Conclusions for Ukraine in Recent OECD Report on Inspection Reform

The legal system of Ukraine is an ongoing reform process. This cliché is particularly apparent when it comes to business regulation. Ukraine has reformed many of the laws in this area(for example see the Tax Code, the Customs Code, the Law on the Protection of the Rights of Consumers, the Law on Market Oversight, the Law on Sanitary Oversight and the Law on the General Principles of State Control Oversight Activity in Economic Sphere) but little has been done to reform the application of regulatory reforms. In this, a second article that I havewritten concerningthe report by the Organisation for Economic Cooperation and Development (OECD), written by Floretin Blanc and entitled “Inspection Reforms: Why, How, and With What Results?”, I would like to highlight some of the conclusions that this report makes, as well as some of Blanc’s recommendations for inspection reform.

The point is not to berate policy makers, but rather to inspire with ideas for real change. Because this is the real value of the report, the idea that too little focus has been on the institutions of regulation, on the actual relationship between the state and business. This is a harder relationship to change, one that requires a revolution in the way in which a society functions. Not sudden revolution, but a gradual revolution, one that will lead to economic improvements and greater sustainability in the legal system.

According to Blanc and the OECD, the first step of the reform process is to diagnose the inspection system. Every country has its own problems, problems that are unique to each local system. The best diagnostic projects combine qualitative and quantitative assessments and lead to consultations with all important stakeholders. The report provides three examples of quantitative assessments because the countries in the greatest need of reform tend to lack qualityquantitative data. And good original data will allow reformers to check to see if there has been progress.

The first assessment is known as the Standard Cost Model. This model is based upon the idea that information about a ‘typical’ business can be defined and from that the burdens of the rest of the business community can be identified. The second assessment is based on business surveys. This form of assessment is perhaps most expensive and difficult to perform, but the outputs it provides tend, according to Blanc, to provide the most accurate information. This can be compared to the third assessment form: official data surveys. This assessment is perhaps the cheapest, but also the one containing the most inherent difficulties. For example, inspectorates may be inclined to under report their actions or that certain actions do not go reported at all.

To assess inspections one must also define inspections. This is not as easy as it seems. There are no common definitions of what inspection bodies actuallyare, let alone what an inspection itself involves in every case. This is true bothbetween different state systems internationally as well as within a country. What can be generalized are the categories of inspections. Blanc gives four: technical, tax/customs, business requested and indirect inspections. There is an inherent conflict as well between the nature of inspections. Many businesses feel that inspections are a burden no matter how effective they may be. This is true in all states, not just Ukraine.

Once inspections have been assessed, then the next step might be to assess the general feelings towards inspection reform in society. It is decidedly difficult, no matter the evidence of poorly functioning inspections, to push for change when there is strong opposition amongst key segments of the population against reform. Blanc actually uses Ukraine as an example where certain business interests who perceive inspection reform negatively and who,via strong political connections, are allowed to speak for all businesses, essential thwarting reform.These business interests understand the current inspection system and are able to game it. So even if reform were to benefit their business, there is an uncertainity that they are uninterested in.

Even if there is popular support for reform nothing can be accomplished without strong political will as well. That politicaldetermination can be forced upon politicians (including by the international community) and can be the result of other realities (including economic crises that require cost reduction). There is also the problem of where there is perhaps support for inspection reforms but a thorough distrust of the government does not allow for reform. Here again Ukraine is used as an example. When attempts at inspection reform were made in 2006, vested interests in the existing system, using sympathetic media, painted reform as dangerous and threatening to public health. It was not until other parties who were sympathetic to reform were able to get their message out that public support increased.

If inspection reform is possible, it is necessary to establish clear objectives. Blanc and OECD identify three probable objectives: greater effectiveness, improved efficiency and reduced burdens. Blanc argues that countries not suffering from endemic inspection problems tend to focus on effectiveness and reducing costs (efficiency). Countries, like Ukraine, with greater problems tend to focus on burden reduction. The defining of objectives is important because the objectives determine the priority of reform actions.

The success of reform actions can be assessed by the use of benchmarks. Benchmarks usually includelevels of burden, targeting of reform, the use of new inspection tools and compliance promotion. If the objective of reform is the reduction of administrative burdens then it is that benchmark area that gets the most attention. This was the case of the work of the World Bank in Ukraine a few years back. Other benchmark areas, particularly with regards to compliance promotion, are harder to quantify and as a result get less attention. Yet it is in these areas that the individuals that make up businesses most feel the effects of reform.

The report also outlines certain characteristics of successful reform implementation. The first is a legal document that outlines the principles, targets and requirements that are to dictate the reform work of inspectorates. This legal document is usually a government statement or policy program. There is usually a coordinating mechanism as well, in the form of an institution that is not an inspectorate but has strong political support. The job of this institution is to coordinate reform, not inspections themselves.

Successful reform has, in addition to the coordinating institution, also other support units. These units are often found within the government and with access to senior policy makers. As Blanc puts it, having such a support unit within the government is not a guarantee for success, but not having one guarantees failure.

The last area that I would like to bring to attention has to do with the very concept of burden. This is particularly important because of the need to dispel the myth that inspections are a burden per se. If is possible to dispel this myth, then the possibilities for reform increase as businesses themselves see what can be gained.

The first burden that Blanc identifies is associated with time lost and resulting direct costs. This is perhaps the most felt burden and the easiest to quantify. It includes prep-time, inspection time and follow time. Costs can include bribes and unjustifiable fines, and loss of turnover as a result of suspended operations. These systematic “losts”also play a role in the second burden form identified, that is negative effects on investments. Overly complicated regulation limits the growth of smaller businesses. Inspections that are not in proportion to the risk of a given business activity means that a business may chose not to invest in an operation if the benefits of the investment are limited at the very beginning. This can be seen as well in inspectorates that do not adjust to new technology while maintaining the right to control all activities.

The final burden that Blanc mentions is linked to compliance and safety. Inefficient and inadequate inspections do not lead to greater compliance. While businesses may face fines for failure to comply, there is little incentive to comply when the inspections themselves do not see it in their interests at businesses follow regulation.

After reading Blanc’s text, one is struck by the difficulty that every state has in reforming inspection bodies, no matter what level of economy the country may have. At the same time inspections have the benefit of being something that responds to a motivated reform work. The key is to identify the areas in greatest need and focus on compliance. This last point is the what I believe is of greatest interest. That regulation should lead to compliance. That inspection bodies should concern themselves only partially with inspecting, and rather place emphasis on the public good, businesses and citizens alike.