UKRAINE’S ECONOMIC CRISIS: IS THERE LIGHT AT THE END OF THE TUNNEL?

Ukraine’s economic crisis: is there light at the end of the tunnel?

By Volodymyr Zviglyanich

If you look at the statistics, Ukraine’s economy is practically nonexistent. Since 1990, when the life of the average Soviet citizen stood up to 15 hours a week in lines to buy a scanty assortment of consumer products, Ukraine’s gross domestic product, as officially measured, has shrunk by approximately 60 percent. If anything like this happened in a Western economy, there would be serious social upheavals and political crises, and the very concept of Western civilization would be put into question.

Nothing of the kind is happening in Ukraine. Despite the inexorable decline of industrial and agricultural production, nobody is starving and no observable protests have been provoked by the statistical collapse of the economy.

This contradiction between real life and the picture painted by statistics forces many researchers to blame the statistics and to argue that most of the Ukrainian economy has gone underground into the "shadow" economy. But this answer does not absolve us from answering the questions: What are the economic and philosophical characteristics of the period through which Ukraine is passing? Why is Ukraine’s political elite showing no noticeable sign of alarm over the apparently catastrophic decline in output? Is there any empirical evidence such as polling data that would suggest that Ukraine can emerge from this crisis and, if so, how?

After a brief period of optimism sparked by the introduction of President Leonid Kuchma’s economic program in 1994, Ukraine has entered a period of "stagnation" comparable to the late Brezhnev era. The Ukrainian political elite prefers stagnation to innovation and is effecting a "clan-based" redistribution of property as Ukraine moves from a bureaucratic-oligarchic style of government to a new "capitalist" order. At the root of Ukraine’s systemic crisis lies the incompatibility between the value system still professed by the Ukrainian political elite and that of the Western, democratic world. Hope for a way out of the crisis depends on a shift in value paradigms in the mentality of the Ukrainian establishment and the inculcation of a new economic culture among the population.

From "October-94" to the "Ukrainian Model"

Leonid Kuchma did not expect to win the July 1994 presidential election and therefore had no economic platform worked out in detail. His economic program during the campaign could be summed up in two theses: 1) restoring ties with Russia; and 2) conducting radical economic reforms on that basis.

"Radicalism" was the key word in the economic promises made by Kuchma-the-candidate, and it attracted the attention of the proponents of "shock therapy" from Harvard, the IMF and the World Bank. Under their guidance and with the participation of Kuchma-the-president’s then advisor on macroeconomics, Anatoly Halchynsky, the "October-94" program of radical economic reforms was worked out and presented to parliament.

The program may be summarized as follows:

1) state subsidies would be cut and prices freed, while inflation would be restrained by fiscal and monetary stabilization;

2) government spending would be cut and the budget deficit reduced to eight percent of GDP in 1995, six percent in 1996, and four percent in 1997;

3) a market would be established by the end of 1994 for state securities, including bonds, short-term treasury notes and other debt instruments;

4) a system for auctioning securities would be created that would establish their real market value, taking inflation into account. (1)

The program was short-lived. Attacks on its "blind monetarism" and its diminution of the role of the state led to an early and dramatic change in direction. Addressing parliament in April 1995, Kuchma joined his critics in attacking "blind monetarism" and insisted that market reforms must take account of the social needs of the population and provide a strong safety net. (2) His speech marked a shift from the radical approach to a gradualist strategy of building a "socially-oriented market economy." In a speech in June 1995, Kuchma made a fundamental "correction" to his reform policy: instead of the inflation ceiling of one to two percent per month agreed upon with the IMF, the new ceiling would be four to five percent. (This relaxation of monetary discipline would allow many ailing enterprises to survive, but would only postpone the re-structuring that was needed for long-term economic health.) Halchynsky explained that the different inflation ceilings represented different economic models and policy goals. The first model was oriented toward the West. The second was a "Ukrainian" economic model.

Why did Kuchma, while preserving his image in the West as a pro-Western economic reformer, back away from the reform plan approved by the West?" There are three possible explanations.

First, the government failed to create the conditions for the success of the program, such as establishing a securities market, conducting monetary reform (the new national currency, the hryvnya, was introduced only in September 1996), curbing inflation, and implementing privatization. (3)

Second, the population did not welcome the radicalism of the "October-94" program and expressed itself in favor of "gradual" rather than "revolutionary" reform. (4) Opinion polls noted a significant paradox: although the population as a whole said it wanted reform, most people perceived no link between the improvement of their own economic situation and the creation of a market economy. Even those who supported market reforms thought that the state ought to guarantee their jobs. (5)

Third, the "correction" marked a dramatic change in Ukraine’s political landscape. The radicalism of "October-94" was an expression of post-election euphoria, when Kuchma and his "Young Turks" were keen to legitimize their unexpected victory in the eyes of potential donor countries and international financial organizations. The conservative wing of the Ukrainian political spectrum, represented by then-premier Vitaly Masol, was marginalized. The March 1995 appointment of Yevhen Marchuk as prime minister marked a sharp increase in the influence of Ukraine’s military-industrial complex, which had opposed the "October-94" program because it threatened to deprive it of state subsidies.

That was when the formation of the new oligarchy began — a coalition between political clans and the state-controlled financial and industrial groups that represented their interests. The "Young Turks" were forced either to withdraw from the political arena (this was the fate of the most prominent exponent of economic liberalism, the "Ukrainian Chubais," Viktor Pynzennyk), or to accept the new rules of the game. Today’s "Ukrainian economic model" is the result of a compromise between the pro-market liberal-minded reformers of Kuchma’s original team and the advocates of "stabilization" represented by a succession of prime ministers — Yevhen Marchuk, Pavlo Lazarenko and Valery Pustovoitenko.

Lessons of the "Ukrainian Economic Model"

The "October-94" program followed the prescriptions of the IMF and the World Bank for the transformation of command economies into market-oriented ones. Its basic premise was that such transformations are governed by scientifically-based, universally-applicable economic and political laws. This thesis is denied by the adherents of so-called "ethnic economics," who tie their economic strategies to the peculiarities of national historical traditions and psyche. Back in the fall of 1995, Kuchma and Marchuk combined the characteristics of "ethnic economics" with insistence on the necessity of increasing the role of the state in the economy. (6) They maintained that a state with strong regulatory functions was compatible with the historical traditions and mentality of the Ukrainian people. This amounted to a rejection of the Western liberal model, which counterposes decentralization, liberalization and competition to the autarky preached by those who search for a "third way" between capitalism and socialism. By creating obstacles to the flow of foreign investment, the "Ukrainian model" prolonged Ukraine’s transition to the market almost indefinitely.

There are important lessons to be drawn here.

Economic Lessons

Despite the significant amount of aid to Ukraine from Western financial institutions and governments, GDP has continued to decline. It fell in 1997 by four percent compared to the same period in 1996. This was an improvement by comparison with the 10 percent decline in 1996, but still left Ukraine near the bottom of post-Communist countries in terms of economic growth; only Turkmenistan and Albania performed worse. (7)

According to Swedish economist Anders Aslund, "Economic problems such as a continued decline in GDP are not perceived as a threat to the state. Therefore, the critical steps of tax reform and deregulation are not being taken." (8) Like the Brezhnev leadership before them, today’s Ukrainian elite have consciously chosen the path of "bureaucratic-oligarchic capitalism." This pays handsome dividends to a few, but does not create a mass base or a propertied middle class.

Political Lessons

The bureaucratic-oligarchic model is facilitating the redistribution of property between the existing political clans — the Kyiv, Dnipropetrovsk, and Donetsk clans. In the opinion of The Economist, "Mr. Kuchma’s error is that he has allowed one clan and one region [Dnipropetrovsk] to get too rich." (9) Natives of Dnipropetrovsk, including Ukraine’s current premier, Valery Pustovoitenko, currently hold 55 of the highest-ranking government positions. (10)

Institutional Lessons

Institutional corruption has paralyzed Ukraine and provoked the flight of companies such as Motorola, Marathon Oil, and Tate & Lyle. According to Jeffrey Sachs of the Harvard Institute for International Development, anyone wanting to do business in Ukraine will have to pay up to fifty bribes: for electricity, land, water, and police cooperation, to name but a few. (11) Traditionally, the Ukrainian government blamed corruption on a few dishonest individuals. But now the government itself is creating fertile ground by refraining from working out universally applicable rules of the economic game. Moreover, the national mentality does not see corruption as a great sin. Dozens of anti-corruption campaigns have been conducted in Ukraine, but not one high-placed bribe-taker has been convicted.

The failure of the "Ukrainian economic model" suggests that Ukraine’s crisis is systemic and has its roots in the incompatibility between the value- and cultural-orientation of the Ukrainian political elite and the Western value system. The Western system sees the opportunity to work and receive a commensurate reward for one’s labor as an individual right and pledge of personal prosperity and freedom. At its heart lies the Protestant work ethic. The Orthodox Christianity of the Slavic peoples preaches, by contrast, the primacy of the collective will over individual choice. Labor is seen not as an individual right but as a punishment imposed by the community on recalcitrant subjects; as such it is to be avoided. Reluctance to violate this unwritten but generally accepted social code underlies Ukraine’s devotion to the "Ukrainian model" and the "third way."

Is There Light at the End of the Tunnel?

Hopes for a resolution of Ukraine’s systemic economic crisis depend on the activation of Ukraine’s creative potential, especially its scientific and technical intelligentsia which, under the present system, is staring extinction in the face. Since 1991, the share of GDP devoted to science has been cut to one-fourth of what it once was, and now makes up 0.7 percent. The level of unemployment among scientific personnel has reached 90 percent as opposed to 40 percent employment for the work force as a whole. (12) Higher spending on scientific research and innovation could facilitate the transition from "degrading destruction" to "constructive destruction."

Under the former, production simply stops and demand is either satisfied with imported goods or is left without. This is what is happening in Ukraine now. Imports exceed exports, and structural changes in the economy are either postponed or do not take place at all. "Constructive destruction," in contrast, describes a situation where innovation squeezes out the old production methods and forces a restructuring of the economy. Only the choice of such a model for Ukraine can shift the emphasis away from the traditional Soviet concentration on the "means of production" and stimulate growth by fostering the emergence of a developed domestic consumer market.

NOTES:

1. Holos Ukrainy, October 13, 1994, pp. 6-7

2. Holos Ukrainy, April 6, 1995

3. Roberta Feldman, "Trends in Privatization in Ukraine," presentation by at the conference "Economic Reform in Ukraine: Progress and Prospects," Washington, DC, September 29, 1995

4. "In Ukraine, National Economy is Public’s Main Concern," USIA Opinion Analysis, January 13, 1995

5. IFES National Survey of the Ukrainian Electorate, prepared for the U.S. Agency for International Development, February 6, 1995, p. 8. See also The Economist, February 4, 1995, p. 47

6. "Marchuk Speaks on Economic Policy, Reform," FBIS-SOV, September 19, 1995, p. 53; "Kuchma Exhorts Economists to Solve Crisis," FBIS-SOV, September 18, 1995, p. 42

7. Ukrainian agencies, December 24, 1997

8. The Ukrainian Weekly, August 24, 1997, p. 8

9. The Economist, December 14, 1996, p. 52

10. Zerkalo nedeli, October 28, 1996

11. Kyiv Post, April 24-30, 1997

12. Holos Ukrainy, April 18, 1997, p. 8

Translated by Mark Eckert

Volodymyr Zviglyanich is a senior research fellow of the Ukrainian Academy of Sciences’ Institute of Sociology, a research associate at George Washington University, and a Senior Fellow of the Jamestown Foundation.

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