It would be an overstatement to call individual entrepreneurs stable subjects of the market and even less so subjects oriented toward strategic development. There are also no signs of the economy becoming less monopolized. With no substantial increase in employment figures (at least in the official sector), the number of official personal incomes remains largely unchanged, but the culture of doing business transparently is not fostered. As a result, the prospects of small business developing into medium business or mass innovations in small business are out of the question. The results of the development of small business in 2002 have yet again made the government reconsider its policy of tax concessions and other preferences granted to small business. It appears the high hopes pinned on this sector of the economy are less likely to bear fruit with each passing day. Small business even fails to perform its banal social function of providing employment. Meanwhile, its participation in the shaping of an innovatory model of economic development is out of the question.
LIGHT AND SHADOWS
Small business has been long associated in public consciousness with the real market economy. For this reason, developing (supporting, stimulating, encouraging, etc.) small business is the overriding goal outlined everywhere from presidential missives to government programs. In the past decade much has been achieved in this sphere. A 1998 presidential decree initiated a simplified system of taxation with tax breaks for entrepreneurs.
The statistics cited by the parliamentary Committee on Industrial Policy and Entrepreneurship Chairman Yury Yekhanurov at the May hearings, Problems of the Development of Business in Ukraine: Regulatory Policy of the Government and Measures to Support Small and Medium Business, suggest that as of early 2003 some 2,660,000 small businesses were registered in Ukraine, of which 2,412,000 were individual entrepreneurs. The number of those employed in the small business sector (entities and individuals included) has reached 4,350,000 people, which is a threefold increase from 1992. Last year alone, small businesses manufactured products and provided services worth UAH 25,182,000,000, which is a fivefold increase from 1992.
Undeniably, 1992 is a good year for comparison. It will be recalled that this year marked the beginning of unprecedented liberalization of the economy. At that time one could only dream about the development of small business (of course, if you do not count the brief episode of cooperatives). On the other hand, the experience of our immediate neighbors has shown that small business could have given our economy much more over a decade. Unfortunately, as earlier, small business does not play any major role in the economic life of the country.
In 2002, small businesses accounted for only 7.3% of the total production volume in the Ukrainian economy. On average, there are fifty-three small businesses per 10,000 population. Notably, according to the State Statistics Committee, only 74.2% of the registered small businesses in fact operate, with the majority of small businesses concentrated in seven regions, that is, in the capital (accounting for 15.5% of the total), Kyiv, Donetsk, Dnipropetrovsk, Kharkiv, Lviv, and Odesa oblasts. The third successive year of active economic growth had almost no positive effect on the performance of small business. Notably, their share of the economy has not grown substantially nor has the number of their employees. According to the committee, 38% of small businesses lost money in 2002. Cause for concern is the fact that Ukraine’s small business reacted to another year of stability and economic growth with further fragmentation and miniaturization. As compared to 2001, the number of small businesses has increased by 55.7%. However, individual entrepreneurs account for the lion’s share of this increase, having grown by 63.5%, while the number of small businesses proper has increased by only 8.6% (indices may vary in different sources in view of different statistics tabulated by the State Statistics Committee and the State Committee on Industrial Policy and Entrepreneurship). As a result, the employment growth rate in small business is falling behind the rate of development of this sector (employment has grown by 34.4%). Meanwhile, the share of small business in the total production volume is growing even at a slower rate. Ukrainian entrepreneurs seem unwilling to further develop their businesses beyond the confines of individual entrepreneurship and use the simplified system of taxation not for reinvestment and expanding their businesses, but to evade taxes as much as possible.
As a result, small business is unable to play its institutional role as a factor to create a market environment. It would be exaggeration to call individual entrepreneurs stable market subjects and even less so oriented toward strategic development. There are also no signs of the economy becoming less monopolized. With no substantial increases in employment (at least in the official sector), the number of official personal incomes stays largely unchanged, and the culture of doing business transparently is not cultivated. For this reason, the prospects of small business developing into medium business or the prospects for mass innovations in small business are out of the question.
