1) For many years, Ukrainian economic policy favorited a few oligarchs. Each of them had a unique agreement with the government (despite who the president or prime minister) to benefit from state-owned assets (gas or electricity prices, budgetary subsidies, central bank loans, etc.). Each of them controls one of the major TV channels. As a result, oligarchs control the political system - limiting access to independent politicians to approach the voters via TV - and they block all (though rare) attempts to implement a long-view economic growth policy, to establish the rule of law, and to eliminate corruption.
President Zelensky, having declared war on oligarchs, substituted it with the fight against his main political competitor, the former president Poroshenko, and with the battle for his administration's control over the TV.
2) A comprehensive economic growth-oriented policy pushed the most active and energy-driven part of the labor force to look for opportunities in Eastern Europe (mainly Poland) and Russia. The number of those who work abroad varies from 3 to 5 million, which is an enormous amount for a country with about 40 million.
First just on Rob Lee's article. It is mostly good, and he answers pretty well the question, why now?
As I would put it, until fairly recently Putin was assuming that the strategy he employed in Georgia would work in Ukraine. There he relentlessly attacked and demonized Saakashvili, scared away western investment, funneled resources to Russia-connected oligarchs and mercenary Georgian politicians, and waited for Georgians to become exhausted and confused enough to bring the pro-Russian party to power. That strategy seemed to be working with the election of Zelensky. But Putin, being at heart a loose-aggressive poker player and not any kind of chess player, became impatient and vastly overplayed his hand against Zelensky, who fought back by capturing Putin's vulnerable forward pawns in Ukraine and pushing to redevelop Ukraine's once-formidable weapons industry.
What Lee doesn't really explain is Putin's views towards Ukraine - Lee seems to take a bit too seriously Russia's propaganda explanations for what they're doing, without sufficiently confronting that propaganda with the details of what Russia is actually doing on the ground. Ukraine is not a security threat to Russia - there is no fear whatsoever in Russia that Ukraine could attack Russia. Russia's military posture towards Ukraine is 100% about forcing Ukrainian subservience and putting down democratic revolutions that might spread into Russia. Putin's main fear now is that if Ukraine is able to redevelop its weapons industry, the cost of Russian intervention will eventually rise to the point that Russia will permanently lose its ability to force Ukrainian subservience.
As Lee must know, Russia's defense of Russia is all about the nuclear. Russia positions its conventional weaponry to defend its claims to areas of its influence and act against US/Western involvement in those regions. But aside from the unique case of Turkey, Russia does not waste resources positioning itself against the non-possibility that a Nato country or ally, including Ukraine, would independently attack Russia without US support. I suppose Putin might have a little real concern about the long-term hypothetical possibility of the US or Nato positioning powerful aggressive weapons in Ukrainian territory, if Putin genuinely cares what happens after he's gone. But that is certainly not a trigger issue here.
Romania provides the lesson: during the Soviet period, Russians thought of Romania as the Warsaw pact's Kentucky - a poor, mud-caked rural backwater. Since the 1990s when Romania was brought into the EU/Nato candidate fold, western investment has poured in, and though Romania remains very corrupt and still has no equivalent to the elite center of Moscow, the average Romanian today is much better off than the average Russian.
Now to your article What you get right is that Ukraine's economic failures are largely to blame for its military vulnerability, and Ukraine made a critical mistake by not restraining its corruption and trying harder to attract foreign investment in the 1990s and 2000s. But you miss other crucial factors.
First, Ukraine became crucially separated in terms of security from Central-Eastern Europe already in the late 1980s, not only in 2014. Practically as soon as the 1989 revolutions occurred there was a strong consensus among Central-East European populations for joining the EU and Nato. East Germany got it done already in 1990. Poland, Hungary and Czechoslovakia began lobbying immediately and got a formal positive signal from Nato already in 1991, while Ukraine was still in the USSR.
Ukrainians had a very different outlook on Nato. This came mainly from their very different history, especially their WWII experience of being devastated in the first half of the war and then being part of the victorious Red Army. Most were assimilated into the Russian-speaking world and even after the USSR breakup by habit continued to watch Moscow TV. Ukraine's drive to cooperate with and possibly eventually join Nato came from the top political level, with initially a large majority of the population opposed to membership.
