Reform package for Belarus: how to narrow competitiveness gap 

Belarus is unique in at least one sense reform-wise. After the collapse of the Soviet Union and the initial stage of chaotic arbitrary transformations in 1991 – 1994, its political leadership chose to restore the main institutions and mechanisms of centrally planned and managed economy. We can say that Belarus chose neo-planned economy as the system of overwhelmingly centralized decision-making. Its political leaders argued that it is a better system to meet the challenges of the period that followed the breakup of the Soviet Union. The first president of Belarus Alexander Lukashenko argued that suspending privatization and liberalization, introducing severe restrictions on stabilization measures in monetary and fiscal policies would lead to faster economic growth with less social costs. Belarusian authorities believed that re-centralization of economic decision process would give a boost to productivity and competitiveness of Belarusian economy. In fact, they wanted to make a case for heavy interventionist policy as an adequate response to challenges of the system transition.

Harvesting old crops 

After 12 years of this experiment, we can estimate whether the means and tool chosen by the Belarusian government to achieve the goals were adequate and whether the goals have been achieved in the first place. Since Belarus rejected the standard path of systemic transformation set forth by the so-called Washington consensus) it has failed to create a single big new plant to change its production structure and to diversify its tax base. It keeps exploiting the assets that were created in the Soviet Union: two oil refineries, a potash fertilizer production plant, chemical plants in Grodno and Mogilyov, Zhlobin metal works and alcohol plants were build long before 1994. Hence, the current authorities have not come out with any genuine plan (though they had two five-year plans and they are in the process of implementing the third one) to liquidate structural imbalanced caused by the breakup of the old Soviet system. Though they crowded out emerging private investment flows and blocked effectively foreign direct investment there is no evidence proving the effectiveness of such investment policies. In summer 2006 prime minister of Belarus Mr. Sidorsky said that the bulk of Belarusian output is produced on old technologies introduced at least 20 – 30 years ago.

Good luck inside and outside

Energy, road, telecommunication and utility infrastructure was also build before the neo-planned model of the incumbent president was launched. The authorities do not create new quality. They do not see the natural production and employment structure as they institutional goal. They are busy redistributing the resources Belarus was lucky to get due to uniquely favorable combination of external demand for oil products, metals and fertilizers on the one hands and growing demand from Russian market on the other. Unlike Ukraine, Kazakhstan or EU countries Belarus had free access to Russian market (free trade and customs union agreements between the countries are mostly formal but they ensured free flow of goods manufactured in Belarus to Russia). There is one major factor that ensured relatively steady growth of Belarusian economy. Cheap gas (in 2006 Belarus buys gas at a bit less than $47 per 1000 m3 which is about 4 times less that the price for EU) and wide-spread oil-refining schemes (Russian crude oil exported to Belarus is exempt from export duties and many deliveries of crude oil are done at prices that are much lower than world prices) add about 13% of GDP in so-called energy rent to the Belarusian economy.

In order to understand the importance of Russian oil subsidy to Belarus we compare the change of two indicators: export oil products revenues and the sum Belarus paid for all crude oil it bought from Russia. In the first quarter of 2003, the difference between them was only $10.9 mln. but in 2005 it reached $271 mln. and remained almost as high in 2006. Having no crude oil of its own Belarus managed to have a very lucrative deal with Russia. It covers all its domestic consumption of oil products by export revenues and still has a considerable amount to spend on other projects. Compared to the first quarter of 2003 the physical volume of oil products export in the 1^st quarter of 2006 went up by 36.9% while export revenue from this increased threefold. Import of crude oil went up by 43.8% and Belarus increased its payment for it by 2.6 times.

We can see how favorable the external demand for major Belarusian export commodities is by looking at two more items – metals and potash fertilizers. In 2002, the revenue for exported metals was $663 mln. and it 2005 it went up to $1195 mln. As for fertilizers in 2002, export revenues amounted to $540.5 mln. and in 2005 - $1536 mln. These goods are produced on old technologies. Belarus was lucky to have such production facilities in place. It could have benefited even more had it cooperated with major international corporations.

Belarusians authorities chose to centralize economic activities. As a result, they increased the country’s vulnerability to external and internal structural shocks. Belarus budget is too much dependent on activities of very few companies. Lack of budget revenue sources diversity is the outcome of the heavy interventionist policies of the government.

