ml# INTERNATIONAL FINANCE CORPOFUTION

The State of Small Business in Ukraine

AN IFC SURVEY OF SMALL, PRIVATE BUSINESSES IN LVIV, CHERKASSY, MARIUPOL, SUM1 AND UZHGOROD

(Summer 1996)

Wendy Jagerson, Gwynne Oosterbaan, Amanda Leness and Konstantine Maninovskiy

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Table of Contents

I. Introduction, p. 1

11. Executive Summary p.3

A. Goals

B. Methodology

C. Highlights of the Findings

D. Conclusions

111. Survey Goals and Methodology p.6

A. Goals

B. The Sample

C. Methodology 1. Surveying 2. Data Analysis 3. Firm Performance Breakdown

IV. General Information about the Survey: Overview of the Respondents and their Firms, p. 10

A. Respondents 1. Positions and Management Experience 2. Education 3. Gender

B. TheFirms 1. Size and Age 2. Legal Form 3. Ownership Change 4. Sector

V. Issues, p. 16

A. The Private Sector in Ukraine Today I . The Official Economy 2. The Shadow Economy 3. Market Entry

a) Intermediaries b) Costs

4. Sectors

5. Differences Between Start-up and Privatized Firms

B. Firms' Financial Status 1. Profitability and Gross Sales 2. Use of Credit 3. Expansion 4. Investment

C. Firms' Internal Dynamics 1. Workforce

a) Trends in Employment b) Workload, Salary and Benefits c) Workforce Skill Level and Training

2. Management a) Managers' Motivations b) Business Training - Managers' perceptions of their Needs c) Planning Ahead

D. Efficiency Indicators - The Market 1. Suppliers 2. Clients 3. Competitors

E. Problems 1. Corruption and the Racket 2. Global Comparison of Problems

VI. Recommendations and conclusions, p. 36

A. Recommendations on the Business Environment

B. Issues with Particular Impact on Small Business 1. Business Regulation 2. Licensing 3. Other Issues and Priorities

The comments of Alyona Voloshina, Project Manager for Small-scale Privatization Project and Valerie Wright, IFC-Ukraine's Director of Public Relations were invaluable in Kiev as was additional input fiom Michael Cully. Also comments of Alexander Pascaver and Andrew Stone were instructive and are greatly appreciated. Thanks to all those who devoted considerable time and energy to all phases of the project during the summer of 1996.

Introduction

In the transitional economies of the former socialist bloc, small businesses are playing a leading role in the emerging private sectors, acting as engines for the renewed growth of local economies. Rapid privatization and supportive environments for start-up enterprises in countries such as Poland and the Czech Republic have led to flourishing small-enterprise sectors, which in turn are contributing strongly to those countries' rapid economic recovery and current growth. In Poland, for example, the small- enterprise sector is nearly two million strong and is a significant factor in the recent high levels of growth in Poland's economy.

The contributions of small business to the growth and recovery of the Polish and Czech economies offer lessons for the entire former socialist bloc. Across the region small businesses emerged largely by seizing opportunities created by the dissolution of the centrally planned economic system. They moved quickly to establish new trade links and entered manufacturing and services where larger, state-owned enterprises failed or languished. As small business grew, it improved daily life by offering consumer goods and providing badly needed jobs. In Russia, for example, 20% of all employment is in small business; a figure that will surely double in two years.'

Apart fiom the significant economic benefits of the small-enterprise sector to transitional economies, small businesses also have the potential to contribute significantly to the political development of the countries the former socialist bloc. The growth of the small-enterprise sectors in these countries provides an opportunity for the creation of a strong middle class which supports the democratic process and the rule of law as a means to personal economic growth. When a critical mass of small-businesses exist, this sector represents a key source of political support for continued market reforms and democratization.

In view of the importance of small business growth to the economic and political development of countries making the transition fiom communism to capitalism, IFC has undertaken a study of the small business sector in Ukraine to determine how the small-enterprise sector in that country is faring. Since 1992, Llkraine has been slowly but steadily privatizing small and medium-sized enterprises, and a significant number of start-up enterprises have been registered. Although methods of counting differ in government and outside agencies assisting privatization, there are now anywhere between 11 1,000 to 175,000 total private enterprises, registered and operating.2 By government accounts, by March 31, 1996, nearly 33,000 of those were small privatized busine~ses.~ Moreover, the pace of privatization and overall private sector growth has been accelerating over the past two years.

' Z.S. Varnaliy, "The State Financial Policy in the Sphere of Small-Scale Entrepreneurship and Ways of Its Perfection," Finansy Ukrainy. No. 2. 1996.

For 11 1,000, see Ministry of Economics, Ukraine. For 175,000, see Brzezinski, op. cit. Speech by Yekhanurov, --head of the State Property Fund, on April 19, 1996.

Furthermore, notable improvement in the macroeconomic environment has been achieved. During 1995, inflation was 180% compared with 400% in the previous year.4 By June and July 1996, single digit monthly inflation was recorded. The exchange rate was unified, prices, particularly for energy, are more decontrolled, the trade regime is liberalizing, the state order system is fiuther dismantled, and the pace of privatization of large enterprises is increasing.

Nonetheless, despite these gains, Ukraine's private sector continues to struggle in the face of economic uncertainty and a difficult policy environment. Small enterprises are especially hurt by the volatility of the economic and political environment, and by the government's uncertain approach to private sector activities. One of the major findings of this survey is that the majority of small-enterprise owners consider the actions and policies of the government to be the greatest obstacle they face in trying to make their small businesses succeed.

Placed in the context of previous years' World Bank studies on the problems of small business in Ukraine, this survey's finding suggest that the steps toward macroeconomic stabilization, while removing some significant obstacles to small business development, have also lessened the opportunities for unusually high profits, as niches are filled and currency arbitrage less feasible. In face of more stable economic conditions, the regulatory obstacles in the Ukrainian business environment come to the fore and now seem to be the key obstacles to small business development. In the last year, inflation and currency issues have fallen greatly in small businesses' rankings of problems, while taxes and regulatory issues have come to rank highest. The characteristization of small businesses that come out of this survey's fmdings supports the hypotheses that regulatory issues hinder small business development.

The inadequacy of the current legislative body for business development - and the kinds of obstacles embedded in government procedures related to business - are rooted as often in a failure to recognize the real and potential benefits of small business as in a lack of knowledge of how to write the law. For example, sources in the Ministry of Economics have stated to IFC that the private sector in Ukraine accounts for only 5% of GDP although World Bank estimates of the size of the private sector puts its contribution at 40 to 50 percent of GDP. Such under-reporting may belie a serious government bias against the private sector, or it may simply reveal government's inability to properly account for a large share of the private sector activities that occur in the country since much goes on unreported in the "shadow economy." Nonetheless, such misperceptions can distort policy toward the private sector. Therefore, there is a clear need for more information on the private sector and small business fiom surveys like this and others to better assess their size, scope and situation and thus determine the obstacles they face in today's economic environment. The resulting information should facilitate the creation of concrete suggestions to policy makers on how to improve the policy framework to encourage small business growth and to bring the shadow economy into the official one.

IFC has been assisting Ukraine to develop a small-enterprise sector since 1992, when the Government of Ukraine invited IFC to begin a small-scale privatization project. To date, that project, which is funded by USAID, has assisted almost all of Ukraine's major cities and many of its smaller ones in privatizing nearly 8,000 enterprises. In addition, in 1994 IFC began a Post-Privatization Project

World Bank, internal documents. The surveys in question are documents written for internal use by the World Bank and cited with the author's

permission. They are: "Ukrainian Private Enterprise: Profiting Against the Odds," by Andrew Stone and Irina Novitskaya, June 1992, and "Private Enterprises in Ukraine: Getting Down to Business. Results of a PrivateEnterprise Su~ey," by Irina and Victor Novitsky and Andrew Stone, 1995.

in Ukraine with financing by the British Know How Fund, which aimed at providing small privatized and start-up businesses with training, information and access to financing for growth. Thus, IFC staff have assisted hundreds of new small-business managers to develop business plans, find partners and improve management practices at their enterprises. Currently USAID is funding a similar IFC project to develop four business centers around Lkaine aimed at assisting small businesses. Annually, since 1992, through its USAID-funded Small-Scale Privatization Project, IFC has conducted a formal survey of privatized enterprises to monitor their progress and determine the main constraints to the growth of privatized businesses. This year, IFC brought to the survey the resources of its British and US-funded Post-Privatization Project to do a more comprehensive and penetrating analysis of the small private sector in Ukraine by looking at both privatized and start-up businesses. This report is the result of that survey.

11. Executive Summary

A. Goals

The overall goal of the private sector survey was to gauge trends and developments in the private, small scale sector of Ukraine's economy three years into privatization, with sixty percent of small scale privatization complete. The specific goals of the survey are:

identify differences between privatized and start-up f m s and compare the characteristics that contribute to their success or failure; profile entrepreneurs fiom both privatized and start-up f m s ; evaluate prospects for small businesses by identifying characteristics that contribute to their success or failure; identify macro and micro constraints on the growth of small businesses; and develop a series of recommendations for policy or programmatic approaches on the local, national and international levels to alleviate these difficulties.

B. Methodology

Five cities were chosen to be survey locations to achieve both regional and size distribution: Lviv, Cherkasy, Mariupil, Sumi, and Uzhhorod. The sample of 235 enterprises was selected randomly fiom lists of privatized enterprises provided by the small scale privatization project at IFC and lists of registered businesses fiom official government sources. The sample contains 113 privatized f m s and 122 start-up firms.

The survey was conducted over four weeks fiom June 9, 1996 to July 5, 1996 by several teams of Ukrainian interviewers familiar with the private sector conditions and trained in survey techniques and methodology. The interviewers used separate questionnaires for privatized and start-up firms using both qualitative and quantitative questions. One-on-one interviews lasted about an hour on average.