Of course, Ukraine was an insecure place to invest also for entirely internal reasons - rule of law was shaky, courts were in the pocket of aggressive oligarchs. But Romania was not less corrupt in the '90s. The difference that got the ball rolling in Romania and not in Ukraine was the very different military security situation. You could go back and read the old private security advice to foreign investors eg. Stratfor who were constantly harping on the Russian invasion risk from very early. I remember it all very well - it was taken for granted that Ukraine was not a place where one could build, for example, automobile manufacturing plant, or even a plant to produce automotive-grade sheet metal.
The biggest battles between the pro-western-investment and anti-western-investment forces were over old-fashioned metallurgy plants, especially Krivy Rig. These produced the basic, cheap forms of steel: hot-rolled coil, rebar. Russia was deeply involved in those battles. Russian investment in Ukraine did not face similar resistance.
And though it's certainly true that Ukraine has performed relatively poorly since 1991, it's deeply silly to suggest Ukraine has become 20% poorer. Just take a quick look at contemporary Ukrainians' obviously vastly greater wealth in terms of cars, home appliances, electronics, communications. Do you really believe that World Bank PPP adjustment can magically turn Soviet administrative prices into realistic American-market values? (PPP GDP is meant to sum the quantities of goods and services produced at the prices they would have fetched in the US - which in practice can't really be done well even for market economies. It's not only you - academic economists seem to collectively suffer from atrophy of the part of the brain that might question the quality of World Bank statistics.)
Another factor (or subfactor) closely related to your second point is low levels of trust. As Jerry Useem writes here, "if, for the past 20 years, Americans had trusted one another like Ukrainians did, our annual GDP per capita would be $11,000 lower": https://www.theatlantic.com/magazine/archive/2021/12/trust-recession-economy/620522/
I visited Ukraine on an investment tour in about 2009. I think if it had halfway decent government it would really leap forward. The soil is fantastic, great waterways, some potentially good cities like Odessa and Lviv, and the nucleus of an advanced education system.
Jan 23, 2022·edited Jan 23, 2022Liked by Noah Smith
To check my own understanding, and hopefully serve others, a recap. (Please chime in with corrections.)
Overall, the story suggests that Ukraine's decline and aborted rise boil down to manufacturing and the oligarchs that grew up around it: Ukraine's economy was anchored by an inefficient manufacturing sector. The sector was propped up by trade with, and cheap energy from, the Soviet Union. So when the USSR fell, the economy shrunk in half, and oligarchs took over the factories.
After bottoming out, Ukraine could have revived manufacturing through foreign investment, and reoriented those exports to Europe, thereby securing growth. Instead, it directed foreign investment to finance and real estate, which grew the economy modestly until being decimated in '08. Simultaneously, the end of cheap Russian gas crippled what was left of the manufacturing sector. Those two blows destroyed the economy's growth engine.
The misdirection of FDI was caused by the manufacturing oligarchs. During the same period, they also hurt growth by reducing public investment (directly, through corruption) and driving half the economy under the table (indirectly, through taxation), with the usual costs that brings: low productivity, bribes to keep the state away, organized crime to replace it. The war in 2014 further depleted foreign and public investment.
Great analysis. Many thanks. Perhaps some more thoughts
1. Bloodlands: Europe between Hitler and Stalin by Timothy Snyder might provide some additional food for thought on the reasons for underperformance. Situated between the centres of civilisation in Europe and Moscow, the factors for starting a market economy in Ukraine have not reached the critical threshold. Thus, the current development is an echo of the wars of the 20th century.
2. Perhaps the lack of support from the European Union also played a role, adding nuance to the theory of geese flying only within certain global or regional parameters. The EU – Ukraine Association Agreement has not lived up to expectations and did not compensated for the loss of Russian markets. Exports to the EU are largely stagnant. Perhaps Eastern Europe offered enough capacity for the outsourcing of cheap and sufficiently skilled labour to Western European a catalyst for growth.
