countries (% of respondents reporting “high” or “very high” charges) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 FIGURE 27 Product Market Regulations, Ukraine and Comparator Countries, 2013 . . . . 27 FIGURE 28 Restrictiveness of Product Market Regulations Pertaining to State Control, Ukraine and Comparator, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 FIGURE 29 Regulatory Restrictiveness in the Railway Sector, Ukraine and Comparator Countries (index scores from 0 [least restrictive]to 6 [most restrictive]) . . . . . . . . . . . . . 31 FIGURE 30 Competitive Neutrality Gap Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 FIGURE 31 An Analysis of Implementation Issues in Ukraine Using the Markets and Competition Policy Assessment Tool . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 FIGURE 32 Priority Areas for Strengthening National Competition Policy . . . . . . . . . . . 38 FIGURE A.4 Coefficient of Variation of Prices Across Ukrainian Cities . . . . . . . . . . . . . . 47 List of Tables TABLE 1 Market Structure Information for Individual Food Products . . . . . . . . . . . . . . 25 TABLE 2 Examples of Market Regulation Distortions and Competition Constraints in Enabling Sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 TABLE 3 Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 TABLE A.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD . . 43 TABLE A.2 Price Comparison Analysis: Kiev, Ukraine vs. Comparator Cities in OECD and Selected ECA Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 TABLE A.3 Price Comparisons Analysis: Ukraine vs. OECD and Selected ECA Countries . . 46 TABLE B.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD and Selected ECA Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 TABLE B.2 Price Comparison Analysis: Dnipropetrovsk, Kharkiv, Kiev, Lviv, Odesa, and Sumy in Ukraine vs. Comparator Cities in OECD and Selected ECA Countries . . . . . . 45 TABLE C.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD . . 44 TABLE C.2 Price Comparison Analysis within Ukrainian Provinces . . . . . . . . . . . . . . . . 46 TABLE D.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD and Selected ECA Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 EXECUTIVE SUMMARY The following report is designed to support the Government of Ukraine as it strives to pro- mote robust and sustainable growth through market-based reforms. The report examines Ukraine’s market conditions, regulatory framework, and approach to government intervention in terms of their consistency with vigorous competition and economic efficiency. The report’s findings inform a set of policy solutions to help Ukraine achieve its growth potential and create inclusive eco- nomic opportunities. As it attempts to accelerate its economic recovery in the wake of the recent crisis, Ukraine has substantial scope to increase productivity by enhancing competition and implement- ing market-based reforms. Between 2010 and 2016, Ukraine’s annual total factor productivity (TFP) growth rate averaged just 0.9 percent, and the contribution of TFP to GDP growth was negative. The country’s industrial sector and export structure are resistant to change, and both remain focused on older industries such as steel, machine-building, and chemical production despite their low levels of productivity. Meanwhile, inflows of foreign direct investment have been very modest, especially in export-oriented manufacturing. Small and medium-sized enterprises play a limited role in Ukraine’s economy, and larger firms and business groups dominate most sectors—suggesting that competi- tive, market-driven processes of entrepreneurship, innovation, and productivity growth are not func- tioning properly. Firms’ perceptions of the power wielded by vested interests and the prevalence of cronyism, anticompetitive practices, and discrimination against foreign firms further underscore the country’s distorted playing field. Addressing these challenges through pro-competition reforms that increase market con- testability and sharpen incentives to allocate resources efficiently could accelerate eco- nomic growth and promote broad-based development. Recognizing the need to increase productivity through private-sector-led growth, the government has begun implementing a set of market-oriented reforms. However, more must be done to build a modern market economy capable of generating robust, sustainable growth and shared prosperity. Ukraine’s markets are concentrated, as government interventions and regulatory barriers—combined with the dominant role of state-owned enterprises (SOEs) and the power of politically connected firms—limit entry and distort competition. The wave of privatizations in the 1990s shifted the ownership of former state monopolies to politically connected private interests, but they did not create fully open or contestable markets, and subsequent 1 2 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE attempts to privatize the remaining SOEs have largely failed. Certain sectors and even specific SOEs remain protected from restructuring despite operating alongside private firms in markets where competition is clearly viable. SOE market shares exceed 50 percent in at least 15 of 28 sectors and markets. These SOEs consume public resources and crowd out private investment, and their continued existence often lacks a clear rationale. In addition, the share of politically connected private firms is unusually high, reaching over 60 percent of sectoral turnover or assets in capital-intensive industries.1 Together, SOEs and politically connected firms are the major players in at least 13 markets, including all of the key productivity-enabling sectors. The Ukrainian economy suffers from weak competitive pressure, with little room for investment in value addition. An analysis of entry and exit dynamics reveals a persistent lack of contestability in Ukrainian markets. Even markets where competition would typically be viable tend to be dominated by a single SOE or a few large firms, often with political connections, which reduces competitive pressure and exacerbates the risk of anticompetitive practices. An econo- metric analysis2 of firm-level data for 2006–2015 finds statistically significant differences in economic outcomes between politically connected firms and other firms, even when controlling for firm sector, size, and age. Not only are politically connected firms less productive than their non-connected peers, they also tend to have slower turnover, employment, and TFP growth rates. The estimated differences range from –5.7 to –16.2 percentage points for the turnover growth rate, –13.0 to –28.9 percentage points for the employment growth rate, and –4.6 to –10.1 percentage points for the TFP growth rate. Concentrated markets and weak competitive pressures increase the costs of goods and services and diminish their quality. Ukraine ranked 83rd out of 140 countries on the 2017–18 Global Competitiveness Index (GCI), and its overall score (4.11 out of 7) has improved little over the past five years. Among Eastern European countries, only Moldova and Bosnia and Herzegovina scored lower on the GCI. Ukraine fares especially poorly on the sub-indicator for goods-market efficiency (4 out of 7) and ranks well behind close regional comparators such as Romania, Bulgaria, and Poland. Prices for basic food products, which comprise a significant portion of Ukraine’s food consumption basket, are an estimated 20 to 50 percent higher than the levels observed in the OECD and in peer countries in Eastern Europe and Central Asia. Markets for certain food products, such as rice and sugar, are especially distorted by powerful interests, and prices for these goods are far above the levels of comparator countries. In addition, domestic prices for food commodities traded on international markets do not appear sensitive to changes in international prices, and domestic price regulations may have served as a floor, preventing downward price adjust- ment due to increased competition from abroad. 1 Firms are considered politically connected if they are able to influence the policy process to their advantage at the expense of the public interest. 2 The World Bank Group and the UK Good Governance Fund (2018). Crony capitalism in Ukraine: impact on economic out- comes (English). Washington, D.C.: World Bank Group. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 3 In Ukraine, the government’s economic interventions have a major influence on market outcomes. The propensity of SOEs and politically connected firms in concentrated markets to lobby for regulatory protections and other policy-based advantages underscores the importance of mainstreaming the principle of competitive neutrality in government interventions. Even rel- atively minor distortions or barriers imposed in specific sectors can substantially impact market dynamics, especially in markets that are not naturally conducive to contestation. To address these challenges, this report proposes measures to improve Ukraine’s regulatory framework, institutional arrangements, and enforcement mechanisms within the context of a national competition policy. Although Ukraine’s economywide and sectoral product-market regulations are relatively progressive in principle, their application must be strength- ened to ensure a level playing field supported by competitively neutral public policies. At present, multiple sectoral regulators and market institutions are not fully independent and cannot effectively execute their mandates. In addition, a high degree of vertical integration in network industries and key productivity-enabling sectors (e.g., electricity and gas) can increase risks of market foreclosure, and in these cases the unbundling of monopolies or dominant players could yield substantial effi- ciency gains that enhance the competitiveness of downstream sectors. Therefore, a holistic competi- tion policy must go beyond antitrust enforcement to: (i) ensure a competitively neutral environment that minimizes the policy-based advantages of SOEs and politically connected firms; (ii) improve the predictability, consistency, and transparency of the regulatory framework, both in principle and in application; and (iii) support the development of robust, independent market institutions. CHAPTER FROM MICROECONOMIC FUNDAMENTALS TO MACROECONOMIC OUTCOMES 1 Ukraine Has Substantial Scope to Boost Productivity through Increased Competition and Market-Oriented Reform Ukraine is emerging from a period of slow growth in the wake of the economic crisis that marked the start of the still-unresolved conflict in the eastern part of the country. The econ- omy has begun to stabilize, with real GDP growing by 2.3 percent in 2016 and 2.5 percent in 2017. However, this follows a cumulative 16 percent contraction in 2014 and 2015.3 The Ukrainian govern- ment is aware that market-based reforms will be vital to accelerate growth, and the authorities have already taken important steps to increase competition. Nevertheless, much more could be done to reduce the distortive impact of the regulatory framework, especially in network industries and services, and the evenhanded enforcement of competition policy by independent market regulators will be necessary to increase investment and improve outcomes for consumers and businesses. In this context, the following report analyzes market competition in Ukraine, evaluates the efficiency of its regulatory framework, and assesses the extent to which government interventions are conducive to competition. The report’s findings are designed to inform policy solutions that will help unleash the country’s growth potential and create inclusive economic opportunities. Strengthening competition policy will be critical to overcome Ukraine’s decades-long lack of productivity growth and leverage the capacity of an efficient private sector to sustain progress on social development by expanding access to affordable, high-quality goods and services. Competition policy encompasses the laws, regulations, processes, and institutions neces- sary to ensure a level competitive playing field and address distortions that could reduce economic welfare.4 A sound competition policy framework promotes economic growth and shared prosperity both by facilitating productivity growth within firms and by enabling the efficient reallocation of resources to more-productive firms and sectors.5 Productivity gains reduce prices and improve the quality of goods and services, benefitting consumers—including lower-income households. Effec- tive competition policies must consider the specific features of different markets, and well-designed 3 World Bank Group (2018). Macro Poverty Outlook for Europe and Central Asia. Spring Meetings 2018. 4 See Motta, M. (2004). Competition policy: theory and practice. Cambridge University Press. 5 See Syverson, C. (2011). What Determines Productivity? Journal of Economic literature. 5 6 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE government interventions are especially important in sectors that are naturally vulnerable to market failures or anticompetitive practices. As it recovers from the recent crisis, Ukraine can accelerate its economic development by adopting pro-competition reforms that sharpen efficiency incentives. In past decades, the economy has experienced a volatile growth pattern, which expansions driven by favorable terms of trade and large capital inflows in a context of weak underlying productivity growth, persistent structural bottlenecks, and serious governance challenges. The country’s industrial sector and export structure are resistant to change, and both remain focused on older industries such as steel, machine-building, and chemical production despite their low levels of productivity. Meanwhile, inflows of foreign direct investment (FDI) have been very modest, especially in export-oriented manufacturing.6 Small and medium-sized enterprises play a limited role in Ukraine’s economy, and larger firms and business groups dominate most sectors—suggesting that competitive, market-driven processes of entrepreneurship, innovation, and productivity growth are not func- tioning properly.7 Firms’ perceptions of the power wielded by vested interests and the prevalence of cronyism, anticompetitive practices, and discrimination against foreign firms further underscore the country’s distorted playing field.8 Ukraine Suffers from Persistently Low Productivity, Limited Investment, and Shrinking Industrial and Service Sectors Weak productivity growth is among the most salient, enduring, and critical obstacles to economic development in Ukraine. During 2000–08, the annual TFP growth rate averaged 6.6 percent, and rising TFP was responsible for over 80 percent of GDP growth. However, the robust TFP growth observed during this period was due in part to rebounding capacity utilization following the sharp post-transition contraction of the 1990s. During the 2008–09 global financial crisis, deteriorating external conditions caused TFP to plummet, and between 2010 and 2016 the annual TFP growth rate averaged just 0.9 percent (Figure 1), well below the rates of most comparable countries in Eastern Europe and Central Asia (Figure 2).9 Low TFP growth rates have detracted from overall GDP growth in recent years (Figure 3). While signs of a recovery in TFP growth have emerged since 2016, restoring productivity growth to pre-crisis levels and sustaining those levels over time pose considerable challenges. 