oDR: Opinion

In Ukraine, liberalisation will not solve the shadow economy

As part of its "turbo reforms", Ukraine's new government sought to write the concept of competition into workplace protections and exclude trade unions from the process. They have since withdrawn their reform, but the guiding principles behind it may return all too soon.

Vitaliy Dudin
10 March 2020
Volodymyr Zelensky
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(c) Pustovit Serhii/Zuma Press/PA Images. All rights reserved

Are Ukrainian president Volodymyr Zelensky’s “turbo” reforms over? After a dramatic and chaotic government reshuffle last week, the future for policy and legislative initiatives is uncertain. Just after the reshuffle took shape, it was announced that a proposed labour reform - a signature initiative by Ukraine’s Ministry of Economic Development - was to be recalled from parliament.

Amid a protest campaign by Ukraine’s trade unions, the Zelensky government had proposed giving employers the opportunity to dismiss workers without declaring a reason, introducing new types of employment contracts and canceling several employer-side social obligations. The reform was supposed to create one million jobs and reduce the time it takes to find a job to two months - fostering economic development, lowering unemployment and fighting informal work at the same time, the government claimed.

But the reasoning behind these calculations was far from clear. While potentially up to 30% of Ukraine’s economically active population are involved in informal labour, the authors of the draft law chose not to predict how far the level of shadow employment would fall if the reform went ahead. Draft Law No. 2708 and its backers assumed that liberalisation, rather than enforcement, would produce the results they wanted. Indeed, Economy Minister Tymofyi Mylovanov stated on several occasions that “competition” would give Ukrainian workers better protection at work than the country’s current Labour Code.

Draft Law No. 2708 may have disappeared for the time being. But the assumptions that guided the Zelensky government’s proposed reform are worth tackling - it’s likely they will return in future legislation.

The past year in Ukraine has seen the rapid expansion of delivery platforms such as Uber Eats | (c) Jaap Arriens/SIPA USA/PA Images. All rights reserved

Ukraine’s labour market has some paradoxical features. Salaries here are some of the lowest in Europe, but the level of unemployment is about 8.5% (the same as France). The level of trade union membership is very high (around six to eight million, comparable to Germany), yet strikes are extremely rare. Indeed, Ukraine figures lower than all neighbouring European countries in the index of guarantees of workers’ rights.

The country’s strict labour regulation, which dates from 1971, gives little “institutional flexibility” on the side of employers in Ukraine, but their level of “actual flexibility” is quite significant due to trade unions’ organisational weakness. Neoliberal experts tell us employment protection adversely affects job creation. Yet Ukrainians currently enjoy weak protection against dismissal at work (our state is rated 34th in the “Hiring & Firing” index of the World Economic Forum), and this situation does not promote job creation.

According to the state employment service, 21% of economically active people are employed informally. In recent years, the state’s policy on eliminating undeclared work has been rather unclear. Speaking in September last year, Tymofyi Mylovanov said that combating the shadow economy is not an “end in itself” - the main priority should be fostering economic growth. But the government’s agenda has since become more clear: informality should be reduced by liberalising Ukraine’s employment legislation.

While the government is responsible for the less-than-ideal enforcement of Ukraine’s current labour legislation, with Draft Law No. 2708 it has supported the opinion that diminishing the regulatory burden and state interference can erase the distinction between Ukraine’s formal and informal economies. The government claims that only 12.5 of 28 million able-bodied Ukrainians are officially employed. (These figures are debatable: experts believe that the number of working-age population is around 16.5 million people).

The EU’s current social policy underlines the importance not only of fighting informality, but also the quality of work. In other words, reforms should not result in more precarious jobs

There were serious problems with this legislation. First, legal remedies are not enough to counteract shadow employment. Although the draft law specified features which indicate the existence of “employment relations”, it did not state which body could recognise a relationship as such - a labour inspector or a court? Another issue is that the draft law removed Article 235 of Ukraine’s existing Labour Code, which allows an employee to establish the existence of an employment relationship in court and receive payment from employer for the period of undeclared work. The financial risks for non-compliance have also been lowered. The simplification of rules on using overtime could mean a growing area of “unregistered” extra work.