3. Finally, as in Afghanistan, Ukraine's weakness is an invitation to foreign powers to protect power and assert interests by shaping the (optimal) national growth trajectory and orientation. The US investment of 3% of Ukraine's GNP in 2014 in democracy promotion (Nuland's 5 billion) was a low-risk, high-impact geopolitical intervention.
Anders Åslund points out that Ukraine had virtually no economic policy for most of the 1990s, neither did it build any institutional framework for a free market. There was no shock therapy, most enterprises spent that debate in a limbo, with central planning gone (unlike Belarus) and nothing to replace it (unlike e.g. Poland).
Corruption and rent seeking are part of the problem. Another problem is the fact when some former Communist countries plus a China seized the opportunity through the downsizing of former state owned enterprises, the Ukrainian oligarchs used their power to bloc the necessary institutional reforms, EU and IMF investors went with likely winners over prospective losers. China and Russia have now inherited Afghanistan. Does the Russian Federation want to prop up Ukraine? The only benefit to Putin is the threat of China or the West gaining more geopolitical muscle in Central Asia.
If I were a poor country that wanted to become a middle-income country, I too would put my chips down on manufacturing. But Australia, Denmark, and Iceland all relied on agriculture (or for Iceland, fishing) and (for Aussies) mining. They're upper-income countries. As far as I can see, there is no single path to prosperity--not even good government. Look at Costa Rica, trapped in the lower-middle income zone with very good government.
1) Population decline in Ukraine is unprecedented. When I was a kid, Ukraine had 52M people while Poland had 38M. Today, Poland still has 38M people while Ukraine has 37M. To be fair, part of that decline in Ukraine is Crimea and occupied Eastern Ukraine but still, the country lost 400,000 people just between Jan-Nov 2021 to natural change (more deaths than births), usually it's around 300,000 a year. And the decline was mostly working-age people. Poland has 16.6M people in employment, Ukraine only has 15.5M.
2) Roads! Roads in Ukraine, even major national roads, are completely impassable. Freeway network is nearly non-existent. Ukraine already is disadvantaged being far away from major European markets (same reason why Poland had the infamous "Why didn't you invest in Eastern Poland - it's just too far) but because of bad state of the roads, it takes 1h40mins to drive 60 miles from the Polish border to Lviv. Same distance in the other direction takes less than an hour, assuming you take the local roads instead of the freeway. And the roads near the Polish border are relatively good quality.
All above points are valid, but one of major importance hasn't been mentioned: brain drain. As much as 3 million Ukrainians are living abroad (according to one estimate), mostly those who are well educated and economically active. Good for remittances, but very bad for economic development.
Yet again, an obvious lack of effort to conduct any type of objective geopolitical analysis.
Why exactly would Russia want to take in a poor, backward, semi-failed state that is Ukraine? There are no resources in Ukraine that Russia needs except for what it already has: Crimea and the Sevastopol naval base.
Secondly, Poland is used as the Eastern Europe success case - and they've done well (although their population is shrinking like all of EU-Eastern Europe). But Poland received hundreds of billions of dollars in economic aid, not weapons, from the EU.
I can't find the link but the number 400 billion euros sticks in my mind. It was in context vs. the East Germany assimilation which cost in the trillion euro range - and this was way back in 2004. Compare with the single digit billion IMF loans and similar EU help to the Ukraine since 2014 - and note both countries are about the same population.
I haven't looked into it, but I would not be at all surprised if significant economic assistance was given to other early Eastern European nations that joined the EU. And yes, while the Ukraine has not joined the EU - it also hasn't received anywhere near massive amounts of aid.
Lastly: exports. Ukraine had high tech industries - aircraft/aircraft parts (Antonov, the big Russian heavy lifter, was an Ukrainian company); the founding father of information technology in the USSR was Ukrainian (Victor Glushkov); rocketry and space (Korolev actually worked in the Ukraine; Ukraine also developed rocket engines). But those were all in cooperation/trade with Russia - and we all know what happened to that after the advent of democracy/capitalism.
So if Ukraine is selling nothing but minerals and food - that's of their own doing.