Part of data analysis was placing each sampled f m s into one of four groups indicating the level of firm performance. Firm performance was measured by several qualitative criteria considered relevant and statistically independent: current profitability, prediction of hture profits, an increase in customers, and a planned or recent increase in employees.

The groups are as follows. The best performing group, "successful firms," is 19% of the sample and was defined as those firms that are currently profitable, predict increasing future profits, and recently have either increased the number of their customers, hired more employees, or plan to hire more in the future. The upper middle group, "striving firms" are 42% of the sample and are characterized by expectations of future profits and positive trends in numbers of customers and employees but also uncertainty on the part of managers of future profitability. The lower middle group, "struggling fms," account for 28% of the sample and all either exhibit negative profit characteristics or lack a clear idea of their economic health. The weakest group, "failing firms" make up 1 1% of the sample, and are both not profitable currently and pessimistic about future profits.

C. Highlights of the Findings

Nature of Private Sector & Market Entrv Official government figures accord the Ukrainian private sector with generating only five percent of GDP. However, estimates of the size of the shadow economy, that figure are closer to 50 or even 60 percent. Respondents and experts alike overwhelmingly state that the private sector is vitally or very important to Ukrainian economy. This subjective view reflects the "hidden economy" of unreported profits, which respondents to this survey estimate between 30 and 50% of Ukraine's total GNP, corroborating outside estimates of the shadow economy. Firms' pride of the value of their work may be explained by the difficulties they encounter simply starting their work; the average firm spends 5 weeks to register and spends over 1,000 USD simply on the administrative procedures associated with opening (registration, utilities hook-up, licenses etc.).

Managers. Managers were highly educated and rely on significant previous experience in running enterprises. Most do not have special business education, and firms with managers who have business training do not necessarily perform better. Yet, managers are eager for additional training; they identify marketing and day-to-day management as particular needs. While a only minority have substantive plans for the next 5 years, nearly all managers are planning at least six months ahead and are seriously considering investment and expansion.

Firm Viabilitv. the scale of f m performance highlights financial health of small businesses. Most fall into a middle group, that can be said to be striving or struggling; only a relatively small portion are failing. Firms are upbeat about their own profit levels, with most claiming to be currently profitable. However, only half of the f m s are optimistic about increasing future profits. Turnover on average remains below $3,000 USDI a month, but half of the most successful firms report turnover levels at least twice that.

Credit. While nearly all of the income of a typical small business is spent on inputs and communal service payments, most firms were skittish of credit. They pointed to high interest rates, the lack of long-term credit, and general lack of credit options. Managers preferred to rely on their own fhds or friends and family to finance their business.

Firm Activitu. While Ukrainian firms seem to be sharpening their focus by limiting activities to a core area, evidence suggests that firms with varied commercial interests tend to be more successful than those with only one main activity. For f m s involved in only one activity, the most profitable sectors are trade and catering; businesses providing services are less successful.

b r . Small business entrepreneurs are fairly content with the size and the quality of their workforce. Most have not made recent changes in workforce size and do not plan major changes, but those who are changing are more often poised to expand than downsize. In fact, seventy percent of f m s cite the rising demand of work as the most important factor explaining hiring decisions. Most fms use their workforce full time and offer competitive salaries and good benefits. On average, the highest salary is $1 15 USDImonth and the lowest is $64/month. The average official salary in Ukraine was $64/month at the time

Market Conditions. Problems with suppliers are decreasing, but businesses cite steadily declining customer demand as a serious problem for their long-term prospects. The number of suppliers has increased, and more of them are private firms and increasingly reliable. Entrepreneurs are not responding pro-actively to signs of a shrinking client base; they are neither attempting to expand client base nor conducting market research. Even the firms in the "successful" group do not conduct significant market research, claiming that they already know their client base or that the fact that their customers have not changed over time indicates that no further analysis is necessary. Start-up firms are more active than their privatized counterparts in attracting clients through advertising and developing the firm's reputation. Entrepreneurs running start-ups seemed more knowledgeable about their competitors. Only 10% of the respondents enjoy market dominance. Competition is either increasing - becoming more private than state in nature - or constant for most f m s . Monopolists do not enjoy more success than f m s with many competitors.

Systemic Problems for Running a Business. The external environment, specifically the role of the government, is the cause of small businesses' greatest worries. Entrepreneurs unanimously singled out taxes and regulations, symptoms of the government's adversarial attitude toward small business. Long- term problems lack a clear single cause: low purchasing power of the population coupled with the uncertain political and legal environment. Firms complained that oppressive bureaucratic structures on both local and national levels were practically "strangling" with a heavy tax burden and complicated legislation. Ninety-five percent of the time, the surveyors confmed that these problems were real and not related to poor management style or techniques.

D. Conclusions

Regulatory problems are coming to the fore as the chief obstacles to development and growth of small businesses. The opportunities for making large easy profits quickly are disappearing with macroeconomic stabilization and completion of some reform; opportunities for currency arbitrage and selling off state assets cheaply are decreasing; many obvious niches in the market are filled. Inflation is no longer a high ranking problem. But the overburdensome regulations - barriers created intentionally or not by government procedures - come out as extremely significant, second only to taxation. The responses on this point are significant regardless of the form of questioning and even when compared to other developing and transitional countries.

Policv recommendations: Overall, the fmdings indicate that there is much that the government can do to facilitate small business development, if it is willing to reduce the regulatory and tax burdens on the sector. To effectively implement such changes, the government will have to continue to work on creating an overall environment where business can grow. Additionally, it will have to address operational, administrative and procedural issues underlying its different interations with businesses.

Policy recommendations presented in this report highlight some key areas in which change is needed, and go into more detail in some of the areas directly examined in the survey, particularly easing market

entry through revision of the registration and licensing procedures. The analysis also proposes some principles upon which a broader review of the legislation that impacts small business development could be evaluated and changed in order to create an environment more conducive to growth.

111. Survey Goals and Methodology

A. Goals:

The overall goal of the private sector survey was to gauge trends and developments in the private, small scale sector of Ukraine's economy three years into privatization, with about 60% of small-scale privatization complete.6 Previous surveys on small business in Ukraine have either focused on changes in privatized f m s only, or examined trends in the private sector overall, without distinguishing between privatized and start-up firms.7 Thus, one of the distinct objectives of this survey is to identify differences between privatized and start-up f m s by comparing their development and the characteristics that contribute to f m success or failure in each type.

Other specific goals of the survey include the following:

to profile entrepreneurs and their firms, both privatized and start-up firms;

to evaluate firm prospects by identifying characteristics that contribute to firm success or failure;

to identify macro and micro constraints on firm growth.

to develop a series of recommendations for policy or programmatic approaches on the local, national and international levels to alleviate these difficulties.

B. The Sample

Five cities were chosen to be survey locations in order to achieve both regional and size distribution: Lviv (population: 850,000) in the West; Cherkassy (population: 350,000) in Central region, south of Kyiv; Mariupil (population: 520,000) in the south on the Black Sea; Sumi, (population: 350,000) a medium-size, industrial city in East; and Uzhorod, a small border city (population: 125,000) in the far west. Each of the major regions of Ukraine is equally represented.

The sample of 235 enterprises was selected randomly f?om lists of privatized and registered enterprises provided by local government agencies. The sample was restricted to enterprises with under 150 employees, although a few enterprises that had recently grown above that limit were also included.

Figure based on IFC Small Scale Privatization Project estimates. The literature on the development of small business and enterprise growth after communism includes: OECD

Poland, Hungary etc.; Andrew Stone and Victor and Irina Novitsky; Leila Webster with others, Newly Privafized Russian Enterprises. World Bank: 1994.

Figure . Proportions of Privatized and Start up Firms in the Sample

Start-up 52%

48%

The sample contains 1 13 privatized firms and 122 start-up firms. An initial sample size of 264 fums was reduced to 235 by excluding firms that either had started operations or were privatized after January 1996. These younger f m s lack the same long-term perspective of the trends relevant to the firm's development.. On average, 23 or 24 privatized and 23 or 24 start-up businesses were surveyed in each city. The sample contains few manufacturing firms 14% of the total). Most of the manufacturing enterprises in the sample are start-up or expanded activities to

include manufacturing after privatization. Thus, the overall representation of manufacturing firms in the sample may be lower than the population of small businesses as a whole, since privatized businesses comprise approximately half of the sample but only 10-20% of small private enterprises overall. Since manufacturing in the Soviet economy was virtually the exclusive realm of large enterprises, one can expect its representation among smaller enterprises to grow, but to still be low at this point.

It is important to note that the sample does not include state fums as a baseline comparison to measure the performance of the private sector overall. Also not represented are enterprises which ceased operations after registration and hence the overall view of the private sector may be somewhat more positive than reality as failed enterprises are not represented. Closing operations and re- registering in some cases are important aspects of private sector activities and worthy of further study in a separate report.

C. Methodology

1. Surveying The survey was conducted over four weeks fiom June 9, 1996 to July 5, 1996 by several teams

of Ukrainian surveyors trained in survey techniques and methodology. The teams were well acquainted with the private sector environment and the problems facing small business in Ukraine fiom their work at IFC-sponsored business centers where they consulted with small business owners or enterprise directors. As consultants to the IFC Post-Privatization Project, each interviewer had already undergone substantial training in several areas critical to understanding and working with small businesses, including, the basics of privatization, and development and writing of business-plans. Working in the IFC business centers around Ukraine they had the opportunity to implement this knowledge for a minimum of six months to a year prior to the survey, gaining important practical experience communicating and interacting with small business directors and owners. For the survey, they received additional training on sampling and interviewing.

The interviewers used two separate questionnaires: one for privatized firms, consisting of 85 questions and another for start-up firms, with 96 questions (see Appendix 1.) Wherever possible, the same questions were used in both documents to maintain consistency so that results could be pooled between the sub-groups. In certain instances, questions differed and could not be duplicated where the survey focused on issues limited to privatized or start-up f m s . (For example, those sections of the

Firms slated for small scale privatization by definition exclude those engaged in manufacturing.

survey devoted to tracing the effects of privatization or sections focusing on the problems associated with starting a new business.) Interviews with firm directors or managers averaged an hour in length.

