Ukraine has to play dodgeball

On a map of risks prepared by the Economist Intelligence Unit, Ukraine was in the same group of countries as Iraq, Iran and Central African ones. All analyzed factors improved but this does not mean that the risk is gone.

The conflict over the Donbass and the annexation of Crimea by Russia has huge economic significance for Ukraine. The Donetsk Basin was the economic center of the country, producing one of the few products that powered other branches of Ukraine’s economy – steel intended for export. Meanwhile the annexation of Crimea cut Ukraine’s remaining territory off from a geopolitically important port city. Economic factors also play a role in the development of the contemporary situation.

Taking the above into consideration, should we expect to see a further escalation of the conflict? How does Ukraine’s economic situation affect that country’s international stability?

From the 1990s Russia was a key trading partner of Ukraine. Now trade with Russia is undergoing a clear decline. In practice this means that Kiev is less susceptible to the Kremlin’s influence, but also that Russia may fear Ukraine’s further gradual exit from its sphere of influence, and this is a factor that could potentially escalate the conflict.

The share of advanced products in Ukraine’s export is declining, which is pushing the country to the role of a periphery state. The export of ships has collapsed. Sales of metal products, construction materials and minerals are still sustained. Cereals and vegetable oils, as well as other food and animal products have an increasingly important role in Ukraine’s exports (39.9 per cent), which is also typical of peripheral countries.

An analysis of the commodity structure of imports to the Ukrainian market leads to a similar conclusion. Processed products such as machinery, electronics, chemicals have a significant share among imported products – they account for as much as 43.6 per cent of total imports.

Between a rock and a hard place

It is precisely the peripheral position of Ukraine that made it the target of a struggle for influence between two centers of power. On the one hand, we have the European Union, for which Ukraine is perhaps not a crucial but certainly an important market for goods (especially for the countries of Central Europe, but also for Germany and other Western European countries). Ukraine is also a potential supplier of raw materials, food products and other unprocessed goods.

On the other hand, Ukraine is still an important market for Russia, which remains the Western world’s main rival in the Eastern Europe. Ukraine receives 2.6 per cent of Russian exports worth USD8.18bn.

Therefore, Ukraine is protected by both spheres of influence – also by Russia, with which it is in conflict – which has a positive effect on its stability, but is not necessarily conducive to a quick and effective resolution of the dispute. It makes no sense for either Russia or the countries of the European Union to make abrupt moves. From this point of view it should be assumed that the conflict will continue with varying degrees of intensity, as is the case in Moldova, Georgia, Bosnia and Herzegovina, and Kosovo.

The loss of Crimea hurt the most from the geopolitical and military point of view. It was thanks to the bases of the Black Sea Fleet in Sevastopol that Russia managed to relatively easily beat Georgia in 2008. The peninsula is also of crucial importance for Russian operations in the Middle East and North Africa. We also cannot underestimate the base’s importance in relation to the increasingly hot Balkans.

For Ukraine, Crimea was also a strong tourist center. Before the conflict, in 2014 alone it attracted about 6 million visitors, 25 per cent of which were citizens of the Russian Federation.

According to Russia Today, Crimea’s greatest treasure lies to the South of the peninsula – the gas deposits in the Black Sea, whose production potential is estimated at 7 million tons annually. ExxonMobil and Shell have concluded a preliminary agreement with the Ukrainian authorities on deep-water drilling. The value of the contract is estimated at USD1bn. The only problem is the fact that the deposits are currently beyond the control of the authorities in Kiev.

The Donbass, responsible for 16 per cent of Ukraine’s GDP, was much more important economically for Ukraine than Crimea. Its share of investments in the country fluctuated around 15 per cent. According to the Euromaidanpress service, the new authorities seized control of 47 companies in the Donbass, which further weakened the Ukrainian state.

The two regions were responsible for 27 per cent of Ukraine’s total exports, with a total value of USD18.1bn. According to the news service Direct Russia, exports to the EU were not able to help Ukraine make up for its losses on the blocked Russian market. The value of Ukrainian exports to Western Europe has declined by approx. USD5bn since 2011.

Following the events of the Euromaidan, the annexation of Crimea and the beginning of the war in the Donbass, the inflow of foreign direct investment to Ukraine fell drastically. Ukrainian experts estimate that in total Ukraine’s GDP has shrunk by 16.5 per cent since the crisis began in 2014. If we take into account the loss of Crimea and the Donbas, then the decline reaches 24 per cent.

The risk of escalation of the conflict

Both Kiev and Moscow have to take into account the risk of further escalation of the dispute concerning Ukraine’s Eastern and Southern borderlands also in the case of a deterioration of the social situation. Ukrainian society has to cope with a very low quality of life on a daily basis. In 2015, GDP per capita (PPP) was only USD7,500. Unemployment is around 10 per cent.

As Tadeusz A. Olszański from the Centre for Eastern Studies wrote in his latest report, “a society that was relatively egalitarian before 1991 has seen the emergence of social stratification that is drastic and not accepted by the public.” Other major challenges include the massive influx of the population from the countryside to the cities, and drug addiction, which has become a social plague alongside alcoholism.

The best reflection of Ukraine’s severe situation is the fact that its population decreased by almost 7 million and, according to the forecasts of the analysts from the Centre for Eastern Studies, this trend is expected to intensify. This tendency will be strengthened, among others, by the liberalization of the visa policy of the EU.

Social discontent is very high, and Ukrainians are comparing their situation not only to the EU countries or Russia, but even to Belarus, where the Lukashenko regime has so far been able to provide stability and security. In this light, the liberalization of the visa regime should undoubtedly be seen as a positive development. It will allow for a relative improvement in the lives of economic migrants and their families.

We cannot underestimate the importance of the earnings of economic migrants for the whole economy of the state. As described in the Financial Observer by Michał Kozak, the remittances of Ukrainian expatriates amounted to 6.45 per cent of GDP in 2015 (read more). Such policy decisions on the part of the EU are on the one hand a manifestation of commonsense thinking, but on the other hand, a continuation of the brain drain from Ukraine.

The Kremlin’s perspective

Ukraine is unfortunately more an object of the game than a participant. Russia still has the most say. If the Kremlin deems the relations with such countries as Germany, France and Italy as fundamentally stable, and the attitude of the individual societies towards Ukraine would be indifferent, then the Russian authorities could be tempted to re-open this chapter, in order to, for example, gain a better connection with the Crimean peninsula.

A significant deterioration of the relationship with the West, a decrease in the export of energy resources, a new opening with China or other emerging markets, such as India or Iran, or in other words, any disruption of the current model of cooperation between the EU and Russia could have a similarly negative effect on Ukraine’s national security.

China’s economic expansion in Ukraine could become an important factor stabilizing the situation in this country (read more). If the Chinese invest more in Ukraine and stay for longer, Russia’s aggressive policy will be in direct conflict not only with the interests of Kiev, but also those of Beijing, which is for the Kremlin an opponent from a completely different league.

It will be difficult to find the right balance between Russia, the EU and China. This balance is difficult to maintain due to the fact that Ukraine is merely the object of the pressure exerted from these three directions, without any influence on its strength.

Ukraine cannot, however, remain alone in a globalized world, and sooner or later will be “adopted” by one of the opposing sides. Russia is the most determined. The EU is offering the most attractive model of development. Meanwhile China guarantees limited interest in the country’s internal politics. The authorities in Kiev additionally realize that making up for a quarter of a century of overdue reforms must go hand in hand with integration with the international market. Ukraine will either choose or be chosen.

Jan Muś, PhD, is a lecturer at the Vistula University.

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