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Table of Contents Show
- Part One. How Putin saw the Ukrainian economic crisis (but did not notice similar problems in Russia)
- Part Two. What really happened to the Ukrainian economy before the war
- Part three. How the mere threat of war led Ukraine to a new crisis, and the invasion led to an economic collapse.
- Part four. What happens to people (or in economic terms, human capital)
- Part Five. Can the Ukrainian economy be restored now – and where to get the money for it?
For over ten years I have been writing about the Russian economy. But even in my worst nightmare, I could not imagine that I would witness in real time how it is being destroyed.
Against the backdrop of what is happening – when people die and cities are bombed – the conversation about economic difficulties seems unimportant and premature. However, war is not only a clash of armies, but also a confrontation of economies. And the longer it lasts, the more important the economic resilience of the warring states begins to play. In the economic confrontation between Russia and Ukraine, it seems clear who the leader is: before the war, the Russian GDP was immediately nine times larger than the Ukrainian one. But now on Ukraine’s side – the European Union and the United States, and together their economies are more than 22 times larger than Russia’s.
My today’s text is dedicated to the economy of Ukraine. Will it survive? What has been happening to it for these months? And what is the cost of war? Of course, the main cost is the loss of lives, but inevitably, we will have to sum it up in money.
Another important question is whether there is hope for the recovery of the Ukrainian economy. Leading experts worldwide are already searching for an answer. I will say this right away: yes, there is hope, but the risks are immense. It may be necessary for Russia itself (and therefore all of us) to partially cover these risks.
This text is dedicated to the Ukrainian economy, but it often mentions the Russian one. Our countries’ economies have many common problems, so it is useful for Russian readers to learn about Ukrainian experience. At the very least, to understand that economic development is possible even in very difficult conditions.
The material contains about 24,000 characters and will take you 15 minutes to read. The text consists of five parts.
The first part is dedicated to what has been happening with the Ukrainian economy over the past eight years. Was it really as bad as Russian authorities and propagandists describe it? The second part is about the economic reforms that the leadership of the country tried to implement in order to improve the situation (though progress was not significant). The third part will tell how the mere threat of war led to an economic crisis in Ukraine, while the invasion itself led to collapse. The fourth is about people and the destruction of human capital. Finally, the fifth part is about forecasts and plans for the future, which are incredibly difficult to build at the moment. However, some of the best global experts are still trying to do so (and Kit managed to talk to some of them).
Part One. How Putin saw the Ukrainian economic crisis (but did not notice similar problems in Russia)
For the past eight years, starting from 2014, propaganda has been trying to persuade Russian society that Ukraine’s economy is awaiting a real collapse (or even “murder“) in the near future.
At the highest level, they are also talking about it. Several days before the invasion, Russian President Vladimir Putin commented on the topic, stating that “Ukraine is experiencing a sharp social and economic crisis.”
The crisis in the economy is understood to mean a decrease in GDP. In 2014 and 2015, due to Russia’s actions, Ukraine lost part of its territory and at the same time faced a military conflict within its borders. In these two years, the country’s GDP did indeed decrease – by 10.1% and 9.8% respectively. But starting in 2016, the Ukrainian economy began to grow again, on average almost 3% per year. This growth continued until the coronavirus year of 2020.
One cannot measure the real economic well-being of a state solely by GDP, which is why Putin also talked about Ukrainian utilities: “Many people simply do not have enough money to pay for utilities, they have to literally survive.” Indeed, prices for utilities in Ukraine have noticeably increased. This was the result of the authorities’ attempts to reform the housing and utilities sector at the request of the International Monetary Fund, which provided loans to the country.
Just like in Russia, people in Ukraine have been paying significantly less than market price for electricity and gas for many years (the maximum tariff being set by legislation). Thus, the government subsidizes the population, but this support has significant drawbacks. Energy companies compensate for the loss of revenue by charging higher tariffs for businesses, causing a hindrance to their development. Entrepreneurs have less money for modernization, implementation of new technologies, and energy efficiency.
Ukraine started the reform of the housing and communal services sector in 2014. Tariffs began to increase. However, the reform was progressing with variable success, and communal payments became very painful for many. Therefore, at the end of 2021, the Ukrainian authorities had to again limit the growth of tariffs, keeping them below the “economically justified” level.