6 FDI represented 1 % of GDP in January-July 2017. World Bank. 2017. Macro Poverty Outlook for Europe and Central Asia and World Development Indicators. 7 World Bank (2014). Opportunities and Challenges for Private Sector Development. 8 Economist Intelligence Unit (2018). 9 Poland, Turkey, Lithuania, Romania, Moldova, Kazakhstan, Bulgaria, Estonia, Latvia, Croatia, Czech Republic, Georgia. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 7 FIGURE 1 Total Factor Productivity Growth, FIGURE 2 Total Factor Productivity Growth, Ukraine, 2002–2016 (%) Ukraine and Comparators, 2010–2016 (%) 15.0 5.0 11.0 4.0 10.0 9.4 7.1 7.1 3.0 5.3 5.7 2.0 5.0 3.8 3.4 2.1 1.8 1.0 0.7 0.3 0.0 0.0 –1.0 –5.0 –2.3 –2.0 –4.8 –3.0 –10.0 Re tia Hu blic Bu ary Uk ria Po ne Ro nd Tu ia Es ey La a a za nia Ge tan M gia va ni Li tvi an do rk a h oa i la to Ka hua or ng ra s pu lg m kh ec Cr ol –15.0 –13.8 t Cz –20.0 2002 2004 2006 2008 2010 2012 2014 2016 Growth 2016 Average growth 2010–2015 Source: The Conference Board Total Economy Database™ (adjusted version), Source: The Conference Board Total Economy Database™ (adjusted version), November 2017 November 2017 FIGURE 3 Contributors to GDP Growth (percentage points) 15.0 10.0 Growth rate (percentage points) 5.0 0.0 –5.0 –10.0 –15.0 –20.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Total Factor Productivity (gA) Labor ((1-α) * gL) Human Capital per Labor ((1-α) * gh) Capital Stock (α * gK) Real GDP (gY) Source: World Bank staff Note: Growth rates are weighted according to the income share of capital (%) = 40% 8 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE Although Ukraine is open to trade, the country could attract much more FDI, especially in higher-value, export-oriented markets.10 While Ukraine performs relatively well on measures of trade openness11 (Figure 4), it attracts less FDI than do many comparable countries (Figure 5). Before the crisis, annual net FDI inflows averaged 5 percent of Ukraine’s GDP, but in 2017 they reached just 2.1 percent, below the levels of the Czech Republic (4.3 percent), Croatia (3.8 percent), Latvia (3.8 percent), Bulgaria (2.9 percent), and Romania (2.3 percent).12 The slow pace of the reform process, unaddressed macroeconomic vulnerabilities, and uncertainty surrounding the 2019 elections are among the key factors weakening investor confidence.13 FIGURE 4 International Trade as a Share of GDP, FIGURE 5 Net FDI Inflows as a Share of GDP, Ukraine and Comparators, 2006–2017 (%) Ukraine and Comparators, 2006–2017 (%) 450 60 400 50 350 FDI, net in ows (% of GDP) 300 40 Trade (% of GDP) 250 30 200 Ukraine 150 20 Ukraine 100 10 50 0 0 6 7 8 9 10 11 12 6 7 8 9 10 11 12 log GDP per capita (PPP 2011) log GDP per capita (PPP 2011) Source: WDI Dataset Source: WDI Dataset 10 These include high-value metal and agriculture products. 11 According to MIT’s Atlas Media for 2016, Ukraine’s top exports are seed oils (US$3.44 billion, 9.8 percent of total exports), wheat (US$2.37 billion, 6.7 percent), corn (US$2.26 billion, 6.4 percent), semi-finished iron (US$2.1 billion, 6.0 percent) and iron ore (US$1.92 billion, 5.5 percent) per the 1992 Harmonized System. The country’s top imports are refined petroleum (US$3.3 billion, 8.7 percent of total imports), packaged medicaments (US$1.37 billion, 3.6 percent), cars (US$1.24 billion, 3.3 percent), coal briquettes (US$1.11 billion, 2.9 percent) and petroleum gas (US$964 million, 2.5 percent). For further information, see: https://atlas.media.mit.edu/en/profile/country/ukr/ 12 Peer countries include Poland, Turkey, Lithuania, Romania, Moldova, Kazakhstan, Bulgaria, Estonia, Latvia, Croatia, Czech Republic, and Georgia. 13 World Bank Group (2018) “Macro Poverty Outlook for Europe and Central Asia.” Spring Meetings 2018. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 9 Since 2009, Ukraine’s most important economic sectors have been stagnating or shrinking. Services account for 60 percent of Ukraine’s GDP, followed by industry (30 percent) and agricul- ture (10 percent). The growth of value addition has been either low or negative in the post-crisis period (Figure 6), and the industrial sector has had the largest negative impact on the growth of total value addition (Figure 7). The service sector has also detracted from total value addition, though its contribution to gross employment has been positive due to an expanding public-sector workforce, as the share of public services in GDP rose significantly between 2010 and 2015 (Figure 8). Agricul- ture, meanwhile, has increased as a share of GDP and is the only major sector that made a positive contribution to value addition between 1991 and 2016. FIGURE 6 Contribution to the Growth of Value FIGURE 7 Contribution to the Growth of Value Addition by Major Sector, 1991–2015 Addition and Gross Employment, 1991–2016 (percentage points) (percentage points) 15.0 0.1 10.0 Agriculture 5.0 –0.4 Percentage Points 0.0 –1.3 –5.0 Industry –0.6 –10.0 –15.0 –0.6 Services etc. –20.0 0.3 –25.0 –1.5 –1.0 –0.5 0.0 0.5 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Percentage points Agriculture Industry Value Added Contribution to Value Added Growth, 1991–2016 Services etc. Residual Growth Contribution to Gross Employment Growth, 1991–2016 Source: World Bank staff Source: World Bank staff FIGURE 8 Supply-Side GDP Decomposition by Subsector, 2010 and 2015 (%) 100% 21.6% 24.1% 80% Administrative, public and other services Transport and logistics FIRE ( nance, insurance, real estate) 60% 11.9% 11.2% Retail trade, catering and hotels Construction 40% Manufacturing 33.3% 28.7% Mining and quarrying 20% Agriculture, forestry and shing 0% 2010 2015 Source: Ukrstat. 10 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE Recognizing the need to increase productivity and facilitate private-sector-led growth, the government has launched important reforms in recent years. These efforts have focused on three areas: (i) privatization, with the government and the State Property Fund working on a privatization plan;14 (ii) energy, with recent reforms attempting to open the electricity market to competition;15 and (iii) digital technology, with the approval of a roadmap to increase productivity by introducing new information and communications technologies (ICT) and leveraging public-private partnerships to invest in broadband internet infrastructure.16 Further reforms will be necessary to build a robust and competitive market economy. Certain sectors and even specific SOEs remain protected from restructuring despite operating in markets that can sustain private firms. For example, Energoatom, which holds a market share of over 90 percent in the electricity-generation subsector, is just one of many SOEs protected from privatization by a 1999 law.17 Moreover, many key pro-competition reforms have only been partially implemented. For example, the state-owned oil and gas company Naftogaz is currently unbundling its transmission functions, yet otherwise it remains fully vertically integrated. While the government has undertaken important reforms under very difficult circumstances, Ukraine’s regulatory frame- work continues to restrict competition. Further improvements in competition policy could boost economic growth by promoting allocative efficiency and encouraging private investment. 14 The new Law on the Privatization of State and Communal Property became effective in March 2018. The government has indicated that the 21 largest SOEs are scheduled to be privatized during 2018, including SOEs in the energy, chemicals, engi- neering, and agricultural sectors. 15 These measures include the unbundling of electricity transmission and distribution, with the goal of establishing a liber- alized wholesale market by July 2019 and liberalized household electricity prices by December 2018. See: The Law on the Electricity Market (13.04.2017 #2019-VIII) available at http://zakon3.rada.gov.ua/laws/show/2019-19 16 Ministry of Economic Development and Trade, cited by Ukraine Digital News at http://www.uadn.net/2018/01/24/ ukrainian-government-approves-digital-economy-strategy-for-ukraine/ 17 The Law on the List of Objects of State Property Not Subject to Privatization 2 CHAPTER SOURCES OF COMPETITION AND MARKET CONSTRAINTS SOEs and Politically Connected Firms Dominate Key Sectors, Weakening Market Contestability and Undermining Efficiency Incentives Surveys and firm-level data both indicate high levels of market dominance in Ukraine. According to surveys conducted for the World Economic Forum’s Global Competitiveness Report, only Moldova, Croatia, and Hungary were perceived to experience more severe market dominance than Ukraine (Figure 9). Firm-level data18 corroborate these perceptions and highlight the increasingly oligop- olistic structure of Ukraine’s manufacturing markets. The FIGURE 9 The Extent of Market Dominance in Ukraine share of oligopolies in the manufacturing sector19 rose 7 from 25 percent in 2008 to 44 percent in 2013, and a rel- atively large share of firms in the sector report operating 6 in an oligopoly or duopoly (Figure 10).20 5 In addition, the large market shares commanded 4 by SOEs and politically connected firms appear to 3 undermine contestability and weaken efficiency 2 incentives. High levels of market concentration are 1 not necessarily a cause for concern, as successful firms can garner large market shares through innovation, 0 Georgia Estonia Moldova Croatia Hungary Ukraine Kazakhstan Latvia Lithuania Romania Bulgaria Turkey Czech Republic Poland process optimization, or other efficiency-enhancing measures. However, market dominance may also occur when firms are shielded from competition by barriers to entry or when they enjoy large regulatory advan-tages Source: World Economic Forum 2017/18 over their competitors. Competitive neutrality— the Note: Values range from 1 (highly concentrated) to 7 (highly contested) 18 World Bank and European Bank for Reconstruction and Development Enterprise Surveys (2008, 2011, and 2013). 19 The manufacturing sector includes food, textiles, garments, leather, wood, paper, publishing, printed and recorded media, refined petroleum products, chemicals, plastics and rubber, non-metallic mineral products, basic metals, fabricated metal products, machinery and equipment, electronics, precision instruments, transportation machines, furniture, and recycling. 20 A description of the Enterprise Survey methodology is available at http://www.enterprisesurveys.org/methodology. 11 12 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE FIGURE 10 Market Structures in the Manufacturing Sector, Ukraine and Comparators 100% 90% 80% 70% 60% 50% 40% 30% 44% 25% 20% 10% 0% Estonia Moldova Latvia Lithuania Ukraine Hungary Romania Poland Georgia Croatia Czech Republic Kazakhstan Bulgaria Turkey Ukraine 2013 2011 2008 Monopoly Duopoly Oligopoly 6 or more Source: World Bank/EBRD Enterprise Surveys for 2008, 2011, and 2013 (manufacturing sectors only) principle that government interventions should not favor certain firms over others—is vital to ensure that the presence of SOEs and politically connected firms does not undermine market efficiency. Due in part to its history as a command economy, Ukraine has an unusually large number of SOEs. A total of 3,591 SOEs are registered in Ukraine,21 though only half are currently operational. These SOEs are not restricted to network industries with natural-monopoly segments (e.g., electricity, gas, water supply, and railways), and they operate in a wide range of manufacturing, agricultural, and financial services markets. Moreover, SOEs have repeatedly been used as instruments in corruption schemes.22 Among comparator countries, Ukraine has an exceptionally large number of markets with at least one SOE (Figure 11).23 Ukrainian SOEs employ about 1 million people, or roughly 5 percent of the national workforce.24 21 Government of Ukraine (2017). See: http://www.spfu.gov.ua/ua/content/spf-stateproperty-Subiekti-gospodaruvannya.html 22 Prime Minister Volodymyr Groysman, cited by Reuters. See: https://www.reuters.com/article/uk-ukraine-privatisation/ ukraine-passes-privatisation-law-needed-for-imf-aid-idUKKBN1F71OD. 23 World Bank and OECD (2018). The product-market regulation (PMR) indicator assesses the extent to which public policies promote or inhibit in several areas of product markets. The PMR methodology encompasses 12 subsectors and policy areas, including electricity, gas, telecommunications, postal services, transportation, water supply, retail distribution, professional services, other subsectors, administrative requirements for business startups, the treatment of foreign parties, and others, such as governance of public-controlled enterprises and antitrust exemptions. The information for Ukraine was collected in 2017, reflecting the status of the regulations as September 2017, and was used to calculate PMR scores in 2018. 