Dismantling Ukraine’s system of crony capitalism will require a combination of deep structural reforms, preventive and repressive measures to restrict corruption, and civic activism to hold politicians, officials and business owners accountable.
Systema as whole in Ukraine has suffered setbacks since the Revolution of Dignity, but it still has considerable residual strength – and the ability to undo some of the most important achievements of the reforms undertaken since 2014. Its four pillars of support provide possibilities for using different mechanisms in different combinations and at different intensity to advance its interests. The greatest disruption to the interests of systema stakeholders has been in the banking, energy and healthcare sectors. Yet in all three cases, there are clear dangers of regression.
Reformist forces have not yet achieved a final victory against the former owners of PrivatBank, as underlined by the resignation of the NBU governor in July 2020, and by the fact that the Constitutional Court is due to rule on the legality of the Deposit Guarantee Fund. This fund is responsible for liquidating insolvent bank assets. If its creation is ruled unconstitutional, this will call into question the entire clean-up of the banking sector during the Poroshenko years.
The arrest of the former deputy CEO of PrivatBank in February 2021, as he tried to flee the country, suggests that the net may be tightening around Ihor Kolomoisky and his associates, particularly as the US authorities imposed sanctions against Kolomoisky for ‘significant corruption’ shortly after. However, there are also serious concerns about the independence of the national gas transmission operator MGU and the oil and gas company Ukrnafta. There are fears, too, that corporate governance reform could further regress, particularly given the summary dismissal of the CEO of Naftogaz, Andriy Kobolev, in April 2021. To enable his removal from office, the government temporarily suspended the company’s supervisory board, all members of which subsequently resigned in protest at this blatant manoeuvre. The decision by Ukrnafta’s supervisory board, in May 2020, to cancel the process for the independent selection of a new CEO was also discouraging. Signs that the big players in the pharmaceutical industry are positioning themselves to reverse changes in the procurement system in their favour are a disturbing reminder of the institutional weakness of parts of government and their susceptibility to manipulation by narrow interests.
By contrast, the agriculture sector appears to offer an example where reform in an area that is particularly sensitive for the public, and which is supported by Ukraine’s international partners, can limit the lobbying capacity of large companies. In this case, too, the IMF made its $8 billion loan package conditional on land reform, among other requirements. Nonetheless, it is important to note that the largest FIGs, and their lobbying capacity, are not present in the sector.
Meanwhile, the stranglehold of the largest FIGs on the media remains the critical factor that preserves the fusion of business and political interests. For example, Zelenskyy could not have launched himself as a presidential candidate without Kolomoisky’s 1+1 channel showing his ‘Servant of the People’ series. At the same time, he and the government depend on favourable media coverage to maintain their authority.
Reform of the judicial system and the law enforcement agencies has suffered significant difficulties, partly because of internal resistance and institutional capacity but mainly because of the interest of systema in maintaining the status quo.
Reform of the judicial system and the law enforcement agencies has suffered significant difficulties.
Since 2014, Ukraine has shown that it has a very active and increasingly capable civil society, and that its population respects democratic values. The 2020 Ukraine in World Values Survey found that more citizens want a greater say in important government decisions today than was the case in 2011. At the same time, large shares of the population perceive state authorities (72.2 per cent) and civil service providers (67.1 per cent) as corrupt. This points to the resilience of systema. Critically, the electorate still has to confront the fundamental issue of why its leaders govern for the few, not the many. Civil society’s focus has been on addressing problems created by systema, and limiting its capacity in certain areas rather than on dismantling it. However, some parts of civil society are starting to consider the problem more broadly. Low standards of living, poor public services and stubbornly high levels of petty corruption are problems largely created by the overall model of governance and the incomplete state of reforms. Zelenskyy’s electoral success in 2019 and the election at that time of a large number of first-time MPs suggest that parts of society are genuinely seeking change. However, the lack of real political parties rooted in society and committed to deep reforms does not allow the translation of these aspirations into reality.
Since the Revolution of Dignity, Ukraine has enjoyed unprecedented attention and assistance from its Western allies. The EU and other major donors as well as international financial institutions (particularly the IMF, the World Bank and the European Bank for Reconstruction and Development) helped to launch important structural reforms by using their political leverage to impose conditionality. The EU has deployed many of the tools it has used successfully in Central Europe to promote good governance and the rule of law, as part of an overall process of political association and ‘legal approximation’ enshrined in the Association Agreement signed with Ukraine in 2014. Weak state capacity explains in part the limited progress on implementing the agreement, but there appear to be other reasons too. Efforts to improve the quality of regulations and their implementation by strengthening the regulatory authorities have, in some cases, been undermined because systema’s major players do not see the benefits and have the capacity to resist change through their influence on lawmaking and government decision-making. For example, despite long-standing efforts supported by the EU and other donors to give it teeth, the Anti-Monopoly Committee (AMCU) still requires further reform to enforce competition rules, including stronger safeguards to ensure its independence.