Two comments to this great overview:
1) For many years, Ukrainian economic policy favorited a few oligarchs. Each of them had a unique agreement with the government (despite who the president or prime minister) to benefit from state-owned assets (gas or electricity prices, budgetary subsidies, central bank loans, etc.). Each of them controls one of the major TV channels. As a result, oligarchs control the political system - limiting access to independent politicians to approach the voters via TV - and they block all (though rare) attempts to implement a long-view economic growth policy, to establish the rule of law, and to eliminate corruption.
President Zelensky, having declared war on oligarchs, substituted it with the fight against his main political competitor, the former president Poroshenko, and with the battle for his administration's control over the TV.
2) A comprehensive economic growth-oriented policy pushed the most active and energy-driven part of the labor force to look for opportunities in Eastern Europe (mainly Poland) and Russia. The number of those who work abroad varies from 3 to 5 million, which is an enormous amount for a country with about 40 million.
One small point. Turkey isn't in the EU but it does have a customs union with the EU that helps with exporting manufacturing goods to the bloc
First just on Rob Lee's article. It is mostly good, and he answers pretty well the question, why now?
As I would put it, until fairly recently Putin was assuming that the strategy he employed in Georgia would work in Ukraine. There he relentlessly attacked and demonized Saakashvili, scared away western investment, funneled resources to Russia-connected oligarchs and mercenary Georgian politicians, and waited for Georgians to become exhausted and confused enough to bring the pro-Russian party to power. That strategy seemed to be working with the election of Zelensky. But Putin, being at heart a loose-aggressive poker player and not any kind of chess player, became impatient and vastly overplayed his hand against Zelensky, who fought back by capturing Putin's vulnerable forward pawns in Ukraine and pushing to redevelop Ukraine's once-formidable weapons industry.
What Lee doesn't really explain is Putin's views towards Ukraine - Lee seems to take a bit too seriously Russia's propaganda explanations for what they're doing, without sufficiently confronting that propaganda with the details of what Russia is actually doing on the ground. Ukraine is not a security threat to Russia - there is no fear whatsoever in Russia that Ukraine could attack Russia. Russia's military posture towards Ukraine is 100% about forcing Ukrainian subservience and putting down democratic revolutions that might spread into Russia. Putin's main fear now is that if Ukraine is able to redevelop its weapons industry, the cost of Russian intervention will eventually rise to the point that Russia will permanently lose its ability to force Ukrainian subservience.
As Lee must know, Russia's defense of Russia is all about the nuclear. Russia positions its conventional weaponry to defend its claims to areas of its influence and act against US/Western involvement in those regions. But aside from the unique case of Turkey, Russia does not waste resources positioning itself against the non-possibility that a Nato country or ally, including Ukraine, would independently attack Russia without US support. I suppose Putin might have a little real concern about the long-term hypothetical possibility of the US or Nato positioning powerful aggressive weapons in Ukrainian territory, if Putin genuinely cares what happens after he's gone. But that is certainly not a trigger issue here.
Romania provides the lesson: during the Soviet period, Russians thought of Romania as the Warsaw pact's Kentucky - a poor, mud-caked rural backwater. Since the 1990s when Romania was brought into the EU/Nato candidate fold, western investment has poured in, and though Romania remains very corrupt and still has no equivalent to the elite center of Moscow, the average Romanian today is much better off than the average Russian.
Now to your article What you get right is that Ukraine's economic failures are largely to blame for its military vulnerability, and Ukraine made a critical mistake by not restraining its corruption and trying harder to attract foreign investment in the 1990s and 2000s. But you miss other crucial factors.
First, Ukraine became crucially separated in terms of security from Central-Eastern Europe already in the late 1980s, not only in 2014. Practically as soon as the 1989 revolutions occurred there was a strong consensus among Central-East European populations for joining the EU and Nato. East Germany got it done already in 1990. Poland, Hungary and Czechoslovakia began lobbying immediately and got a formal positive signal from Nato already in 1991, while Ukraine was still in the USSR.
Ukrainians had a very different outlook on Nato. This came mainly from their very different history, especially their WWII experience of being devastated in the first half of the war and then being part of the victorious Red Army. Most were assimilated into the Russian-speaking world and even after the USSR breakup by habit continued to watch Moscow TV. Ukraine's drive to cooperate with and possibly eventually join Nato came from the top political level, with initially a large majority of the population opposed to membership.