Second, removing workers’ guarantees also removes their incentives to being legally hired. According to Ukraine’s draft labour law, an employer can dismiss a worker without any reason, but with payment of severance allowance. This deprives people of the right to stable employment relations (the current Labour Code contains an exhaustive list of reasons which justify dismissal). Today, the possibility of protecting your job remains the main reason to enter into legal employment, especially in Ukraine’s public sector. Additional protection is given to working mothers with children under the age of three, minors and union members - these categories could lose their extra guarantees.

Third, the legalising of “very flexible” contracts would not prevent shadow employment. The Ukrainian government thinks that extending flexible forms of employment will reduce the level of informality. But Soviet by-laws already provide opportunities for seasonal work, working from home and flexible work schedules. The only atypical arrangement that is not regulated by Ukraine’s Labour Code is a zero-hour contract. There is a risk that a section of “normal” jobs will be replaced by these kind of contracts with no guarantee of minimum wage. We should bear in mind that the phenomenon of bogus self-employment is increasing, even in places where labour laws propose a wide set of atypical contracts.

Flag of the Independent Union of Railway Workers amid trade union protest in central Kyiv, 15 January 2020 | (c) Yuliya Ovsyannikova/Zuma Press/PA Images. All rights reserved

The question, then, is: how should Ukraine deal with informality and the lack of workplace protections? Well, it could consider the following:

1) Raise wages to encourage legal employment. The level of minimum monthly wage in Ukraine is currently €175, compared with €312 in Bulgaria. While many countries recommend that the minimum wage should be lowered to encourage legal employment, in Ukraine these recommendations are pointless. In this context we have a similar situation with Bulgaria, where small wages go hand in hand with a large informal economy. The draft law could have even made Ukrainians earn less following a reduction in surcharges for overtime. Studies show that the greater the share of the population living below the national poverty line, the higher the level of informal employment. The minimum wage should be increased in order to encourage employees to take up official employment.

2) Reshape Ukraine’s tax policy. The use of pseudo self-employment in Ukraine is driven by high (in the opinion of the country’s business class) social contributions rather than rigid labour market regulations. The big gap between taxation of wages and self-employed income leads to the use of civil contracts, rather than official employment. The taxes for using civil contracts should be raised. It is also important to release the lowest salaries (e.g. 150% of minimum wage) from taxation.

3) Introducing an integrated approach to enforcement. Ukraine’s shadow economy cannot be explained as a consequence of the country’s strict labour legislation. All factors that can reduce informal employment fall into four groups: (a) tax policy, including social security contributions, (b) labour regulations, (c) broader business regulations, and (d) institutional reforms, including sanctions for non-compliance. Higher levels of informal employment result from the under-regulation, rather than over-regulation, of economies and a lack of state intervention to protect workers from poverty. The start of a workplace inspection campaign at the beginning of this year (without waiting for the labour reform) can be seen as a positive signal. But the sanctions should be tightened (today the fine for using undeclared work in Ukraine is about €1,740 compared with €7,000 in Poland). We should support programmes to increase the employability of vulnerable categories of workers. Employers will be incentivised to employ people legally if they want to receive state compensation for employing or training young people, disabled workers and employees with family obligations.

Final lessons

The EU’s current social policy underlines the importance not only of fighting informality, but also the quality of work. In other words, reforms should not result in more precarious jobs. But the Ukrainian government tried to move in the opposite direction. Their attempt at reform would have denied access to decent work, which includes wages that enable workers to support their household, contractual stability, and protection from unjustified termination of employment.

Liberalisation and deregulation is not the answer to every challenge. In my view, the Zelensky team’s innovations would have encouraged emigration, rather than moving people from the shadow economy into employment. In similar situations with informal economies, such as Croatia, liberalising workplace legislation has not led to a reduction in the informal economy - instead, youth unemployment has decreased, but only as a result of emigration.

By themselves, liberal labour reforms can’t eliminate the problem of undeclared work. Сareless steps could bring only harm, but Ukraine’s new government still has a chance to reconfigure how it combats the shadow economy.

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