Snapshot on Ukraine’s economy amid current geopolitical crisis
Over the past couple of months, Ukraine has been topping the news in the major English language media outlets again. The “Ukraine crisis” issue has resurfaced after its first appearance in 2014.1
Back then, Russia’s leadership staged a military invasion and effectively annexed a sizable and economically viable part of Ukraine's territory. It seized the Crimean peninsula and parts of the industry-centered Donbas region.
Now, in early 2022 (eight years since the invasion), there is talk of Russia’s leadership considering another and possibly bigger military intervention into other parts of Ukraine’s territory.
On Twitter, leading economic commentators with a large audience such as Adam Tooze, history professor at Columbia University, and Noah Smith, a Bloomberg Opinion columnist, shared their opinions on the matter.
Tooze published two articles this year so far, see (2022a) and (2022b). The first one published in January was titled “Putin's Challenge to Western hegemony―the 2022 edition” and the second one was published in February and titled “Permanent crisis or Black Earth agro-giant? Alternative futures for Ukraine.” Smith (2022) was trying to make a bigger statement in solving the growth puzzle in his article, “Why is Ukraine such an economic failure? An urgent mystery.”
Both authors were reflecting on the “Ukraine crisis” in their own way. However, what makes these opinions so noteworthy is that both of them framed their premise in terms of Ukraine’s “economic failure.” Hence, economic weakness is among key other factors that invite a greater power interference. For example, Tooze put it this way:
What makes Ukraine into the object of Russian power is […] its economic failure. (Tooze, 2022a)
As a Ukrainian, I would like to provide my own view on the matter here.
Previously, I had argued that Western sanctions on Russia as economic retaliation for the 2014 invasion of Ukraine would rather help the Kremlin to fix Russia’s ailing economy than impose costs on it (please refer to these articles: here, here, and here). The argument was―and it still stands, in my view―that sanctions have been grounded on an imperfect economic theory from the very beginning. It is not worth emphasizing this point here.
In this piece, rather, I would like to reflect on this recent alleged notion of Ukraine’s “economic failure.”
Last year, in 2021, Ukraine’s economy recorded a real GDP growth rate of 3% compared to the previous year. The pace of consumer price inflation sped up to a higher-than-expected 10% YoY by the end of the year from the 5% seen in December 2020. Domestically, financial markets for overnight rates and the hryvnia’s exchange rate, the national money of account, have been rather subdued. The domestic overnight rate for central bank balances was at the floor of the central bank target range, firmly under control of the central bank. The foreign-exchange rate of the hryvnia (Ukraine’s national money unit of account) versus the U.S. dollar was fluctuating within an acceptable range, and it helped strengthen the widely held market view of achieved exchange-rate nominal stability, when the FX rate does change from day to day, while at the same time, an erratic runaway depreciation was absent.
In part, steady increases of the central bank’s target range for its overnight rate has supported the FX rate over the past year and year to date.
It should be noted, too, that producer price inflation in December 2021 reached 62% year-on-year, which is the fastest pace on record since June 1996. When the COVID-19 pandemic hit and put the global economy into lockdown, Ukraine’s producer price inflation was trending in negative territory in year-on-year terms most of the time during 2020, recovering only in the last quarter of that year.
Now, it appears that global commodities markets that saw a spike in prices of raw commodities from food to energy in 2021 found a reflection of this in the consumer price situation in Ukraine’s economy. Both consumer and producer price indices reflected that to an extent, in addition to other factors.
The year-ago projections by Ukraine’s central bank assumed that the economy would grow 4.1%2 in real terms for 2021, and the pace of consumer price inflation today would be at 7%, with producer price inflation at 6.8%. All of these projections did not materialize precisely. Price metrics turned out to be a bit higher than expected, as mentioned above, while the growth metric was lower than expected. This occurrence serves as a reminder of just how tricky economic forecasting is, even by quite resourceful economists at the national central bank.
Growth-wise, the 2021 results show that Ukraine’s economy as of today is about 3% below its pre-COVID trend. Such a shortfall from the trend is rather comparable to how many other countries have fared since the pandemic (see here). For example, the US economy fell just 1.4% short of the pre-COVID trend by the end of 2021,3 while some of the Eurozone member countries had shortfalls in the 2-6% range as of end-3Q 2021.4
This recent episode contrasts sharply with the extended history of Ukraine’s economic growth data.
Before the pandemic, economists used to rely upon the pre-Global Financial Crisis (GCF of 2007-08) trend as a reference to how quickly an economy recovers after a crisis. Viewed from this perspective, Ukraine’s economic performance has been outstandingly sluggish; its shortfall relative to the pre-GFC trend is currently deep in the double-digit area (see chart below). If one extends the historical data further into the early 1990s, when Ukraine gained its independence, the shortfall in the trend (before the break-up of the Soviet Union) would only increase even further.