Zelenskyy appeared to side with systema in the spring of 2020 when he criticized the number of foreigners on supervisory boards of state companies, and in pushing for the resignation of the head of AMCU. Some observers have suggested that an alliance of forces associated with Kolomoisky and Medvedchuk as well as former prime minister Tymoshenko is working to reverse the progress made on corporate governance in state companies. Amos Hochstein, a US businessman, resigned from the supervisory board of Naftogaz in October 2020, alleging ‘sabotage’ of its good governance reforms by the government and ‘oligarchs’ seeking to enrich themselves. Shortly before this, the highly regarded Swedish economist and Eastern Europe expert Anders Åslund had similarly resigned from the supervisory board of the national railway company, claiming that the working conditions of supervisory board members had been made impossible, and that Zelenskyy and his ‘loud MPs’ do not believe in good corporate governance.
By June 2021, however, after the Ukrainian authorities had introduced sanctions against Medvedchuk’s assets in February and placed him under house arrest on charges including treason, Zelenskyy felt sufficiently emboldened to table draft legislation to curb the influence of big business on politics and the economy. He threatened to hold a referendum on the issue if parliament failed to support the new law.
The challenge of reining in systema goes much deeper than forcing the wealthiest businesspeople to declare their assets and disclose their contacts with officials as the draft law intends. Systema has left Ukraine with a serious lack of expertise in government that contributes to weak state capacity. The major FIGs attract and retain much of the best talent in the country, putting it to work to make governing institutions work for them. This imbalance is likely to take many years to correct. The EU’s considerable efforts to encourage public administration reform will inevitably take time to produce results because of the long-term nature of change programmes of this kind.
Similarly, efforts by Western donors to promote rule of law and anti-corruption initiatives through measures such as strengthening of regulatory bodies, judicial reform and the creation of new investigative and prosecutorial agencies, as well as the requirement for unprecedented levels of transparency of assets held by officials, have so far produced only modest results. This is not surprising, since the experience of transition in Central European countries has shown that reforms in these areas are typically met with strong resistance and require considerable effort over many years. However, there have also been clear examples of success on the anti-corruption front, including the cleaning up of Naftogaz and reforms in administrative services, banking, the patrol police, procurement and taxation. Decentralization has also created new opportunities for citizens to hold local authorities accountable for managing public resources.
Recognizing the importance of accountability for high-level corruption crimes in an effort to promote the rule of law, Ukraine’s international partners have placed heavy emphasis on establishing new anti-corruption bodies, including the National Anti-Corruption Bureau (NABU), the Specialized Anti-Corruption Prosecutor’s Office and the High Anti-Corruption Court. NABU and the Specialized Anti-Corruption Prosecutor’s Office have suffered from the absence of a properly functioning judicial system, and NABU has come under increasing political pressure from systema interests concerned about its investigations. Judicial reform conducted in parallel has encountered obstruction from within the judiciary itself. As a small ‘island’ surrounded by hostile systema interests, the anti-corruption infrastructure developed since 2014 is likely to face further efforts to limit its effectiveness.
There is also a risk that some forces could try to use the anti-corruption infrastructure to conduct politically motivated investigations and prosecutions against rivals. It will be important for Ukraine’s international partners to monitor developments closely, and to step in if necessary to protect the independence of these institutions. The country has bitter experience of politicized justice from the Yanukovych years. Efforts by opponents to bring criminal charges against Poroshenko through the Prosecutor’s Office are an indication that this risk is real. Oversight by its international partners remains essential at this stage of the reforms when rule of law is weak and Ukraine has still to develop a set of reliable checks and balances for investigative and prosecutorial bodies to function without abuses.
A vicious circle is at work: the largest FIGs have a clear interest in ensuring that they can continue to enjoy access to rents and limit competition, since most of them do not have another business model.
Systema has also retained the capacity to fight against measures designed to improve the law enforcement agencies and free the courts from external interference, because the reforms conducted so far in other areas have not weakened it at its core.
The reforms that have most heavily affected systema’s interests are those that have closed down major schemes for diverting public funds. In the case of the banking and gas sectors, there was a national security imperative to do so. The healthcare sector was different: a determined reform team at the Ministry of Health successfully faced down the pharmaceutical industry with the backing of Prime Minister Volodymyr Groysman as well as Western governments and the international organizations that took over procurement of medicines and delivered huge savings. The owners of the pharmaceutical companies and distributors did not have the institutional strength at the time to cancel these measures.
The operation of the electronic public procurement platform Prozorro, developed by civil society and reformers in government together with business, has helped to close down well-established corruption schemes that were prevalent in the Yanukovych era. Punitive measures are also a necessary means to deter corrupt practices and must accompany efforts to restrict the space for corruption, although they must not become a substitute for other efforts to reduce systema’s influence.
A vicious circle is at work: the largest FIGs have a clear interest in ensuring that they can continue to enjoy access to rents and limit competition, since most of them do not have another business model. To do so, they have an incentive to remain politically connected and maintain control of the media to shape the political agenda and influence the execution of government policy. For their part, a large number of politicians and senior officials have an interest in continuing to benefit as the FIGs’ enablers. In turn, the layers of bureaucracy below them have a strong incentive to continue operating the machinery that keeps the system functioning because they receive income from the corruption that it spawns. Consequently, the instigators and enablers of rent seeking have an interest in limiting their accountability before the law. This clearly places a serious brake on judicial reform and the establishment of reliable courts.