24 World Bank (2016). Systematic Country Diagnostic, p. 76 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 13 FIGURE 11 The Number of Markets with at Least One SOE, Ukraine and Comparator Countries 30 Ukraine*, 28 25 Ukraine, 19 20 OECD Average,13.7 15 10 5 0 Panama Honduras United Kingdom Cyprus Estonia Latvia Malta Netherlands El Salvador Ireland Denmark Guatemala Japan Korea Rwanda United States Chad Bulgaria Canada Germany Iceland Nicaragua Paraguay Slovak Republic Uruguay Brazil Chile Costa Rica Jamaica Peru Austria Belgium Portugal Senegal OECD Average Australia Finland Kenya New Zealand Colombia Czech Republic Dominican Republic Greece Mauritania Namibia Hungary Israel Lithuania Switzerland Argentina Russia Slovenia South Africa Bolivia France Italy Philippines Spain Sweden Norway Tunisia Ukraine Ecuador Indonesia Venezuela Turkey China Croatia Romania India Poland Egypt Ukraine* Source: Markets and Competition OECD-WBG PMR indicators (2018 for Ukraine; or most recent year) Note: *Includes additional sectors beyond those reported in the Market and Competition World Bank/OECD PMR data. Ukrainian SOEs are present in almost 30 economic FIGURE 12 Distribution of Ukraine’s 100 Largest sectors, and they hold significant market shares in SOEs by Sector more than half of the markets in which they operate. A Other plurality of Ukraine’s 100 largest SOEs operate in the service 23% sector (Figure 12). SOEs play an especially significant role in transportation (Figure 13), as well as other productivity-en- Services 41% abling sectors such as electricity and banking. SOEs are also present in extractive industries such as oil, gas, and coal Agriculture mining, manufacturing industries such as chemicals and 10% machinery, and commercial activities such as real estate. SOEs hold market shares greater than 50 percent in at least 15 of 28 subsectors and markets in which they operate.25 Industry The law explicitly prohibits privatization of some of these. 26% In addition to Energoatom, the list of SOEs protected from Source: MEDT (2015). privatization includes NJSC Naftogaz Ukrainy (the monop- Note: “Other” includes media companies, other public services, and real estate. oly gas importer), PJSC Ukrtranshaz (the monopoly gas transporter), PJSC Ukrzaliznytsia (a railroad-infrastructure operator and passenger and freight transporter); PJSC Ukrainske Dunayske Paroplavstvo (a freight and passenger According to Markets and Competition OECD-WBG (2018) and MEDT (2015), at least one SOE operates in 28 subsectors and 25 markets. However, this assessment is not necessarily exhaustive, and SOEs may also be active in additional subsectors and markets. 14 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE transportation service provider), Dnipro and Kharkiv FIGURE 13 Distribution Ukraine’s 100 Largest SOEs by Subsector Metropolitan (a passenger transportation company), the Pivdennyi Machine-Building Plant (a manufacturer of Banking 6% fabricated metal products, machinery and equipment), Transportation Chemicals 22% 6% Antonov (the national aircraft manufacturer), Antonov Coal Mining Airlines, Kiev Boryspil Airport, all of the country’s seaports, 7% all regional road-infrastructure operators, all companies involved in water collection, treatment, and supply,26 the Electricity Hotel Dnipro in Kiev, and the State Design-Research Insti- Real Estate 13% tute of Transport Construction(“Kyyivdiprotrans”). 11% Many Ukrainian SOEs lack a clear economic or Food & public-policy rationale to justify their existence, Other Agriculture 12% 10% and there is little indication that their benefits Oil & Machine Gas Building outweigh their costs. SOE losses strain the govern- 3% 10% ment’s limited fiscal resources, and the market domi- Source: MEDT (2015). nance of SOEs risks crowding out private investment. Note: “Other” includes media companies, other public services, and real estate. While some Ukrainian SOEs operate in sectors with national security implications, natural-monopoly char- acteristics, or other features that could potentially jus- tify a role for the state, most SOEs are involved in sectors and markets where there is no obvious basis for government participation. Although a detailed analysis could reveal market failures that warrant SOE involvement, the international experience indicates that many sectors in which Ukraine’s SOEs operate—including alcohol production, commercial banking, hotels, agriculture, and machine building—tend to function efficiently without SOEs, and SOE involvement in these sectors is rarely justified by strategic considerations or development policy objectives (Figure 14). The country’s large and persistent SOE footprint in a context of weak economic perfor- mance suggests that barriers to entry and market distortions are limiting the role of private firms in sectors where competition would be viable. National statistics indicate that almost half of Ukraine’s largest SOEs are unprofitable, yet loss-making SOEs continue to operate—consuming productive resources that would otherwise be employed by more efficient private firms. Of Ukraine’s 100 largest SOEs,27 only 57 were profitable in 2014, and their average net profit margins were low.28 26 Article 14 of the Law on Drinking Water, Water Supply and Drainage (available at http://zakon4.rada.gov.ua/laws/show/ 2918-14) provides for the privatization of SOEs that supply drinking water. 27 Their combined assets totaled UAH 982.5 billion (roughly US$44.7 billion) in the first half of 2015. Their revenue averaged UAH 241.7 billion (about US$10 billion) between 2012 and 2014. Earnings before interest, tax, depreciation, and amortiza- tion (EBITDA) over the same period fluctuated between UAH 3 and 30 billion (US$250 million to US$2.5 billion). See also: http://www.me.gov.ua/News/Detail?lang=en-GB&id=5fe878f1-885c-4690-ab84-6c612b0504e2&title=MinistryOfEconomic DevelopmentAndTradeOfUkrainePublishedTheFirstReviewOfThe100-LargestStateEnterprises 28 MEDT (2015). Ukraine’s Top 100 State-Owned Enterprises. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 15 FIGURE 14 Ukrainian SOEs across Sectors by Commercial Viability and Rationale for Government Intervention  Transport of oil and oil products by major pipelines (Naftogaz, SE represented by PJSC Ukrtransnafta)  Transport of natural gas by major pipelines (Naftogaz, SE represented by PJSC Ukrtransgas)  Electricity import (Ukrinterenergo) Rationale for government  Transmission of electricity (National Energy Company Ukrenergo) intervention to limit entry  Railways (State Administration Ukrzalinitsya)  Air tra c control (SE Ukraerorukh) YES Private sector  Airports (Kiev Boryspil Airport, Lviv International Airport) excluded/limited  Seaports Private sector due to market failure  Aerospace manufacturing (Antonov, Pivdennyi Machine Building) excluded for  Specialized services of transport terminal and warehouses for Legal monopolies strategic/public Exclusivities ammonia (PJSC Odessa preport Plant) policy reasons Statutory restrictions  Postal services (SE Ukrposhta) on the sale of state  Local telephones (PJSC Ukrtelecom) controlled shares  Water distribution (national or subnational governments)  Health care Commercial  Ethyl alcohol production (Ukrspyrt) viability NO YES  Electricity generation (Energoatam, PJSC Centrenegro)  Oil extraction and manufacture of re ned petroleum products (PJSC Non Ukrnafta) commercially SOEs compete  Banking (Pryvatbank, oschadbank, Ukreximbank, Ukrgazbank) viable for private with private  Construction (PJSCHC Kyivmiskud) sector unless operators  Hotels (Hotel Dnipro)  Air transport state intervention  Water transport NO  Poultry (PJSC MHP)  Agriculture (State Food, Grain Corp. of Ukraine +9 others)  Manufacture of chemicals (PJSC Sumykhimprom +5 others)  Manufacture of aluminum foil (SE Factory aluminum foil)  Coal mining (SE coal of Ukraine, SE Selydivvuhillya +5 others)  TV and radio broadcasting (Broadcasting, radio communications & TV concern) Source: Author’s elaboration Note: Sectors that typically attract private investment are in blue. According to data from Ukraine’s Ministry of Economic Development and Trade (MEDT), the country’s operational SOEs contributed about 20 percent to its GDP in 2015. In the same year, the 46 largest SOEs accounted for 94 percent of SOE assets and 92 percent of SOE losses.29 Concentrated markets with large SOE footprints are at high risk of producing poor out- comes, especially in the absence of a fully implemented competitive-neutrality framework. While the presence of SOEs is not necessarily incompatible with competitive market outcomes, a competitive-neutrality framework is vital, particularly in markets that are naturally concentrated. To ensure their economic efficiency, SOEs must be exposed to competitive pressures from private firms on a level playing field, or they must be subject to economic regulations that establish effective per- formance incentives. Like SOEs, private firms that enjoy regulatory protection tend to create markets that are not fully contestable or competitive. Explicit or tacit collusion between firms can also weaken competitive pressure and distort incentives. 29 World Bank (2016). Systematic Country Diagnostic, p. 76. 16 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE In Ukraine, high levels of market concentration and a heavy SOE footprint are compounded by an unusually large share of politically connected private firms. Firms are considered polit- ically connected when they are able to influence the policy process to their advantage at the expense of the public interest. Recent research has found that between 0.5 and 2 percent of all firms in Ukraine are politically connected, yet these firms account for over 20 percent of total turnover.30 Politically connected firms tend to operate in capital-intensive industries such as mining, energy, and transportation, where they account for over 40 percent of total turnover and over 50 percent of total assets (Figure 15). FIGURE 15 Market Shares of Politically Connected Firms by Subsector, 2015 (%) 70% 60% 50% 40% 30% 20% 10% 0% Fishing Mining and quarrying Manufacturing Construction Wholesale and retail trade Hotels and restaurantes Transport, storage and communications Financial intermediation Real estate, renting and business activities Public administration and defence, social security Education Other service activities Agriculture, hunting and forestry Electricity, gas and water supply Health and social work Agriculture Industry Services Sector’s number of rms Sector’s turnover Sector’s assets Source: The World Bank Group and the UK Good Governance Fund, 2018. Many politically connected firms are owned by the country’s oligarchs who wield enormous political and economic power. The Ukrainian oligarchs emerged during the country’s transition and privatization process in the mid-1990s, when the leaders of newly formed business groups rapidly accumulated economic assets and began investing in politics to defend their market positions.31 The Ukrainian air-transportation market is currently dominated by the oligarch-owned Ukrainian 30 The World Bank Group and the UK Good Governance Fund (2018). Crony capitalism in Ukraine: impact on economic out- comes (English). Washington, D.C.: World Bank Group. http://documents.worldbank.org/curated/en/125111521811080792/ Crony-capitalism-in-Ukraine-impact-on-economic-outcomes. This analysis uses two approaches to identify politically con- nected firms. The first approach is based on publicly available information on the ownership and control of businesses by individuals who have been entrusted with prominent public functions, including senior politicians and party officials, senior government, judicial or military officials, and senior executives of SOEs. A firm is considered connected if it has at least one such person among its owners, shareholders, or managers. The second approach includes companies that possess political connections through an oligarch or a business group. 31 Wojciech Kono´ nczuk, Denis Cenus¸a and Kornely Kakachia (2017). Oligarchs in Ukraine, Moldova and Georgia as key obstacles to reform. Available at: http://www.3dcftas.eu/system/tdf/Oligarchs_14%20June_FINAL_0.pdf?file=1&type=node&id=358%20 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 17 International Airlines (UIA), which carries over 80 percent of domestic passengers and is the only airline on most domestic routes, though it also serves many international destinations. Two of the three largest players in the mining and steel markets are Metinvest and Interpipe Group, both of which are owned by oligarchs. The third, ArcelorMittal, is a former SOE that was successfully privatized in 2005 after an initial privatization attempt in 2004 was marred by a corruption scandal. Another oligarch controls a group of companies known as Ostchem, which supplies over 80 percent of the domestic market for several varieties of mineral fertilizer. Yet another oligarch owns Myronivsky Hliboproduct (MHP), the market leader in poultry production and sales. Business groups owned by Ukraine’s oli- garchs tend to operate across multiple markets and economic sectors, leading to significant multi- market contact among politically connected firms and SOEs (Figure 16). FIGURE 16 Multimarket Contacts SOE Transportation Coal Real Estate Airlines and storage Steel Titanium Chemicals Grain Airports & Shipping Ports Poultry Meat Energy aerospace lines Media Iron ore Milk Fixed generation manufacturers Banking broadband Fertilizers Engineering Eggs Insurance Shipbuilding Sports Confectioneries Pharmaceuticals Oligarch Oligarch Oligarch Oligarch Oligarch Oligarch Other 1 2 3 4 5 6 Source: Author’s elaboration based on publicly available information. Note: The markets covered by this figure include the main product markets with SOE and/or oligarch presence. Together, SOEs and politically connected firms are the main players in all productivity- enabling sectors of the Ukrainian economy. SOEs operate alongside politically connected firms business. in least 13 markets, including banking, transportation, mining and quarrying, energy, and agri­ The relationship between SOEs and politically connected firms varies widely from market to market. For example, the energy-generation subsector includes at least one SOE and at least one firm owned by each of the country’s four most powerful oligarchs. All of the country’s four biggest banks are now SOEs, after the largest, PrivatBank, was expropriated from an oligarch in 2016 due to alleged risky lending