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Why is Ukraine so much Poorer than its Neighbours?

In Economic Transition, Ukraine on September 1, 2010 at 11:03 pm

Having known Ukraine only from visiting Kiev on previous business trips, I decided I would dedicate three weeks to it this August. I travelled into the country from the West – with the train from Krakow in Poland, over to Lviv. I also went to the Carpathians, then travelled by train to mythical Odessa, on the Black Sea coast. I had a quick look at Donetsk in the East and ended again in Kiev. To my friends who stopped smiling the moment I announced I was going to spend my holidays in Ukraine – yeah, U-kraine-, I must say that they don’t know what they’re missing out on. The country is full of beauty – both Lviv and the port city Odessa, for example, are all under-reported splendour.  The atmosphere in the country is relaxed.  One gets good value for money, the people are friendly and helpful, and the weather in the summer is just perfect. And it’s safe. But apart from providing free advertisement for the Ukrainians, what I wanted to do was to get a little bit under the skin of a big, important country just next door to the European Union, sandwiched between its eastern borders and Russia. I switched off international news and mobilised my senses instead: eyes, ears, smell, taste. But now time to switch back on the analytical brain.

I got involved with Ukraine while putting together financial sector conference programmes on Ukraine in London with business and government. I even organised one conference directly in Kiev in 2006. These were the years of post-Orange Revolution euphoria , and of stellar economic growth (almost 8% annual average in 2000-2007) on the back of high world steel prices. Western banks were buying into Ukrainian banks. My first impression of the country was that it was very lovely and endearing. Ukrainian conferences were my favourites. But they were such a hassle, there was so much chaos! Dealing with government speakers at conferences – always quite a feat – is such an extreme challenge in this country that even high-flying economist Anders Aslund reports on the issue in his last  book on “Ukraine – How Ukraine Became a Market Economy and Democracy”:

“As any conference organizer in Kyiv knows, ministers were reluctant to commit themselves to events, and, if they did, they often cancelled”. (p.134).

 The page on which he mentions this issue deals with the years before the Orange Revolution, but I can report that this hadn’t changed at all after 2004!

The second impression I had from Ukraine in 2010 is – apart from ATMs in every corner thanks to an efficient and modernised banking system – its wide-spread poverty. Starting a trip to Ukraine with the West and the Carpathians is both endearing and depressing. Mass poverty is still a reality in this country. The Babushkas one sees on tourist leaflets, with their flower-patterned headscarves are sweet to look at first. But then I grew sad when after bumping into them all the time. These ladies are often hunch-backed, have no longer any teeth, and are probably younger than they look. They sell a few plums and mushrooms on the dusty roadside to survive. The roads, trains, tramways, and the general public infrastructure are in shambles. On the first day of arrival already, you really ask yourself what has gone wrong.  In comparison, Poland, where I had been before, and whose income per capita levels are already much lower than in your average Western European country  is paradise. IMF sources indicate that income per capita levels at current US$ stood at 13,860 in 2008 for Poland, against, e.g. 50,000 for Austria, 42,000 for France, and even 21,000 for Portugal. And only 3,900 current USD for Ukraine! Although charmed by the beauty of  Lviv and its Austrian-Empire flair, the sight of stagnation, of deep-rooted inertia filled me with melancholy. Later on I received a more differentiated picture of the country by travelling to other places. Of course Kiev is much better off – it is a buzzing place, despite the crisis. Odessa, with its trade and tourist activities, is also more prosperous, as is Donetsk, the industrial town. But better not venture too far outside the city centres: there it starts looking miserable again. I can report that Odessa’s outskirts are outright slummy.

So why is this? Fundamentally, because Ukraine has not done away with Soviet state structures. If one follows Anders Aslund in the book I quoted above, what happened to the country is the following: Ukraine focused on becoming independent in 1991. Nationalism went over structural reform in the political priority list of the day. There was a grand bargain of sorts between the state Nomenklatura and the Ukrainian nationalists. The Nomenklatura accepted democracy and independence but was allowed to stay on in power. It has captured the political process ever since. Economic reforms started in 1993-1994 only. Poland, Russia and others started years earlier, and it took a while for Ukraine to realize that the country was plunging even deeper into poverty than its neighbours. Before 1990, Ukraine was considered richer than Russia and Poland. Now it is the poorest of all. In the mid 1990s, there was some privatization, and a crackdown on hyperinflation leading ultimately to the creation of the national currency in 1996. Then nothing until the 1998 financial crisis, due to President Kuchma’s blockage of reforms. In this period, civil liberties suffered too. The media were curtailed. Journalists died. The country’s economy was in the hands of shady gas traders. Tax levels were extortionary – with massive tax evasion and exemptions for the privileged.

The Yuschenko government in 1999-2000 initiated a raft of reforms that have contributed to the big economic boom Ukraine witnessed until 2008, such as: further privatization, land privatization, tax reform (reduction of taxes,  elimination of tax loopholes, limits on the prevailing predatory tax inspection system for businesses), cleaning up the gas trading sector (it still needs much more reform, but that’s material for another blog post). According to Aslund these reforms have facilitated the emergence of new rich businessmen outside the energy sector – from steel to banking to agribusiness – some of whom supported the Orange Revolution in 2004. Since the Orange Revolution, however, apart from WTO accession, not much in terms of internal reforms can be reported. The Ukrainian economy shrank significantly with the crisis when global steel prices plummeted and international finance dried out (-15.1 %, according to the IMF).  

Who, in the race to prosperity in the former Soviet bloc, west of Russia, has performed best? A graph I put together comparing (click:) GDP Per Capitalevels based on IMF figures shows that Ukraine has trailed behind its former Soviet peers in the Baltic states (a whopping 17,000 USD for Estonia in 2008), Russia (11,700 USD) and its neighbour to the west, Poland (14,000 USD). While the Baltic States – which have been the most radical reformers and liberalisers of the entire former Soviet bloc – have significantly raised income levels, Ukraine has stagnated. Poland too, the land of oft-decried “shock therapists” like Leszek Balcerowicz, has performed well and steadily. Ukraine has continued living with “socialism” for too long. This has cost it dearly.

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