But this problem is certainly not unique. The system of state tariff subsidies dates back to the Soviet Union. The Russian energy sector is still suffering from it. For years, energy officials have been cautiously calling for a transition to market pricing (without government restrictions on tariff growth), and officials are also cautiously “working out the issue.” In the fall of 2021, it became known once again that tariff reform in the housing and communal services sector is being discussed in Russia. Moreover, on the same principles as in Ukraine: to raise tariffs to “economically justified” levels and provide compensation for the most needy. Deputy Prime Minister Marat Khusnullin instructed responsible ministries and departments to work out the issue, but the results of this work are still unknown.
Caution here is politically justified. Housing and communal services tariffs in Russia have long been a problem. Even with state regulation, they steadily increase and complaints about unaffordable utility bills are regularly heard on direct lines with the President. According to a survey by Levada Center, Russians hoped that in the current presidential term of Vladimir Putin, tariffs would decrease. Expectations have not been met: the rise continues even during the war.
But let’s return to Ukraine. According to Putin, the main reason for Ukraine’s economic collapse is corruption: “The dowry received not only from the Soviet era, but also from the Russian Empire, was squandered and distributed among pockets.” However, if we rely on international assessments, in this regard, Russia and Ukraine are not very different. The situation in Ukraine is even more favorable.
So, the corruption perception index, which is measured by Transparency International*, in 2021 was 32 points (122nd place in the world ranking) for Ukraine and 29 for Russia (136th place). The higher the value of the corruption perception index, the lower the level of corruption. Meanwhile, Russia’s index value has not improved over the past 10 years, while in Ukraine it has slightly, but still increased – from 26 points in 2012 to 32 in 2021.
The final diagnosis that Putin made for the Ukrainian economy may also seem painfully familiar to you: “Poverty, hopelessness, a loss of industrial and technological potential.”
All of this applies equally to Russia, and with the start of the war and the imposition of sanctions, it has become more relevant than ever. Prior to the invasion, the Ukrainian economy did indeed suffer from poverty as well as slow technological and industrial development.
However, unlike the Russian one, it’s not out of desperation.
Part Two. What really happened to the Ukrainian economy before the war
The Ukrainian economy is a vivid example of how painful reforms based on international models (including those recommended by the International Monetary Fund) can somewhat improve the situation, but negatively affect citizens.
However, some reservations must be made here. If these reforms are carried out on the basis of old inefficient institutions, too slowly and with great resistance in society, it is still quite difficult to catch up with the lag in economic development.
A little theory to make clearer what you just read. By institutions, we mean the rules and norms that govern society – both formal and informal. A simple example of formal rules is the rules of the road. Compliance is ensured through mechanisms of coercion: fines, administrative and criminal cases for violations. However, this is not effective in all countries. If the responsibility for the violation is small or easily avoided, people will actively ignore the rules. Therefore, formal institutions work more effectively when they are additionally supported by informal norms (public attitudes). If driving under the influence or bribing inspectors is considered unacceptable, there will be public condemnation in addition to formal punishment. With such a system, citizens of the country are much more law-abiding.
For the economy, it is important how the institutions of state regulation, law enforcement, and the judicial system function. But it is difficult to separate the economy from politics, so the rotation of power, representation of the interests of different groups in parliament, freedom of speech, assembly, and other freedoms also have a direct or indirect impact on the economy. Therefore, when any or even all of the named institutions start working incorrectly and inefficiently, it hits the growth of prosperity for the entire society.
The Ukrainian economy gradually started to recover after the recession of 2014-2015, largely due to the reforms initiated by the country to obtain financing from the International Monetary Fund. In fact, the reforms were a condition for the financing. However, progress was not significant. By 2016, Ukraine’s GDP per capita was only 30% of the equivalent figure in Poland, which joined the EU as early as 2004 (the economies of these countries are quite similar, which is why we compare them). It was not possible to significantly reduce this gap. Inefficient institutions became one of the key obstacles to Ukrainian economic development, according to IMF economists in the spring of 2021.
Here’s how they describe Ukraine’s economic problems. Despite the development of market institutions, the state’s influence on the economy remained too great. The issue is the state control over the country’s key companies. The largest infrastructure enterprises in Ukraine are either fully or partially owned by the state, including the energy giants “Naftogaz,” “Ukrenergo,” “Ukrhydroenergo,” and “Energoatom.” State-owned banks accounted for 56% of all assets in the Ukrainian banking system.