The questionnaire was designed to elicit both quantitative and qualitative information. Questions requiring one-word answers, "yes" or 'no" choices, and multiple choice options provided data that could be counted and often quantified. More in depth "probe" questions reached in more depth into the meaning of various answers. Thus, respondents were able, for example to tell in some depth story of the start-up of a new enterprise, and make suggestions as to how the government could improve the environment for small business. In addition, the questionnaire included an optional section of questions directed at the shadow economy.

In order to evaluate the validity of the information given by respondents, the interviewers filled out an assessment form for each enterprise, providing their own opinion of what they saw and heard during the interview. (Appendix 2) While the impressions of the surveyors are subjective in nature, their extensive background and experience in small business has additional value and sheds light on processes not captured in a quantitative way by the questionnaire. Therefore, the surveyors' views are only used as a validity check on certain questions. The limits of the applicability of such subjective interpretations was taken into consideration, and the use of these answers is clearly noted in the text..

2. Data Analysis Once recorded in a database, multiple choice and yeslno answers were processed and read by a

statistical computer program. Qualitative, detailed responses to short answer, probe questions and interviewer opinions were analyzed, categorized and coded to be manipulated for data analysis. Statistical correlations, cross-tabulations, and Chi-squared tests were run on relevant questions and comparisons. The most important explanatory variables were sector (type of activity and number of activities) and origin of f m (start-up vs. privatized). Other interesting factors were the education levels of workforce and training of workforce. All correlations were significant at 0.05 level or lower (meaning greater significance) unless otherwise noted, where the sample size or response rate was too low to determine significance. Therefore, the report does not specifically mention levels of statistical significance for simplicity's sake. The breakdown of answers to all questions are recorded in appendix 1.

3. Firm Performance Break-down In order to determine the factors influencing f m success, the sample was sorted into sub-

groups indicative of f m performance. The criteria used to define these groups are:

current profitability, prediction of future profits, an increase in customers,

and a planned or recent increase in employees.

These criteria were tested for statistical correlation and were considered relevant and independent. The groups are as follows:

Successful f m s (1 9% of the sample) are the best f m s in the sample. They

are currently profitable

predict increasing future profits and

have either increased customers, hired more employees, or plan to hire more in the future.

Striving firms (42% of sample) are f m s which have clear potential to become better f m s . They

expect future profits or

show positive trends in the customer and employee variables where managers were uncertain about future profitability.

Struggling firms (28% of the sample) are f m s which have equal chances of becoming better or worse. They

have current or future assessments of negative profits or

lack a clear idea of their financial standing or economic health.

Failing f m s (1 1% ofthe sample) provide a glimpse at what leads to enterprise downfall; They

are not profitable and

remain pessimistic of future profits.

See Figure 1 f0.r a breakdown of the sample based on these groups.

Figure 1. Breakdown of Sample by Firm Performance

45

40

35

30

25

20

15

10

5 0

Successful Striving Struggling Failing

The report refers to the groups throughout the text where relevant and interesting comparisons could be made. A full analysis of general characteristics of each type is in Section VI and in the

textboxes which serve as profiles of typical firms and managers in each group.

IV. General Information about Survey: Overview of the Respondents & their Firms

A. Respondents

I . Positions and Management Experience Three-quarters of the respondents are directors of their enterprises. While none of the

respondents is the sole or majority owner of his or her firm, all clearly had the experience and knowledge to answer the questions properly. Sixty-eight percent of all respondents have had previous management experience and 18% of start-up directors have previously owned businesses.

The Ukrainian entrepreneurs surveyed generally possess experience acquired fiom work or management positions in the state sector. Over half of those with a background in management had also occupied high level management positions in the state sector. (58%) Only a very small portion, 12%, possessed previous management experience in the private sector. This finding corresponds with the information on respondents' most previous positions: 66% came directly fiom the state sector to work in their present enterprises. Not surprisingly, only 18% had any work experience in the private sector, a group which also tended to be younger. (Other previous positions included those in the scientific sphere, military service; a small percentage stated that this was their first position - all start-up managers) More detailed analysis of the managers" background is in the section on management.

The respondents' previous work experience corresponds with that noted in previous World Bank studies conducted in earlier years. There as here the largest proportion of respondents were entering the private sector for the first time but brought managerial experience fiom the state sector. In both surveys the second largest groups are those who had also worked in other private sector ventures. The smallest proportion in both studies came from other backgrounds, often institutes or the military, with some also in their first work experience ever.

Figure 2. Breakdown of Respondents' Prevlous Management Positions

state sector

M i d d l e management positions in state sector

OLow level management positions in state sector

OManagement positions in private sector

2. Education While Ukrainian managers appear to have significant experience in the actual management of

enterprises, a minority actually have had the opportunity to study business in an academic setting. Only 15% had some type of business education or training, with a majority of those studying in Ukraine (80%) and another 15% studying in other CIS countries.

However, in terms of general education level, managers are very well educated, with 67% having the highest level university education and 28% with specialized middle level education. These proportions are also similar to those in the earlier World Bank studies.

3. Gender The respondents in the survey were almost evenly split along gender lines, with 55% of

respondents men and 45% women. While most women tend to manage privatized enterprises, (72% of the managers of privatized enterprises surveyed are female), the reverse is true of start ups. Many more men than women are opening new businesses; 71% of managers in start-up fums surveyed are men. (See Table X) Managers, across the board, are in the middle of their careers; the average age of respondents is between 36 and 45 years old.

Figure 3. Breakdown of Respondents by Gender

100%

90%

80% 70%

60% .Women

50%

40%

30%

20%

10%

0% Start-up Privatized

B. The Firms

1. Size and Age The fums in the sample were generally very small, with half of them employing under 10

people. (More detail on number of employees in the firms surveyed is in table X). However, slightly more firms had increased their workforce since privatization or start up than decreased.

The firms in the sample were generally young: the majority, 63%, had started their business or were privatized either in 1994 or 1995. The ages of the privatized f m s reflects the progress of privatization in Ukraine, where at least half of the small enterprises privatized in 1994 and 1995. The sample as a whole, however, is a result, most likely, somewhat younger than the whole population of small private enterprises in Ukraine, since the share of privatized fums in the sample is disproportionately large and overall registration of start ups businesses has slowed

recently. It is interesting to note that 15% of the sample had been founded as private enterprises before 1991, some as early as 1987, the very start of the perestroika reforms. There is no statistical correlation between age and f m performance.

Table 1 : Firm Size and Age

2. Legal Form Over half of the firms (53%) are limited liability companies. In order of frequency, the other

versions of organizational structure of the firms surveyed are private enterprise, closed stock company, or open stock company. A large majority of the privatized firms had been bought out by their workers (85%), which is consistent with the overall proportion of small firms privatized by workers buy-out in Ukraine (80%). A small but significant portion of the sample (14%) was purchased through auction.

Firm Size Under 10 employees 5 1 % 1 1-25 employees 29% 25-50 employees 13% 5 1 - 1 50 employees 5% Over 150 employees 2%

3. Ownership Change Few f m s sampled had changed ownership, from one set of private hands to another.; 96% of

firms' original private owners (either at registration or privatization) were still the owner at the time of the survey. One of the goals of the survey was to trace the effects of ownership change. The low number of ownership changes in the sample leaves little to study. Yet the question is interesting and important as the ease with which new enterprises can be purchased or change ownership influences the overall effectiveness of management. For the market to work, entrepreneurs need to be able to enter the market, and the forces that drive out inefficient managers need to be able to act. Ownership change reflects the overall dynamism of the sector.

Year Registered/ Privatized inhefore 1991 15% 1992 7% 1993 12% 1994 29% 1995 34% 1996 3%

To some extent, ownership change is difficult to trace in the format of this questionnaire as for start up firms, only those that could be easily found are surveyed. Nonetheless, in the context of the probe questions, f m s offered some possible explanations why their individual f m had not been bought and lor was not likely to be bought. Managers cited negative attitudes toward privatization, even among the very workers in privatized enterprises. Some managers, themselves, pointed out that their business was so weak that no one would want to buy it.

Several structural issues may also contribute to the explanation. First, enterprises with many owners, such as those privatized through workers buy-out, are difficult to purchase as consent of all owners is typically required., a significant logistical obstacle to purchase. Also, the legislation on restructuring and liquidation are unclear. Thus, fums changes in ownership if effected by shut-down and re-registration are also difficult to trace. In other countries where the legal base is also incomplete, ownership change can happen more slowly and subtly as a silent partner takes a greater and greater

A "private enterprise" is similar to a sole proprietorship; a "closed stock company" is similar to a partnership. An "open stock company" has more "shareholders" than a closed stock company and different rules on how shareholders may enter and exit the company, that is sell their shares.

role, perhaps providing informal credit. None of the firms in this survey, however, reported such a situation.

4. Sector Following on a trend observed in the previous World Bank studies, the bulk of the f m s , 68%,

concentrate their activity in one main sphere, in only one or two ~ocations..'~ Nearly 80% of f m s in the sample have one core area of business. The increase in the proportion of single-profile f m s since the earlier World Bank surveys may reflect the relative stabliization of the Ukrainian economy on a macroeconomic level. The World Bank surveys explained that f m s engaged in activities in more than one sector primarily to : (i) hedge against failure in any one given sector; (ii) exploit opportunities in various niches as they arose; (iii) guard against currency risk by including barter trade among the activities of a fm otherwise engaged in another sector. It is likely that the stabilization of the currency has reduced the need for and profits in barter. Also, it seems likely that experience in the market has enabled f m s to chose a single speciality among the many in which it experimented. Concentration of activities may also reflect a specialization driven by the closing of niches or increased competition within them.