Noah Smith builds his argument on Ukraine by referring to this long history of fluctuating economic performance. Adam Tooze also implicitly references it in his January’ article, while in his February one, he acknowledges it with the statement:
Ukraine’s performance between 1990 and 2017 was not just worse than its European neighbors. It was the fifth-worst in the entire world. (Tooze, 2022b)
Hence, it is not an exclusive by-product of the Russian military aggression since 2014. There is something more to it than that. And, the above-mentioned economic commentators concur with this statement of mine.
Their conclusion, so far as the economy is concerned, differs from mine, however. They argue that a more active economic reforming will solve the elusive mystery of slow growth. And in addition to that, Smith concludes that:
External military threat has been a catalyst for development for countries throughout the ages, most notably Japan and South Korea. Hopefully it will do the same for Ukraine now.” (Smith, 2022)
This notion is quite popular among the highest echelon of the Ukrainian reformers, who define that view the following way: “A common enemy might help to consolidate reforms.”5
What unites these views is the fact that: (i) ongoing economic reforming remains unquestioned; (ii) Ukraine’s leadership has continuously been either too corrupt or at least lacking political will; and (iii) external threat by an enemy might help to reform the economy at a more rapid pace.
My view is a bit different, in the following way. Ukraine's inquiry―by that I mean an investigative inquiry into the country’s economic situation―must start with the following question. What if the concept of economic reforms is a cause of Ukraine’s economic underperformance, when measured by a real GDP metric?
The answer to the question is quite complex, no doubt. It is so, indeed, even if we set aside geopolitics for a while. (For sure, Russia’s pressure on Ukraine will be present for many years to come. Thinking of it as helpful is quite an irony).
At this point, I would like to call attention to my interpretation of Ukraine’s overall economic situation.
It is grounded on my past professional experience in the domestic financial sector and on my current academic research I am carrying out in tandem with the modern monetary theory economists, known as MMT’ers.
In Ukraine, there has been a widespread notion that since 2014, the economy has been “fixed” and has now achieved macroeconomic stability.
A number of market-based reforms were pushed through. Markets for land, labor, banking, and non-banking financial services, etc., either were established (on agricultural land) or re-established (in commercial banking). The parliament adopted a series of laws that cemented the notion of the central bank’s independence. Since then, It has been acting to prove its credentials as a serious inflation fighter. The Ukrainian central bankers adopted a nickname for their own institution of Bundesbank on the Dnipro river, which is quite a statement. The Ministry of Finance depoliticized its debt management and fine-tuned its operations to supply attractive debt instruments to the global investment community through both domestic and Eurobond financial markets.
Adoption of fiscal rules for capping the total budget deficit at 3% of GDP escaped public scrutiny and instead took place in a comfortably calm political environment. The economy has now been migrating toward an even greater mode of market-based finance than it was before.
All these developments took place after 2014, and some of them after 2019, i.e., under the watch of the incumbent president of Ukraine.
Few market-based reforms are left to be implemented, however, as judicial, pension, and health-care reforms are of top priority for the near future.
All of the above analysis can be read as a playbook by economic orthodoxy adopted globally that allegedly assures prosperity and fast economic growth once a country implements a comprehensive reform package.
I tend to disagree with the above, however. In both episodes―prior to 2014, before the recent reforms wave, and since 2014, when they were pushed through―there is a common and unifying thread. Now and then, the economy functions with sizable usage of foreign monies of account alongside the national one. This means that Ukraine’s private and state-owned businesses create debt denominated in the foreign money of account quite liberally. The fact of the matter is that this practice breeds future financial fragility across different sectors of the economy.
If in the post-2014 period, banks were considered as cleansed of the above-mentioned liberal handling of debt creation denominated in foreign money of account. That issue was never really addressed for the entire economy and especially for the government. This is what MMT’ers regard as a low or shallow degree of monetary sovereignty. It subjects the economy to the wide swings inherent in international private finance (IPF) and requires a foreign lender of last resort to readily stand by to counteract the negative swing of the IPF.
The latter service arrives with strings attached, no matter who provides it. Western institutions such as the IMF and EBRD have been doing it for years now. Russia’s sovereign wealth fund was also doing this briefly before 2014. Either way, Ukraine has tied itself to private foreign finance even more than it used to be, hence, financial fragility stemming from liberal usage of the foreign money of account. This was never cured, but rather keeps accumulating instead. And that is why austerity-focused policies dominate in Ukraine’s economy.
To better illustrate my point, it is noteworthy mentioning this. Over past month, the U.S. dollar sovereign bonds of Ukraine experienced a sizable drop in prices (and rising yields). True, this happened as a market reaction to the growing awareness of the threat of invasion by Russia.
However, such a quick revaluation is another reminder that Ukraine’s government is subject to a possible strike from the private bond market investors (also known collectively in the West as bond vigilantes). It does not matter who stirs up the uncertainty—the Kremlin or some other factor(s)—the result is the same. Ukraine does require a standby lender from abroad. Otherwise, domestic debts—and foreign ones such as Ukraine sovereign eurobonds—in foreign money of account cannot be validated, and hence they deflate (lose value). This is the root cause of the “economic failure” Tooze and Smith are talking about.
