The economics of Ukraine: Corruption, black market, and subsidies

The economics of Ukraine: Corruption, black market, and subsidies

Vladimir Putin

WASHINGTON, May 15, 2014 — As Vladimir Putin’s forces continue to annex parts of Ukraine, either through force or through allegedly rigged elections, the Ukrainian economy continues to suffer. How did they get in such a poor position?

On December 26, 1991, the Soviet Union was officially disbanded, eventually creating 14 separate countries including Ukraine which had a long history as part of the Russian empire. For the first nine years after the break up, Ukraine experienced sharp declines in GDP. However, from 2000 to 2008 the Ukraine experienced rapid growth.

In 2007, the Ukrainian economy grew at a 7 percent rate, but in 2009 their economic output decreased by 15 percent and has never fully recovered. The financial crisis in 2008 hit Ukraine hard, and although they had growth in the 4 to 5 percent range in 2010 and 2011, they have stagnated for the past three years.

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Ukraine’s economic problems are largely political in nature. The economy depends on exporting minerals and steel to Russia and former Soviet republics, such as Belarus and Kazakhstan.

Although Ukraine has some energy reserves, their largest import is natural gas from Russia. This has caused a large structural deficit. It has also put the country at the mercy of the Russian government. This vulnerability has allowed Russia to weaken Ukraine’s economy, which has encouraged further political turmoil.

The other major problem is corruption. Ukrainian politicians have estimated that as much as 50 percent of economic activity occurs in the shadow economy, and therefore goes unreported and generates no tax revenue. The result is that the government has had to raise taxes and reduce subsidies, which slowed growth even more. At the same time, Ukraine’s new prime minister said that $37 billion went missing during former prime minister Yanukovych’s rule.

The Heritage Foundation’s Freedom Index ranks Ukraine at the very bottom, placing it in the repressed range. Transparency International’s Corruption Perception Index gives Ukraine a ranking of 20 on a 0 to 100 scale, placing it in the most corrupt category possible.

The combination of the underground economy, reliance on Russia for purchases of key exports and for the importing of energy, a corrupt government and lack of economic freedom has severely weakened Ukraine’s economy. A rising poverty rate created a population ready for major change. That’s when the Russians stepped in.

Some Ukrainians have welcomed Russia into their country, believing that under Russian control, they are likely to fare better than they would as an independent nation. This works well for Putin, who has an interest in expanding Russia’s influence throughout the region.

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The International Monetary Fund tried to help. In 2010 they agreed to lend Ukraine $15 billion with conditions that the Ukrainian government institute some reforms. The IMF froze the funds in 2011 because the Ukrainian government failed to institute the required reforms, further complicating the Ukrainian position.

Today, Ukraine faces about a $25 billion shortfall in current accounts and to pay foreign creditors. With the loss of Crimea and further separation votes taking place, things are likely to worsen. The poor economic conditions have led to unrest from the Ukrainian people.

In the past month, things have worsened. The IMF and interim Prime Minister Yatsenyuk have initiated some difficult measures to meet the conditions of the emergency bailout. Yatsenyuk realizes the difficulty, but notes that it is necessary, since Kiev is broke, desperate for cash and can no longer count on Russia as a partner.

Among the reforms are a rollback of the energy subsidies which will result in a more than 60 percent increase in energy prices for most consumers. Layoffs of 24,000 state workers and 80,000 police officers nationwide will increase the already high unemployment rate. Taxes will increase on vodka, beer and cigarettes. And changes in property tax calculations mean homeowners will be paying more. Also, now that the currency is not propped up by the central bank, its value continues to fall.

Ukraine’s problems are an example of how corruption, an underground economy, massive government subsidies of key products like energy and dependence on a large corrupt trading partner can cause serious damage to an economy in the long term. How this will end for the Ukraine is anybody’s guess.

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