Although the proposition of firms operating in only one sector seems to have grown, this survey suggests that multi-profile firms do particularly well. Of f m s engaged in multiple activities, about 50% fall in the "successfU1 fm" category. Two-thirds of multiple sector f m s are start-up f m s , demonstrating how start-up firms can take advantage of their greater flexibility to grow and operate in more than one sector. (The conditions of privatization for many firms in Ukraine include requirements to continue activities in a given sector for a period of several years.) The multi-profile f m s tend to pursue related and complementary activities; for example 44% of them combine wholesale with retail activities. The table below shows how start-up firms tend to be more diversified.

Overall, 40% of firms engaged in one sector are in retail trade. The most profitable sectors are wholesale and retail trade as well as catering. "

The sector breakdown-own of privatized and start up firms differs: Wholesale trade and manufacturing are strongly represented by start-ups while catering and services were nearly all privatized fms . " The sectoral distribution among privatized f m s is not surprising, as it corresponds with the major areas of activities fiom those firms slated for privatization, especially since 68% of privatized f m s were required to maintain fm profile for at least one year and as long as 5 years, preventing them fiom changing the business' sphere of activities to a more profitable sector and deterring expansion. See Table X below which shows the sectoral break-down of firms only engaging in one sector.

Number of Sectors 1 sector 2 or more sectors Total

10 See lrina & Victor Novitsky with Andrew Stone, "Private Enterprises in Ukraine: Getting Down to Business: Results of a Private Enterprise Survey" 1995: 5.

Privatized 85% 15% 100%

Start-up 73% 27% 100%

l 2 In Ukrainian legal terminology, "catering" refers to food services and includes restaurants and cafes.

Overall Percent 79% 2 1% 100%

V. ISSUES

A. The Private Sector in Ukraine Today

1. The Official Economy With a population of 52 million people, Ukraine has between 11 1,000 and 175,000 private

enterprises, of any size, operating and approximately 300,000 registered.I3 In comparison with neighboring Poland with two million private enterprises serving 38 million, Ukraine's private sector clearly remains underdeveloped.14 As noted earlier, some government statistics estimate that the private sector contributes only 5% of GDP in 1995. Not only is such an estimate meager compared to other former communist countries, but it appears artificially low, considering the economic accomplishments that have been achieved, particularly in small-scale privatization. In contrast, by 1994 the Polish and Hungarian private sectors contributed on average 55% to their respective countries' GDP; and in Czech republic, 60% of GDP was generated by the private sector.

The World Bank estimated the share of the private sector in the Ukrainian economy range 30 and 50%. When survey respondents were asked for their assessments of the contribution of the private sector to the Ukrainian Gross Domestic Product, close to 40% estimated it at over 30% while another 42% put it between 10% and 305. In other words, over 80% of the entrepreneurs surveyed estimated the share of the private sector in GDP to be at least twice that of the government estimate. Only 18% believed the private sector to contribute less than 10% to GDP. Furthermore, 93% of managers of start up firms and 82% of privatized viewed the private sector as vital or very important to the economy.

Although the entrepreneurs assessments are subjective, the difference in their view fiom the official statistics is significant. Ukrainian entrepreneurs are clearly value highly their own contribution to the economy. They see private firms becoming part of a strengthening network of private firms. Respondents noted that the number of private suppliers is increasing. Firms are also likely to include the shadow economy in their estimates of the size of the private sector.

2. The Shadow Economy The World Bank reports the size of the shadow economy in Ukraine as 40 to 50 % of GDP. l 5

Even the government recognizes that the shadow economy is large; when he was Acting Vice Premier in mid July 1996, Viktor Pynzenyk announced that over 43% of the total volume of cash or 3 19.5 tn KBV was circulating in the shadow e c o n o m ~ . ' ~ Comparatively, the shadow economy in Central and Eastern European Economies is much smaller, contributing between 10 and 30% of GDP in Poland and 25-40% of GDP in ~ u n ~ a r y . ' ' These comparative statistics reflect, primarily, the better overall atmosphere for small business and lower incentives to operate in the shadow economy in these countries..

World Bank research shows the size of the shadow economy growing, even as the economy as a whole shrinks. Incentives to participate include high taxes, pressure ffom government bodies, and an abundance of red tape. As put bluntly by economist Jeffiey Sachs, "This country [Ukraine] is still

l 3 Ukrainian Ministry of Statistics (for the number of registered private enterprises). 14 The World Almanac and Book of Facts. Mahwah, NJ: The World Almanac, 1994. 15 D. Kaufmann, A. Kaliberda, "Integrating the Unofficial Economy into Dynamics of Post-Socialist

Economies: A Framework of Analysis and Evidence." March 1996. l 6 UNIAN, July 1 1, 1996. l 7 OECD: 20.

hostile to private business in dozens of ways." Under such conditions, businesses find it expedient, more profitable and easier to operate off the official books, outside of legal procedures, and beyond government control or intervention. Yet, operating in the shadow economy introduces inefficiencies of its own besides reducing the government's tax base and credibility. The intricacies of hiding illegal activities takes time and cleverness that entrepreneurs could otherwise direct toward business activities themselves.

The shadow economy in Ukraine includes three main types of activities: tax evasion through concealed production of goods and services or non-reporting of wages by registered legal entities; informal activity (i.e., legal activities conducted without a registered enterprise, also a form of tax evasion); and an illegal economy, encompassing bribes, fraud, racket, contraband, prostitution, drug trafficking, and other criminal but lucrative activities.Ig At one level or another, the shadow economy touches the lives of the vast majority of Ukrainian citizens, with estimates that as much as 75 to 80% of personal income is earned in the shadows.20

This story told be an enterprise in Sumi testifies, the appeal of operating in the shadows is becoming harder to resist:

The former director of the store got rich embezzling from the store, and after abandoning the workers' collective and saddling them with 1 billion KBV (= usd?) in debt, he started his own business. Now he buys produce in Kharkiv at a low price to sell in Sumi. The only costs he has are the truck he purchased for transportation and bribes to supervising bodies -- a negligible cost compared to the expenses incurred by the store. Conclusion: one is far better off to engage in illegal trade than selling according to the norms and rules of a privatized store.

In the context of a shrinking official economy and growing unofficial one, the decline in numbers of businesses registering and paying taxes is particularly alarming. The table below illustrates the decline in the proportion of registered businesses that file tax returns." Such a decline when the share of business in the official economy is low is likely caused by market entry barriers and obstacles to on-going business, and is a poor indicator for future private sector development. Although this survey could not include enterprises that had closed, examination of the problems faced by those in the market will shed further light on the causes of these trends and possible remedies.

18 Brzezinski, op cit. 19 Alexander Paskhaver, "Ukraine's Shadow Economy During a Period of Transition," The Ukrainian

Economic Monitor Vol 111, # 6. June 1996: 6. 20 Interview with Alexander Iosevich Paskhaver. 21 Z. S. Varnaliy. "The State Financial Policy in the Sphere of Small-Scale Entrepreneurship and Ways of Its

Perfection," Finansy Ukrainy. No. 2. 1996.

Figure X. The Decline in the Rate of Business Registration

Figure. Registered Enterprises that are Operative

50%

40%

30%

20%

10%

0%

1992 1993 1994 Jul-96

Ascertaining the degree to which private enterprises feel the need or are forced to engage in the shadow economy is part of the survey's examination of the constraints on business development. Due to the sensitivity of this question, it was asked at the end of the survey and presented as an optional section. Presenting the question as option reduced the number of respondents compared to past World Bank surveys. Nonetheless, the results are worth examination.

22% of respondents were willing to discuss their unreported profits; half of these respondents indicated that over 30% of profits went unreported: 19 % stated that between 30 and 50% went unreported and another 28% stated that over half of their profits went unreported. Only 20% of the respondents stated that they did not hide profits. [See figure 21 That 20% of respondents is only 6% of the total sample. It seems reasonable to assume that respondents that do not want to discuss tax evasion, by and large, have something to hide.

Figure 2. Amount of Unreported Profits by Respondents, Answering Probe Questions.

% 30%

25%

20%

15%

10%

5%

none 10-20% 3050% over 50% unreported unreported unreported

3. Market Entry According to official registration statistics, it appears that fewer and fewer Ukrainians register

new ventures. In one of the survey cities, Lviv, statistics reveal that the growth rate in the number of registered businesses is not steadily increasing as it should be, but levelling off and declining.22 (See Figure X)

Figure : Registration Statistics in Lviv.

Figure. Cumulative Quantity of Registered Enterprises in Lviv

Percent growth over previous period

3 5

30

25

20

15

10

5

0 rr V, iD ? 7' 7' r-

9 9 5 ? C, C, C, 9

F

* Projection based on data for the first 6 months of 1996.

One of the conclusions supported by the results is that the rather complicated and expensive procedure for registering a new business contributes heavily to the decline in new registrations. According to the respondents the average period for the businesses to become operational (excluding purchase of inputs, preparation of premises, etc.) is 7.3 weeks. During this period a business registers itself and makes all necessary arrangements for its operations -- a range of general preparatory work. It took an average of 5 weeks for the businesses to register an enterprise. The majority of the f m s were registered in 4 weeks (47%), while only 28% managed to register in less than a month.

22 Lviv Oblast Tax Inspectorate, July 1996.

a) Intermediaries In order to register a business and make it operational, an entrepreneur choose to go through

the administrative procedures themselves or use an intermediary. Intermediaries include law f m s or similar organizations created to facilitate this process, individuals within

Figure . Use of intermediaries for registration

A state Law firm official

MA state officlal

NO

The same intermediaries also perform other useful services related to opening a business. They can assist in opening a bank account, making arrangements with communal services and other departments of local administrations in addition to the registration departments. It appears that during this post-registration period the assistance of the intermediaries is most helpful. It reduces time spent on preparing to be operational by about two weeks. The companies using the assistance of the intermediaries became operational in about 6 weeks on average, while self reliant companies spent over 8 weeks. The efficiency of different types of intermediaries is demonstrated in the diagram below:

the various government bodies or other personal connections of their resvondents. 6 1% of the resvondents stated that they handled the registration procedures by themselves. Most of the other 39 % used law firms (or other entities created specifically for this purpose), state officials, apparently working in the relevant bodies of city administrations or other intermediaries

intermediary

Figure . Time Needed to Become Operational: Efficiencv of Different l-es . .