practices. In the oil and gas subsector, the government owns 51 percent of the joint stock company Ukrnaftaone, one of Naftogaz’s main production and refining subsidiaries, while an oligarch is a minority 18 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE shareholder. That same oligarch controls an oil-transportation company and owns the country’s largest network of gas stations. These multi-market contacts facilitate explicit or tacit collusion. Most markets in Ukraine are highly concentrated, with the same firm or firms persistently com- manding large and stable market shares. Markets with a large SOE footprint that have not been subject to privatization have tended to retain their structure over time. This is particularly true in the electricity and gas production and import subsectors. Other markets, including air transportation and fertilizer production, remain concentrated even though they lack strong network effects or other charac- teristics of natural monopolies. The enduring concentration of these normally contestable markets likely reflects uneven competitive playing fields due to the preferential tax treatment of incumbents and/or unnecessarily high administrative barriers to entry, including restrictions on foreign investors (Figure 17). FIGURE 17 Market Concentration in Key Sectors with SOE and Oligarch Participation Market share of largest player (%) 100% Energy imports Gas imports Dry eggs Fertilizers 80% Airlines Tomatoes Oil Energy extraction 60% Generation Airports Iron ore Mobile Coal telecom 40% Shell eggs Poultry Pork 20% Milk Ports Meat Grain Concentration Low Medium High index (HHI) (<1000) (<2500) Source: Author’s elaboration based on publicly available information. Notes: Product markets are colored green when one or more SOE(s) is (are) present in the market, blue when one or more oligarch(s) is (are) present, and orange when SOEs and oligarchs are both present. The concentration indexes shown are lower limits. It should be noted that the subadditivity of costs may cause high levels of con- centration in certain markets, such as mobile telecommunications, airports, energy generation, and energy imports. SOEs and politically connected firms are often the dominant players in their markets. As noted above, SOEs command a market share of over 50 percent in 13 of the 28 subsectors in which they oper- ate (Figure 18). In many of the remaining sectors, multiple SOEs hold a combined market share of over 50 percent. For example, three SOEs account for a combined 60 percent of the market for port infrastruc- ture and services. In addition, politically connected firms command a market share of over 50 percent in six of 25 subsectors in which they operate (Figure 19). Together, SOEs and politically connected firms hold a market share of over 50 percent in almost half the markets in which they operate (Figure 20). REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 19 FIGURE 18 Does One SOE Hold More Than 50% FIGURE 19 Does One Politically Connected Firm of the Market? Hold More Than 50% of the Market? No No Yes Retail Banking Insurance Construction Fixed broadband Hotels Transportation and storage Electricity generation Grain Energy generation Electricity import Meat Shipbuilding Gas generation Milk Shipping lines Gas import Chemicals Media Railways Aluminum Sports Airports Titanium Pharmaceuticals Water cargo transport Chemicals Real Estate Oil extraction Fixed broadband Coal Health care Ports Steel Aerospace manufacturing Airlines Yes Titanium Ethyl alcohol production Shipping lines Confectioneries Retail Banking Engineering Transportation and storage Shell eggs Coal Mineral fertilizers Real Estate Meat Chemicals Poultry Airlines Grain Iron ore Dry eggs Note: This figure shows markets with SOE presence and potential private-sector Note: This figure shows markets with oligarch presence for which information on investment for which information on market shares is available. market shares is available. FIGURE 20 Does One SOE or Politically Connected FIGURE 21 Has a New Producer Entered Firm Hold More than 50% of the Market? the Market in the Last Three Years? No No Fixed broadband Electricity generation Yes Electricity import Ports Shipbuilding Gas production Electricity generation Shipping lines Gas import Electricity import Transportation and storage Railways* Gas production Insurance Airports Gas import Pharmaceuticals Yes Health care Oil extraction Steel Chemicals Railways Construction Titanium Oil extraction Airports Hotels Aluminium Aerospace manufacturing Airlines Real Estate Media Ethyl alcohol production* Water cargo transport Meat Sports Retail banking Aerospace manufacturing Grain Real Estate Mineral fertilizers Health care Confectionaries Construction Sports Ethyl alcohol production Engineering Hotels Insurance Retail banking Pharmaceuticals Confectioneries Shipbuilding Engineering Airlines Shell eggs Coal Mineral fertilizers Water cargo transport Meat Poultry Chemicals Transportation and storage Poultry Milk Coal Media Grain Titanium Iron ore Aluminum Milk Steel Dry eggs Ports Fixed broadband Source: Author’s elaboration Source: Author’s elaboration Note: Information on market entry is based on investment announcements and news reports. Market entry is not possible in sectors declared legal monopolies (*). Natural monopolies are excluded from this figure. 20 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE New producers have been observed entering just 14 of the 34 markets in which SOEs or politically connected firms operate (excluding those classified as legal or natural monop- olies32), and in many cases these firms were only able to enter the market after obtaining an explicit government endorsement. Several of the new entrants were large international firms with considerable investment resources and the capacity reduce infrastructure gaps and improve service quality (Figure 21). However, even major international players have struggled to enter the Ukrainian market. For example, Ryanair failed to enter the air transportation market in 2017, but it later succeeded in obtaining approval from the Ukrainian government and has announced that it will launch operations in October 2018.33 Similarly, P&O Maritime—which is owned by DP World Group, the world’s largest port operator—started operations in Ukraine in January 2018 and will provide towing services in the Odessa region.34 Even in markets that are not dominated by SOEs, entry remains limited. Between 2006 and 2016, the average entry density in Ukraine’s formal private sector was low, both by global standards and by the standards of comparable countries (Figure 22 and Figure 23). Low entry density weak- ens competitive pressure in domestic markets, contributing to low productivity growth. Multiple factors could explain Ukraine’s low entry density, including a lack of investor confidence due to the country’s difficult macroeconomic and political situation in recent years, but regulatory barriers to entry and policies that protect certain incumbent firms almost certainly play a major role in pre- venting open competition. 32 The Law on Natural Monopolies of 20.04.2000 (#1682-III) identifies the following markets as natural monopolies: transpor- tation of oil and oil products by pipelines, transportation of natural gas and LPG by pipelines, other transportation pipelines, large-volume natural gas storage, electricity transmission and distribution, of electricity (transmission of electric energy by local electricity grids); use of railway tracks, dispatch services, stations and other infrastructure items, providing traffic to general rail transport; air-traffic control, centralized water supply and drainage systems, thermal energy transportation infrastructure, riverine and maritime port services, certain airports, and household waste-disposal services. 33 See Ryanair’s corporate website: https://corporate.ryanair.com/news/ryanair-cancels-planned-ukraine-services-as-kiev-air- port-fails-to-honour-commitments/ and https://corporate.ryanair.com/news/ryanair-brings-low-fares-to-ukraine/ 34 See SD Capital Press Office: http://sd.capital/2018/01/04/the-worlds-largest-port-operator-dp-world-group-enters-the- ukrainian-market/ REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 21 FIGURE 22 New Business Entry Density FIGURE 23 New Business Entry Density Gap (average 2006–2016) Among Comparator Economies (2006–2016) 30 16 14 25 12 10 8 Entry density rate 20 6 4 15 2 0 Bulgaria Croatia Czech Republic Estonia Georgia Hungary Kazakhstan Latvia Lithuania Moldova Poland Romania Turkey Ukraine 10 5 Ukraine 0 6 7 8 9 10 11 12 Observed Predicted log GDP per capita PPP (constant 2011 $) Source: World Bank Enterprise Surveys and WDI database Source: World Bank Enterprise Surveys and WDI database Note: Bars show the observed density rate (average 2006–16). Dots show the bench- Note: New business entry density is defined as the number of newly registered mark predicted by a (linear) regression with (the log of ) average GDP per capita formal private limited-liability firms per 1,000 working-age people (ages 15–64). 2006–16 adjusted for (2011) purchasing-power parity as the explanatory variable. In sum, Ukraine’s markets are highly concentrated and frequently dominated by SOEs and politically connected firms, with very limited entry observed in recent years. Market concen- tration is aggravated by a lack of contestability in markets where competition is viable. Many large players are SOEs, which are not subject to the same general profit-maximizing incentives as private firms, while others enjoy strong political connections that enable them to lobby for regulatory protec- tion. Moreover, multi-market contacts facilitate explicit or tacit collusion among market players. The following section examines barriers to entry, regulatory capture and protectionism, and the uneven enforcement of regulations in greater detail. High Prices and Low Service Quality Indicate Ample Space to Improve Market Dynamics and Generate Efficiency Gains The combination of a heavy SOE footprint, numerous politically connected firms, high levels of market concentration, pervasive cross-ownership, and low rates of market entry have undermined competitive pressure and left little room for investment in value addition. Many Ukrainian markets, even those in which competition would typi­ cally be viable, are structured around a single dominant SOE or a small group of powerful firms, some of which enjoy regulatory protections and advantages. Intense market concentration coupled with widespread cross-ownership weakens efficiency incentives and greatly exacerbates the risk of anticompetitive behavior. An econometric analysis of firm-level data from 2006 to 2015 reveals 22 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE statistically significant differences in economic outcomes between politically connected and non-connected firms, even when controlling for firm size, age, and sector. Not only are politically connected firms less productive than non-connected firms, they also tend to have slower turnover, employment, and total factor productivity (TFP) growth rates. Estimated differences range from –5.7 to –16.2 percentage points for the turnover growth rate, –13.0 to –28.9 percentage points for the employment growth rate, and –4.6 to –10.1 percentage points for the TFP growth rate.35 An anemic competition environment in upstream sectors increases input costs and weakens service quality, undermining efficiency across the economy. SOEs and politically connected firms are especially prevalent in productivity-enabling services (e.g., utilities, transpor- tation, and logistics) and sectors that supply industrial inputs (e.g., cement, steel, fertilizers, and oil products), and competitive distortions in these markets negatively affect overall domestic produc- tion and export competitiveness. Ukraine ranked 83rd out of 140 countries on the 2017–2018 Global Competitiveness Index (GCI), and its overall score (4.11 out of 7) has improved little over the past five years. Among Eastern European countries, only Moldova and Bosnia and Herzegovina scored lower on the GCI. Ukraine’s ICT sector is the weakest among comparator countries—a serious liability for an economy in which services account for 60 percent of GDP. Ukraine scores poorly on the ICT Development Index, lagging regional comparators such as Moldova and Romania (Figure 24). Ukraine’s internet bandwidth per internet user is especially low at just 45 percent of the European average. FIGURE 24 ICT Development Index 2017 10 8 6 4 2 0 Ukraine Georgia Turkey Moldova Romania Kazakhstan Bulgaria Poland Hungary Czech Republic Lithuania Croatia Latvia Estonia Source: International Telecommunication Union (2018) 35 World Bank Group and UK Good Governance Fund (2018). Crony Capitalism in Ukraine: Impact on Economic Outcomes. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 23 High costs and low service quality are especially FIGURE 25 Port Infrastructure Quality, Ukraine sector. In 2016, the prevalent in Ukraine’s port sub­ and Comparator Countries (% of respondents Ministry of Infrastructure reported that average port reporting “poor” or “very poor” quality) charges in Ukraine were 2.5 times higher than those in Bulgaria other regional ports. In 2015, cargo transshipment tar- Czech Republic iffs in Odessa and Mykolaiv were US$15 and US$13 per Ukraine ton, respectively, about 2–3 times the European average of US$5–7 per ton.36 In surveys conducted for the World Kazakhstan Bank’s 2016 Logistics Performance Index, respondents Lithuania in Ukraine were more likely than those in most compar- Turkey ator countries to report that port infrastructure quality 0% 20% 40% 60% 80% 100% was either poor or very poor (Figure 25) and that port Source: WBG 2016. Logistics Performance Index charges were high or very high (Figure 26). Although tar- Note: In Estonia, Georgia, Moldova, Poland, Latvia, Romania, and Hungary, 0% of respondents found quality of port infrastructure to be low/very low iffs reportedly decreased by 30 percent in 2016–17, there is still ample room for improvement. FIGURE 26 Port Charges, Ukraine and Comparator The poor condition of Ukrainian railways increases Countries (% of respondents reporting “high” transportation costs. The current rail network (exclud- or “very high” charges) ing Russian-controlled Crimea and Donbas) covers more Ukraine than 41,500 kilometers. However, the poor condition of the country’s railways does not allow for high-speed Kazakhstan travel. In 2016, Ukrzalyznytsia, a state-owned railway Turkey that provides 50 percent of passenger and 82 percent of Estonia cargo transportation services, reportedly fulfilled only 30 Romania percent of demand for cargo cars and locomotives, forc- Czech Republic ing potential exporters to wait and pay for idle time.37 Bulgaria Domestic prices for basic food products that Latvia comprise a significant portion of Ukraine’s Lithuania food consumption basket38 appear to be 20–50 0% 20% 40% 60% 80% 100% percent higher than prices for comparable goods in Source: WBG 2016. Logistics Performance Index OECD countries and regional peers.39 Until 2016, the Note: In Georgia, Moldova, Poland, and Hungary, 0% of respondents found port government regulated the prices of food products charges to be high/very high 36 KyivPost (2017). Ukraine’s infrastructure needs $30 billion, more transparency. Available at: https://www.kyivpost.com/ business/ukraines-infrastructure-needs-30-billion-transparency.html 37 Ibid. 38 The following basic food products are included in the price analysis: apples, bananas, beef, butter, chicken, eggs, fresh fish, lettuce, local cheese, pasteurized milk, mushrooms, onions, oranges, peanut or corn oil, pork, potatoes, tomatoes, white bread, white flour, white rice, and white sugar. 39 Using 2010-2017 data from Numbeo and the Economist Intelligence Unit (EIU) (see Annex). 24 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE considered “socially important,”40 yet a cross-country empirical analysis indicates that basic food products in Ukraine cost as much as 50 percent more than they do in OECD countries.41 The differences in the average prices for key food products in Ukraine vis-à-vis its comparators may indicate a lack of competition in certain food-product markets. While prices for chicken and eggs are broadly similar to those of comparator countries, which may reflect relatively robust competition from EU producers in the Ukrainian poultry market, Ukrainian households appear to pay significantly more for milk, onions, oranges, tomatoes, wheat bread, and white rice than do households in comparable OECD countries and regional peers (Table 1). Industrial associations, such as the Dairy Alliance and the Food and Vegetables Association, operate in many of these markets, and higher prices may indicate the presence of price or market-sharing agreements, with negative implications for consumers.42 In addition, a comparison of food prices in key cities reveals that residents of Kiev, Ukraine’s capital, pay about 40 percent more, on average, for basic food items than do residents of similar cities in the OECD and regional comparator countries. The results of the city-level analysis remain robust when using alternative datasets that include other major Ukrainian cities like Dnipropetrovsk, Kharkiv, Lviv, Odessa, and Sumy. A domestic price comparison shows that food prices were about 13 percent higher in Kiev than in other Ukrainian provinces between March 2014 and December 2017, even after controlling for demand drivers (e.g., population and disposable income) and cost drivers (e.g., labor and transportation costs).43 Oligarchs dominate several of Ukraine’s major food-product markets. These include chicken, eggs, rice, and sugar. While chicken and egg prices are broadly in line with those of comparable coun- tries, the average Ukrainian prices for rice and sugar appear to be significantly higher.44 40 Food products classified as socially important include flour, bread, pasta, cereals, sugar, beef, pork, poultry, sausage products, milk, cheese, sour cream, butter, sunflower oil, and buckwheat meal. See http://artlife.rv.ua/?area=ukrainian-news/31139 41 The Numbeo database includes data for 35 OECD countries (Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, South Korea, Latvia, Luxembourg, Mexico, The Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Swit- zerland, Turkey, the United Kingdom, and the United States) and 7 additional regional comparators (Bulgaria, Croatia, Georgia, Kazakhstan, Lithuania, Moldova, and Romania). The EIU database includes data for 32 OECD countries (Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, South Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Swit- zerland, Turkey, the United Kingdom, and the United States) and 3 additional regional comparators (Bulgaria, Kazakhstan, and Romania). The analysis considers differences in demand and cost factors impacting prices such as income per capita, import costs, and tariff rates, and all specifications are included in Table A.1 in the Annex. The results are generally robust to the inclusion of additional regional peers (see Table B.1 in the Annex). While the analysis uses purchasing-power parity conversion rate, the results remain robust when the market exchange rate is used (see Tables C.1 and D.1 in the Annex). 42 An in-depth competition assessment could analyze market dynamics and gauge the risk of anticompetitive outcomes. 43 The analysis uses food-price data from the World Food Program for 23 basic food products: beef, beetroots, buckwheat meal, butter, cabbage, carrots, chicken, curds, eggs, pasteurized milk, mixed sausage, onions, pasta, pork, potatoes, rye bread, salted pork fat (salo), sour cream, sunflower oil, white bread, white flour, white rice, and white sugar. For the full specifications, see Tables A.2, B.2, and C.2 in the Annex. Price dispersion across Ukrainian provinces is generally low for the food products analyzed, but some products such as salo, cabbage, and potatoes exhibit greater price dispersion (see Figure A.4 in the Annex). 44 For all specifications, see Table A.3 in the Annex. TABLE 1 Market Structures for Individual Food Products Level of Prices in Ukraine/Ukrainian Cities . . . Dnipropetrovsk, Tariff MFN Ukraine Kharkiv, Kiev, LVIV, Kiev vs. (Average vs. OECD Odessa, and Sumy vs. Comparator Market Share of Ad (Numbeo Comparator Cities Cities of Largest Vertical Industry Valorem Importance Importance Product Data) (Numbeo Data) (EIU Data) Number of Firms Player[1] Integration Association Duties) of Exports[2] of Imports[3] Chicken — — — Over 270 industrial 38% x Poultry Breed- 12.7% 27% 11% producers ers Union of Ukraine Eggs — — — Over 200 industrial 31% shell eggs / x Poultry Breed- 12% 2.7% 2.6% producers; over 87% dry eggs ers Union of 1,000 households Ukraine Local cheese Higher Higher N/A — 23.2% — — 10% 3.6% 5.9% Milk Higher — Higher Over 3 23% x Dairy Alliance 10% 10.3% 3.1% Onions Higher — Higher — — x Fruit and 10% 0.0% 0.9% Vegetables Association Oranges Higher Higher Higher — — — — 0% 0.0% 0.1% Pork N/A N/A Higher — 22% x Association of 11% 0.6% 3.4% Pig Breeders Tomatoes Higher Higher Higher — 80% — Fruit and 10% 0.4% 2.0% Vegetables Association White bread Higher Higher — >100 bakeries — — — 10% — — White flour N/A N/A Higher — — — — 15% 0.7% 0.1% White rice Higher Higher Higher — — — — 5% 0.0% 2.0% White sugar N/A N/A Higher Over 50 industrial 28% — National Asso- 50% 3.4% 2.0% producers ciation of Sugar Producers of Ukraine [1] Source: AMCU and publicly available information. Data availability allowed the estimation of a Herfindahl-Hirschman index (HHI) for the following products: chicken (1,631), indicating a moderately concentrated market; eggs (558), an unconcentrated market; sunflower oil (1,747), indicating a moderately concentrated market; and white sugar (603), indicating an unconcentrated market. Based on the HHI, the concentration levels are classified as follows: (i) unconcentrated markets: HHI below 1500; (ii) moderately concentrated markets: HHI between 1500 and 2500; (iii) highly concentrated markets: HHI above 2500. See U.S. Department of Justice and Federal Trade Commission 2010. Horizontal Merger Guidelines. [2] MIT Atlas Media. 2016. For further information, see https://atlas.media.mit.edu/en/profile/country/ukr/ [3] Ibid. 26 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE In addition, domestic prices for certain internationally traded food commodities do not appear sensitive to global price changes, suggesting that domestic distortions may limit the pass-through effect of imports.45 An analysis of various food commodities reveals that domestic prices for rice and sugar do not respond to international price changes. The insignificant impact of international prices on domestic prices may reflect price regulations, which applied to these two food products and many others during the period under analysis.46 Rather than acting as a ceiling to keep staple food prices affordable, Ukrainian price regulations may actually have served as a floor, preventing downward price adjustments due to import competition.47 In August 2016, the government launched a pilot project eliminating state price regulation on most of the food products, and in July 2017 these price regulations were permanently lifted. Reforming Ukraine’s Regulatory Policies and Market Interventions Can Reduce Distortions and Improve Outcomes for Firms and Consumers Many Ukrainian markets lack adequate competitive pressure to ensure efficiency, and government interventions play a major role in shaping market outcomes. Given the pro- pensity of SOEs and politically connected firms in concentrated markets to lobby for regulatory protections or undue advantages, the design and implementation of government interventions have a major impact on economic efficiency. In this context, aligning economic policies with competitive- neutrality principles will be vital to restart productivity growth. Competitive neutrality is espe- cially critical in upstream sectors and markets that are not naturally conducive to contestability, as even minor distortions or regulatory barriers in these areas can negatively impact economy-wide productivity and competitiveness. Excessive state control over the economy and the prevalence of barriers to entry in net- work industries are major obstacles to competition. Ukraine’s aggregate Product Market Regu- lation (PMR) indicator48 is broadly comparable to the OECD average (Figure 27). However, regulations 45 A pass-through analysis was conducted to determine whether domestic prices of rice, sugar, sunflower oil and wheat flour respond significantly to differences between international and Ukrainian prices and, if so, to determine the speed of adjust- ment and whether upward and downward price adjustments are symmetrical. International prices were obtained from the World Bank’s Commodity Price Database, and Ukrainian national average prices were obtained from the World Food Program. 46 Price data are from March 2014 to December 2017. 47 National Investment Council. 2017. https://mfa.gov.ua/mediafiles/sites/uae/files/NIC_Middle_Year_Report_2017.pdf 48 The OECD-WBG PMR data are part of the WBG’s Markets and Competition Policy Database. Each area addressed within the PMR methodology sheds light on specific restrictions of the regulatory framework, both economy-wide and in key sectors of the economy. These areas include: electricity; gas; telecommunications; post; transport; water; retail distribution; professional services; other sectors; administrative requirements for business startups; treatment of foreign parties; and other issues such as SOE governance or antitrust exclusions and exemptions. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 27 FIGURE 27 Product Market Regulations, Ukraine and Comparator Countries, 2018 (index scores from 0 [least restrictive] to 6 [most restrictive]) 6 5 4 Barriers to Investment, 0.41 3 State Control, 0.87 Barriers to Entry, 0.26 2 1 0 Top 5 Average Estonia Hungary Slovak Republic Czech Republic OECD Average Chile Lithuania Ukraine Bulgaria Latvia Poland Romania Slovenia Colombia Mexico Peru Nicaragua Croatia Guatemala South Africa Panama Dominican Republic Jamaica Costa Rica Paraguay Turkey Philippines Brazil Uruguay Egypt China Honduras India Argentina Bolivia Tunisia El Salvador Ecuador Source: Markets and Competition OECD-WBG PMR indicators. 2018 PMR scores for Ukraine. Notes: The top 5 performers are the Netherlands, the United Kingdom, the United States, Austria, and Denmark. that allow for state control over certain aspects of the economy or that establish barriers to compe- tition in network industries are high by international standards and may impose binding constraints on competition. As described above, Ukraine has a much larger SOE footprint than do most comparator countries. Ukraine’s PMR score for state control (2.62) is well above both the OECD average (1.72) vand the scores of neighboring countries such as Hungary (2.05) and the Slovak Republic (2.17) (Figure 28). SOE governance is the largest contributor to the restrictiveness associated with public ownership, and Ukraine’s PMR score in this area (4.5) significantly exceeds the OECD average (3.57).49 49 Higher scores indicate more restrictive policies and regulations. 28 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE FIGURE 28 Restrictiveness of Product Market Regulations Pertaining to State Control, Ukraine and Comparators, 2018 (index scores from 0 [least restrictive]to 6 [most restrictive]) 4.0 3.0 57% 2.0 33% 33% 1.0 0.0 Top 5 Average Estonia OECD Average Peru Czech Republic Mexico Latvia Hungary Chile Nicaragua Panama Lithuania Guatemala Dominican Republic Slovak Republic Colombia Paraguay Slovenia Brazil Croatia Philippines Ukraine Honduras Romania Bulgaria Uruguay Jamaica Poland Costa Rica South Africa Bolivia Turkey China Argentina Egypt Tunisia India El Salvador Ecuador Source: Markets and Competition OECD-WBG PMR indicators; 2018 PMR scores for Ukraine. Note: The top 5 performers are the Netherlands, the United Kingdom, the United States, Austria, and Denmark. Restrictive regulatory frameworks in network industries—where many Ukrainian SOEs operate—limit the entry of private firm in segments where competition is viable. Ukrainian law defines certain segments of the electricity, gas, and transportation sectors as nat- ural monopolies, while the postal services, railways, alcohol production, and water distribution markets are all legal monopolies.50 While natural monopolies can, in principle, be efficient, legal monopolies may restrict entry in markets where competition would be both viable and beneficial. The entry of new firms is explicitly capped in several services markets. Bilateral agreements impose quantitative limits on the entry of foreign firms in the road passenger transportation sub- sector, and the participation of foreign investors in the fixed-line telecom sector is limited. These caps ultimately reduce competitive pressure both in markets subject to regulatory restrictions and in substitute markets. 