Share of 10, 50 and 100 biggest budget forming organizations (BFO)
in the general budget revenues, %

Source: Ministry of taxes and fees of Belarus 2006

The rent that Belarus gets from Russia enables the government to increase salaries for various groups of the population that are crucial in ensuring political stability of the regime. Police, army, the judiciary, top layers of nomenclature are paid at least $500 a month. Overall monthly monetary income of those employed in so called natural monopoly sectors also is above $500 and for top managers it is close to $1000. Workers at 20 enterprises that generate about 60 – 65% of the country’s export are also paid well. In general, about 250 – 300 thousand households (out of more than 3.8 mln.) are quite well off according to Belarusian standards. They are the beneficiaries of the existing system of wide scale redistribution of wealth generated in the economy. Belarusian authorities just changed the form of taking resources from one social groups (they represent the overwhelming majority of the population) and transferring them to others (those who keep close ties with decision makers in the government). Inflation, devaluation, generous budget subsidies and loans with subsequent debt cancellation, numerous government programs and investment schemes - these are popular tool that were used and still are used with various degree of intensity in Belarus. Big construction projects (hockey palaces, railway stations, the national library) along side with subsidized residential contraction (it is another scheme to benefit the few who get access to cheap apartments) helped the government to boost domestic demand and create the illusion of economic “miracle”.

Measuring social economic performance

There is nothing in economic theory that tells us that a centrally planned economy cannot grow and produce certain kinds of goods and services in the short run especially if it is strongly supported by a foreign state (in our case it is Russia). However Belarus has failed to prove that a heavy interventionist economy can generate higher productivity, more hi-tech goods with bigger value added, more new products and better quality services, more environmentally friendlier and energy efficient manufactured goods, better business climate, more efficient and citizens’ friendly government or more effective judiciary and property rights protection system.

Though Belarus boasts to have the annual growth rate of GDP at 8.2% in 2002-2005, the officially registered unemployment less than 2% in 2005-2006 we can hardly take Belarus as a model for other countries to follow. The official statistics have a few serious flaws that put the official data into question. In 2006, IMF in its report stated that “based on macroeconomic data you can not get a full situation in the country. The statistical system in general is in good shape but state control and non-market mechanisms permeate all spheres of economic activities. They considerably change the contents of the information and the meaning of data”.

In this situation, it is more accurate to measure Belarus performance by different indicators. According the most recent report Doing Business 2007 Belarus ranks 129^th out of 175 countries on the quality of business climate. This indicator measures 10 areas of regulation that are also essential to competitiveness of a country. In fact, the quality of business climate is one of the important components of the Index of Global competitiveness and Index of business competitiveness designed by World Economic Forum. The quality of Belarus’ business climate got worse during the last five years increasing the fiscal and administrative burden on Belarusian residents.

Another index that we can use to illustrate the quality of the Belarusian model is Capital Hospitality Index designed by Forbes in 2006. It takes into account various complements that make a country a good place to invest. Belarus ranks 131^st out of 135 countries. The ten factors that Forbes’ team takes into account are 1) restrictions to foreign capital, 2) prices and wages, 3) state regulation, 4) competitiveness, 5) technological level, 6) quality of bureaucracy, 7) investors’ rights protection, 8) corruption, 9) personal liberties, 10) corporate income tax rate.

Belarus has the following results. In the first category – restrictions to foreign capital Belarus is better than 33% of countries in the list which is similar to Russia and Ukraine but much worse than Poland or Baltic states. On “prices and wages” that measures price stability and liberalization Belarus is better than just 3% of 135 countries. The quality of government regulation in Belarus puts the country above just 8% of the listed countries. It is much worse than in Russia, Ukraine and Kazakhstan to say nothing about the countries of central and Eastern Europe. Though Belarusian authorities severely restrict any political competition and deny public control over its activities they have failed to create efficient bureaucracy. Belarus’ bureaucracy ranks just 117^th out of 135 countries. Repression of individual liberties did not make Belarus a better place to invest either. Hence, the argument that Belarusian authorities make on the necessity to suspend privatization and individual liberties to fight corruption and bring order can not be proved by any evidence.

Capital Hospitality Index

Source: Forbes magazine, February 2006 www.forbes.com

Another important indicator that help us understand the degree of Belarus competitiveness is World Bank Governance index. It consists of six factors: 1) voice and accountability, 2) political stability and lack of violence, 3) government effectiveness, 4) quality of government regulation, 5) rule of law and 6) control over corruption. In 2006 report Belarus scored very poorly on all six factors. World Bank estimated the countries for 2005. Belarus for “Voice and accountability” has 5.3 points. It means that it is better than 5.3% out of 213 countries in the list. In 1996, Belarus had a better result, which was better than 18.8% of the countries. It is much worse than in Russia and Kazakhstan to say nothing about Baltic state and Poland.