But that’s not all. Protection of private property rights in Ukraine is limited by the weakness of the judicial system, which is still subject to the influence of oligarchs and political leaders. The country continues to experience a high level of corruption and has not developed a strong enough market competition. Some sectors of the economy are even monopolized – meaning that elites enrich themselves while foreign investments that help the economy develop are difficult to attract.
The problems faced by the Ukrainian economy in recent decades are very reminiscent of those faced by Russia. However, it is important to remember two important differences. First: in 2014, Ukraine began reforms aimed at overcoming these problems – nothing similar happened in Russia. And second: the annexation of Crimea and the conflict in Donbass have both complicated economic development in Ukraine as a whole and influenced the pace of reforms in particular.
But the reforms were still ongoing, albeit not as quickly as desired. And then the war began.
Part three. How the mere threat of war led Ukraine to a new crisis, and the invasion led to an economic collapse.
The main enemy of an investor is uncertainty. And armed conflicts are one of its most powerful sources.
In the 2010s, against the backdrop of the annexation of Crimea and the conflict in Donbass, direct investments in Ukraine literally collapsed: from $8.4 billion in 2012 to $410 million in 2014. Two years later, their inflow resumed, but they never returned to the previous level.
Of course, the cost of the conflict in Donbass is not only the lost foreign investment, but primarily the loss of human life. From 2014 until the beginning of 2022, more than 14,000 people have become victims of the conflict. Additionally, defense spending in the budget has increased from 1.6% of GDP in 2013 to 4.1% in 2020. This could not but affect other peaceful expenditure items. In other words, there was less money left in the budget for the development of infrastructure, education, healthcare, culture, social benefits, and much more.
From the end of 2021, as Russia was deploying troops to the Ukrainian border, pursuing reforms became almost impossible. Even investors who had been investing in Ukraine for years hastily withdrew their money. This was the first blow of the war to the Ukrainian economy, even before the invasion began.
The National Bank of Ukraine found itself facing the threat of financial collapse. The hryvnia sharply depreciated. Foreign investors sold off 20% of Ukrainian government bonds in two months. Ukrainians began to massively buy foreign currency.
To somehow improve the situation, the National Bank was forced to resort to currency interventions, selling off international reserves. It tried to assure people and markets that the country had enough reserves and currency liquidity to continue to timely repay external debts. But from the first day of the war, no assurances could persuade anyone. And the National Bank had to introduce strict currency restrictions: a ban on currency exports, as well as limits on currency withdrawals. After that, the Ukrainian Central Bank switched from a floating exchange rate of the hryvnia to a fixed one.
In early March, Ukraine received the first tranche of emergency aid from the IMF to support financial stability – $1.4 billion. And by May, the situation had stabilized (as much as one can say during a war). The National Bank even resumed the publication of monthly economic reviews. By the way, they are quite interesting. In conditions of war, economists do not have access to a significant part of traditional statistics, so they have to use alternative indicators, including monitoring the Ukrainian segment of Twitter.
Experts are counting the number of tweets with photos and geolocation tags in different regions of the country. Research has shown that as a rule, the share of tweets from a particular region correlates with the share of the country’s GDP that is accounted for by that region. That is, the number of tweets can indicate whether economic activity is returning to pre-war levels in a specific area or not.
In the recent overview, the National Bank reported that in May the economic activity in the country continued to recover – by the end of the month, only about 14% of the country’s enterprises were not working. However, it is not about full-fledged work: the capacity utilization is 40% lower than the pre-war level. Nevertheless, gradual recovery was observed in all sectors of the economy, according to the National Bank. Thus, in the industry, individual metallurgical enterprises managed to de-conserve production, solve logistics problems, and resume exports.
In the service sector and retail, the return of refugees home is helping with the recovery: 2.3 out of 7.3 million people who left their homes have already returned to Ukraine. Turnover in the food service industry has increased, and retail chains continue to open stores that temporarily stopped working due to the war. However, of course, the economy of Ukraine continues to face a huge number of problems: the fighting itself, the destruction of infrastructure and major difficulties in exporting goods.
Export is critically important for the Ukrainian economy, but restoring it is currently not possible. According to the National Bank data, April’s export volume remained at March’s level. Due to the war, not all exporters can continue to produce goods, and those who still do face significant logistical difficulties, including the blockade of seaports. Prior to the war, Ukraine exported about 70% of its exports by sea, mainly through the ports of Odessa.