50 Ordinary letters weighing up to 50 grams and simple postcards are carried by Ukrposhta, which is designated as the national postal services provider under Art. 15 of the Law on Postal Services of 04.10.2001 #2759-III (http://zakon2.rada.gov.ua/laws/ show/2759-14). Passenger and freight railroad transport services are provided by Ukrzaliznytsia, which is designated as the national basic railroad service provider under Art. 4 and 9 of the Law on Railroad Transport (http://zakon2.rada.gov.ua/laws/ show/273/96-%D0%B2%D1%80) .Ethyl alcohol is produced by SOEs in line with Art. 2 of the Law on State Regulation of the Production and Sale of Ethyl, Cognac, and Fruit Alcohol, Alcoholic Beverages, and Tobacco Products (http://zakon3.rada.gov. ua/laws/show/481/95-%D0%B2%D1%80) REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 29 Market concentration and regulatory protections can facilitate anticompetitive behavior. For example, a lack of clarity regarding the regulation of firms with significant market power and the use of termination rates can encourage abuse of dominance in the fixed-line telecom market. Likewise, the absence of regulations or guidelines aimed at preventing collusion by trade associations could facilitate price fixing or market sharing. The current configuration of Ukrainian market institutions and their regulatory frameworks is inconsistent with ensuring competitive and efficient markets. Even in markets were an inde- pendent regulator exists, SOE dominance and regulatory constraints can still inhibit competition. For example, without extensive SOE unbundling and regulatory liberalization of the wholesale electricity market, private investment in the generation and transmission segments will be inadequate and may even accentuate weaknesses in competitive neutrality and facilitate anticompetitive practices. Con- versely, regulatory reform may be insufficient to foster competition in the absence of an independent sectoral regulator. The liberalization of certain transport subsectors (railways, ports) and telecom assets (spectrum allocation) may not facilitate market opening or accelerate growth without effective sectoral regulators. In addition, inadequately enforced regulations in the mobile telecom and airport subsectors may undermine service provision and encourage anticompetitive behavior. Similarly, a lack of regula- tory clarity and transparency in the road transportation and fixed-line telecom subsectors may distort network investments, increase administrative costs, weaken incentives to comply with regulations, and potentially advantage larger or better-connected market players. Table 2, below, maps the impact of regulatory distortions and constraints on competition across sectors, and Box 1 identifies the potential gains from reducing regulatory restrictiveness in network industries and services. Beyond the aspects captured by the PMR, in practice: (i) the regulatory framework is implemented in a discriminatory manner in the network and enabling sectors, (ii) there is a lack of competitive neutrality, including in markets dominated by SOEs, and (iii) enforcement of the overall competition policy and law is not fully tackling anti­competitive behavior. Unclear regulations and uneven or discriminatory enforcement increase administra- tive costs, weaken compliance incentives, and tend to benefit large firms and incum- bents. Ukraine scores 5.8 out of 10 on the Bertelsmann Stiftung Transformation Index for market organization, lagging behind the average for comparator countries. The index measures the perception that clear rules are in place to guide stable, market-based competition. Moreover, numerous instances of discrimination have occurred regardless of the regulatory framework. For example, Ukraine International Airlines has historically received preferential rates for passenger transfers, aircraft service, and parking space at the country’s largest airport, the state-run Kiev Boryspil, as well as preferred parking space for aircraft and prime real estate in the airport termi- nals. In some market segments, such as airline baggage-handling services, the regulatory frame- work is limited, and enforcement is wholly inadequate. TABLE 2 Examples of Market Regulation Distortions and Competition Constraints in Enabling Sectors Electricity Gas Transport Telecoms Generation Import Transmission Distribution Generation Import Transmission Distribution Road Railways Ports Airlines Airports Mobile Fixed Market structure Market share of largest 60% >90% 100% 50–90% >90% >90% >80% 60% 42% player (%) State participation in Yes Yes Yes No Yes Yes Yes No Yes Yes No Yes No Yes the largest firm Private-sector presence Yes N/A No Yes Yes Yes Yes Yes No No Yes No Yes Yes Number of firms 1 25 > 56,000 1 13 Government interventions a) That restrict entry Legal or natural monopolies* Relative ban on entry b) That facilitate anticompetitive conducts Collusion Abuse c) That distort the competitive playing field Largest player has access to preferential conditions Discriminatory treatment of foreign operators Institutional arrangements and market structures No structural unbundling of SOE No regulator No independent regulator* No regulatory frame- work or ineffective regulations Lack of regulatory clarity Lack of transparency Source: Author’s elaboration Note: * the Telecommunication Regulator lacks independence, notably regarding spectrum allocation. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 31 n BOX 1 Potential Gains from Reducing Regulatory Restrictiveness in Network Industries and Services A less-restrictive regulatory framework could significantly enhance competition in Ukraine, especially in network industries and services. Simulations show that a decrease in regulatory restrictiveness in network-based input sec- tors (e.g., electricity, gas, and water supply), as well as postal and telecommunications services, retail and wholesale trade, transportation, and other business services, would significantly accelerate the growth of value addition, generating up to 0.015 percentage points of additional annual GDP growth, all else being equal. As Ukraine’s annual GDP growth rate has averaged 2 percent over the past two years, this increase would be significant. Moreover, this estimate is a lower-bound figure, as it reflects the country’s current regulatory framework; regulatory reforms and improvements in enforcement could further strengthen competition in these industries, magnifying their contri- bution to growth. FIGURE 29 Regulatory Restrictiveness in the Railway Sector, Ukraine and Comparator Countries (index scores from 0 [least restrictive]to 6 [most restrictive]) 6 Ukraine, 6.00 5 OECD Average, 3.52 4 3 2 1 0 Latvia Poland Hungary Slovak Republic OECD Average Bulgaria Slovenia Colombia Mexico Bolivia Brazil Chile Argentina Panama India Jamaica Croatia Ukraine Philippines Guatemala Costa Rica Uruguay Turkey China South Africa Egypt Tunisia Peru Top 5 Average Romania Czech Republic Lithuania Estonia El Salvador Ecuador Source: Markets and Competition OECD-WBG PMR indicators. Note: The top 5 performers in the railway sector are the United Kingdom, Peru, Romania, the Czech Republic, and Canada; information for Nicaragua, the Dominican Republic, Paraguay, and Honduras is not available. Discriminatory treatment tends to be especially problematic when institutional arrange- ments create conflicts of interest between regulatory policies and commercial objectives. For example, the railway SOE, Ukrzaliznytsia, handles freight traffic (and the associated infra- structure assets), and it holds a legal monopoly on international and domestic passenger trans- portation. This market structure, combined with the lack of an independent sectoral regulator, makes proper regulatory enforcement almost impossible. In the water transportation subsector, 32 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE the government simultaneously acts as an operator and a regulator, causing conflicts of interest. The lack of both an independent regulator and a regulatory framework that includes third-party access regulations creates inconsistency between the state’s regulatory and operational roles and incentivizes the creation of barriers to entry. The regulatory framework or implementation weaknesses related to the existing pol- icies applicable to SOEs and private sector point to the lack of competitive neutral- ity. The regulatory framework for SOEs grants them advantages over private firms. Moreover, corporate governance rules differ depending on whether SOEs are fully public firms or joint-stock companies,51 and while Ukrainian legislation defines commercial and non-commercial SOE activ- ities, unbundling is not yet effective.52 SOEs are also legally protected from competition in other­ wise competitive sectors that are not listed as legal or natural monopolies. The discretionary enforcement of regulations further distorts the competitive playing field. Governmental respon- sibilities for SOE oversight are dispersed across institutions with overlapping mandates, and SOE performance is not transparently reported, preventing an objective assessment of their effective- ness and market impact. As of November 2015, only 40 percent of operational SOEs had published reports online.53 Moreover, SOEs have traditionally enjoyed preferential access to finance through state-owned banks or government guarantees, and public guarantees to SOEs were equivalent to 18 percent of GDP in 2014. Direct subsidies to SOEs represented around 2.5 percent of GDP in 2014 and 1.3 percent in 201554 with direct subsidies to the coal and energy sector alone accounting for about 1 percent of GDP.55 Inadequate competitive neutrality extends to competition among private firms, as polit- ically connected business groups use various channels to obtain preferential treatment from the government. Such treatment may include favoritism in the public procurement process, preferential access to privatized state assets, trade regulations that restrict imports, favorable tax treatment, subsidized loans from state-owned banks, concessional development financing via public debt guarantees, and state aid in the form of direct transfers from the budget.56 Figure 30, below, presents a competitive neutrality gap analysis for Ukraine. 51 While joint-stock companies are subject to the same corporate rules as private firms, fully public SOEs are not. See Art. 73 of the Commercial Code. 52 An unbundling process is underway in the gas and electricity sectors. An SOE was formerly responsible for electricity generation, importation, supply, transmission, and distribution. However, under Art. 32 of the Law on the Electricity Market of 13.04.2017 #2019-VIII (http://zakon3.rada.gov.ua/laws/show/2019-19), which took effect on December 12, 2017, electric- ity transmission is now separated from generation, distribution, and supply. According to Art. 47, which will take effect on December 12, 2018, electricity distribution is to be separated from generation, transmission, and supply. 53 MEDT. 2015. Reform of State-Owned Enterprises. Presentation in November 2015. 54 IMF. 2016. Ukraine. Technical Assistance Report – Reforming Management and Oversight of State Assets. 55 IMF. 2015. IMF Country Report No. 16/31, Ukraine, Reforming Management and Oversight of State Assets, p. 27. 56 World Bank Group and UK Good Governance Fund. 2018. Crony Capitalism in Ukraine: Impact on Economic Outcomes. p. 6. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 33 FIGURE 30 Competitive Neutrality Gap Analysis Competitive neutrality Subsidiarity analysis: the role of the State in the economy Firm-level principles: Separation of SOE commercial and non-commercial activities 1 Streamlining the operational 2 Identifying the costs of 3 Achieving a commercial 4 Accounting for public form of government business any given function rate of return service obligations  No provisions in Ukrainian legislation  Draft methodology for separating  No requirement to show: a positive  Lack of transparency and objective requiring business separation (legal commercial and non-commercial NPV in investments; market criteria in the compensation of PSOs developments underway in electricity activities of SOEs to be adopted consistent rate of returns in sales delivered by SOEs Ukraine and gas)  SOEs do not disclose their  No private sector benchmark of performance SOE transactions  Legislation requires business  Accountancy for separating  SOEs commercial operations and  Compensation paid to SOEs for the separation of SOEs commercial and non-commercial investments are required to have provision of PSOs is based on activities of SOEs positive NPV, market consistent transparent accountability and Benchmark  SOEs objectively assessed based on rate of returns and to being objective criteria. Cross-subsidization transparent performance reports measured based on private sector is avoided. performance Principles embedded in cross-cutting regulatory frameworks and sectoral policies 5 6 7 8 Debt neutrality and Regulatory neutrality Public procurement Tax neutrality outright subsidies  Preferential access to trade protection  Preferential access to public  SOEs receive tax exemptions, subsidies and debt guarantees (tax exemptions and state assets for politically procurement for politically and subsidies are also available to private sector) connected rms connected rms  Preferential access to subsidies, tax exemptions, state guarantees and others, for Ukraine  Legal monopolies established by law;  Design facilitates bid rigging politically connected rms. sectors exempted from the practices privatization law  Companies compete on a level playing  Market based competition in public  Tax exemptions, subsidies