The underachiever:Ukraine’s economy since 1991

Pekka SutelaCarnegie Endowment

27 January 2012

1Pekka Sutela

Track record

• Ukraine has grown with the region– Was in 1990 one of the poorest of Soviet republics

and has remained in a similar position: no catching up, no lagging behind

• Growth in 2011 (>4%) and expectation for 2012 (<4%) essentially identical with Russia

• Inflation in 2011 higher than in Russia, and expected to remain so

• The 2012 Index of Economic Freedom: 163/183 countries, lowest in the European region

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Issues for 2012• Foreign trade and payments

– Current account deficit 8.75 BUSD in 2011:1-11 (2.13 BUSD in 2010)

– Capital outflow due to European financial regression– Servicing 8.2 BUSD of public and >50 BUSD (est.) of total debt

• Government bonds (maturing 2117) yield 6.9 in 2011:7, 10.9 in 2012:1

• Official reserves 38.2 BUSD in 2011:8, 30.4 BUSD in 2011:12• Fiscal affairs

– Headline budget deficit 4.3%/GDP, more in state banks and companies

– Exceptionally large pension burden with declining and greying population

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• Gas– Import price 400 USD in 2011:IV, according to

contract 416 USD in 2012:1 (without Kharkiv discount?). Ukraine aims at 250 USD (with discount?)

– Less transit revenue due to Nord Stream– European buyers demanding and getting price

discounts: puts also pressure on transit fees– Ukraine claims to be able to decrease gas imports

from 40 Bm3 in 2011 to 27 Bm3. From gas to coal?

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World Bank’s Doing Business 2011:Kazakhstan, Russia and Ukraine

(out of 183)Kazakhstan Russia UKRAINE

Altogether 59 123 145

Starting a business 47 108 118

Dealing with construction permits

147 182 179

Registering property

28 51 164

Getting credit 72 89 32

Protecting investors 44 93 109

Paying taxes 39 105 181

Trading across borders

181 162 139

Enforcing contracts 36 18 43

Closing a business 48 103 150Pekka Sutela 5

Ukraine / IMF situation

• Press briefing yesterday: ”an active dialogue through technical teams in the period ahead”

• No timeline

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Three questions

• Why is such a badly functioning economy able to grow as fast as others in peer group on average?

• Why is Ukraine such a badly functioning economy?

• Is the combination of bad functioning and average growth a vicious circle?

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(1) Why is such a badly functioning economy able to grow as fast as

others in peer group on average?• We do not really know how fast countries have been

growing– General problems in changing statistics from Soviet ones

to market based– True depth of decline in the 1990s unclear, due to high

inflation, change in price relations and structural change – Estimating the true size of shadow economy difficult ,

especially large in Ukraine• Steep decline in GDP provides for fast recovery growth– probably

• Neither are the others in peer group well-functioning– But Ukraine seems to be the worst on these indicators

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• Perhaps Ukraine inherited better capital stock, infrastructure?– Possible, due to post-war reconstruction– But Ukraine not better in infrastructure and general

industry reform (EBRD Sector Transition Indicators 2011)

• Then, Russia and Kazakhstan are resource rich, Ukraine resource wealthy– Russia has Resource Curse, no Dutch Disease– How about Ukraine?

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The Ukrainian Curse

• In the 2000s Ukraine’s terms of trade improved by 50%– Unit values of exports (metals, metallurgy,

petrochemicals) rose with fast global growth– Prices of energy exports from Russia (gas!) remained low– This created a rent division game with need of access to

state resources and corruption– Privatization to domestic owners (oligarchs); little access

by outsiders including Russians• Logistics as another source of rents– Pipelines, railways, roads, harbors

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The windfall is not sustainable• By 2006 Russian leadership had concluded that the country

could not develop on resources– Very slow growth of oil and gas production– GDP expected to grow faster due to structural change, financial

deepening etc– Maintaining export volumes only possible with improved energy

efficiency, which demands higher prices and much more (modernization)

– Jobs could therefore no longer be subsidized through low energy prices. Much wider competitiveness (diversification) needed

• The economic reasons for gas price disputes do not exclude political ones. But why give Ukraine priority access to raw materials and logistics windfalls?

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Ukraine aiming at best of both worlds: the grey zone

• Export markets are in Europe and Asia– Ukraine does export high-value goods also, but only ones

produced in Soviet-time plants, and in small volumes: no real diversification

– Collapse of machinery exports to FSU has made exports more one-sided and lower value-added

– Agri-business an argument for free trade with EU– Few incentives to adopt acquis as no membership perspective

available. Motivation for ”free and comprehensive free trade”at best unclear

• Import markets are in Russia. How to combine– National independence– Access to cheap raw materials and logistics windfall

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(2) Why is Ukraine such a badly functioning economy?

• Modern economics says– Long past institutions and culture have an impact on modern

performance• Lack of individualism• Impact of different empires, with Russia as the dominant one

• Tragic 20th century– Battle field of world and civil wars– Stalinism, collectivization, holocaust, forced population movements– From internationalism to Soviet closedness

• Peculiarities of the 1990s– Nation building over structural reforms– Free room for asset-grabbing

• The Ukrainian Curse

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(3) How can the circle be broken?

• Only the Ukrainians can do it• There is no lack of reform blueprints• Political will does not exist

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