Ukraine

 

harold james is professor of history and international affairs at Princeton’s School of Public and International Affairs, and an associate at Princeton’s interdisciplinary Bendheim Center for Finance.>

Published January 23, 2024

 

These days, serious discussions about the postwar reconstruction of Ukraine inevitably start with analysis of the appalling physical damage inflicted by Russia’s attack, and the consequent need to rebuild everything from hospitals to rail lines to power plants. Last spring the World Bank, working with the Ukrainian government, the United Nations and the European Commission, estimated the bill at $411 billion, 2.6 times the country’s GDP in 2022.

The figure is dauntingly, offputtingly large, especially as this is a moment of rising interest rates that is straining the budgets of every plausible funder – Ukraine itself, obviously, but also the U.S. and the European Union. It may be neither realistic nor wise to expect Russia to pay large sums in reparation.

In my view, though, the debate about the cost and who should pay the bill puts the cart before the horse. The overriding issue: how does Ukraine fit into the world economy?

Even before the latest phase of the decadeold war with Russia, the country offered insights from three successive eras of globalization. The first was the globalization of the old world in the 19th and early 20th century, which was dependent on commodity production and exports, mostly of grains and metals. The second characterizes globalization in the late 20th and early 21st centuries, distinguished by the creation of complex supply chains. And finally, Ukraine offers a glimpse of the future, of IT-driven globalization fueled by necessity and creativity.

learning from the marshall plan

It would be a mistake to think that rebuilding must mean going back to the dysfunctional post-Soviet Ukraine. The country has an opportunity to build back better, and it is uniquely positioned to take advantage of the next historical stages of globalization.

That opportunity is especially important in light of the enormous uncertainties with which Ukrainians must operate today. No one knows how long the war will last, or when they can afford to shift attention from conflict to reconstruction. It could be years. But I’m an optimist: given the rot revealed by Putin’s stumbling efforts to project military power, it is also quite possible that the war will soon tip in favor of Ukraine. And in that case, it is vital to have a well-thought-through plan ready because a chaotic Ukraine – and indeed, a chaotic Russia – would only be a breeding ground for divisions along the fractures created by Ukraine’s past.

In thinking about Ukraine’s future, there is an obvious precedent in the provision of largescale aid from the U.S. to Europe after World War II. After the June 2022 G7 summit in Germany, Chancellor Olaf Scholz declared there was a consensus that a new Marshall Plan was needed. The European Recovery Program (aka the Marshall Plan) of 1947 is always held up as the gold standard for economic reconstruction in the wake of political, military or economic devastation because it marked the beginning of an era of unprecedented growth coupled with political stability. And since the breakup of the Soviet Union, there has been a nearly constant call for an encore.

The ghost of Marshall was summoned up to respond to the transition in the former Soviet satellites (and Russia, as well) in the 1990s in the aftermath of the collapse of communism.

The calls came again for Iraq after the 2003 war, for broad swathes of the Middle East in the wake of the Arab Spring uprisings, for Syria after its brutal civil war, for Western Sahara in the 2010s, for Haiti after the earthquakes in 2010 and 2021. Mostly, these calls proved a substitute rather than a precursor to action.

James Harold Reconstructing Ukraine Economy 2

Now, it is clear to anyone familiar with contemporary Europe that a Marshall Plan for Ukraine cannot simply involve a rehash of the 1947 initiative. But there is some value in looking back at the issues that preoccupied Marshall’s planners and administrators – war-tested economic geniuses like Studebaker Corporation President Paul Hoffman, whom Marshall brought in to administer the plan, and the great MIT economist Charles Kindleberger. They were spot-on in identifying the core issues: how the amount of aid provided relates to the scale of the intended effects, how aid done right serves as a catalyst for productivity growth rather than a social safety net, and how the support can bind the recipient to a deep network of international connections.

The Marshall planners wrestled with the problem of how much should be organized by governments and how much would be better left to the private sector. In all these areas, there are strong (and still relevant) lessons to be learned. Above all, don’t just splash money around, but focus on how aid can be targeted so that it opens new opportunities rather than simply easing the economy back to the prewar status quo.

Arguably most important, much of the direction must come from the aid recipients themselves. As Marshall himself eloquently explained in the commencement speech at Harvard that sketched out the broad outlines of his thought: “It would be neither fitting nor efficacious for this Government to undertake to draw up unilaterally a program designed to place Europe on its feet economically. This is the business of the Europeans.”

