The real sector of economics is a bottomless abyss where billions of hryvnias disappear without a trace – this opinion is articulated by politicians and public officials with increasing frequency. An argument is often brought forward that the real sector of economy in Europe, except for the agriculture, is not subsidized.
We have attempted to test this thesis and compare the fiscal policies related to the real sector support in Ukraine and the European Union. Hence, we would like to bring to your attention 5 basic observations based on the results of our examination.
1. The current practice of using fiscal levers and tools for the promotion of development of real sector enterprises in Ukraine is radically different from the EU practice from the viewpoint of structure, tools and scale. The total expenditures on the economic activity in the EU countries fluctuates from 4% GDP in non-recession years to 5% GDP in the times of crisis (see the details below).
Instead, a reduction of these expenditures relative to the GDP is observed in Ukraine – from 5.6% in 2007 to 3.1% GDP in 2015.
* subsidies and current transfers granted to enterprises (institutions, organizations)
** capital transfers granted to enterprises (institutions, organizations)
A cutback of expenses on the economic activity to 2.4% GDP was scheduled in 2016 pursuant to the National Budget Law. A critically low level of these expenses is complemented by an investment pause in the economy caused by the military threat and partial occupation of Ukraine’s industrial regions by the neighboring country.
2. The main recipients of state financial support in Ukraine are still represented by enterprises operating in certain industries (sectoral support) with over 90% of the total volume allocated thereto. Meanwhile the sectoral support in EU countries does not exceed 15-20% of the total amount of governmental financial aid and has a tendency towards further reduction. In Ukraine two thirds of sectoral support are attributed by the state to national banks and Naftogaz Ukrayiny National Joint-Stock Company. Dozens of billion hryvnias contributed by taxpayers sink in Naftogaz Ukrayiny NJSC; in particular, an assistance of 96.6 billion hryvnias was granted in 2014.
Figure 1 illustrates the dynamics of subsidies given to enterprises at the cost of budgets at all levels in EU countries and Ukraine. Total direct subsidies at the cost of budgets at all levels to enterprises in the national and private sectors in Ukraine were curtailed from 3.6% GDP in 2008 to 1.4% GDP in 2014, thus approaching the EU level where government grants to enterprises did not exceed 1.3% GDP. But this comparison is not adequate due to the fundamentally different approaches towards determination of the circle of potential subsidy recipients (different industry affiliation of the recipients).
Figure 1. Subsidies to EU and Ukrainian businesses in 2007-2016
3. The largest portion of Ukrainian subsidies was provided to collieries and agricultural businesses while in the EU these industries are given 0.3% GDP maximum. A drastic contraction of subsidies to 1.4% GDP in 2014 and to 0.8% GDP (scheduled for 2016) did not imply a change of strategy in the domain of fiscal support of the real economy sector. This is explained by a reduction of subsidies to lossmaking collieries which are mostly situated in the occupied territories. Sectoral government aid in Ukraine is still provided in the form of direct grants to enterprises operating in coal mining, energy production and supply, metallurgy, road maintenance and agriculture.
4. EU countries use all available fiscal policy channels of influence to develop the real sector businesses, including tax, budget and credit channels.
The budget channel is and will remain the chief channel in EU countries. In 2007 it was used to finance 10% of capital accumulation in the real sector, and this figure increased to 12-14% in the post-crisis years. The tax channel takes on about 1% only, and the credit one contributes no more than 0.2% to the source of investment funding in EU countries.
Capital transfers to enterprises are one of the most substantial forms of fiscal support via the budget channel. Figure 2 compares the dynamics of capital transfers granted to enterprises at the cost of budgets at all levels in EU countries and in Ukraine with regard to the GDP (%). The capital transfers to GDP ratio in Ukraine decreased from 2.7% GDP in 2007 to 0.6% GDP while in the EU it ranged 1% to 1.5% GDP. It is worth paying attention to the indicator’s pro-cyclicality in Ukraine – its pre-recession value went down to 0.9% GDP, and reached a critically low level of 0.5% GDP following the neighboring country’s attack on Ukraine.
Figure 2. Capital transfers to EU and Ukrainian businesses in 2007-2016
The reduction of national capital transfers in 2014-2016 was not caused by a change of the country’s economic development model but was due to the general economic collapse provoked by the Russian aggression and lack of fiscal space for funding countercyclical measures of the fiscal policy. The negative outcomes of such curtailment are aggravated by the irrational sectoral affiliation of the recipients of such transfers. These are prevailed not by innovative projects but by ongoing businesses in the oil and gas sector and in other traditional economic activities which are incapable of assuring the continuity of operations at their own cost in market conditions.
5. The past years’ reduction of fiscal aid to real sector business (compared against the EU countries) and its irrational structure undermine the efficiency of the real economy. Investing billions of hryvnias into the real sector to see them disappear in an unknown direction is not what we need. Neither is it necessary to propagate myths that everything is fine with the economy and that it does not need nourishment.