As a corollary, Ukraine’s central bank focus is currently narrowed towards attempts to fight inflation. It raises an alarm (and policy rate) every time wage growth accelerates. Meanwhile, it tolerates unemployment rate of 9% because it is close to the 8.5% mark, which is deemed by the central bank as a “natural” unemployment rate.
Meanwhile, more Ukrainians are working abroad, many taking low-paying jobs and much less taking high-paying, professional jobs. In Poland alone, the phenomena of Ukrainian migrant workers gained such significance over the past several years that it gave birth to an entire research project among the Polish academia, bringing grateful workers from Ukraine with precarious jobs into the spotlight:
They mostly take on the unattractive (from the point of view of the local worker) work-world positions: ones that are low paying, temporary, and offer insecure and uncertain lengths of employment. (Polkowska & Filipek, 2020)
Now, the following must be mentioned. At the end of the third quarter of 2021, the wage share in GDP declined to 41% from 44% a year earlier, but this went largely unnoticed. Moreover, it was never explained how wage share dropped from a peak of 55% in the middle of 2013 to all-time low of 37% in early 2017. Meanwhile, profit share of GDP has been on the rise, to 44% in the third quarter of 2021 from 42% a year before. Profit inflation was never acknowledged explicitly in Ukraine as a precursor of the inflation-targeting regime.
To conclude, fixing Ukraine’s economy in a comprehensive way requires quite a different approach. A ‘more-of-the-same’ approach, which is endorsed by both Smith and Ukraine’s top reformers, is a pro-growth strategy that shuns still-depressed wages and domestic employment prospects. Ironically, it also finds the threat of foreign military aggression useful. This must be replaced by a new strategy, which must be pro-wage and pro-employment growth.
Tooze (2022b) backs an idea that Ukraine’s agri-businesses collectively will drive Ukraine’s economy into prosperity. In my view, it belongs to the 'more-of-the-same’ approach. Already now the Ukraine’s private agri-businesses require less, not more, workers’ hands. They are highly liberal in finance, extending dollarization not limiting it. Hence, this development yields the ‘more-of-the-same’ outcomes for the country as a whole.
Thinking carefully along these lines may even help economists to take a different view of the “Ukraine crisis,” behind which Russia is hiding its own economic failure to deliver prosperity to wider segments of its population. I am talking here about the majority of Russians, the working-class people, not the political and business elite and the professionals. Attention of these people is turned away from the economic hardships they face on a daily basis and instead eclipsed by the grand geopolitical battles the country’s leadership is carrying out.
It was just 30 years ago when broad ranks of Russian citizens backed a major sociopolitical turning point from a society of no private ownership of large-scale methods of production towards a new and promising system that welcomed private profits. Since then, inequality has run rampant in Russia. The “Ukraine crisis” is a useful invention.
References
Polkowska, D., & Filipek, K. (2020). Grateful Precarious Worker? Ukrainian Migrants in Poland. Review of Radical Political Economics, 52(3), 564-581. doi:doi:10.1177/0486613419857295
Smith, N. (2022, January 23). Why is Ukraine such an economic failure? An urgent mystery. From Substack: https://noahpinion.substack.com/p/why-is-ukraine-such-an-economic-failure
Tooze, A. (2022a, January 12). Chartbook #68 Putin's Challenge to Western hegemony - the 2022 edition. From Substack: https://adamtooze.substack.com/p/chartbook-68-putins-challenge-to
Tooze, A. (2022b, February 12). Chartbook #81 Permanent crisis or Black Earth agro-giant? Alternative futures for Ukraine. From Substack: https://adamtooze.substack.com/p/chartbook-81-permanent-crisis-or
Valchyshen, A. (2016, November 29). Ukraine has a lesson for Donald Trump – Vladimir Putin is no friend of America. From International Business Times: https://www.ibtimes.co.uk/ukraine-has-lesson-donald-trump-vladimir-putin-no-friend-america-1593411
Valchyshen, A. (2017, February 23). A (Contrarian) View From Ukraine: Russian Sanctions. From The Daily Caller: https://dailycaller.com/2017/02/23/a-contrarian-view-from-ukraine-russian-sanctions/
Valchyshen, A. (2018, April 15). Letter to the FT’s editors. From Medium.com: https://alexvalchyshen.medium.com/letter-to-the-fts-editors-april-15-2018-1f3705b2d795
WIIW. (2021, December 15). Online panel discussion: 30 years of reforms since the collapse of the USSR. From YouTube Channel of the Vienna Institute for International Economic Studies (WIIW): https://youtu.be/7spq8iToA2s
A shorter version of this op-ed was published by The Institute for War & Peace Reporting on February 15, 2022. Link: https://t.co/QXq33rpUkg
National Bank of Ukraine (January 2021) Inflation Report, source: https://bank.gov.ua/admin_uploads/article/IR_2021-Q1.pdf
See https://www.brookings.edu/blog/up-front/2021/12/08/a-most-unusual-recovery-how-the-us-rebound-from-covid-differs-from-rest-of-g7/. Ukraine’s shortfall was about 6% by the end 3Q 2021, according to the author’s calculations.
(WIIW, 2021): watch video, starting at 54:10 minute, link: