Ukraine Deserves the West's Support

February 3, 2015 10:00 AM

 

Ukraine's situation is desperate but not hopeless. Russian artillery is ravaging the strategic city Debaltseve in eastern Ukraine and pro-Russian troops occupy a significant territory. Presumably Russian-sponsored terror attempts are common also outside of the war zone, mainly in Odessa and Kharkiv, while life in the capital Kiev is surprisingly normal. At least such was the case during a visit by a group of senior economists and former ministers to the Ukrainian capital on January 19–22.

All signs of depression were apparent during our stay. Output fell probably by 7.5 percent last year and another decline of 4 to 5 percent is expected this year. The exchange rate of the hryvnia plunged by more than half last year, prompting prices to rise by 25 percent. Most banks are bankrupt and many shops have closed.

But there are also signs of light. As Lithuania's former prime minister, Andrius Kubilius, summarized it in our group, "The real end of communism occurs when people knock down the Lenin monuments." In Lithuania, Lenin's monuments fell in 1991. In Ukraine this occurred only last year. Last October, scores of young democratic activists were finally elected to the Ukrainian parliament and in December they took over the government. As a result, the Ukrainian nation has come together because of the Russian aggression and hardship. Hardly any civil society is more active than Ukraine's. New volunteer organizations spring up and do whatever the government fails to do, thriving in Ukraine's free-wheeling blogosphere.

Our group was in Kiev at the invitation of Minister of Economy Aivaras Abromavicius, one of the young reform leaders. The new government is dominated by West-oriented investment bankers in their late thirties. Many are idealists who have given up well-paying jobs to make a difference. All but two of the twenty ministers speak English. In President Viktor Yanukovych's last government, only two ministers spoke English. All our many meetings took place as planned, more or less on time, and we conducted them in English without interpretation.

We felt like we were in Central Europe after the fall of the Berlin Wall in 1989. Youth, professionalism, and idealism have taken over on a broad scale in both government and parliament. Most of the parliamentarians have never before sat in parliament. Ukraine has gone through a fundamental rejuvenation and modernization. It is not likely to go back to its old Soviet ways.

One reflection of the current openness of Ukraine to the West is that three foreign nationals have been appointed ministers. The two strongest contingents of foreign reform advisors come from Lithuania and Georgia, with at least half a dozen senior officials from each country. These two countries have carried out successful reforms in recent years. The Lithuanians focus on structural economic reforms while the Georgians deal with health care and law enforcement reform.

As is always the case in a period of turmoil, some new officials have figured out how to pursue reforms, while others are left to explain why change is impossible. Reform is being prepared on a broad front, perhaps too broad, and it is too early to say what will succeed and what will fail.

Three big economic reforms are under way and look promising. The most important is the unification of all energy prices at the market level, which would eliminate the greatest cause of top-level corruption and the need for vast subsidies. Unification of gas prices is vital to safeguard Ukraine's energy security from Russia and to stimulate energy saving as well as domestic energy production. Unifying energy prices could save the Ukrainian government as much as 8 percent of GDP.

Another ongoing reform is the elimination of dozens of inspection agencies, permits, licenses, and certifications, whose only purpose is to allow parasitic officials to extort businessmen. A third major reform attempt is to clean up the remaining large state enterprises from corruption. The Ministry of Economy has singled out the 62 biggest state corporations for adopting international audits, professional managers, and boards with independent directors.

The greatest outstanding issue is fiscal consolidation. The newly appointed government pushed a budget through the parliament just before the New Year, but apart from the energy reforms it does not contain any cuts of Ukraine's far too large public expenditures. The government's budget proposal was aggravated by hostile populist amendments, such as capping all public salaries at a very low level. This budget needs to be revised, which Prime Minister Arseniy Yatsenyuk acknowledges, to gain the approval of the International Monetary Fund. Otherwise the substantial international assistance that Ukraine so badly needs may be in doubt.

If the energy prices really are unified and thus the energy subsidies are eliminated, Ukraine will have accomplished most of its fiscal adjustment. But Ukraine must also cleanse public procurement, which should save the government at least 2 percent of GDP. Special pensions for the old privileged groups account for 4 percent of GDP, and most of it should also be cut.

The government needs to emphasize expenditure cuts in programs that promote or finance corruption. A debt restructuring seems to be in preparation, but that will hardly give more than $9 billion in total. Ukraine still needs substantial additional financing from the International Monetary Fund, the United States, and the European Union of at least $27 billion this year. So far, about $18 billion has been committed. All funders need to come up with more.

Social tensions are growing. Living standards are falling in front of our eyes, but many Ukrainians are more upset about corruption, and all are concerned about the Russian military aggression. Independent and democratic Ukraine and its economic reforms need all the support we can give.

Anders Åslund is a senior fellow at the Peterson Institute for International Economics and was an economic advisor to the Ukrainian government in the 1990s.