Of course, Ukraine was an insecure place to invest also for entirely internal reasons - rule of law was shaky, courts were in the pocket of aggressive oligarchs. But Romania was not less corrupt in the '90s. The difference that got the ball rolling in Romania and not in Ukraine was the very different military security situation. You could go back and read the old private security advice to foreign investors eg. Stratfor who were constantly harping on the Russian invasion risk from very early. I remember it all very well - it was taken for granted that Ukraine was not a place where one could build, for example, automobile manufacturing plant, or even a plant to produce automotive-grade sheet metal.
The biggest battles between the pro-western-investment and anti-western-investment forces were over old-fashioned metallurgy plants, especially Krivy Rig. These produced the basic, cheap forms of steel: hot-rolled coil, rebar. Russia was deeply involved in those battles. Russian investment in Ukraine did not face similar resistance.
And though it's certainly true that Ukraine has performed relatively poorly since 1991, it's deeply silly to suggest Ukraine has become 20% poorer. Just take a quick look at contemporary Ukrainians' obviously vastly greater wealth in terms of cars, home appliances, electronics, communications. Do you really believe that World Bank PPP adjustment can magically turn Soviet administrative prices into realistic American-market values? (PPP GDP is meant to sum the quantities of goods and services produced at the prices they would have fetched in the US - which in practice can't really be done well even for market economies. It's not only you - academic economists seem to collectively suffer from atrophy of the part of the brain that might question the quality of World Bank statistics.)
Another factor (or subfactor) closely related to your second point is low levels of trust. As Jerry Useem writes here, "if, for the past 20 years, Americans had trusted one another like Ukrainians did, our annual GDP per capita would be $11,000 lower": https://www.theatlantic.com/magazine/archive/2021/12/trust-recession-economy/620522/
Curious about demographic explanations for Ukraine's lousy economic growth. The population has shrunk a lot since 1990!
I visited Ukraine on an investment tour in about 2009. I think if it had halfway decent government it would really leap forward. The soil is fantastic, great waterways, some potentially good cities like Odessa and Lviv, and the nucleus of an advanced education system.
To check my own understanding, and hopefully serve others, a recap. (Please chime in with corrections.)
Overall, the story suggests that Ukraine's decline and aborted rise boil down to manufacturing and the oligarchs that grew up around it: Ukraine's economy was anchored by an inefficient manufacturing sector. The sector was propped up by trade with, and cheap energy from, the Soviet Union. So when the USSR fell, the economy shrunk in half, and oligarchs took over the factories.
After bottoming out, Ukraine could have revived manufacturing through foreign investment, and reoriented those exports to Europe, thereby securing growth. Instead, it directed foreign investment to finance and real estate, which grew the economy modestly until being decimated in '08. Simultaneously, the end of cheap Russian gas crippled what was left of the manufacturing sector. Those two blows destroyed the economy's growth engine.
The misdirection of FDI was caused by the manufacturing oligarchs. During the same period, they also hurt growth by reducing public investment (directly, through corruption) and driving half the economy under the table (indirectly, through taxation), with the usual costs that brings: low productivity, bribes to keep the state away, organized crime to replace it. The war in 2014 further depleted foreign and public investment.
Great analysis. Many thanks. Perhaps some more thoughts
1. Bloodlands: Europe between Hitler and Stalin by Timothy Snyder might provide some additional food for thought on the reasons for underperformance. Situated between the centres of civilisation in Europe and Moscow, the factors for starting a market economy in Ukraine have not reached the critical threshold. Thus, the current development is an echo of the wars of the 20th century.
2. Perhaps the lack of support from the European Union also played a role, adding nuance to the theory of geese flying only within certain global or regional parameters. The EU – Ukraine Association Agreement has not lived up to expectations and did not compensated for the loss of Russian markets. Exports to the EU are largely stagnant. Perhaps Eastern Europe offered enough capacity for the outsourcing of cheap and sufficiently skilled labour to Western European a catalyst for growth.