(more than likely fiiends or connections

Law firms State officials Other No intermediaries

related to the local administrations). The survey results show that using an

intermediary reduces time spent on regishtion by only half of a week. The efficiency of intermediaries varies significantly, as law f m s and fiiends decrease the registration period to 4 weeks, while state officials are the least expedient form, increasing the average time by a week and a half.

b) Costs

However, intermediaries are expensive, averaging about 260 USD, given that the average salary in Lkaine was only $64 a month as of June 1996. (FN: WB Stats) The cost breakdown for bringing a Ukrainian company to an operational stage, not including investment into the firm's premises or costs of inputs, are as follows:

Table X. Administrative Costs of Opening a Small Business

average cost of registration 185 USD average cost of obtaining licenses and permits 730 USD other payments 149 USD

Total: 1,069 USD

The total sum necessary is extremely high, a fact confmed by a majority of the respondents qualitatively: they indicated that this cost is a very large problem for the average business. Another 33% of all respondents recognized the start up costs as a very big problem. Moreover, the entrepreneurs generally confi-ont the costs and the problems by themselves. Most enterprise managers figured out how to go through the various stages of registration on their own, with less than 20% going to government bureau. The formidable cost of simply preparing to open a business can be a deterrent as well as counterintuitive process to new business owners. As summed up by one who recently opened a business in Surni, "It is difficult to start a business in this country because the business has not yet made any money but payments are required as much as fi-om f m l y established companies."

4. Sectors Firms in wholesale trade and catering were the most successful, as a group, while firms

involved in services tended to be worse off. Of the f m s which engage in a single sector, wholesale trade is dominated by those this survey would categorize as "successful" (53%) and "striving" (40%) firms; catering attracts 55% of the "striving" firms and 15% of the "successful" ones. In contrast, 28% and 36% of f m s only involved in services are "failing" and "struggling."

No one explanation for these differences comes fiom the survey itself, but several possibilities seem likely. On one hand, there appears to be low and undeveloped consumer demand, reflecting the underlying weakness of the Ukrainian economy. The general population's purchasing power is low and continues to decline due to the remaining effects of recent high inflation and wage arrears. Thus, the Ukrainian economy may not be developed enough that a large enough portion of population can support a service industry, widely dispersed across the country. On the other hand, the survey may reflect the difficulties faced by the firms in the service sector that were privatized through workers buy-out and have thus not generally been as entrepreneurial as other firms in the market. Service firms which previously could get by with the doing the bare minimum are performing poorly as they face increasing competition; (it is very easy to enter the service sector). Therefore, the poor performance of these types of service f m s could simply be a sign that market conditions are in effect.

Another explanation for the seeming low performance of services relates to the shadow economy. Since service business require relatively little' investment and concentration of capital, they leave less of a paper trail and lend themselves to underreporting. Some of the service f m s in the sample may be underestimating their true profitability, resulting in a lower f m performance rating. Indeed, a

1994 World Bank survey estimated that trade and service businesses do not report as much as 86% of their incomes.23

5. Dtfferences Between Start-up and Privatized Firms Lacking the constraints that often accompany privatized firms' entry into the private sector,

start-up f m s are in better financial health overall. With higher profits and turnover, they tend to expand through purchase of privatized businesses. The survey's probe questions elicited their serious investment plans. It is notable that start up firms tend to purchase (or plan to purchase) new equipment with investment fimds, while privatized firms prefer to fmance new buildings. These differences may simply reflect the operational aspects of opening such a business. Start ups in Ukraine may be opening only when they have a premises, so equipment is a logical need; privatized businesses, on the other hand, tend to receive equipment as part of privatization, but less often does privatization also lead to their ownerhsip A good sign for the firther development of privatized business is that half reported that they had made substantial re-investments in their businesses.

Figure. Breakdown of Start-up and Privatized Firms by Performance

I Successful Striving Struggling Failing I

23 Daniel Kaufmann, Irina Novitsky, Vladimir Novitsky, "Would the Removal of Administrative Controls Atti-act Unofficial Activities to the Official Economy?'Empirical Results from Ukraine Survey. Work in Progress, Kiev, Ukraine, December 1994.

B. Firms' Financial Status

I . Profitability, Gross Sales Firms assessments of their profitability were mixed. On one hand, respondents were fairly

upbeat about their overall profitability. Several questions attempted to ascertain in a qualitative way firm's perceptions of their financial situation. Most private business believe they are succeeding in meeting basic criteria for success in business in that they are breaking even (3 1%) or bringing in profits (57%). Only 11% reported their financial state as unprofitable. (See Figure X below.) When asked how the firm characterizes its financial position, 31% of those who answered the question viewed it as "good" or "satisfactory." Many more firms described it as "unsatisfactory" (42%). 80% of the f m s who viewed themselves as unprofitable were dissatisfied with their financial situation. Moreover, firms with some profits may wish that they had more profits.

The fact that f m s had expectations of declining profits or neutral hopes for the hture underscore the continued difficulties of doing business in Ukraine. Despite generally positive views of current profits, about half of the respondents either expected the firm's profitability to decrease, were unable to predict their profitability, or anticipated the same profits. Another 47% predicted their profits would increase either by a little or a lot.

Inquiries about firms7 gross sales were the quantitative approach to assessing f m financial health. Most firms (57%) reported gross sales of under $3,00O/month. However, successful firms tend to have higher monthly gross sales, with half of them reporting sales of $6,000 or more a month. When asked about net income, 66% of respondents reported a profit: average net income as a percentage of sales among these respondents was 12%. The difference in profitability between privatized and start-up firms was significant: start-up f m s average net margin is 14% whereas privatized f m s ' is only 9%. 24

It is interesting to note that three f m s that answered that there were no profits reported a positive net income as a percentage of sales. This may reflect the duality of thinking about profits in the ambiguous business environment of Ukraine and the lack of commonly accepted financial terms or lack of knowledge of financials.

Nearly half of a firm's monthly income goes to taxes. Of the other half, the average f m s surveyed spent 17% on inputs, 14% on labor, 12% on communal services and about 1% on payments to rackets or state officials. Under such circumstances, it would appear that the average firm is handtied and has little or no remaining h d s to even consider reinvestment into enterprise.

2. Use of Credit Considering the substantial costs of inputs, market entry and restructuring, private f m s might

consider seeking outside financing in a developed economy. However, most f m s in the survey did not seek credit either for beginning the business (start-up of operations or privatization) or additional purposes. Only 19% sought credit for start-uptprivatization; 24% for additional purposes. Although many f m s (32% of the sample) said that they would like to receive credit, they tended to turn to other means. generally relying on their own savings or that of close relatives or fiiends. If formal credit was

24 These figures, and those that follow on the use of income, must be analyzed with some caution. There was great variation in the answers, and many managers were reluctant to answer. Also, the terms "net margin" or "profit" are not used in a standard fashion by managers. Different ways of considering shadow economy activities further complicate the picture.

sought, the most common sources of credit was banks, either local or national; very few f m s relied on private individuals with whom they were not already acquainted.

Indeed, credit is not easily available to Ukrainian small businesses. Ukrainian banks offer an annual interest rate of about 90% on 3-month loans in local currency, even as inflation has fallen significantly. Longer-term credit is in practice unavailable to small businesses. There are several donor-funded credit lines in Ukraine, that offer much lower rates on long term loans; but they can hardly meet all of the needs.

Did not seek credit 81% 1 63% said that high interest rate very serious or

significant problem. Other problems with credit, while rated as "less severe" or "negligible," included complicated applications, unclear criteria,

and corruption. In terms of the problems posed by credit, there is no correlation between f m performance and the greaterllower degree of problems encountered with credit. How problems with credit figure comparatively to other problems will discussed in the context of general firm problems in the Problems Section.

Firms were generally skittish of credit, a feeling confmed by the fact that between 40 and 70%

3. Expansion Most f m s report that they have maintained the same core activities over time' less than 20%

had changed activities in the last 6 months. In terms of expansion, 11% have purchased privatized objects (buildings or single businesses units); of those that had purchased privatized object the average number of objects purchased was 2.5. 11% of the firms sampled plan to purchase additional businesses in the future. 44% of those who have bought privatized objects plan to buy additional ones. Firms that have expanded the sphere of activities tend to be start-ups. Start-up f m s and successful f m s are significantly more likely to purchase or to have plans to purchase privatized objects or additional businesses.

Figure. Usage of Credit

Sought credit sought form a bank

credit from 15% private people

4. Investment Investing in new equipment and new buildings are the two most frequently cited goals for small

business for the short-term (6 months to 3 years). Over half of the respondents consider these as realistic objectives for their business in the next six months. As might be expected, the more secure and stable a f m ' s fmancial situation, the more likely it considers such investment important or integral to the firm's future development. 52% of successful f m s and 23% of striving firms plan on investing in new equipment in the next six months.

f m s did not answer all questions about credit. The most common explanations for f m s not actively seeking credit include the lack of credit availability, ignorance of the options, high interest rates, lack of long-term credit. In addition, a small percentage (8%) feared their inability to return borrowed finances. Of those who answered questions: 72% of tirms said that lack of long term credit was either a very serious problem or a significant problem and

Start-ups are slightly more likely than privatized businesses to invest in new equipment, while privatized firms seem more inclined to invest in new buildings. One possible explanation for the

differences in re-investment goals is that privatized f m s are either receiving, for the fust time, the right to buy the premises where they are located or they are becoming more interested in locating better premises as they pass the time limit on seeking new premises that was imposed as part of the privatization process. About half of the privatized firms have already reinvested in their businesses. The trends in planned investment are a good indicator of f m health and a positive sign for small business growth, as they reveals long-term intentions and thinking-ahead by f m management. Moreover, such tendencies indicate some recovery in the economy. Investment in business is a proxy for restructuring of the small scale sector.