What can Ukraine’s international partners do?
Other countries that have attempted fundamental governance reform can provide useful reference points for thinking about what may limit the power of systema in Ukraine. For example, South Korea’s successful experience of reducing the influence of its chaebols and Chile’s exceptional achievements in becoming one of the least corrupt countries in Latin America deserve attention. There is also much relevant experience closer to home: in Bulgaria, Greece and Romania.
There is no universal model for achieving a transition from a ‘limited access order’ whereby rent seeking is the norm to a politically and economically competitive ‘open access order’ where the needs of society come first. Every country is different, and progress may sometimes be the by-product of other changes rather than the direct result of reform measures. Antitrust legislation can over time be part of a framework to create a competitive economic environment, but it cannot be a solution on its own to addressing the wider problem of systema, particularly when Ukraine lacks an independent judiciary and other institutions that could enforce new rules. A combination of deep structural reforms, preventive and repressive measures to restrict corruption, and civic activism to hold politicians, officials and business owners accountable are necessary to address the problem as a whole.
As a general principle, reducing the influence of systema requires changing the calculus of the main players. Rent seeking needs to become more difficult, to carry greater risk and to be less profitable than wealth creation through the establishment of well-managed, transparent businesses that attract investment and generate employment. Economic growth will then create new players and diversify the asset-owning class. The reduced appeal of rent seeking will encourage greater political competition through the diversification of constituencies. Regulating further the use of media for electoral campaigning purposes and developing a properly resourced independent public broadcaster could be part of this process, along with further efforts to regulate and control campaign financing.
Some systema interests may be strengthened, and others weakened, as the economic crisis triggered by the COVID-19 pandemic plays out. Some FIGs may find themselves rewarded by the government for their support, while others may lose ground because of the conditions of future IMF support. It is notable that during the ‘lockdown’ period from March to May 2020, large companies were able to continue working, while small and medium-sized business could not. FIGs and their affiliates benefited, as did their employees.
Privatization of state companies, and improving the corporate governance of the remaining ones, offers considerable opportunities to reduce traditional rent seeking and force some of the FIGs to reconsider their business models. However, this presupposes that the process of privatization is competitive, and not prone to the type of insider dealing seen in the past. The possibility, under legislation adopted in March 2018, to apply English law to large-scale privatization sale and purchase agreements is an encouraging development in view of the failure so far to improve the delivery of justice in Ukrainian commercial courts.
Judicial reform is a long-term process that requires sustained support from Ukraine’s international partners, but with their acceptance that the principles of the Council of Europe do not easily translate into local reality. The attempt to respect the principle of judicial independence by leaving the unreformed High Council of Justice in charge of the reform process has produced predictably meagre results. International support to civil society and investigative journalists should continue, since they play an important watchdog role in monitoring reforms – for example, by exposing the rigging of judicial appointments and drawing attention to disciplinary proceedings in the case of allegations of malfeasance. The international partners must distinguish between cosmetic and substantial reform of the judiciary. A reminder of the state of the judicial system is that Kolomoisky’s defence against claims by state-owned PrivatBank looks much weaker in foreign jurisdictions than it does in Ukraine. International partners also need to tie financial and other support to real judicial reform. Strict IMF and EU conditionality made it possible to create the new anti-corruption infrastructure, and should make it possible to conduct deep judicial reform. Ukraine is likely to need significant financial support over the next two years to service its foreign debt and cope with the economic impact of the COVID-19 crisis and a shortage of foreign investment.
Ukraine’s international partners must distinguish between cosmetic and substantial reform of the judiciary.
The most powerful tool for challenging systema is the greater part of Ukrainian society that does not benefit from it nor from preserving the status quo. Sustained calls by the public to stop specific rent-seeking practices will put pressure on the FIGs and their enablers in government and parliament. An alliance of reformist politicians, business figures and civil society has the potential to play an important role in this process, but only if backed with appropriate support by Ukraine’s international partners. Dismantling systema and replacing it with robust, competent institutions will be a long-term process that is unlikely to be linear because of the political battles that will need to be fought along the way, and because of the need to co-opt the progressive-minded part of the elite that sees the need to look beyond maintaining the status quo. To drive this effort, civil society will need to broaden its capabilities and expand beyond the biggest cities, while the public must have better access to balanced reporting via independent media.
Finally, Western countries must show much greater resolve to investigate suspected money laundering by the beneficiaries of rent seeking and corruption in Ukraine. There is abundant evidence of the latter’s ability to use banks in EU countries and in the UK to buy real estate, educate their children and protect their assets in rule-of-law jurisdictions. Some of these individuals bear heavy responsibility for Ukraine’s weak institutions and the national security problem that they have created. Continued failure to deter these practices will not only sustain systema. It will also increasingly lead to accusations of Western double standards and tarnish the EU’s image in Ukraine as a community of law-governed states that is genuinely committed to upholding democratic values and supporting reform in the country.