Ukraine at the Edge

by robert looney
Saul Loeb/AFP via Getty Images

bob looney teaches economics at the Naval Postgraduate School in California.

Published December 30, 2019


Donald Trump’s demand for Ukraine’s help in his reelection campaign thrust the country’s new president, Volodymyr Zelensky, into the center of an American political crisis. The contretemps is especially unwelcome as Zelensky begins an uphill battle to fight Ukraine’s notorious corruption, even as he presses for measures to jump-start sustainable growth in this terribly poor country.

Zelensky, a political novice who got elected by playing a corruption-fighting teacher-turned-president on a wildly popular TV sitcom, faces daunting challenges. To deliver on his campaign promises he will need to push through long-overdue economic and governance reforms that are bound to alienate a variety of stakeholders. But facing an oversized foreign debt, inadequate foreign exchange reserves and Vladimir Putin cheering on his enemies, Zelensky has little time to show he is up to the task.

Post-Soviet Blues

Ukraine’s economic history since the collapse of the USSR is a sorry, if now familiar, tale. After contracting sharply under corrupt, incompetent leadership in the early post-Soviet years, GDP growth rallied to average 6.7 percent between 2000 and 2009, albeit from a very low baseline. The surge was fueled by rising foreign demand for steel — Ukraine’s Soviet planners did leave the country with massive, if inefficient, steelmaking capacity — along with access to cheap oil and gas from Russia, which needed transit rights to deliver natural gas to western Europe.

But Russian patronage evaporated after Ukrainians rose up in the 2013-14 revolution to oust the corrupt pro-Russian government of Viktor Yanukovich and press for admittance to the European Union. In retaliation, Russia seized Ukraine’s Crimea region and fomented an interminable ethnic-Russian separatist rebellion in eastern Ukraine. The economy contracted by 6.6 percent in 2014 and 9.8 percent in 2015. Meanwhile, the loss of Crimea and the ongoing low-intensity war in the east is costing an estimated $7 billion a year. 

Russia also began exploring alternatives to Ukraine’s pipeline. These include the newly inaugurated Nord Stream pipeline via the Baltic, together with plans to build the South Stream pipeline outside Ukrainian territory via the Black Sea. Once the new pipeline complex is complete, Ukraine could lose an additional $3 billion a year in desperately needed foreign exchange.

The Rot Beneath

Underlying the short-term crisis is a long-term crisis. Ukraine ranks as the third most energy-inefficient country in the world, leaving it ill-positioned to make a transition to a diversified industrial base able to compete in international markets. Agricultural output, which represents around 42 percent of total export earnings, is running an estimated 30 percent below its potential.

Ukraine's economy ranks 85th on the World Economic Forum’s 2019 Competitiveness Index, putting it just above Moldova, arguably the Soviet Union’s most wretched castoff.

Meanwhile, thanks to the mess left by communism and the subsequent rise of Ukraine’s crony capitalism, the country’s economic freedom ranking is last among 44 European countries. No wonder, then, that the economy ranks 85th on the World Economic Forum’s 2019 Competitiveness Index, putting it just above Moldova, arguably the Soviet Union’s most wretched castoff.

Ukraine’s per capita income, roughly equal to that of Poland when the Soviet bloc collapsed, is just one-third that of its neighbor to the west. The World Bank estimates that, absent game-changing reforms, it will take Ukraine more than 50 years to reach Poland’s 2019 living standard.

A Way Forward?

President Zelensky has shown himself to be open to the aforementioned gamechangers, though he is still somewhat vague on specifics. His stated goal is to expand the economy by 40 percent over the next five years. But meeting this target will be impossible without a tsunami of foreign direct investment, which will not be forthcoming unless corruption is pushed back and the rule of law improved. And that will be very tough; according to the World Bank’s Doing Business 2019, the country lags behind even Russia in critical areas such as protecting investors, enforcing contracts and starting a business.

So what does Ukraine have going for it? The ironic advantage of being down so low that the only direction is up. For one thing, wages are modest compared to other European countries. That, combined with the EU’s interest in keeping a pro-Western government in charge of Ukraine, might be sufficient to attract much of the needed investment, provided foreign businesses can trust Zelensky to deliver on reform.

Consider, too, that Ukraine's underground economy produces an estimated 40-60 percent of GDP. This shadow economy ballooned largely to escape the corruption-fueled regulatory bureaucracy. If corruption were reduced and the otherwise legitimate activities of the shadow economy could be coaxed (or bludgeoned) into returning to the formal economy, Ukraine could see a boost in growth and tax revenue.

Zelensky has gotten off to a pretty good start on the anti-corruption front. He has done away with the immunity from prosecution previously enjoyed by members of parliament. And he has managed to appoint some honest souls to the National Council on Anti-Corruption Policy established by his predecessor.

But reforming agriculture is almost as important as tamping down corruption. Nearly 30 years after independence from the Soviets, more than a quarter of Ukraine’s agricultural land remains state-owned. Worse, the vast majority of state lands were previously unregistered, allowing oligarchs to avoid taxes on rents they collected from the individual farmers who account for the bulk of agricultural production.

The agricultural structure is also highly fragmented, a situation made worse by a long-standing moratorium on selling agricultural land. The reliance on small farms and low-margin crops combines with lack of mechanization, fertilizer and insecticides to lower agricultural profitability, offsetting the relative advantage of Ukraine’s famously fertile black soil.

Zelensky’s government has begun working on land reform to allow the privatization of state lands and promises to open up of the land market in 2020. Hopefully, food and agricultural policies will likewise shift toward promoting trade rather than containing food prices.

• • •

With the now-notorious July 2019 phone call with Trump revealed, the pressure is no longer on Zelensky to dig up dirt on the Biden family in order to receive military aid needed to fight on in eastern Ukraine. But the fundamental dilemma facing Zelensky remains. He needs to placate the Trump administration, even as he convinces domestic interests, the EU, the international funding organizations and foreign investors that his anti-corruption reform agenda is his first priority. Quite a task for a politician who got all his training for the role on a TV sitcom.

main topic: Region: Europe