Saturday, June 25
Укр Eng
Log In Register
2 June, 2011  ▪  Volodymyr Dubrovsky

The Looming Tidal Wave

Ukraine will have to clean the Augean Stables of the tycoon-controlled economy regardless of how the global financial crisis develops

Prime Minister Mykola Azarov recently announced that the second wave of the financial crisis is looming over Ukraine and asked voters to tighten their belts, prepare for the worse and return to ploughs and spades in an effort at reviving the experience of the 1990s when many survived on small private plots. Clearly, the government believes that attack is the best form of defence as why else would it admit to its incapability of resolving problems that are tormenting Ukraine when it could very easily blame everything on the global economy?  

The crisis is very much like a flu epidemic. A healthy body withstands the virus or suffers only light symptoms, while a weak body is more hard hit and risks not overcoming the disease. The 2007-2008 crisis, just like a flu, by-passed some countries, including Latin America, China and most Asian states. Ukraine’s closest neighbor Poland also experienced no economic recession, except for a decline in GDP growth.

Ukraine’s economic and financial infrastructure turned out to be seriously ill. The government should have immediately dropped all of its populism and focused on the economy, tied to arrange for a soft landing after the boom or, at least, halt theft from the State Budget. Eventually, the only thing that Ukrainians obtained were promises that the government would “keep the crisis away.” In spite of this, the global financial crisis arrived uninvited for Prime Minister Yulia Tymoshenko whose Cabinet turned out to be completely unprepared and wasted all their efforts at extinguishing local fires while rarely succeeding even in this endeavour. For instance, the refinancing of crisis-ridden banks by the National Bank (NBU) assisted them in earning a small pittance on the devaluation of the hryvnia, while the recapitalisation mechanism became a complete fiasco as the Government rushed to rescue banks which became bankrupt due to their own inept policies, not the global financial crisis. It is clear today that the Government spent more cash to recapitalise banks than they really needed to pay back  their depositors. Bailouts to some companies, such as car makers, whose owners were long used to living on state support and fleecing consumers, looked no more reasonable. In any case, the crisis should have removed uncompetitive companies from the market. Yet, this never happened and the Ukrainian economy failed to restructure itself.

Any economy is a self-regulated mechanism. As the hryvnia rate plummeted in 2008, Ukraine’s export-oriented manufacturers improved their competitiveness and trade balances. Businesses cut payrolls, thus pushing down personal incomes, leading to significant decreases in their expenses. In March 2009, the Ukrainian economy began to revive notwithstanding an incompetent government policy. This revival continues today; however, the government has not contributed to this. Poorly crafted decisions by Mrs. Tymoshenko were replaced by even worse policies of Mr. Azarov. In 2011, just as before, Ukraine’s slow revival largely results from the growth of external demand for domestic resources. Ukrainian business owners are quite resilient to crises as they survived a lot in the past; they are still operating in what seems to be the worst possible business environment; and they are masters at adjusting to changes.  

In fact, the government is not really passive; for example, it has never terrorised businesses as much as it does now. The advance collection of taxes in and preferential VAT reimbursement to companies with close ties to the authorities is being accompanied by the forced redistribution of already privatised assets. It is at all possible that some big companies are in a better situation today (tables for 2010 point to Ukrainian billionaires having become wealthier) and GDP is slowly increasing.  At the same time, Ukraine’s current growth rate is hardly strong and the Cabinet still only supports select, individual businesses which mostly include chemicals and metallurgy, while covering gaps in the budget at the expense of other sectors. Small and medium enterprises find it much harder to operate now. This approach merely further increases the dependence of the economy on energy resources on the one hand, and mercurial external markets on the other. Ukraine remains as vulnerable to future shocks in global markets as before.

The government should have learned lessons from the crisis long ago and started establishing an environment for the development of SME’s (Small-Medium enterprises), science-based industries, agriculture, food processing industry and other sectors. Building a full-scale balanced economy requires a clearly formulated plan of action, including the courage to take unpopular steps. Of course, those in power did draft an action plan but how sufficiently implementable is it? Even reasonably formulated action plans have failed for political reasons. After Mr. Yanukovych was elected president, it was immediately obvious that the Cabinet of Ministers would lack legitimate powers to implement these plans. The new Head of State has undertaken no steps to become the president of the entire country. Currently, the popularity of Viktor Yanukovych and the Party of the Regions are plummeting. Meanwhile, the Government is totally confused as it can see that force does not work and yet it understands no other way of operating.  

It is unfortunate that those in power hate freedom and their ideology prevents them from generating efficient economic policies. The governing team do have some efficient managers, although they barely understand how the market economy (in contrast to a tycoon-controlled one) operates. The government believes that everything can be manually managed and, at the same time, overestimates the impact and enforcement of state authorities. The government is seeking to manage an unmanageable structure using instruments that are only workable in an efficiently managed system, which looks like a big dose of wishful thinking. Tax compliance should be a voluntary process and therefore seeking to extract taxes by force could spark  an uprising, as in physics where every action is accompanied by a counter-reaction that is of equal magnitude.

Take government policy to bring business out of the shadow economy, for instance. Obviously, the grey, shadow economy is a perfectly natural response by tax payers to the excessive tax burden imposed on them by the authorities. At the same time, people cannot live by regulations that are so removed from the real world. The further escalation of pressure on businesses will trigger a massive closure of SMEs (Small-Medium Enterprises). This will result in stagnation in the short term and economic disaster over the long-term.

Social unrest is inevitable in Ukraine if the government continues to act with as little understanding as it has until now. The (Anti) Tax (Code) Maidan was the just the first red flag flown at the authorities. Then, hopefully, the government took notice of the problem it had until then been ignoring. This had come as a big surprise for those in power, and it would have been a beneficial thing if it had also blown wind into their sails. However, a series of plans to tighten state budgets have been put on a long hold as neither the Labour nor Residential Codes have been adopted by parliament; the plan to increase the retirement age for women from 55 to 60 has been postponed, as has another round of household utility gas prices for households. This could be all for the better, but at the same time the old problems remain in place and the government has not come up with alternative policy options.

Therefore, near future prospects for Ukraine are either stagnation or minimum growth. The economy has some potential left in itself but this will not last long. The outcome is unpredictable if those in power keep undermining the economy and economic policy. Ukraine’s social cauldron will inevitably explode sooner or later but the question will be then ‘Who will agree to clean up the resultant mess?’

Related publications:

Copyright © Ukrainian Week LLC. All rights reserved.
Reprint or other commercial use of the site materials is allowed only with the editorial board permission.
Legal disclaimer Accessibility Privacy policy Terms of use Contact us