C. Firms' Internal Dynamics

I . Worllforce a) Trends in Employment

Firms sampled reported fairly steady employment levels; their average size is 10 employees. While most f m s in the sample are not making any major changes in employment, more plan to expand than downsize. Over half of the f m s have not made any recent changes in workforce size and 76% of f m s have no plans to change the number of employees in the future. Those f m s which have added to labor force since start-up or privatization have made only incremental additions: the average number of workers hired was 5. Of note, f m size has no correlation firm performance according to the evaluation.

Not surprisingly firms which have either laid off workers or anticipate further decreases in employees tend to be doing worse: 19% of failing f m s are planning a decline in size in the next three months, while only 2% of successful f m s are contemplating downsizing. While these personnel decisions appear to be associated more with declining revenues than efficient business planning, there is no strong correlation between downsizing and unprofitability. More start-up firms than privatized are anticipating growth and start-up firms. Conditions of privatization often include a requirement to maintain the number of employees for two years. This might explain why few are making big changes. Yet, those planning a decrease in employees are equally likely to be start-up or privatized f m s .

The overall tendency to maintain or increase firm size is confmed by the fact that 70% of fums attribute their hiring decisions to the need for additional workers. Only 6% identify the inability to generate profit as the most important factor shaping hiring decisions. Firms' expectations for continued or increased work levels and upbeat attitude about profit levels are two likely explanations for steady or slight increases in employment level.

b) Workload, Salary and Benefits Most (77%) firms are using employees on a full time basis. That firms are basing hiring

decisions on the increased workload indicates that the private sector may be experiencing some real growth. Successful f m s are slightly more likely than others to employ workers full-time. If firms did not employ workers full time, reasons in order of fi-equency were the preference of the management to employ workers less than full time, the lack of money, or the lack of work. Firms who have increased workforce recently are more likely to be using their employees full-time.

Those in the private sector seems to provide better wages than the economy as a whole. The average salary in the sample is $78.50 USDImonth, while the average Ukrainian salary at the time was $ 6 4 ~ S ~ / m o n t h . ' ~ In terms of wage dispersion the average "highest" salary paid by all f m s is $1 15

25 See World Bank, "Ukraine" May 1996, op cit.

USDtmonth, while the average "lowest" salary paid is $42. These numbers must be used with caution since it is not clear in all cases whether the salaries quoted by respondents may reflect unreported salaries, and a sizable group of respondents (37%) preferred not to answer the question; often the surveyors themselves thought were given lowerhigher figures than they would have expected.

Responses on changes in salaries over time reflect a positive trend; they have increased or remained the same more than they have decreased. The rationale for salary increases appears to reflect a stabilizing economy. 21 % of managers are cited increasing profits as a reason for increasing salaries; another 10% said that they increase salaries to better motivate employees. If real or average salaries declined in a f m , the most common explanation was the lack of funds.

Successhl firms tend to pay their workers more than failing f m s . Successhl f m s ' highest salaries are $92/month higher than those of failing f m s ; successfUl firms lowest paid workers make $26/month more than those in failing f m s . Start-up firms pay their employees more than privatized f m s . The average highest salary in a start up f m is $153, while the average highest salary in a privatized f m is $78.

There are also notable sectoral differences, although their significance is less valid since the sample sizes are smaller. The overall highest salary in multi-profile f m s was $1500, which may reflect the higher managerial skills needed or the greater profits in such f m s ; the overall highest salary reported to the surveyors in all others sectors are clustered between $250 and $450.

Although 47% of f m s do not currently provide incentives to workers, over half of the f m s are beginnirig to reward employees through bonuses, raises or on the quality of work performed. A very small portion are rewarding employees by permitting them to take home money earned over the day's quota (particularly in service industries.)

Figure. Average Highest 8 Lowest Salaries, Based on Firm Performance

180

160 140

120 100

80 60 40 20 0

Successful S t r i v i n g St rugg l ing F a i l ~ n g

Figure. Average Highest 8 Lowest Salaries, Based on Firm Type

160 140

120 100

80

60 40

20

0 S t a r t - u p P r i v a t ~ z e d

Sometimes, benefits act as a non-monetary incentive or reward to employees. At least half of the f m s are offering additional benefits besides those required by law, including (in order of importance) extra vacation with pay, retirementlpension funds or some other combination.

c) Work$orce Skill Level and Training

Managers seem generally satisfied with the skills their workers bring to the firm. An overwhelming majority reported having no problem keeping or getting skilled employees, in general. However, when they did have problems recruiting workers, the biggest difficulty reported was lawyers and accountants. In terms of quality, many f m s complained of the difficulty in finding honest employees.

Most privatized enterprises have employees with sales skills, in part reflecting the dominance of retail, services and catering among privatized f m s . There are correlations between success of firm, origin of f m , and education level of employees: start-up f m s are more likely to have employees with university education. Moreover, 93% of failing f m s said most of their employees lacked university education, so successful firms are more likely to have university-educated workers.

Only a quarter of f m s provide training for employees; successful firms are much more likely to train their employees than other firms. The most likely forms of training are on-site training or commercial training and courses. World Bank surveys conducted in previous years reported significantly higher rates of training (70% of firms polled), but this difference may be due to inclusion of more larger f m s in the sample. 26

2. Management a) Managers ' Motivations

The three most compelling reasons respondents offered for starting their own business were the desire for independence, material gains and a chance to apply one's experience and knowledge. When discussing this question in more detail, respondents cited previous operational experience, a desire to work more and business connections coinciding with professional interest as other important reasons for their decision to start a new businesses. There was a certain pride in starting one's own business and the importance of self-reliance. For example one entrepreneur explained his reason to go into business with, " I decided to take my fate into my own hands so that my financial standing depended on myself and not the state." Moreover, managers seemed quite satisfied with their career move and overwhelmingly said they would start the same business all over if given the choice.

b) Business Training: Managers Perceptions of their Needs Most managers, 86% of the sample, do not have previous business education, but would

welcome additional management training. Possible explanations for the lack of specialized business training are 1) the demands of running a small business prevent one from taking the necessary time off to gain fiu-ther skills in a structured environment; and 2) the opportunities are still few or not readily available. Interestingly, there was no statistical correlation between a manager's business education and f m performance; directors with a formal business education do not necessarily make for more successful enterprises. This finding, however, may not be representative since the overall number of managers with business education is low.

The more successful a f m is according to the f m performance scale, the more likely the manager wants additional management training. These managers are more likely to understand and pinpoint their specific needs. However, all managers' requested areas of study appear to reflect focused and advanced needs to match a growing level of sophistication, such as marketing or certification on European standards. Both market research and learning how to complete a marketing plan, are areas of training Ukrainian managers request most. Other top choices include fiu-ther education in confronting daily management concerns: taxes, finance, bookkeeping and legal issues. the surveyors found that

26 Stone 1995.

regardless of fm performance, at least three-quarters of the time, the respondents they interviewed were in need of additional management training.

Figure. Priorities in Planning

40%

35%

30%

25%

20%

15%

10%

5%

0%

E $ - .F ? F m o w = 5 z

E E I k g g g 9 c 0

> .= o E W ! 2 Z $ .; 5 & g E E - 2 5 E

C $j g ,L

c) Planning Ahead Management is focusing on survival and growth, depending upon the size and strength of the

f m . Most f m s plan for at least six months in advance; the longer the window of the future, fewer and

Within the shorter time h m e , investment and qualitative improvement of financial or marketing skills within the firm are paramount objectives. Confirming managers' personal preference for fbrther training, improving the firm's marketing was one of the top five plans for the future.

-

Figure. How Far in Advance Enterprises Make Plans

100%

80%

60%

40%

20%

0% 6 months 2-3 years 5 years

Small business growth is an important indicator of a strengthening economy. For the short-, medium- and long-term, it is apparent that fums are becoming ambitious by contemplating expansion seriously and generally disregard the expediency of downsizing or laying off employees. Expansion of various sorts is the number one choice for long-term plans; firms planning five years ahead look forward to expanding either into local, foreign or export markets and enlarging the company size. The appeal of locating a foreign partner is greater than finding a local one.

fewer struggling or failing f m s contemplate plans. While managers are making definitive plans for the short-term, long-term. planning remains difficult, due to the continued uncertainty of Lkrainian economic conditions. Most managers are planning at least 6 months in advance, while a time-fiame of 2-3 years ahead appears to present more difficulty. Less than half of all managers have considered specific ideas for the next 2 or 3 years and only 23% of them are thinking concretely five years ahead. Only very solid f m s are considering plans for the next five years.

Successful and Striving f m s are contemplating their objectives in more depth and farther ahead. The surveyors drew on their experience in business planning to discuss with f m s the content of these long-term plans. Their assessment of the likelihood that f m s ' plans would be successful correlated with the performance scale; that is, the firms whose plans surveyors rated as likely to be implementable and profitable tended to be those that fell into the more successful groups.

Figure . Firms' View of Future 2 to 3 years in Advance 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

business

Not planning

Planning ahead

I Successful Striving Struggling Failing I D. Efficiency Indicators

1. The Market a) Suppliers

While problems with suppliers appear to be lessening, continued and increasing low consumer demand poses a serious problem to long-term business prospects. Firms appear to be facing a mixed blessing due to the uncertain nature of contemporary market conditions. On the one hand, the Ukrainian market has opened up to a degree that there is greater choice among suppliers and more of these firms are private; on the other hand, the continued decrease in purchasing power and the growth in unemployment severely reduce customer demand, which in turn limits small business development.

Most firms reported an increase in the number of suppliers; moreover, on average firms' suppliers are more private f m s than government-owned. Most suppliers are located in f m s ' own oblast or in Ukraine; some are either in Ukraine or other CIS; an even smaller portion identify both Ukrainian and foreign suppliers. Comparison with the data fiom the World Bank surveys on the state of small business in recent years also shows improvements, that is increases, in the number of suppliers, and in the proportion of suppliers that are private firms. Only 18% of the respondents in this survey reported encountering problems with suppliers, and these are primarily related to payment policies or the lack of necessary goods, two problems that will probably continue to be better resolved as market conditions become more f m l y established.