Due to the decrease in export revenues, Ukraine has been deprived of foreign currency inflows. However, any country needs currency to pay for imports. According to the National Bank, imports to Ukraine have recovered faster than exports. This creates problems for the country’s balance of payments, but they are being overcome for now by foreign funds. By the beginning of June, financial assistance to Ukraine (money specifically allocated to support the country’s financial system) exceeded 30 billion dollars.
Another pressing issue is the military aid to Ukraine, which is directly linked to the country’s economic resilience. When defense spending is too high, the civilian sector suffers and the crisis worsens. It is important to note that war is not just a confrontation of armed forces, emphasizes Professor Yuriy Gorodnichenko of the University of California, Berkeley.
He is one of the most well-known economists of Ukrainian origin and one of the most cited economists in the world over the past decade. Gorodnichenko says that war is a major economic competition. Who can provide more armaments and equipment? Whose reserves are larger? Thanks to foreign aid, Ukraine does not have to search for resources for this war on its own – for example, by printing more money. This is significant support, but the danger of the situation is that foreign aid cannot be a constant resource for waging war, warns the economist. To win the war of attrition, Ukraine needs a working economy and a constantly replenished budget.
How to achieve this? Through taxes, for example. In late May, Ukraine’s Minister of Finance, Serhiy Marchenko, announced that the taxes that were temporarily suspended at the beginning of the war will be reinstated. The value-added tax on imported goods and import duties will be collected again, which will also support Ukrainian producers who compete with imports. The minister warned that gradually all taxes in the country should return to pre-war levels.
Part four. What happens to people (or in economic terms, human capital)
The longer the war lasts, the more money will be needed later to restore the country’s economy. Perhaps this spring you read forecasts that Ukraine’s GDP will lose 30-45% by the end of the year. It sounds more than serious, but in reality, everything is much worse than you can imagine.
The thing is this. Usually, even big drops in GDP are a result of serious crises. Economic activity of people sharply decreases during such periods. It’s understandable – they lose income sharply and are afraid to spend. As the economy enters a new cycle, enterprises restore production, workers return to their positions, and GDP growth resumes.
The long-term consequences of war are much more dramatic than just a decline in GDP. War destroys infrastructure and production capacity – so you can’t just go back to them, they have to be recreated first. This requires people, a lot of people, but war destroys human capital. Many thousands are killed and injured. Millions are refugees.
The loss of human capital is not limited to this. Many people will not receive education because of the war, which means they will not have a profession. And some will not be able to work for a long time or never at all – due to physical or psychological traumas.
In their June research, Yuriy Gorodnichenko, Marianna Kudlyak from the Federal Reserve Bank of New York, and Aishwarya Seshadri from the University of Texas at Austin sought to estimate the losses of Ukrainian human capital. According to their estimates, more than 60% of the country’s population, not including military personnel, have already suffered from the war.
The problem is not only the scale of the blow to human capital, but also that the negative consequences of this blow can persist for many years, according to the authors of the study. According to May estimates from the International Labor Organization, employment in Ukraine has decreased by 30% compared to pre-war levels, which means that there are 4.8 million fewer jobs.
If the war were to end right now, 3.4 million of them could be quickly restored (how quickly – the authors of the study do not specify). But the longer it lasts, the harder it will be. Moreover, it will be difficult to return both the previous jobs and those who occupied them.
After remaining unemployed for a long time, people lose their skills in their profession and even the desire to return to it (especially workers of pre-retirement age). In addition, some refugees who managed to settle in other countries will not return to Ukraine.
There is also some good news – during the period of recovery and renewal of the Ukrainian economy, there will surely be a demand for new professions. However, the reverse process will also occur – many old professions will become obsolete. For example, this concerns employees of not the most modern industrial enterprises: they will need retraining and qualification improvement programs. And for those people who are currently at war and will return to peaceful life – rehabilitation and reintegration programs. And also, the number of people with disabilities in the country will noticeably increase, and special infrastructure will have to be built for them.
All of the above is part of the overall approach to rebuilding the Ukrainian economy under the principle of Build Back Better (i.e. “Better than Before”). This approach is recommended to Kiev by leading economists around the world.
Part Five. Can the Ukrainian economy be restored now – and where to get the money for it?
In April, the influential non-governmental organization Centre for Economic Policy Research (CEPR), bringing together hundreds of economists-researchers from around the planet, published a report called “A Blueprint for the Reconstruction of Ukraine”.
The work on the report was headed by Ukrainian economist Yuriy Gorodnichenko. The team included almost a dozen outstanding global economists, including two former chief economists of the International Monetary Fund. Their proposed scenario is called a new Marshall Plan for Ukraine – similar to the program of aid to Western European countries after World War II proposed by US Secretary of State George Marshall.