In the contemporary context, two elements stand out. First, external support should be catalytic rather than comprehensive and designed to realize an already existing potential. The net aid West Germany received was merely 3 percent of the country’s GDP at the outset of the plan, which is a long way removed from the figures that are bandied about in the case of Ukraine. Second, the Marshall Plan was as much about making new international connections as it was about stimulating productivity in a single country.

James Harold Reconstructing Ukraine Economy chart
Backwardness

There are also obvious differences between Ukraine today and the Marshall Plan scenario: pre-Second World War Germany was an industrial powerhouse. Ukraine is anything but – at least on the face of it. Before the all-out Russian assault in February 2022, Ukraine appeared weak, poor and divided. Indeed, that appearance provided one of the rationales for Russia’s attack.

Putin, we now know, was badly misled at least in part by myths about Ukraine’s place in Europe. The weird historical fantasy in his programmatic essay from the summer of 2021 on “the historical unity of Russians and Ukrainians” began with statements about religious and linguistic commonalities, along with reflections on the “baptism of Rus,” the baptism of Saint Vladimir (Vladimir the Great, but Volodymyr to Ukrainians) in the town of Chersonesus in Crimea in the year 998. The essay of the would-be modern Vladimir the Great, however, culminated in an argument about economics.

In Putin’s view, Ukraine had condemned itself to poverty by systematically breaking ties and ending cooperative projects with Russia from 2014 onward – from the Maidan revolution and the collapse of the presidency of Viktor Yanukovych. As the Russian president put it:

Ukraine used to possess great potential, which included powerful infrastructure, gas transportation system, advanced shipbuilding, aviation, rocket and instrument engineering industries, as well as world-class scientific, design and engineering schools. … Today, high-tech industrial giants that were once the pride of Ukraine and the entire Union, are sinking. … The scale of deindustrialization and overall economic degradation is visible in Ukraine’s electricity production, which has seen a nearly two-time decrease in 30 years. … Before the coronavirus pandemic broke out, Ukraine’s GDP per capita had been below $4,000. This is less than in the Republic of Albania, the Republic of Moldova or unrecognized Kosovo. Nowadays, Ukraine is Europe’s poorest country.

Ukraine’s poverty was a fact. Compared with either Russia or, say, Poland, post-communist life in Ukraine looked miserable. Incomes stagnated. But Putin’s claim that its miserable performance followed from the Maidan Revolution in 2014 was a flat-out lie.

After 2004, there was a brief credit-fueled Ukrainian surge of growth, but it collapsed with the 2008 global financial crisis at the same time as similar bubbles in many other countries. When inflows of foreign exchange slowed, the currency (the hryvnia) sharply depreciated. Debtors – the government, big corporations, farmers – experienced a massive rise in their foreign-currency denominated debt. And there was a threat of a doom loop, as banks faced losses on their holdings of government debt and the broke government struggled to recapitalize banks.

In 2009, the economy contracted by 15 percent. By comparison, the financial crisis in Russia reduced GDP by 7.8 percent, while in the United States, the epicenter of the crisis, GDP fell by just 2.6 percent.

James Harold Reconstructing Ukraine Economy 3

A long analytical literature has surveyed the paradoxical advantages as well as the costs of economic backwardness. And Putin is a much less reliable guide to Ukraine’s bumpy economic history than the great economist Alexander Gerschenkron. Born in Odesa, his family fled after the Russian Revolution. He moved to Vienna and then eventually to Massachusetts, where at Harvard in 1951 he wrote a seminal paper, “Economic Backwardness in Historical Perspective.

The article starts as a reflection on the policy predicaments of pre-Soviet Imperial Russia and its relationship with more advanced industrial economies. The key insight was that economically backward countries might leapfrog stages of development. Gerschenkron was intrigued by the way early 20th century Russia seemed replete with weird incompatibilities: modern steel mills alongside peasant agriculture, with the mills themselves combining the latest in Western design with manual operations by unskilled workers moving fuel and iron ingots by handcart. Bearded peasants in smocks and wooden clogs toiled alongside clean-shaven university-educated engineers.