 For “political stability and absence of violence” Belarus has the score better than in 44.8% countries. For “government effectiveness’ is better than just 10.5% out of 213 countries and for “quality of government regulation” it is even worse – just 6.4% of the countries. For “rule of law” Belarus is better than 15% of the countries. Even in fight with corruption Belarus can not boast any meaningful achievement. It is better than just 19.2% of the countries. Hence, fighting corruption does not require keeping 80% of the assets and resources of the country in the hands of the state and preserving government monopolies in all major sectors of the economy. Belarus has over 100 state bodies that can audit and inspect companies but such extensive net of controllers are failing to build effective institutions of fighting corruption. Since 1996 when World Bank began to measure these indicators Belarus demonstrates considerable deterioration of almost all six factors.

Quality of governance in Belarus 1996- 2005

*the lower the rating the worse the governance 

Source: Kaufmann D., A. Kraay, and M. Mastruzzi 2006: Governance Matters V: Governance Indicators for 1996-2005. 

Governance in Belarus compared to other countries

Source: «A decade of measuring the governance. Governance matters 2006»

Measuring prosperity and social security

Scientific Research Mises Center in Minsk suggested its own methodology to measure social well-being and the degree a person enjoys his social security. It designed the index called “Ivanovna”. It indicates how long an average citizen should work (presumed he earns an average salary in the country) to buy 35 goods and services. The list of goods and services includes food products, consumer goods, durables, an apartment, higher education, health and a car. Retail prices and wages are taken from each country. The assumption is that a person is better off if he has to work less to buy the same goods and services than his counterpart in other countries. The index “Ivanovna” shows that in 2005 an average Belarusian person has to work 33 years to buy the set of goods and services. An average Russian has to work 27 years, a Pole – less `than 15 years and an average American – less than 9 years. It is hard evidence that Belarusian model has failed to deliver better social and economic results that the models based on principles of political, civic and economic competition deliver. As Baltic states, Poland and other eastern European countries were equally poor under Soviet rule the success of new EU member states proves that the Belarusian neo-planned model is doomed to lose competition in the globalized world of international trade, investment and new technologies.

How long should one work to buy 35 goods and services *
(time in years, months, hours and minutes**)

*prices in USD in retail in each country in the given year
**мин  - means minutes, ч. – means hours, мес. – months, лет – means years,
Source: Scientific Research Mises Center, Minsk Belarus www.liberty-belarus.info

Finally, it is worth presenting one more indicator that estimates the quality of the Belarusian system and its competitiveness. It is Happy Planet Index – HPI – designed by New Economics Foundation. HPI takes into account three components: 1) life satisfaction (polls result), 2) life expectancy and 3) ecological footprint. Out of 178 countries Belarus took 165^th position. It means that the policies of the government do not make people happy and do not generate environmentally friendly results.

Hence, we can conclude that Belarus has not built a model that can support long-term economic growth, high standards of living and increase competitiveness of its companies in the domestic and external markets. Temporary successes of the economy are mostly due to structural and political luck and favorable external demand. The authorities stimulated internal demand, crowded out private investment, monopolized all major spheres of the economy but did nothing to prepare the country for looming structural problems. Competing in prices and in low value added merchandize markets Belarus has already lost the competition battle in much more attractive markets and increased the opportunity costs of the strategic mistake that the government of the first Belarusian president made in 1994.

Challenges of catching up in competitiveness

Belarus will be forced to begin structural reforms and liberalization in the near future. The state of negotiations between Belarus and Russia on gas and oil deliveries for 2007 indicate that the new gas prices and crude oil refining schemes may push reforms in Belarus as early as in 2007. At present, A. Lukashenko does not have adequate human resources and the strategy of how to launch systemic market reforms in the status of an obvious later starter.

However, Belarusian think tanks analytical center “Strategy” and Scientific Research Mises center worked out concepts and draft laws that can be used to begin reforms in the country. As a late starter, Belarus has both advantages and disadvantages. Policymakers know what reforms proved to be successful and what measures failed to deliver positive results. If Belarus wants to catch up with its more successful western neighbors it can not afford gradualism in reforms. Secondly, Belarus does not have mature institutions, the culture of rule of law, independent judiciary and well-trained personnel to copy the complex welfare state model with heavy government regulation and generous subsidies from the state. It means that deregulation, debureaucratization and liberalization should go hand in hand. Thirdly, Belarus should take into account the intense competition of legislations and in the globalizing economy. If countries with similar status have tax burden in the amount of 30 – 35%, free trade regime and effective system of property rights protection Belarus can not afford to raise taxes to 40 – 45% of GDP and carry on with heavy interventionist policies in financial, merchandize, service or foreign trade sectors.

