What’s next for Ukraine’s economy?

In 2014, a quarter century since the collapse of the Berlin Wall, the people of Ukraine wrested from a discredited regime another chance to remake their nation. In the wake of the people’s uprising, Ukraine has earned the renewed attention and respect of the major advanced democracies. It will now be incumbent on the Ukrainians to tap into their own strengths and the good will of their friends, to forge a new economy that will underpin a robust democratic state. In a virtuous circle, the state, and the rule of law it implies will enable growth thus creating a unique chance to reimagine Ukraine’s economic model in its entirety.

No two countries have traveled the same road of the post-Soviet transition, and none of the roads has been smooth. The latest transformation of Ukraine was sparked by the desire of its people to expedite integration in the European economic space. A trade-enhancing agreement with EU emerged as the symbol of that drive. However, Ukraine is returning to the global marketplace on the other slope of the economic cycle: it was first thrust into global market in the early 1990s, when the global economy was on a major upswing, the nascent European single market next door felt buoyant, the Russian market held the promise of immense riches, and the global credit supply was abundant. The world that Ukraine is rejoining today is different from the one it faced in the wake of the first Orange Revolution. The regional and global marketplace reflects several years of financial crisis, diminished demand for basic commodities, new patterns of production, financing and consumption. Ukraine’s erstwhile niche as a supplier of high-volume energy-intensive commodities to other emerging markets has run its course.

Given the rift with Russia and overall loss of competiveness, trade alone will likely be an insufficient engine for growth. According to the OECD, Ukraine’s merchandise exports declined in 2014 by over 14% compared to the same period in 2013, while merchandise imports plummeted by almost 30%. Even with this decline in trade, in January 2015 Ukraine notified its WTO partners of an import surcharge of 5-10% of the customs value of imported goods, with exemptions for hydrocarbons, some essential medicines and medical devices. If foreign trade remains depressed, what other drivers are available to the Ukrainian economy? Given the constraints of the IMF support, the answer lies in a combination of privatization and strategic allocation of limited resources available domestically and from international institutions, to sectors that can support Ukraine’s regional competitiveness.

Deregulation has to be front and center to reduce the cost of capital formation and bring out entrepreneurship amongst the Ukrainian population. Without deregulation, privatization will not produce robust growth since private investors will not be able to grow the assets they acquire. Just in agribusiness there are literally hundreds of permissions and procedures that can only be justified by rent-seeking. Ukrainian labor code is hobbled by the legacy of the Soviet times. There is a lot that can be done to reduce the cost of government. While privatization will reduce the pressure on the budget and bring better management to some companies, it will take a long time before the assets are fully restructured and begin contributing to growth and employment.

As the bureaucratic dross is being cleaned up, and state-owned entities prepared for the market, it is essential to mobilize the country’s human resources behind a vision of future growth that corresponds to the realities of today’s economy, not the memories of the global credit bubble. Longer-term investors too will come if they can buy into an economic vision offered by the new Ukraine.

This is where the global business community can make another important and immediate contribution. We should offer to the Ukrainian policy-makers and to business an honest assessment of the global and regional trends with the goal to help identify where Ukraine has a better chance of leapfrogging a few transition stages. What are the areas where Ukraine can create domestic supply that feeds into the international demand? It is unlikely that investing in legacy industries will turn them around if it has not happened over the last 20 years.

Should Ukraine strive to revive highly energy-dependent smokestack manufacturing in the expectation of a pick-up in global demand for commodities or create or put all the resources into the best broadband capacities in the region? Is the future of Ukrainian agriculture in volume production or specialty crops? The government has to hear from business about the likely scenarios for the next 5-10 years when the investments and reforms of today will pay off in sustainable economic growth. The resources inevitably spent on post-conflict reconstruction can provide the valuable domestic demand in a concentrated way. Healing and growth should be part of the same political vision. If it seizes the moment, Ukraine can emerge as a major contributor to regional and global growth taking full advantage of the trading arrangements for which it has paid a heavy price.

Author: Gary Litman, Vice President, International Strategic Initiatives, U.S. Chamber of Commerce, Washington, D.C.

Image: An employee stands near gas pipes at Oparivske gas underground storage in Lviv region September 30, 2014. REUTERS/Valentyn Ogirenko