Also worrying is a trend toward lower labor productivity of workers in small businesses, proved by simple calculations. The number of employees of small businesses was up 6.2% in 2002, that is, the average number of employees in one company reached eight persons (against seven employees in the previous years). If you compare this with the mentioned production volumes, you will see that while in 2001 an average employee of a small business produced UAH 6,900 worth of products, in 2002 this figure plunged to UAH 5,800. Thus, we see a decline in labor efficiency (at least in the official sector) of the most economically active social class. This is indirect proof of small businesses going further into the shadows and more subtle in the use of legal mechanisms to evade taxes.
NEW OVERRIDING GOALS FOR THE STATE COMMITTEE ON ENTREPRENEURSHIP
The reasons behind such a state of affairs are understandable and banal. Despite the fast rate of economic growth, the business climate in Ukraine leaves much to be desired. Because credit and financial institutions are underdeveloped, the effect of economic growth experienced by exporting companies and highly competitive producers of consumer goods for the domestic market slowly and painfully spreads to other sectors of the economy, businesses, and regions. Banks, whose rights as creditors are not adequately protected under law, are not interested in extending loans to small businesses in view of the high costs of such services and high credit risks. Non-governmental loan guarantees by non-banking financial institutions is virtually nonexistent.
One can say that the current economic growth has been caused primarily by the market situation, not any fundamental restructuring of the economy. Meanwhile, the punitive and fiscal tax system absorbs the financial results of economic growth, thus preventing the reinvestment of profit into economic restructuring. The unchanging fiscal priorities of the government preserve the burdensome control and regulatory mechanism that primarily affects small business. According to the deputies and experts addressing the mentioned parliamentary hearings, central, regional executive, and local bodies do not coordinate their legislative work to meet the underlying principles of government regulatory policy, which are to reduce the cost to entrepreneurs of audits, inspections, other regulatory burdens, as well as to make legislation transparent and simple.
The strategy to support the development of small business has thus far focused on attempts to deregulate it, which immediately ran up against the inflexible priorities of financing the central and local budgets. Notably, the local governments that in fact lack autonomous sources of funding were forced to seek various forms of off-budget funds, and small business was hit hardest. Such practices have led businesspeople to question the officially declared intent to protect and support small business while creating in the business environment a mindset such that businesses reveal as little as possible about their performance in official statements. The tax concessions granted to small businesses and individual entrepreneurs have not only failed to yield the result desired, but actually distorted the structure of small business. Instead of becoming the flagship of economic transformations and engine of economic growth, Ukraine’s small business is miniaturizing and becoming a way to survive for ordinary Ukrainians.
All these things lead to the conclusion about the inefficiency and hopelessness of the current strategy for the development of small business in Ukraine. The Committee on Industrial Policy and Entrepreneurship, the major state body charged with shaping governmental regulatory policy and solving the problems of business development, has in fact become a committee of deregulation and, paradoxically, a state structure that helps entrepreneurs fight the bureaucracy in state structures. Undoubtedly, countering the bureaucratic pressure on small business is an important and necessary function. However, in doubling the functions of non- governmental organizations and associations the committee has in fact overlooked the need to coordinate the interests of entrepreneurs with the goals of developing the nation’s economy and streamline the activity of small business so that it would serve the long term goals of Ukraine’s economic development.
Within this context, the dismissal of committee chair Mrs. Kuzhel seems quite logical and can be viewed as a sign of realization of the need to change the model of the relationship between the state and small business. New Chairperson Bohoslovska faces a tough challenge: on the one hand, not to lose the trust of entrepreneurs, who look to the committee as a protector and arbitrator called upon to resolve disputes with the local and central bureaucracies (which, incidentally, is a major political card in the pre- election period), and, on the other, to fit in with the new style of economic policy with its rigid centralism and fiscal consolidation, as well as pragmatism in setting political and economic goals. The bazaar model of small business with its prevailing isolated individual entrepreneurs will soon be replaced by a system of small and medium businesses, most of which will contribute to the turnover of big domestic or foreign capital and will act within the confines of international regulations. To lead or at least regulate and streamline these changes while making them least painful for Ukrainian business is the overriding goal for the State Committee on Entrepreneurship and the essence of the new model for the government strategy in its relationship with small business.