and debt guarantees granted following competitive eld, with no trade protection and procurement neutrality principles market based competition for rights to  Bids/auctions designed to reduce Benchmark invest in state assets the risks of bid rigging  Sectors where competition is feasible are open to private investment Control of state support measures to SOEs and private sector operators Level playing eld in the market between SOEs and privately owned operators Source: Author’s elaboration While product market regulations are relatively progressive, serious implementation gaps and pervasive deficiencies in competitive neutrality underscore the considerable scope for improvement. Inadequate institutional and regulatory arrangements in input and network sectors increase the cost to compete, and weaknesses in competitive neutrality benefit some players over others, distorting the allocation of resources (Figure 31). Even sectors that were technically liberalized continue to perform poorly. For example, the lack of operational indepen- dence by the telecommunications regulator and the presence of an SOE in charge of spectrum assignment has effectively precluded an efficient allocation of the mobile telecommunications spectrum, which may help explain why Ukraine’s international internet bandwidth per internet user is less than half the European average (Box 2). Further improvements in the enforcement of competition policy will be necessary to ensure the effectiveness of the legal framework. Strengthening enforcement is particularly important for the Anti-Monopoly Committee of Ukraine (AMCU). Within its competition-advocacy mandate, the AMCU 34 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE FIGURE 31 An Analysis of Implementation Issues in Ukraine Using the Markets and Compe- tition Policy Assessment Tool Market features Economies of scale vs Multi-market contact Vertical integration SOEs and PCFs market size Government regulations Pro-competition interventions aim at:  Opening markets to entry, reducing rm dominance  Eliminating rules that could be conducive to collusion or increase the cost to compete  Leveling the playing eld for players in the market  Enforcing e ective antitrust policy Public implementation  Requires an adequate institutional set up  Commercial, regulatory and political objectives must be separate and independent Firms react to market features and government interventions, leading to market outcomes Market outcomes Anticompetitive Concentration and Investment Productivity behavior market entry Source: Author’s elaboration Note: The grey arrow represents the influence of SOEs and politically connected firms over regulatory design and enforcement, which directly—and negatively—impacts market outcomes. is expected to work with sectoral regulators and line ministries to identify and address competition con- straints in key sectors of the economy. However, the AMCU’s enforcement capacity is inadequate to police cartel behavior and discourage harmful abuses of dominance. The AMCU’s independence vis-à-vis the state and the private sector remains inadequate, and its existing institutional guarantees and financial and human resources are inadequate to fulfill its mandate. In addition, the unclear prioritization of com- petition principles across all stages of the public procurement process and the limited enforcement of rules against bid rigging compromise public expenditure efficiency and distort the competitive playing field. To minimize competitive distortions associated with state aid, both to private firms and SOEs, the authorities should begin by carefully review-ing the state aid granted to large SOEs—especially those with poorly defined public-service obligations—and to politically connected firms, with a view toward minimizing preferential treatment and strengthening the overall state-aid control framework. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 35 n BOX 2 The Impact of Market Concentration, Conflicts of Interest, Weaknesses in the Regulatory Framework, and the Lack of an Independent Regulator on the Telecommunications Sector Due in part to limited competition in the telecommunications sector, Ukraine lags comparator countries such as Romania, Poland, and Kazakhstan on key measures of ICT development, especially internet penetration. Ukraine’s fixed and mobile telecommunications markets remain relatively concentrated: three operators provide fixed-line services, Ukrtelecom, Kyivstar and Datagroup. Ukrtelecom owns fixed-line infrastructure. Ukrtelecom dominates fixed-line services, with a market share of 80 percent in 2017.57 The mobile telecommunications subsector features a larger number of players but remains relatively concentrated. The largest providers are Kyivstar, Vodafone, Lifecell, and Intertelecom. Ukrtelecom is also present on the mobile telecom market through its Trimob brand.58 Ukraine’s internet bandwidth per user is equivalent to 45 percent of Europe’s bandwidth. The Ukrainian telecommunications framework is expected to be aligned with the relevant EU legisla- tion, which should help address some of the distortions that currently impact both mobile and fixed-line services. Fixed-line telecommunication services The licensing and authorization regime for the fixed-line services market is unclear.59 The blurred distinction between licenses and authorizations increases the cost of competing in the market, as navigating the regime is burdensome for businesses. This ambiguity also allows the National Commission for the Regulation of Communications and Informa- tization (NKRZI) to limit the number of players in the market.60 Moreover, only firms registered in Ukraine are eligible to be telecommunications operators, which likely creates a barrier to entry for foreign firms.61 The framework for regu- lating operators with significant market power is also poorly defined, which may result in either the under-regulation of operators with significant market power or the over-regulation of operators without market power, discouraging innovation and investment and potentially reinforcing the dominance of the incumbent.62 Generally, telecommunica- tions operators are not subject to rules requiring functional or accounting separation, and the resulting prevalence of (continues on next page) 57 Fixed-line internet service providers included Ukrtelecom (with a market share of 23 percent ), Kyivstar (11.5 percent), Volia (8 percent), Datagroup (4.6 percent), Farlep (2 percent) and Lanet (1 percent) in 2017 (NKRZI, 2019). 58 In 2017, in the mobile telecommunications market, Kyivstar had a market share of 48 percent, Vodafone: 34.4 percent, Lifecell: 14.1 percent, Intertelecom: 3 percent, Trimob: 0.64 percent and Telesystems: 0.18 percent (NKRZI, 2019). 59 Under Article 42(7)(7) of the Telecommunications Law (http://zakon.rada.gov.ua/cgi-bin/laws/main.cgi?page=1&nreg= 1280-15), the following sectoral activities are subject to licensing: (i) providing fixed-line services and operating telecom- munication networks; (ii) providing wireless access to the telecommunications network and operating telecommunications channels; (iii) providing mobile telephone services and operating telecommunication networks and channels; and (iv) main- taining and operating telecommunications networks, radio broadcasting, and broadcast television networks. While general authorization regime has yet to be developed, Article 42(2) of the Telecommunications Law creates an authorization and reg- istration regime, under which “Business entities wishing to carry out activities in the field of telecommunications shall, not less than a month before the beginning of their submission, submit to the national commission that carries out state regulation in the field of communication and informatization, the application for inclusion in the register of operators, telecommunication providers in the form approved by the national commission that carries out state regulation in the field of communication and informatization.” Only firms that have been added to the registry may offer telecom services, subject to compliance with the applicable rules for the specific type of telecom service provided. 60 Law on Telecommunications, Article 47. 61 Law on Telecommunications, Article 27(2). 62 For example, the scope of interconnection obligations for network operators and telecommunications providers under Article 39(1)(12) is unclear. 36 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE vertical and horizontal integration facilitates the abuse of market power, reinforces dominance, and increases the risk of anticompetitive behavior. Finally, the lack of clarity regarding the cost-based measure for national and international termination rates may hinder efforts to regulate markets where operators have significant market power. Mobile telecommunications The lack of pro-competition regulation in the mobile telecommunications subsector appears to be slowing the devel- opment of mobile services in Ukraine. The NKRZI contributes to developing the National Table of Radio Frequencies Allocation, but the final regulatory decisions are taken by the Council of Ministers of Ukraine (CMU).63 Similarly, the NKRZI is authorized to grant licenses for the use of the radio spectrum, but determining the fees for issuing, renewing, extending, or duplicating these licenses is the responsibility of the CMU.64 The NKRZI’s limited independence over spec- trum matters risks reinforcing dominance or restricting entry through the discretionary application of rules. The Law on Radio Frequencies divides the authority for spectrum licensing and spectrum assignment, and it allocates the latter to an SOE, the Ukrainian State Center for Radio Frequencies, which appears to carry out both commercial and regulatory functions.65 This conflict of interest may compromise the state’s competitive neutrality by encouraging discrimination between operators and protecting vested interests. The transfer, trading, or leasing of radio-spectrum licenses is not allowed, and the lack of a secondary market constitutes a barrier to entry and expansion, which could reinforce market dominance. The absence of a framework for unlicensed portions of the spectrum also hinders innovation and restricts market access among businesses and industries that rely on those portions of the spectrum, such as those that use technologies associated with the so-called “internet of things.” In addition, there is no framework that takes into account competition considerations for sharing infrastructure or assets (including the radio spectrum),66 which risks facilitating anticompetitive agreements among market players. Infrastructure-sharing agreements can promote efficiency and foster market competition, as they lower barriers to entry and expansion. A system for assessing how active and passive infrastructure sharing affects competition must account for the following factors: (i) the degree of cooperation or auton- omy between the parties to the agreement, which is also a function of the passive or active nature of the infrastructure; (ii) the parties’ market power; (iii) the agreement’s duration; and (iv) the broadness, density, and other characteristics of the infrastructure or assets covered by the agreement. 63 Article 14(2)(3) and (4) of the Radio Frequency Law (Law No. 2244-VIII of December 7, 2017) 64 Article 14(2)(5) of the Radio Frequency Law. 65 Article 16(3)(1) of the Radio Frequency Law. For a description of the activities of the Ukrainian State Center of Radio Frequencies, see http://www.ucrf.gov.ua/en/about-the-centre/main-activity/ 66 A draft law #5051 that is currently reviewed by the Verkhovna Rada of Ukraine proposes rules on radio spectrum sharing. See also the Law “On access to construction, transport and power engineering facilities for the development of telecommuni- cation networks”: https://zakon.rada.gov.ua/laws/show/1834-19. 3 CHAPTER PROPOSALS TO STRENGTHEN MARKET INSTITUTIONS, REGULATION, AND COMPETITION One of the most important goals of a successful competition policy is ensuring that government policies and regulations do not unnecessarily restrict entry, facilitate collusion, increase the cost of competing, or distort the level playing field by providing an undue advantage to specific firms. In 2016, Ukraine’s renewed commitment to enhance market competition resulted in the AMCU planning the adoption of a new National Competition Policy. As discussed above, weaknesses in the competition framework adversely affect market outcomes in Ukraine. Many manufacturing subsectors are dominated by SOEs and politically con- nected firms, and barriers to entry contribute to the formation of oligopolistic market structures. Constraints on competition are especially binding in network industries and productivity-enabling sectors, increasing production costs economy-wide. High levels of vertical integration, especially in public utilities such as electricity and gas, can increase the risk of market foreclosure if not prop- erly addressed through unbundling and effective regulatory enforcement. While the country’s economic regulations are relatively progressive in principle, their uneven application prevents market institutions from ensuring a level playing field and maintaining competitive neutrality. Moreover, several key sectoral regulators and market institutions are not fully independent and cannot effectively support competition. Addressing these challenges will require improvements in the country’s regulatory framework, institutional arrangements, and enforcement mechanisms. A holistic competi- tion policy must go beyond antitrust enforcement to: (i) ensure a competitively neutral administrative environment that minimizes the policy-based advantages of SOEs and politically connected firms; (ii) improve the predictability, consistency, and transparency of the regulatory framework, both in principle and in application; and (iii) support the development of robust, independent market insti- tutions. Specific recommendations for strengthening Ukraine’s competition policies and institutional arrangements are presented in Figure 32 and Table 3, below. 