The decline in the number of problems associated with suppliers is probably related to the increase in the number of private firms among suppliers in the market. This increase in suppliers, however, also supports the hypothesis put forth at the beginning of the report that niches that could once be served very profitably by entrepreneurs are being filled and becoming more competitive. In such

conditions, businesses profit margin decreases, and the share of profits taken by regulatory inefficiencies and high taxes becomes more significant.

Since a majority of the respondents rely primarily on "local residents" of the city or oblast for clientele, the decreasing or non-existent salaries in Ukrainian economy are very harmful for business. Slightly more f m s indicated that their number of clients had declined (43%) than increased (35%). Most firms note that in general, the nature of their client base hasn't changed, in part reflecting the nature of their small business - targeted to the general population. Where changes have occurred, they have been in the direction of increasing the number of private clients.

b) Clients Although f m s report concern that the number and financial strength of their clients is

declining, few seem to be taking pro-active steps to maintain or expand customer base. When asked how actively they perform market research, f m s ' responses indicate a sort of complacency; 42% claimed that they already know the market and another 38% responded that they do not conduct market research at all. Further, successful firms seem more confident than the others: half of the successful f m s claimed they already know the market. Struggling and failing f m s either did not know how to conduct market research or were misguided in thinking that reliance on previous sales qualified as research. Although a relatively small percent of f m s answered that they did not know how to conduct marketing research, the kinds of answers others gave despite their decreasing client base implies strongly that they do not fully understand what marketing is.

Asking f m s how they built their client base was a more effective way to learn about marketing activities. However, in general, f m s are not active in such activities. A vast majority considered the fact that their clientele hasn't changed and that the firm has a good reputation as indications that they had little additional to do in this area. Start-up firms tend to be more active in attracting clients than privatized. The most common mechanisms for building client base for start-up f m s were advertising and maintaining or building the f m ' s reputation; privatized f m s tend to try to maintain their client base and reputation and have reasonable prices. "Successful" start-up f m s in start-up tend to rely on advertising (63%) whereas successful privatized firms rely on reputation and the high quality of goods.

c) Competitors While around 10% of firms report having no competitors, the majority report that the number

of competitors is either increasing or remaining the same. About half of the firms note that their competitors have increased and another 35% report the number is the same. While it appears that f m s facing an increasing number of competitors are slightly more likely to succeed and that f m s facing stagnant competition tend to be failing more than successful, it was not a st atistically significant difference. This might suggest (but is not a foregone conclusion) that the free market is forcing f m s to respond to competition with efficiency. Monopolists do not seem to be any more successll than those facing multiple competing f m s . Most firms have anywhere between 1-10 competitors, reflecting the nature of small scale sector rather than firm performance. Fitms are finding that most (76%) of their competitors are also in the private sector.

E. Problems. The largest obstacles to business growth, according to the firms surveyed are all related to their interactions with the government. Regulatory problems cited included the quantity of regulations, the frequency with which they change, and, to a lesser degree, the difficulty of receiving licenses. Businesses expressed great hstration with their interactions with the government. The director of a privatized enterprise in Sumi stated, "We are sick and tired of new reporting forms in accounting and taxes introduced retroactively; each time we must redo everything. We fail to catch up with the abundance of new rules and requirements, numerous fines and check-ups."

When question was posed in a slightly different way, "what are the biggest problems in day-to-day operations," the answers were similar. Cross-tabulations by city and by sector revealed no significant differences in the ranking of problems.

On taxation, respondents were emphatic about problems of high taxes, the large number of types of taxes and the frequency of changes in the tax code and tax reporting. In the words of the manager of a start-up firm in Sumy, "I agree to pay taxes if I see that this money goes to build good roads in my city, but as long as it goes to Kiev to provide for state bureaucrats and other governmental units, I rebel."

The most significant difference between the ranking of problems in this analysis and that of years past in the similar World Bank surveys is that political instability, inflation and currency exchange no longer rank as top problems. The tax and regulatory issues, that were present all along, are now considered the largest obstacles to growth.

Systemic factors followed closely. Of the systemic issues, short-term development is hampered most by low demand. Over the long-term, instability in laws, political and policy uncertainty, problems related to sales of product rated highest.

In the "probe" questions, firms fiuther emphasized high taxes and the "oppressive" attitude of government bureaucracies. Intricate and complicated legislation and the low purchasing power of the population were the next highest ranking topics of deeper discussion. Only 10% of respondents to the probe questions surmise that in Ukraine are were no fundamental obstacles to doing business. The surveyors found the firms self-assessments valid, in as much as firms seemed to be pointing to real problems and not trying to place blame for their own managerial inadequacies.

Problems given the middle rank, three, were determined as those one encountered fiom time to time but could be resolve. Problems receiving this rating for their impact on day-to-day operations were: lack of management skills, real estate market, access to credit, government and criminal pressure, lack of information on suppliers or potential customers and the bad credit of customers. Government pressure was a rated more serious a problems than criminal elements. Problems for business development or growth ranked similarly, although access to credit, access to finance, and the cost of loans were somewhat higher.

The least problematic issues for day-to-day operations and business development included procurement of inputs, inhastructure problems, production and technology services of business, lack of access to foreign exchange, and the real estate market. That these problems had decreased in importance snce earlier surveys which reflects gradual improvements in the macroeconomics conditions of Ukraine.

While the differences were insignificant across geographical areas and sectors, there were notable differences correlating with fm performance. Low demand, for example, is a worse problem for unsuccessful f m s than for the most successful ones. However, it is important to note that "low demand" can be cited as a way to cover up other problems or an indication that the management is less able to respond to changes in a dynamic way. Moreover, access to credit is much more of a problem for failing f m s than for successful firms. (3.96 for all failing firms vs. 2.5 for successful f m s . )

Access to credit is slightly more of a problem for successful f m s than striving ones, which suggests that the more advanced or sophisticated a firm, the more it may have specific needs regarding credit not yet problematic for an average f m . Similarly criminal and government pressure is slightly worse for successful firms. Criminal elements are rated worst for the successful f m s than any other group. One possible explanation is that good f m s are more likely targets for both government and criminal elements. This comment is supported by responses fiom some of the failing f m s which responded to the question about racket or mafia problems rhetorically with, "Why would mafia bother with us since we are so miserable?'

In general, the older fm was or the earlier it had been privatized the lower it rated government pressure as a problem. Perhaps the older firms had developed the necessary ties and acquired the needed licenses. Certainly older f m s have the benefit of experience. It is also possible that the regulatory obstacles have grown and that newer f m s , that face all of the new regulations at once are hit harder.

Overall, start-up f m s gave higher ratings to a wider range of problems which may indicate their higher expections or the fact that they are more active thus have more opportunities to run into obstacles. This observations is confmed by start-up f m s rating systemic factors lower than did privatized businesses. Inffastructure problems, low demand and high taxes, matters encountered by all businesses, are more serious problems for privatized than start-up firms. Alternatively, quantity of regulations and receiving licenses are more problematic for start-ups than privatized firms, indicating that that start-up f m s receive the greatest brunt of the government intervention, but also logical considering that privatized f m s do not have to go through these processes. However, both complain about government pressure equally. Privatized and start-up f m s gave similar ratings in the middle range - inffastructure problems, procurement of inputs or and at the very top - taxes.

Very big problem

Not a problem

'igure . Comparison of Selected Current Problems for Privatized and Start-up Firm

5

4.5

4

3.5

3

2.5

2

1.5

1

0.5

0

a

Corruption and the Racket

Expecting corruption to be a delicate question, answering the survey's questions in this area was optional for respondents. Only a small proportion of the firms surveyed answered the questions about government corruption and racket (10-30% for each question), even when the question was phrased in a less implicating way, for example, "how much do you estimate a fm similar to yours pays for...?' Although the responses can not be considered statistically significant, the trends they reflect are revealing of the declining problems associated with corruption and racket.

However, the continued resistance on the part of firms to discuss these taboo areas contradicts the average level of seriousness accorded to them in the problem ranking section. In general both are considered to be expected, almost normal costs of business; and firms were more bitter about government interference than difficulties with racket. This suggests, and was confmed by the surveyors, that racket has developed to a sophisticated level and in some cities it actually provides such services as security, property insurance, and protection fiom destabilizing factors. Racket has nearly become a sector of activity in its own right, demonstrating how pervasive the shadow economy really is. Figures will refer to "those firms who answered."

In terms of payment to racket, majority answering said they didn't pay a small number pay under $1001 month. No fum pays over 1,000. From answers to some of the probes, some of the ''successful" f m s admitted to being part of the racket or were so established and respected that they did not need to pay anything.

Racket generally appears soon after the fum has made a presence in the market or has been operational long enough to be thought profitable. Specifically, most firms experience problems with racket between one and three months time. This usually coincides with demonstrable profits or immediately after advertising that they were targeted by racket.

Govenunent corruption typically takes the form of requests for provision of free services. Bribes and "presents" are fairly widely acknowledged as useful if not necessary for speeding up administrative procedures. Previous IFC research revealed one city fire department requesting "voluntary agreements" in which businesses were required to directly h d e d their own fire protection through the fire department.

Most f i s who said that there was unreported salary f i s in a similar sphere would not say how much. If answered, the figure appeared to be under 50%. (8 answers) Only 2 firms would say how much of their own salary went unreported, either 40% or 100%. 25 who answered that they do not report salary would not say how much. Several firms, however, did admit in probe questions that they have unreported salary as it is commonly known that there are two types of salary. The primary reason they cited was high tax rates.