TIME TO SEEK AN ALTERNATIVE TO SIMPLIFICATION
Based on the results of the hearings, the parliamentary committee prepared recommendations for Verkhovna Rada that will consider bills aimed at further shaping the legislation designed to create favorable conditions for the development of small and medium business in conformity with EU requirements. Moreover, it has recommended that when drafting the 2004 budget the parliament should provide for measures to implement the National Program to Promote the Development of Small Business in Ukraine while fostering the creation of systematic cooperation of the legislative, executive, and judicial branches to protect private ownership rights and increase the responsibility of state bodies for the decisions made and their consequences.
Committee members believe it necessary to recommend that local government and the national executive provide funding for regional programs to support the development of small business in the amount of 0.5% of local budget and off-budget funds.
The committee has recommended that the government take steps to enforce legislation designed to protect ownership rights, eliminate red tape, ensure effective ownership, and speed up the creation of regional centers to provide integrated government services. By July 1, 2004, the government should provide for the creation of a common automated system of state registration of entrepreneurs and businesses.
The proposed recommendations cannot be considered fundamental policy changes, but under the existing circumstances even they can bring positive results. Unfortunately, nothing more has been offered for our miniaturized small business.
In granted tax concessions to small businesses, the state expects increased revenues to offset any losses. Since this is not happening for the reasons mentioned, the idea repeatedly voiced to abolish the simplified system of taxation sounds very logical. In particular, First Vice Premier Mykola Azarov made a statement to this effect. “We have undertaken a radical reduction of tax pressure and in the legislation to be adopted we will try to simplify the administration of taxes as much as possible. Under present conditions there cannot be more than one system of taxation,” he said in a televised interview on “Dilovy Svit” [business world].
The first step on the way to the unification of tax legislation were amendments initiated by the Cabinet of Ministers that abolished the simplified tax system for businesses and entrepreneurs that has been used in some parts of Ukraine and was based on special patents for small and medium businesses.
The new chair of the State Committee on Industrial Policy and Entrepreneurship actively opposed the abolition of the simplified tax system and even threatened to resign should this happen. Mrs. Bohoslovska has proposed a moratorium on the abolition of the simplified system, which, in her view, will stimulate investment in small business. However, it is not quite clear why this investment, of which there was none in the previous years, should come now, when the simplified system is becoming more and more fragile despite all the statements and moratoriums.
Simultaneously, the committee chair admitted there are countless violations of the simplified system that cause major revenue losses. The committee has shown a constructive approach previously unknown in proposing a set of steps to improve the simplified system, which could help preserve it by restricting it to a specified category of entrepreneurs.
Nonetheless, despite all the proposals, one has to admit that the period of massive tax avoidance by manipulating the simplified system is gradually becoming a thing of the past. Tax concessions for small business are still supported by the economically active population. However, it is already facing resistance from representatives of big business, who often and with reason view the simplified system as an obstacle to relieving the overall tax burden on the Ukrainian economy. Moreover, the reduction of the income tax has substantially relieved the social acuteness of the problem, making it unnecessary for citizens with high incomes to register as individual entrepreneurs and conceal their incomes behind fixed-rate taxes. This makes the abolition of excessively simplified schemes of taxation for small business a real prospect, especially in view of the need for fiscal consolidation next year.
Thus, small business oriented toward long-term prospects should look for alternative ways of development such as establishing long-term contacts with major Ukrainian and foreign companies and corporations. This will give them access to investment resources and enable them to establish lasting relationships, on the basis of which they will be able to build a strategy of development, attain financial stability, and operate at a profit in a legal and reformed regulatory environment.