3. Finally, as in Afghanistan, Ukraine's weakness is an invitation to foreign powers to protect power and assert interests by shaping the (optimal) national growth trajectory and orientation. The US investment of 3% of Ukraine's GNP in 2014 in democracy promotion (Nuland's 5 billion) was a low-risk, high-impact geopolitical intervention.
Anders Åslund points out that Ukraine had virtually no economic policy for most of the 1990s, neither did it build any institutional framework for a free market. There was no shock therapy, most enterprises spent that debate in a limbo, with central planning gone (unlike Belarus) and nothing to replace it (unlike e.g. Poland).
Corruption and rent seeking are part of the problem. Another problem is the fact when some former Communist countries plus a China seized the opportunity through the downsizing of former state owned enterprises, the Ukrainian oligarchs used their power to bloc the necessary institutional reforms, EU and IMF investors went with likely winners over prospective losers. China and Russia have now inherited Afghanistan. Does the Russian Federation want to prop up Ukraine? The only benefit to Putin is the threat of China or the West gaining more geopolitical muscle in Central Asia.
If I were a poor country that wanted to become a middle-income country, I too would put my chips down on manufacturing. But Australia, Denmark, and Iceland all relied on agriculture (or for Iceland, fishing) and (for Aussies) mining. They're upper-income countries. As far as I can see, there is no single path to prosperity--not even good government. Look at Costa Rica, trapped in the lower-middle income zone with very good government.
This was very eye-opening on Ukraines troubles, great article!
I'd list two potential factors.
1) Population decline in Ukraine is unprecedented. When I was a kid, Ukraine had 52M people while Poland had 38M. Today, Poland still has 38M people while Ukraine has 37M. To be fair, part of that decline in Ukraine is Crimea and occupied Eastern Ukraine but still, the country lost 400,000 people just between Jan-Nov 2021 to natural change (more deaths than births), usually it's around 300,000 a year. And the decline was mostly working-age people. Poland has 16.6M people in employment, Ukraine only has 15.5M.
2) Roads! Roads in Ukraine, even major national roads, are completely impassable. Freeway network is nearly non-existent. Ukraine already is disadvantaged being far away from major European markets (same reason why Poland had the infamous "Why didn't you invest in Eastern Poland - it's just too far) but because of bad state of the roads, it takes 1h40mins to drive 60 miles from the Polish border to Lviv. Same distance in the other direction takes less than an hour, assuming you take the local roads instead of the freeway. And the roads near the Polish border are relatively good quality.
All above points are valid, but one of major importance hasn't been mentioned: brain drain. As much as 3 million Ukrainians are living abroad (according to one estimate), mostly those who are well educated and economically active. Good for remittances, but very bad for economic development.
https://www.nbcnews.com/news/world/brain-drain-devastating-ukraine-n976936
Yet again, an obvious lack of effort to conduct any type of objective geopolitical analysis.
Why exactly would Russia want to take in a poor, backward, semi-failed state that is Ukraine? There are no resources in Ukraine that Russia needs except for what it already has: Crimea and the Sevastopol naval base.
Secondly, Poland is used as the Eastern Europe success case - and they've done well (although their population is shrinking like all of EU-Eastern Europe). But Poland received hundreds of billions of dollars in economic aid, not weapons, from the EU.
I can't find the link but the number 400 billion euros sticks in my mind. It was in context vs. the East Germany assimilation which cost in the trillion euro range - and this was way back in 2004. Compare with the single digit billion IMF loans and similar EU help to the Ukraine since 2014 - and note both countries are about the same population.
I haven't looked into it, but I would not be at all surprised if significant economic assistance was given to other early Eastern European nations that joined the EU. And yes, while the Ukraine has not joined the EU - it also hasn't received anywhere near massive amounts of aid.
Lastly: exports. Ukraine had high tech industries - aircraft/aircraft parts (Antonov, the big Russian heavy lifter, was an Ukrainian company); the founding father of information technology in the USSR was Ukrainian (Victor Glushkov); rocketry and space (Korolev actually worked in the Ukraine; Ukraine also developed rocket engines). But those were all in cooperation/trade with Russia - and we all know what happened to that after the advent of democracy/capitalism.
So if Ukraine is selling nothing but minerals and food - that's of their own doing.