Global Comparison ofProblems Although entrepreneurs around the work complain about high taxes and burdensome regulation, the situation in Lkaine is indeed serious. Figure X, taken from a 1994 World Bank study, shows the amount of time that a manager of a business spends resolving administrative issues, of the type outlined above. In Ukraine, a manager spends nearly 30% of his or her time on such matters. In Lithuania, managers spend just over half as much time. Moving along the scale toward greater efficiency are Gabon, Brazil, Uganda, Guatemala, Pakistan, Uruguay and El Salvador, which are not widely known for efficient regulation.

El Salvador

Uruguay

Pakistan

Guatamala

Uganda

Brazil

Gabon

Lithuania

Ukraine

0% 5% 10% 15% 20% 25% 30%

VI. Recommendations and Conclusions.

Small business development is affected by a wide range of policies. One important goal of this survey is to give Ukrainian government officials and foreign donors a clearer picture of small business in Ukraine today so as to inform and improve the policy-making process both toward small business and the private sector as a whole.

This section of the report will provide some general recommendations on necessary steps for improving the business environment that the survey's findings suggest. It will also look in some depth at changes that are proposed to the legislation governing registration and licensing. These areas are crucial to market entry in Ukraine.

A. Recommendations on the business environment.

High taxes, large numbers of taxes and 6equent changes in tax reporting were the leading problems cited by respondents. The fact that the managers of most of the small businesses surveyed are relatively well-educated, and have been in the market for several years gives extra credibility to their complaints, which are further bolstered by the comparative international data. The government could address these problems head on by taking the following steps.

3 Limit and simplifv government regulations. Ukrainian businesses and companies spend a disproportionately large share of their time on regulatory compliance, as compared to other transition economies. These regulations go beyond tax reporting to include a wide range of administrative procedures. Excessive regulatory compliance and 6equent changes in the legislation underlying them represent a huge opportunity cost to development of Ukraine's private sector; resources that might otherwise by used for productive work like innovation and product development are diverted to overhead. The current practice of introducing regulations that are effective retroactively deters business development by significantly adding risk.

3 Decrease the level of taxation and the number of different taxes. Enterprises, particularly small ones, finance further growth primarily through internally generated funds. If Ukrainian enterprises were allowed to retain a larger share of their earnings, investments in small businesses would expand greatly. Individual businesses would be better able to finance themselves and to find local investors as they too would have more money. Similarly, Ukrainian enterprises currently spend a tremendous amount of time filling out numerous tax reports each month and keeping up with the rapid changes in tax legislation. This complexity essentially acts as an additional cost to taxation, and another opportunity cost.

Currently, the Ukrainian government is considering substantive tax reform. Although the profit tax is at a normal rate given world experience, the total tax burden faced by a Ukrainian enterprise is high. The proposed tax reform includes reduction or omission of payroll taxes and other taxes ancillary to the profit tax (such as the Chernobyl Fund) and consolidation of funding for the purposes they serve. Donors and the multilateral financial institutions are providing advice during this process. Clearly lowering the overall tax rate, reducing the kinds of taxes and simplifying reporting are needed and should be supported to stimulate private sector growth.

2 Move toward intemationallv accepted accounting principles. Local and foreign investors find that the current financial statements do not give a fair impression of the true fmancial health of an enterprise. The current system leaves Ukrainian managers who want to know more information about the profitability of operations - for their own knowledge or for an investor's - needing to keep additional accounting records, on top of the already complex tax reporting. This ambiguity discourages many investments that might otherwise be sound and profitable. Furthermore, the treatment of depreciation under international accounting standards encourages growth.

3 Continue and step-up privatization. Privatization needs to continue, of course, emphasizing open competitive methods and including more enterprises and objects (such as agroindustrial firms, other firms currently excluded from privatization, infrastructure, unfinished construction sites).

3 Clarifv ownershiv rights. Private ownership rights for land need to confirmed, worked out and stabilized in the legislation following from the constitution. Communal ownership needs to be clarified; if such property is considered not state-owned, then legislation should be adopted to fiuther its full privatization.

Improve bank regulation. Improvement in bank regulation would improve guarantees to depositors and investors. Specific regulations and an overall more efficient banking sector would lead to better credit conditions.

3 Develou and streamline bankruptcy legislation. The mechanisms for bankruptcy need to be developed, so that market participants that fail can exit the market and then if possible re-enter, revived. The distinction between financial and operational bankruptcy needs to be established. Currently a business can be brought to court for bankruptcy if it is over one month due on a bill regardless of the reason.

B. Issues with particular impact on small businesses

Two key issues that are addressed in the economic reform package currently before parliament are new business registration and licensing. Both of these issues, in different ways, were highlighted by the respondents to the survey. Problems with registration arose with its cost and with the improper administration of already burdensome administrative procedures. Licensing did not rate highest on business's list of problems, but it is reflected in their evaluations of the regulatory climate and their low assessments of government's attitude toward the private sector.

1. Business registration.

A strict comparison of the Ukrainian administrative procedures for opening a business to those in more developed market economies could yield the mistaken conclusion that Lrkraine's procedures are simple. Indeed, Ukraine lacks many kinds of regulation and controls that are present in West European countries and the United States. The array of legal entities from which one chooses when registering a business is much simpler, in terms of the number of categories and the background documentation needed to establish one.

A description of how the existing procedures play out in practice, however, points to the problems with the current processes. The survey's descriptions and analysis of steps and costs a Ukrainian

entrepreneur needs to undertake to learn what the law says, interpret the law, and possibly find an intermediary to assist with registration and other administrative procedures related to opening a business (such as utilities connections and licenses) are revealing. The time and money expended due to arbitrariness, complexity, insufficient transparency, and weak accountability act as barriers to market entry and drags on business activity with no corresponding gain in information or systemized policy implementation for the government.

The new proposal to simplifL registration is currently under review by parliament and undergoing frequent revision. The components of the drafts of this piece of legislation are most likely to improve market entry in Ukraine are those that:

reduce the number of steps needed to open a business; decrease the fees required to open a business and their frequency simplify and enforce the list of the maximum amount of information required for a business to be registered establish clear objective criteria for rejection of a business's proposal to register; reduce the number of different offices to which a business must report to fulfill its obligations in opening a business and ideally give the registration office responsibility for contacting these other government offices

Whatever the new registration system is, it should be widely publicized and available so that its terms are widely known and all interested can participate.

Again, reading the laws of Ukraine would give a misleadingly incomplete picture of licensing regulation in Ukraine. The law on entrepreneurship sets out the areas of activity requiring licenses and states that additions to this list require changes in the law. It would seem that the number of licenses and the criteria for their issuance is clear and manageable.

In practice, ministries and other bodies add to the types of licenses virtually at will. They follow are no set criteria for licenses (time periods of validity documentation required, model procedures, controls on issuance). Few government officials, even those designated to work on licensing, are comfortable stating the total number of licenses issued in Ukraine by Central government organs.

In an effort to address this situation, a Chamber of Licensing was established in 1995. This Chamber is situated inside the Ministry of Economics and has, on paper, the authority to control licensing. In practice, it has not be capable. of so doing.

As part of the reform package, draft legislation on licensing has been proposed, and is undergoing Parliamentary review. As presented to Parliament, the legislation proposed strengthening the licensing chamber so that there would be a control over license issuance. The key features to maintain in this legislation as it goes through review, in order to improve the simplicity, transparency, accountability, and fairness of licensing in Ukraine are:

up-holding a short clear list of the subjects of licensing; establishing clearly and firmly long renewal periods for licenses (one draft proposed a 3-year validity period); keeping a short clear list of criteria for license issuance and the grounds and procedures for requests for additional materials;

decribing clearly all procedures and responsibilities.

With more time or simply greater political will, additional changes will make sense. One would be to improve the definition of licensing so that "licenses" are the only kind ofpermissions necessary for undertaking commercial activities and they are necessary only for activities that may cause danger to society. Currently, many different kinds of permissions are required to start a business, some called licenses, others called certificates or patents, but all operating as licenses. This definition would enable the law to cover all of the activities acting as licenses.

The proposed law implies a process whereby government organs to whom licensing functions will be delegated, f?om the chamber, will undergo review. This process, as well as the new law and its other supporting legislation, (if passed) will be more effective if they are widely publicized. Beyond publishing the text of the legislation in the relevant newspapers, trade journals and reference sources, creating some press interest so more detailed articles are written would help as would making available an appropriate source to explain the law and its applications. Good publicity and availablity of information will improve the transparency and thus address a key aspect of the regulatory burden.

3. Other issues and priorities.

Small business assistance programs around the world include many other kinds of measures. Small business support programs in Russia, Ukraine and Belarus stipulate creation of legislation andlor institutions to establish leasing companies, cooperative savings schemes, insurance for small businesses and science parks. These programs propose training programs for government officials and better distribution of commercial information. At some point, they have all considered government loan schemes and sector-based subsidies.

The institutions serve important roles in SME development more developed market economies. Their effectiveness depends largely on the more stable economic conditions in these countries. The strength of those markets, in terms of both the number and health of businesses and the vitality of the banking sector, make leasing more profitable and insurance viable. Some of the other instituions cited, such as science parks and government loan programs, require significant up-front allocations either in terms of foregone income in tax breaks or actual cash and directly benefit only a small portion of the SME sector. When funds are limited for government outlays for small business development, revising legislation so as to improve the business climate may well be the most cost-effective way to achieve broad based results.

Closing comments.

In many of the neighboring transition economies and in countries with more developed market economies, small and medium enterprises are an engine of growth. They contribute favorably and significantly to employment and GNP, as well as serving as a key source of innovation. If the population of small businesses is to grow, a large number of businesses need to be able to enter the market and operate effectively. At this point, it is less important what percent of them fail - a concern often used to support government intervention - than how many are left and how well they operate.

Overall, the government needs not just to vocalize its commitment to private sector development but to demonstrate that it has the political will to continue reform. There has to be a better understanding of what small business is, how it works and what it needs. Policies that areintended to stimulate private

sector development or small business growth have to emphasize outputs, that is results in terms of numbers of businesses and their contribution to the economy.