37 38 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE FIGURE 32 Priority Areas for Strengthening National Competition Policy IMPLEMENTATION AND LEGAL AND REGULATORY ENFORCEMENT Adopt rules requiring business separation Mandate the disclosure of SOE performance in vertically integrated SOE, and mandate information, including the costs associated with that SOEs earn rates of return comparable commercial and non-commercial activities to private-sector operators E ective regulatory Unbundle vertically integrated SOEs (e.g., in Develop and revise regulatory frameworks frameworks that the gas and electricity sectors) for the use of unlicensed spectrum, telecom licensing and authorization, and ensure Enforce rules against cartel behavior and sharing mobile-telecom infrastructure predictability, penalties for violating the Competition Law transparency, and Revise regulations that protect competitive Develop a registry of state-aid recipients incumbents, including SOEs (e.g., in the neutrality transportation sector) Review tax exemptions and other forms of Upgrade competition rules to state aid and align them with regulations explicitly prohibit cartels and increase legal certainty and National predictability competition Prioritize pro- policy A market Develop competition public environment that comprehensive procurement Stronger market minimizes undue rules for state processes institutions and more advantages aid e ective institutional among SOEs and collaboration politically connected rms Ensure the independence of sectoral regulators to avoid con icts of interest between policy objectives and SOE incentives (e.g., in the transportation and telecom sectors) Strengthen the AMCU’s institutional guarantees and provide it with the necessary resources to ful ll its mandate INSTITUTIONAL Source: Author’s elaboration REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 39 TABLE 3 Policy Recommendations Short term Medium term Responsible institutions Legal / Regulatory Recommendations Adopt rules requiring business sepa- MEDT/ SPF/AMCU ration in vertically integrated SOE, and mandate that SOEs earn rates of return comparable to private-sector operators Develop and revise regulatory frame- CMU/Ministry of Infrastructure / NCSRCI/ works for the use of unlicensed AMCU spectrum, telecom licensing and authorization, and sharing mobile- telecom infrastructure Revise regulations that protect CMU/Ministry of Infrastructure/AMCU/ incumbents, including SOEs (e.g., in the other government agencies transportation sector) Upgrade competition rules to explicitly AMCU/CMU prohibit cartels and increase legal certainty and predictability Develop comprehensive rules for state aid AMCU/CMU Implementation / Enforcement Recommendations Mandate the disclosure of SOE MEDT/SPF/line ministries performance information, including AMCU the costs associated with commercial and non-commercial activities Unbundle vertically integrated SOEs CMU (e.g., in the gas and electricity sectors) Ministry of Infrastructure Enforce rules against cartel behavior and AMCU penalties for violating the Competition Law Develop a registry of state-aid recipients Review tax exemptions and other AMCU/MEDT/ Ministry of Finance /other forms of state aid and align them with line ministries regulations Prioritize pro-competition public AMCU/MEDT procurement processes Institutional Recommendations Ensure the independence of sectoral CMU/Ministry of Infrastructure/other regulators to avoid conflicts of interest government agencies between policy objectives and SOE incentives (e.g., in the transportation and telecom sectors) Strengthen the AMCU’s institutional CMU/AMCU guarantees and provide it with the necessary resources to fulfill its mandate REFERENCES Government of Ukraine (2017) Unified Registry of the State Property Objects. Available at: http://www.spfu.gov.ua/ ua/content/spf-stateproperty-Subiekti-gospodaruvannya.html International Monetary Fund (2016) Ukraine. Technical Assistance Report – Reforming management and Oversight of State Assets. KyivPost (2017) Ukraine’s infrastructure needs $30 billion, more transparency. Available at: https://www.kyivpost. com/business/ukraines-infrastructure-needs-30-billion-transparency.html Martínez Licetti, Martha; Iootty, Mariana; Goodwin, Tanja; Signoret, José. 2018. Strengthening Argentina’s Integra- tion into the Global Economy: Policy Proposals for Trade, Investment, and Competition. International Development in Focus. Washington, DC: World Bank. Ministry of Economic Development and Trade (2015) Ukraine’s Top 100 State-Owned Enterprises. Ministry of Economic Development and Trade (2015) Reform of State-owned enterprises. Presentation in Novem- ber 2015. Motta, M. (2004) Competition policy: theory and practice. Cambridge University Press. 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World Bank Group (2018) Ukraine: A New Vision for Competition Policy to Boost Competitiveness and Growth. World Bank Group & UK’s Good Governance Fund (2018) Crony capitalism in Ukraine: impact on economic out- comes (English). Washington, D.C.: World Bank Group. 41 ANNEX TABLE A.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD (1) (2) (3) Ukraine 0.523 *** 0.477 *** 0.534*** (0.070) (0.101) (0.113) Log of GDP per capita PPP (2011 international $) 0.100** 0.095** 0.180** (0.046) (0.044) (0.066) Log of cost of import 0.044 0.077 (0.108) (0.067) Tariff rate, applied 0.066** (0.030) No. of observations 3,142 3,142 3,142 R-squared 0.887 0.888 0.896 Notes: Results are from an OLS regression using 2010–2017 data from the Numbeo. All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. TABLE B.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD and Selected ECA Countries (1) (2) (3) Ukraine 0.370 *** 0.312 *** 0.328*** (0.043) (0.047) (0.066) Log of GDP per capita PPP (2011 international $) 0.005 0.023 0.058 (0.031) (0.030) (0.045) Log of cost of import 0.100 0.105** (0.067) (0.048) Tariff rate, applied 0.047 (0.034) No. of observations 3,706 3,706 3,706 R-squared 0.883 0.885 0.889 Notes: Results are from an OLS regression using 2010–2017 data from the Numbeo. All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. 43 44 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE TABLE C.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD (1) (2) (3) Ukraine 0.404 ** 0.482 ** 0.529*** (0.161) (0.177) (0.162) Log of GDP per capita PPP (2011 international $) 0.795*** 0.803*** 0.874*** (0.110) (0.110) (0.124) Log of cost of import –0.074 –0.047 (0.112) (0.082) Tariff rate, applied 0.055** (0.027) No. of observations 3,142 3,142 3,142 R-squared 0.874 0.875 0.880 Notes: Results are from an OLS regression using 2010–2017 data from Numbeo. All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. TABLE D.1 Price Comparison Analysis: Ukraine vs. Comparator Countries in the OECD and Selected ECA Countries (1) (2) (3) Ukraine 0.202 0.228* 0.243* (0.124) (0.130) (0.137) Log of GDP per capita PPP (2011 international $) 0.655*** 0.647*** 0.677*** (0.087) (0.090) (0.094) Log of cost of import –0.046 –0.042 (0.082) (0.081) Tariff rate, applied 0.040** (0.030) No. of observations 3,706 3,706 3,706 R-squared 0.868 0.868 0.871 Notes: Results are from an OLS regression using 2010–2017 data from Numbeo. All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 45 TABLE A.2 Price Comparison Analysis: Kiev, Ukraine vs. Comparator Cities in OECD and Selected ECA Countries (1) (2) (3) Ukraine 0.281** 0.295** 0.414*** (0.126) (0.111) (0.112) Log of GDP per capita PPP (2011 international $) –0.104 –0.105 –0.031 (0.077) (0.080) (0.075) Log of cost of import –0.020 –0.026 (0.100) (0.081) Tariff rate, applied 0.046*** (0.014) No. of observations 14,385 14,385 14,385 R-squared 0.855 0.855 0.861 Notes: Results are from an OLS regression using 2010–2017 data from the Economist Intelligence Unit (EIU). All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. TABLE B.2 Price Comparison Analysis: Dnipropetrovsk, Kharkiv, Kiev, Lviv, Odesa, and Sumy in Ukraine vs. Comparator Cities in OECD and Selected ECA Countries (1) (2) (3) Ukraine 0.435 *** 0.409 ** 0.419*** (0.143) (0.152) (0.151) Log of GDP per capita PPP (2011 international $) 0.785*** 0.787*** 0.806*** (0.084) (0.082) (0.083) Log of cost of import 0.039 0.037 (0.094) (0.094) Tariff rate, applied 0.028 (0.039) No. of observations 16,051 16,051 16,051 R-squared 0.823 0.823 0.824 Notes: Results are from an OLS regression using 2010–2017 data from Numbeo. All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. 46 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE TABLE C.2 Price Comparison Analysis within Ukrainian Provinces (1) (2) (3) (4) Kiev dummy 0.093 *** 0.127 *** 0.114 *** 0.131*** (0.006) (0.027) (0.027) (0.031) Log of disposable income per capita –0.032 –0.036 –0.059 (0.026) (0.027) (0.044) Log of population 0.026 0.024 (0.017) (0.034) Log of labor cost 0.004 (0.022) Log of price of fuel (diesel) –0.408*** (0.012) No. of observations 25,657 25,657 25,657 25,657 R-squared 0.938 0.938 0.938 0.939 Notes: Results are from an OLS regression using 2014–2017 monthly data from the World Food Program. The dependent variable is the logarithm of retail prices (LCU/kg). All regressions include product, month and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. TABLE A.3 Price Comparisons Analysis: Ukraine vs. OECD and Selected ECA Countries (1) (2) (3) (4) Ukraine 0.380 *** 0.380 *** 0.324 *** 0.341*** (0.026) (0.044) (0.046) (0.064) Oligarchs products 0.531*** 0.531*** 0.531*** 0.531*** (0.025) (0.025) (0.025) (0.025) Oligarchs products*Ukraine –0.067** –0.067** –0.068** –0.070*** (0.026) (0.026) (0.026) (0.025) Log of GDP per capita PPP (2011 international $) –0.000 0.017 0.051 (0.032) (0.031) (0.047) Log of cost of import 0.096 0.101** (0.068) (0.049) Tariff rate, applied 0.046 (0.034) No. of observations 3,706 3,706 3,706 3,706 R-squared 0.090 0.090 0.092 0.096 Notes: Results are from an OLS regression using 2010–2017 data from the Numbeo. All regressions include product and year fixed effects. Standard errors clustered at the country level are in parentheses. ***, **, and * indicate significance at 1 %, 5 %, and 10 %. REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE 47 FIGURE A.4 Coefficient of Variation of Prices Across Ukrainian Cities Salo Potatoes Rye bread Beetroots Carrots Cabbage Mixed sausage Wheat bread Onions Beef Milk Curd Pasta Wheat our Butter Sour cream Pork Rice Buckwheat grits Sun ower oil Eggs Chicken Sugar 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 Percent Notes: Price dispersion is measured by the coefficient of variation. 48 REDUCING MARKET DISTORTIONS FOR A MORE PROSPEROUS UKRAINE n BOX 3 Price Comparison Analysis: Are Prices of Basic Food Products Higher in Ukraine? The analysis assessing whether food prices are significantly higher in Ukraine than in comparator countries uses two data sources: (a) “Numbeo” – an online global database of user contributed data on cost of living with information on consumer prices, and (b) Economist Intelligence Unit (EIU) – a survey-based database of consumer prices for over 160 items. The sample was restricted to products available in Ukraine and where yearly data were available in either the Numbeo or the EIU database. The sample covers yearly information on prices of 14 and 20 products, respectively, in the Numbeo and EIU databases from 2010 to 2017. Both databases apply different methodologies in gathering price data across countries, thus strengthening the comparability of price information used in this analysis. The baseline empirical specification for the price comparison analysis follows the equation: ln(Priceit) = β1Ukraine + β2ln(Zit) + ηi + δt + εijt where for each food product i in country j in year t; Price is the price (US$/kg), X is a vector of cost and demand shifters such as GDP per capita PPP (2011 international $), cost of imports, and tariff rates, Ukraine is a dummy variable for observa- tions in Ukraine, η are product fixed effects, δ are year fixed effects, and e is the error term. The Ukraine dummy variable captures the difference in average food prices in Ukraine relative to the average prices across the comparator countries after adjusting for the differences in per capita GDP PPP, import costs, customs duties, product types and time effects. The variable capturing costs to import (taken from the Trading Across Border dataset) accounts for domestic transport costs. Other sources of transport costs (oversees shipping) depend on the origin and destination of each product, for which data is not consistently available. The food products were selected based on their relative importance to the average Ukrainian consumer and availability in the databases67. The analysis uses different sets of comparator jurisdictions to account for potential distortions in markets of other countries68. 67 The analysis used the following 14 products from the Numbeo database: Apples (1kg), Banana (1kg), Beef Round (1kg or Equivalent Back Leg Red Meat), Chicken Breasts (Boneless, Skinless, (1kg), Eggs (regular, 12), Lettuce (1 head), Loaf of Fresh White Bread (500g), Local Cheese (1kg), Milk (regular, 1 liter), Onion (1kg), Oranges (1kg), Potato (1kg), Rice (white, 1kg) and Tomato (1kg), while the following 20 products from the EIU database we analyzed: Apples (1 kg), Bananas (1 kg), Beef (filet mignon, ground or minced, roast, steak, stewing, 1 kg), Butter (500 g), Chicken (fresh, frozen, 1 kg), Eggs (12), Flour (white, 1 kg), Fresh fish (1 kg), Lettuce (1 head), Milk (pasteurized, 1 liter), Mushrooms (1 kg), Onions (1 kg), Oranges (1 kg), Peanut or corn oil (1 liter), Pork: (chops, loin, 1 kg), Potatoes (2 kg), Sugar (white, 1 kg), Tomatoes (1 kg), White bread (1 kg) and White rice (1 kg). 68 The comparator countries with available data in the Numbeo database include 35 OECD countries – Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, South Korea, Latvia, Luxembourg, Mexico, The Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, United Kingdom, and United States – and 7 additional selected regional – Bulgaria, Croatia, Georgia, Kazakhstan, Lithuania, Moldova, and Romania. The comparator countries with available data in the EIU database include 32 OECD countries – Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, South Korea, Luxembourg, Mexico, The Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, and United States and 3 additional selected regional – Bulgaria, Kazakhstan, and Romania.