Gerschenkron saw something positive here, arguing that the absence of advanced technology – or the destruction of modern equipment in war – opens the opportunity to build and operate at the creative frontier. The extent to which an economy lags behind is thus a Gerschenkronian indicator of the potential for rapid growth. However, it was obvious to Gerschenkron, and it has become more obvious since then, that not every poor country has what it takes to catch up.

Three Ukraines

Imagine the native of Odesa transported to today’s Ukraine. Gerschenkron would not find the country’s current predicament all that surprising. Backwardness creates vulnerability. And backwardness is a story of dramatic contrasts. There are in fact three Ukraines today, with a contrast of worlds even more extreme than that observed by Gerschenkron in the czarist Russia of his youth.

One is a sad story of backwardness, poverty and low productivity, reproducing the conditions of 19th-century globalization in which a poor periphery dominated by extractive trading companies sends raw materials and food to richer countries. But Ukraine has a second economy, reflecting the conditions of late 20th- or early 21st-century globalization, in which poorer countries managed to insert themselves into complex global value chains and supply systems, usually by producing textiles or labor-intensive components for advanced manufacturing. And finally, there is a third Ukraine, operating at the cutting edge of a technological and institutional revolution that is sweeping the world. This is the Ukraine that is poised to do the leapfrogging.

James Harold Reconstructing Ukraine Economy 4

Agriculture – especially grain – is a key part of Ukrainian identity. You can see it proudly presented in the two-color flag, where a golden wheat field lies under a blue sky. It is also central to history and memory, and to the Ukrainian understanding of their people’s tragedy. The defining crime in Ukrainian history is the Holodomor, the famine of 1932-33 produced by Stalin’s grain procurement policy that stripped the countryside to feed rapidly industrializing Soviet cities and to generate foreign currency earnings.

A UN report concluded that 7 to 10 million Ukrainians (out of a total population of about 30 million) died. And while many scholars think the tally of victims was probably smaller, the Holodomor stands out as a great peacetime catastrophe in modern European history. Strikingly, the catastrophe was ignored or glossed over at the time by those eager to celebrate the triumph of Stalinist modernization – infamously by The New York Times’ Walter Duranty – even while some journalists like Gareth Jones and Malcolm Muggeridge dispatched surprisingly accurate accounts of the horror.

Fast-forward to an ominous globalized echo of the Holodomor. Since the Russian invasion in 2022, the world has focused on Ukraine as an agricultural producer and exporter. The Middle East – especially Egypt – relied on Ukrainian wheat, but places as far away as Indonesia are also major consumers of Ukrainian agricultural products. Putin’s on-again, off-again restrictions on grain movements by sea have threatened to bring widespread hunger to some of the world’s poorest people.

To an extent, the story of Ukrainian grain exports can be told as a success, but a rather blighted one. Agricultural production has certainly grown since the mid-1990s, by which time the dislocations brought by the collapse of the Soviet Union had reduced output. In 1996, Ukraine grew 13.5 million tons of wheat; in 2000, 21.4 million tons; and in 2020, 24.9 million tons. It is now the eighth largest wheat producer in the world. But productivity, both per worker and per acre, remains low – substantially below the European Union.

The explanation for the poor performance lies in the direction of post-Soviet land reform. The giant collective farms that lay at the heart of the Soviet system were broken up. Agricultural workers, some seven million people or two-fifths of Ukraine’s rural population, were given land shares, termed pai, of 10 acres on average. In addition, rural residents who had not been members of collective farms were awarded about 2 acres each. Small-plot farming is, of course, inconsistent with high-yield grain farming that requires efficient crop planning and mechanization.

Very large farms reemerged, this time as giant private agribusinesses that farmed land leased from the peasants. To protect the small farmers (at least notionally) from exploitation, the sale of land was prohibited until 2021. It’s thus only very recently that the Zelensky administration acknowledged the consequences of Ukraine’s archaic agricultural base.

The new large farms were gigantic. The largest, UkrLandFarming, incorporating over 1.6 million acres, was created in 2007 by Oleg Bakhmatyuk, who became the largest egg producer in Europe. The agribusiness complex rapidly became dominated by oligarchs. These oligarchs were also at the center of the borrowing dynamic that exacerbated the debt crisis after 2008. And they were at the heart of the endemic problem of corruption and Kremlinassociated political influence in Ukraine.

DF Agro was founded by Dmytro Firtash, a Gazprom associate labeled by the U.S. Department of Justice as an upper-echelon figure in Russian organized crime. He was arrested in Vienna, and since 2014 has been subject to a U.S. extradition request. In 2011, Rinat Akhmetov founded HarvEast Holding. He was the major sponsor of the pro-Russian Party of Regions, and in November 2021 (a few months before Putin invaded the old-fashioned way) was accused of involvement in an attempted coup against Zelensky. Bakhmatyuk, the oligarch sitting on 1.6 million acres, was suspected of bank fraud in the banking crisis of 2014-15, and the Ukrainian Anti-Corruption Bureau has recently joined the chorus asking for his extradition from Austria.

Low agricultural productivity wasn’t just caused by inefficient organization and corruption: Ukrainian infrastructure was also poor. A World Bank study in 2019 estimated that the cost of moving grain from Ukrainian farms to the Black Sea ports is approximately 40 percent higher than moving grain an equivalent distance in France or Germany, and 30 percent higher than in the United States. The World Bank report cited inadequate rail infrastructure and a surprising reluctance to use water transport in spite of the fact that rivers offer natural passage to Black Sea ports.

The agribusiness oligarchs were suspicious of closer integration in European markets. In part this was rational because protectionism pushed by French and Polish farmers would limit their production. More importantly, the oligarchs feared that the EU’s insistence on business transparency and the rule of law would end their dominance. A very different sort of Ukrainian business – part of a community that saw globalization as conducive to building prosperity and geopolitical security free of Kremlin influence – began to push for closer linkages with the EU in the 2010s.

Part of Ukraine – especially western Ukraine – saw a chance for prosperity in an adaptation of the Asian model of exportoriented growth, focusing on supplying laborintensive intermediate goods for global supply chains. The old factory that used to make the Zaporozhets automobile, a classic of Soviet motor production, moved on to make components for German and Japanese producers.

When Putin invaded in 2022, European automobile producers temporarily lost access to their supply of wire harnesses used to bundle the mares’ nests of electric cables in modern vehicles. Indeed, the disruption of equipment plants in Stryi and Kolomyja meant that BMW and Mercedes needed to slow their production lines.

MR101 interior 0003s 0003 James Harold Reconstructing Ukraine Economy 3

Very large farms reemerged, this time as giant private agribusinesses that farmed land leased from the peasants. To protect the small farmers (at least notionally) from exploitation, the sale of land was prohibited until 2021. It’s thus only very recently that the Zelensky administration acknowledged the consequences of Ukraine’s archaic agricultural base.

The new large farms were gigantic. The largest, UkrLandFarming, incorporating over 1.6 million acres, was created in 2007 by Oleg Bakhmatyuk, who became the largest egg producer in Europe. The agribusiness complex rapidly became dominated by oligarchs. These oligarchs were also at the center of the borrowing dynamic that exacerbated the debt crisis after 2008. And they were at the heart of the endemic problem of corruption and Kremlinassociated political influence in Ukraine.

DF Agro was founded by Dmytro Firtash, a Gazprom associate labeled by the U.S. Department of Justice as an upper-echelon figure in Russian organized crime. He was arrested in Vienna, and since 2014 has been subject to a U.S. extradition request. In 2011, Rinat Akhmetov founded HarvEast Holding. He was the major sponsor of the pro-Russian Party of Regions, and in November 2021 (a few months before Putin invaded the old-fashioned way) was accused of involvement in an attempted coup against Zelensky. Bakhmatyuk, the oligarch sitting on 1.6 million acres, was suspected of bank fraud in the banking crisis of 2014-15, and the Ukrainian Anti-Corruption Bureau has recently joined the chorus asking for his extradition from Austria.

Low agricultural productivity wasn’t just caused by inefficient organization and corruption: Ukrainian infrastructure was also poor. A World Bank study in 2019 estimated that the cost of moving grain from Ukrainian farms to the Black Sea ports is approximately 40 percent higher than moving grain an equivalent distance in France or Germany, and 30 percent higher than in the United States. The World Bank report cited inadequate rail infrastructure and a surprising reluctance to use water transport in spite of the fact that rivers offer natural passage to Black Sea ports.