Experts have preliminarily estimated that an amount of 200-500 billion euros will be required for the post-war recovery of the Ukrainian economy. This is more than the entire original Marshall Plan, if it were recalculated in today’s dollars, commented Sergey Guriev, a professor at Sciences Po in Paris and a member of the team behind the “Plan”.
The main donor of the Marshall Plan was the United States. Economists are calling for Europe to become such a donor for modern Ukraine. One of the central ideas of the plan is that Ukraine will “embark on the path to joining the EU.”
On June 24, the heads of EU member states unanimously decided to grant Ukraine the status of a candidate country. After this, the country has the right to begin formal negotiations on joining the bloc. In order to do this, it needs to meet several criteria: have effective institutions, a market economy, and the ability to fulfill all the obligations of a member state (foreign policy, economic, and monetary).
The process of entering the EU can take years and even decades. For example, Turkey has been unable to do so since 1999. However, it should not be seen as a purely symbolic event that Ukraine has been granted this status, emphasizes Yuriy Gorodnichenko in a conversation with Kit: “This is a formal recognition that Ukraine is part of the European family and now has a path open to membership in the European Union.”
“Candidate status will give Ukraine many new opportunities,” he continues, “the country will begin to receive significant advisory and financial assistance. Overall, from now on, the European Union will be more formally responsible for supporting Ukraine,” says Gorodnichenko.
The European Union has already promised to provide Ukraine with 9 billion euros. This amount will help Ukraine stabilize its budget for the next two months. And the leaders of the G7 countries have assured that they are ready to financially support Ukraine as much as necessary.
But it’s not just about money. Candidate status will become an important incentive for new reforms in Ukraine, and over time, the country’s legislation will become more similar to European legislation. This will undoubtedly stimulate economic development, and at the same time European technologies and institutions (including anti-corruption ones) will be “imported” into the country. The very accession to the EU can sharply accelerate economic growth. For example, in Poland, in the first incomplete 15 years of membership in the European Union, GDP per capita grew by more than 80%.
How soon can Ukraine become a member of the EU? According to Gorodnichenko, this could happen within the next five years and it is an “achievable goal”. “Turkey is an example of how one can hold candidate status for many years without any progress. There are also good examples – such as the Baltic states or Croatia, which joined the European Union shortly after the war on their territory. We need to pay more attention to such positive examples and learn from their experience,” he comments.
At the same time, Gorodnichenko emphasizes that the five-year term can only start counting after the war is over. Therefore, “now everything depends not so much on Ukraine itself as on Russia”: “We are talking with you on June 27th – today Russian troops fired missiles at a shopping center in Kremenchuk. It is difficult to maintain the economy in such conditions.”
By the way, about Russia. Part of the money for post-war reconstruction in Ukraine is proposed to be collected from the Kremlin. Ukrainian economist Viktor Tsyrennikov estimated Ukraine’s total losses from the annexation of Crimea, the conflict in Donbass, and the current invasion at $1.36 trillion. According to the economist’s calculations, if the Kremlin were to transfer 25% of its oil and gas revenue to Ukraine, at the current level of supply and oil price of $100 per barrel, Russia would be able to pay off its debt to Ukraine in 15 years. And if frozen $300 billion of international Russian reserves seized during sanctions were also taken out, it would be paid off in 11 years.
In general, there are various recipes proposed. But it is still not entirely clear how to get out of such a large-scale economic crisis, emphasizes economist Guriev. According to him, it will take years to recover in any case.
“This is an unprecedented challenge, and I will not exaggerate our understanding of how to deal with these risks,” the economist stated. And yet, there is hope, he says. Over time, Ukraine may not only return to pre-war GDP levels, but also have a much more modern economy structure that is more competitive and even more environmentally friendly.
In the coming years, Ukraine will remain a relatively poor country, Guriev acknowledges – much poorer than Russia.
However, the vectors of further development of the two countries are fundamentally different. No matter how difficult the situation in Ukraine may be, it has a way forward and light at the end of the tunnel, Yuri Gorodnichenko continues the thought. Russian authorities, on the other hand, are sinking deeper and deeper into isolation, which will turn the country’s economy into a technologically backward one.
But this sad conclusion does not want to be considered final and irreversible. Perhaps someday the experience of rebuilding and developing a new Ukraine will be useful for a new Russia.