Globalization imposes certain standards and discipline on Belarus to a bigger degree than on Central European countries in the beginning of 1990-ies. They have already attracted many transnational corporations and integrated into their vertical or horizontal production chains. As Belarusian internal market is rather small and neighboring countries have already accumulated substantial volumes of FDI Belarus should make not just one but at least three extra miles to catch up in competitiveness with its western and eastern competitors. It means that its regulatory framework, taxes, the quality of the judiciary and property rights protection should become its comparative advantage. It is a big challenge if you take into account the starting conditions and the propensity of the incumbent decision makers to accelerate market reforms. However, any delay will increase opportunity costs in the form of structural imbalances and subsequent unemployment, growing budgetary constraints and lowering living standards.

The reforms should be consistent, quick and be carried out simultaneously in several key sectors. Unlike CEE countries, Russia and Ukraine the privatization of banking and real sectors should go hand in hand with five key reforms: 1) administrative, 2) judiciary, 3) budgetary, 4) tax and 5) business climate transformation. These reforms will enable Belarus to narrow the competitiveness gap with maximum speed and with minimal costs. Of course, we presume that rule of law, democratic processes and basic human rights and freedoms are restored in the country though it may happen that political reform and democratization will lag behind economic reforms. These reforms will help

- build sound public institutions of transparent and effective governance, accountable and functional bureaucracy,

- achieve macroeconomic stability in monetary and fiscal areas,

- enhance market efficiency and boost competition in the internal market,

- create flexible labor market and prepare the adequate highly skilled workforce supply to meet the growing demand for knowledge, skills and innovations;

- liberalize the financial market and facilitate financing of new ventures in the country;

- concentrate on advancement of new technologies and telecommunication infrastructure development.

These factors are essential elements of global competitiveness and should be dealt with in the first place. We can just highlight the main elements of each of the key reforms here to have a better understanding of what is proposed. In the framework of administrative reforms there will be strict division of powers between the president and his administration and the Council of Ministers. State bodies will be not allowed to get involved in commercial activities. All government assets and resources (except for republican ad local budgets) – shares in banks, enterprises, land and real estate) will be passed to the Ministry for government assets and privatization. One and the same state body will not mix legislative, commercial and control functions. They will be separated. Each function will be vested upon a separate structure. Other measures to carry out administrative reform and to build an effective chep and accountable state include

• creating a new, mobile government which focuses on the implementation of economic policy. It will consist of only 8 ministries and 12 agencies.
• ensuring real independence of the judiciary and improvement of the financial status of the courts.
• separating the functions of law making, administration and control that are exercised by state bodies. All ministries, departments (including the National Bank of Belarus), and local executive committees will sell shares of commercial companies. The only body, empowered to own and manage assets will be the Ministry for State Property;
• introducing the legislative norm of obligatory publication of all normative acts
• ensuring free internet access to income statements of all state officials and to all protocols of session of all government bodies;
• introducing the legislative norm that obliges publication and free internet access to balance sheets of all state administrative structures, and enterprises where the state owns more than 50% of the assets.
• revising tender and auction procedures for government procurement,
• carrying out income amnesty. Every citizen of Belarus will be able to legalize his capital by depositing it in a Belarusian bank account without paying income tax. The capital amnesty will last for 18 months.
• Declaring amnesty for citizens imprisoned for minor economic violations that are the results of prosecution using contradictory or vague legislation;
• Ensuring the provision of affordable judicial services for the poor by means of a significant simplification of the judicial and administrative process in the courts.
• Making legislative provisions to provide for free access of the mass media to the information relating to state bodies and their activities.

Measures of macroeconomic stabilization and institutional change will include the following:

- ensuring institutional independence of the National Bank of Belarus;

- introducing inflation targeting to achieve 3% average annual inflation during the first tree years of transition;

- eliminating barriers of entry to foreign financial institutions to the Belarusian market;

- introducing basic propositions of Basel-II Agreement in Belarusian banking and financial sectors;

- creating private bureaus of credit information;

- deregulation and privatization of insurance market;

- creating  a single economic area within the country with the elimination of all legal, administrative and economic barriers in merchandize, services, financial exchange and labor movement;

- eliminating the residence permit system and the easing of the procedures for foreign travel;

- carrying out deep budget and tax reform. The tax system will consist of the following taxes” 1) retain merchandize and service tax (flat rate of 15% or 20%), 2) personal income tax (flat rate 0f 10%), 3) excise tax based on EU rates, 4) regression payroll tax (20 – 15- 10%), 5) import duty (flat rate of 5%), 6) real estate and land tax (0,5%). During the first three years of reforms the general government expenditures should be stabilized at 25 – 28% of GDP;