The agribusiness oligarchs were suspicious of closer integration in European markets. In part this was rational because protectionism pushed by French and Polish farmers would limit their production. More importantly, the oligarchs feared that the EU’s insistence on business transparency and the rule of law would end their dominance. A very different sort of Ukrainian business – part of a community that saw globalization as conducive to building prosperity and geopolitical security free of Kremlin influence – began to push for closer linkages with the EU in the 2010s.

Part of Ukraine – especially western Ukraine – saw a chance for prosperity in an adaptation of the Asian model of exportoriented growth, focusing on supplying laborintensive intermediate goods for global supply chains. The old factory that used to make the Zaporozhets automobile, a classic of Soviet motor production, moved on to make components for German and Japanese producers. When Putin invaded in 2022, European automobile producers temporarily lost access to their supply of wire harnesses used to bundle the mares’ nests of electric cables in modern vehicles. Indeed, the disruption of equipment plants in Stryi and Kolomyja meant that BMW and Mercedes needed to slow their production lines.

James Harold Reconstructing Ukraine Economy 5

Similar linkages apply in clothing and fashion. Ukraine Invest, the government agency tasked with attracting foreign capital, explains that big Western textile and shoe companies – among them Adidas, Zara, Esprit, Next, Mexx, United Colors of Benetton, Tommy Hilfiger and Hugo Boss – all buy from Ukrainian companies. Indeed, exports constitute 80 to 90 percent of the Ukrainian textile and apparel industry’s revenue.

But supply chains are not all there is to power Ukraine’s economic trajectory in a peaceful world. The pride and joy of a futureoriented Ukraine is the tech sector. Before the Russian invasion, Ukraine’s labor force included around a quarter of a million tech professionals trained in the country’s competitive education system. The value of IT exports increased from $4.2 billion in 2019 to $6.8 billion in 2022.

Ukrainian startups have their roots in the immediate post-Soviet period. SoftServe was created in 1993 by two former graduates of the Lviv Polytechnic National University and rapidly developed major international connections, including with GE. It created the visualization basis for Google Street View.

The immediate aftermath of February 2022 provided a stunning demonstration of Ukraine’s technical potential. Ukrainian soldiers used 3D printers to make plastic collars that they attached to cheap drones so they could carry sensors and ordnance. But the contribution of new tech is most obvious in software.

Within hours of the attack, the software development community built platforms on which ordinary Ukrainians with smartphones could relay observations about Russian troop movements and locations. Coders easily hacked into insecure Russian telecommunications – many Russian soldiers used unprotected phones to transmit messages and instructions.

Western intelligence services noted with incredulity how the hackers and cybercriminals from the old Ukraine turned into the patriots and heroes of the new Ukraine. Many were amazed that Russia had not been able to destroy Ukraine with cyberattacks: the explanation was that Ukraine was home to better cyber warriors.

At the outset of the war, Mykhailo Fedorov, Ukraine’s Minister of Digital Transformation, rightly celebrated the leapfrogging: “The enemy has been preparing for full-fledged [technology] war for 20 years. We made a technological leap in 10 months.” He was talking pure Gerschenkronianism.

James Harold Reconstructing Ukraine Economy 6
You Gotta Have Faith

Not every “backward” country catches up. Not every military attack leads to a resilient response. At the conclusion of his famous 1951 essay, Gerschenkron added an almost mystical element:

To break through the barriers of stagnation in a backward country, to ignite the imaginations of men, and to place their energies in the service of economic development, a stronger medicine is needed than the promise of better allocation of resources or even of the lower price of bread. Under such conditions even the businessman, even the classical daring and innovating entrepreneur, needs a more powerful stimulus than the prospect of high profits. What is needed to remove the mountains of routine and prejudice is faith – faith, in the words of Saint-Simon, that the golden age lies not behind but ahead of mankind. … In a backward country the great and sudden industrialization effort calls for a New Deal in emotions.

When he wrote this, Gerschenkron, who for a time in the 1930s had been a communist (he regretted that later and kept it hush-hush), had in mind the way in which the czarist modernizers had been unable to motivate Russians. He thought that Lenin and Stalin used faith in Marxist doctrine as the secret sauce. Today it is much easier to see the roots in a transformation of belief – or an awakening of faith. For modern Ukraine, it is very clear that the war has, in effect, created a nation that has put in place the conditions for a high-tech future.