Ukraine needs a new Marshall plan

The Ukrainian economy is growing very slowly. Meanwhile, the World Bank is recommending a thorough reconstruction of the entire system.

Last year, Ukraine managed to reduce its debt-to-GDP ratio for the first time since 2011. In 2016 this ratio reached 80.9 per cent and now only amounts to 71.8 per cent. The GDP increased not by 2 per cent, as originally projected, but by 2.5 per cent.

The International Monetary Fund (IMF) predicts that this year the Ukrainian economy could grow at a rate of 3-3.5 per cent. It notes, however, that such growth will be insufficient to overcome the decline and to improve the standard of living. The estimates of the Ukrainian government are more cautious – it is currently predicting that in 2018 the GDP growth rate will be 3 per cent.

“Ukraine’s economic growth at the moment does not match the capabilities and the needs of the country. We have not been able to implement a plan that would ensure stable and fast economic growth matching the country’s needs and capabilities”, admitted the Ukrainian Prime Minister Volodymyr Groysman.

According to the economist Oleg Ustenko from the Blazer Foundation, in order to maintain Ukraine’s ability to repay debts on international markets, the country should grow at a rate of at least 5 per cent. However, the rate of growth is not the only thing that counts. “We’re pointing to the importance of the so-called inclusive growth of the economy, which should be harmoniously and evenly spread among citizens, leading to a reduction of the differences between the poor and the rich”, he said.

The direction forward

There is no simple recipe for faster growth. According to data from the Organization for Economic Cooperation and Development (OECD), Ukraine is already among the countries with the longest working hours in Europe. Ukrainians work 1990 hours per year, on average, while the incomparably more affluent Germans only work 1336 hours per year. The only problem is that the amount of time put into work does not translate into the desired results.

The economist Boris Kushniruk points out that Ukraine should be moving away from its current post-Soviet commodity economy and its role of a supplier of semi-finished products towards the production of highly-processed goods. In his opinion, the country also needs to change its monetary policy and to depart from the restrictive monetary policy that is being implemented in Ukraine right now. “Due to the policy of high cost of loans, enterprises are deprived of resources for growth. In this way we ourselves are limiting the possibilities of faster economic growth”, he argues.

According to the World Bank, one of the spheres of the economy that could be expected to drive the growth of the Ukrainian GDP is agriculture, which has not yet reached its full potential. “You were once called the granary of Europe”, commented Satu Kahkonen, the World Bank Country Director for Belarus, Moldova, and Ukraine, in an interview with the weekly Novoye Vremya. She emphasized that more action was necessary in order to convince foreign investors that it’s worth putting money into businesses in Ukraine.

The Norwegian economist, Erik Rainert, who was once associated with the IMF and wrote the book “How Rich Countries Got Rich and Why Poor Countries Stay Poor”, indicates another direction for Ukraine. “Ukraine was a developed industrial state, but is now gradually losing its industry and is becoming an agricultural country. Meanwhile, we can observe a certain rule – countries that have managed to keep their industrial base are doing fine, while those that lost their industry – are becoming impoverished. You should rebuild your manufacturing industry and all the related services”, he said last autumn at the Kiev International Economic Forum.

In his opinion, what the World Bank is proposing for Ukraine, is a new version of the Morgenthau plan, a proposal to eliminate Germany’s arms industry, and the removal or destruction of other key industries basic to military strength. The United States ultimately failed to implement it after the war. According to Mr Rainert Kiev needs instead is a new Marshall plan.

Even the Ukrainians themselves are divided when it comes to the preferred direction for the development of the Ukrainian economy. According to a poll published in February by the Kiev-based public opinion research center Rating, 43 per cent of respondents agree with the thesis that Ukraine should become an “agrarian superpower”, and the same percentage believe that industrialization is necessary in Ukraine.

Interestingly enough, the “agricultural” option is supported by the majority of inhabitants of the rather well-industrialized northern part of the country, while the vast majority of the rural inhabitants of the southern steppes, i.e. the potential beneficiaries of such a developmental direction, are against it.

Political connections are hampering growth

It seems that an important factor in discussions on how to accelerate economic growth in Ukraine is the reform of the economic system. At least this is the conclusion of the World Bank’s latest analyzes concerning the strength of connections between the Ukrainian economy and the political sphere and the impact of these connections on GDP growth.

The experts at the World Bank determined that a company is considered politically connected if it has at least one politically exposed person among its owners, shareholders or managers. The World Bank’s purview doesn’t include companies that Ukrainian politicians control through third parties.

Politically connected companies play an important role in Ukraine’s economy – the share of such companies in the Ukrainian market is not only huge but is also increasing with each year, states the World Bank.

Although according to the methodology adopted by its experts, such companies represent only slightly more than 2 per cent of all enterprises, they control over 20 per cent of the total turnover and almost 29 per cent of all assets. They are concentrated in the strategic sectors: mining, energy and transport, where they account for 40 per cent of turnover and more than half of all assets. They have also become firmly rooted in agriculture where they account for one quarter of turnover and assets, mainly in the field of grain production and grain exports.

According to the findings of the World Bank, companies connected with Ukrainian politicians were 61 per cent less likely to be audited by the tax authorities than other market participants. It should be noted that in Ukraine tax audits can prevent the normal functioning of companies, they often involve the seizure of servers and key documents.

The World Bank concludes that there is a strong negative correlation between a company’s political connections and its productivity. Companies with such connections are larger and employ more people but at the same time they are less productive and increase their turnover at a much slower pace. Their lack of efficiency can be demonstrated by comparing the share of turnover and the share in assets. An increase in the latter does not translate into an increase in turnover – to the contrary, they exhibit a downward trend in this respect.

The World Bank estimates that if political connections were removed from the Ukrainian economy, its annual growth would be 1-2 percentage points faster than today.

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