- banning general budget deficit;

- restructure state enterprises, the transfer of non-production assets from enterprises to local and republican state bodies;

- carrying out privatization (mostly to strategic investors for cash). Privatization will cover enterprises, mass media and banks. 60 - 65% of the privatization revenues will be transferred to the National Pension Fund to be used during for pension reform. The sale of large enterprises will be pursued on a case-by-case basis;

- price liberalization: during the transitional period (until 2010) public transportation and utility tariffs will be regulated by the state. The government will undertake all necessary measures to joint WTO within the first 3 years of reforms;

- introducing a visa free regime for the US, EU, Japan and other OECD citizens coming to Belarus, maintaining the visa free regime with CIS countries, simplification of visa procedures for the Belarusian citizens to travel to the US and EU;

- full liberalization of the capital account and the creation of dynamic financial and stock markets.

Narrowing competitiveness gap means following advice of the new growth theory based on importance of economic liberty. The recent Cato Institute and Frazer Institute report “Economic Freedom of the World 2006 shows obvious correlation between economic freedom and various factors that are key to achieve competitiveness on micro and macro level. Belarus ranks in the bottom 15 countries of the world in economic freedom. Stripping consumers, investors and entrepreneurs off their right to manage their own assets and resources stifles competitiveness of the country. Hence the faster Belarus frees its economy and builds sound market and state institutions the faster it narrow the competitiveness gap.

Correlation between economic freedom and other factors

Источник: Economic Freedom of the World 2006. Annual Report, Frazer Institute

The program of favorable business climate creation and the increase of national competitiveness includes the following measures:

- change the present employment contract system to ensure employee protection in the framework of flexible labor market;

- elimination of administrative barriers for business in order to boost self-employment, simplification of incorporation, introduction of a single annual payment instead of paying taxes and registration, abolition of the provision of mandatory minimum authorized capital; transition to voluntary notary public confirmation of documents for the registration or licensing process;

- channeling budgetary resources for re-training of the unemployed;

- abolition of special tax breaks and benefits for all enterprises and industrial sectors along with the implementation of a constitutional provision equalizing of conditions for economic activities;

- creation of equal conditions for the economic activities of both Belarusian and foreign companies;

- abolition of the “golden share” (the special right of the state to impose control over assets of any stock holding enterprise) and the existing practices of asset confiscation;

- building workers dormitories in Minsk and the regions to ensure and promote labor force mobility;

- introduction of limits on the size of fines for enterprises and entrepreneurs: with a maximum of 10% for the additional sum paid to the budget as a result of tax audit. For other violations – a maximum 10% of the monthly wages paid by the company;

- abolition of retail trade licensing, as well as other kinds of economic activities that do not pose a direct threat to lives and health of citizens;

- unification of procedures for the licensing and granting of permissions, adoption of a single list of documents that are required to gain a license or permission;

- passing an effective bankruptcy legislation to ensure quick elimination of investment and production mistakes;

- creation of a dynamic land market and the introduction of private ownership;

- development of financial, industrial, transportation and telecommunication infrastructure;

- joint production of high-tech commodities based on license agreements with leading multinational corporations;

- ensuring the protection of intellectual property rights. Building institutions to fight against infringements of intellectual property rights;

- ensuring wireless internet access throughout Belarus including schools and universities by the application of the most up-to-date technologies.

All the measures described above will have a positive impact on the process of narrowing the competitiveness gap between Belarus and its neighbors. The proposed measured are described in detail in the book “Belarus” road to the future” published by AC “Strategy” (edited by J. Romanchuk and L. Zaiko). They were presented to the government, the parliament and different structures of the civil society. Unlike most CEE countries Belarus can learn by the mistakes of Russia and Poland, Ukraine and Czech Republic that these countries made in privatization and fiscal sphere, labor market and governance. Belarus has the potential to repeat the success story of Estonia and Ireland. If its elites choose a different path it may as well plunge into the legislative chaos and lawlessness of Russia and Ukraine. The rest of repeating the mistakes of these countries would be turning Belarus into a highly dependent oligarchic state with low productivity and secondary outdated technological production facilities. He risks of such turn of events are high. However, the odds still are that Belarus may choose a different path of narrowing and eliminating the competitiveness gap. It can create a vibrant socially oriented sustainable economy only its elites choose to base the forthcoming reforms on the basic principles of small efficient and accountable government, economic liberty, rule of law, free trade and competition.