Economy

The most striking – and depressing – aspect of life in the new Ukraine was the dismal state of its economy. It overshadowed all other issues, problems, and achievements of the first decade of independence.

Between 1991 and 2000, the country’s GDP had sunk over 63%, one of the worst declines in the former USSR. Its trade plummeted, debts burgeoned, and foreign investment was little more than a trickle. In an American survey that measured the “freedom” of economies to develop, Ukraine ranked 125th out of 156 countries.⁹ Many of the country’s huge, uncompetitive factories barely functioned, its dangerous mines were unprofitable, and its collective farms could hardly sustain themselves. Villages were neglected and the urban infrastructure was in disrepair. People were badly fed, shabbily dressed, inadequately housed, and in poor health. The standard of living plummeted to the point where about 70% of population were close to or below the poverty line. Worse still, prospects for improvement were bleak. How and why did such a catastrophic state of affairs develop?

Even before independence, the deficiencies of the Soviet economy were coming to the fore, and astute observers of the USSR concluded that economic decline was unavoidable. As a key part of the Soviet economic system, Ukraine was, therefore, highly vulnerable. Moreover, the economic costs of the abrupt separation in 1991 were unexpectedly high. Russia was the main – indeed, almost exclusive – market for Ukrainian products. When the two countries were separated by tariffs, duties, and other barriers to trade, this crucial market became less accessible.

There were other serious economic problems as well. A key one concerned the industrial structure. A central, and politically motivated, principle of Soviet economic planners had been that the production cycles of most goods manufactured in a republic should be incomplete – that is, a product could not be completed in a republic without using the resources or facilities of other republics. Consequently, when the USSR disintegrated, Ukraine discovered that a great majority of its industrial products depended on materials or parts located in what were now foreign states. Another economic shock was energy costs. In Soviet times, Ukraine’s huge and inefficient factories received artificially cheap oil and gas from Russia. But after 1991, Russia began to charge world prices, and Ukrainian industry, indeed, the entire economy, was traumatized by sky-rocketing energy costs. Finally, Chernobyl continued to be a serious drain on the budget.

Economic dislocations associated with the disintegration of the USSR were only part of the dilemma. Another factor was that the people who had presided over a collapsing Soviet economy were now charged with transforming Ukraine into a market economy. The situation was comparable to engaging Wall Street “sharks” to transform a capitalist economy into a communist one. Obviously, most of the new/old Ukrainian elite had neither the will nor the ability to introduce effective economic reforms. And if it did introduce reforms, they were usually ones that served its own interests.

Even among those few members of the new elite who realized the need for reforms, there was a lack of consensus. Some argued for a radical approach or “shock therapy,” which had been applied successfully in neighboring Poland. Others believed that a gradual, sequential approach would be more effective.

There were important variations in the leadership’s attempts to deal with the economic crisis. Kravchuk paid relatively little attention to the issue; he concentrated on state- and nation-building. Another reason why he avoided serious economic reforms was that he feared their destabilizing effect on society. For him, social and political stability was clearly more important than economic reform. When he did introduce economic measures, their goal was to ensure the economic sovereignty of Ukraine – that is, to reduce the impact of the Russian economy. Thus, in November 1992, Ukraine formally withdrew from the ruble zone, and its provisional currency, the karbovanets or coupon, was introduced.

When production began to plummet, the administration, led by Vitold Fokin, resorted to old Soviet remedies: it provided money-losing factories with large subsidies and allowed them to run up huge deficits. The goal was to keep up production at all cost, even if no one wanted the goods that were produced, and to avoid unemployment. The result was predictable: inflation rose dramatically. In January 1992 alone, it jumped 435%, and this was only the beginning. Bowing to public discontent and pressure, in September 1992 Kravchuk replaced Fokin with Kuchma.

To the surprise of many, this classic “Red director” asked for emergency powers and introduced strict monetary controls. Subsidies were reduced, deficits no longer tolerated, and tax collection expanded. Moreover, the privatization of state property was seriously considered. It seemed, briefly, that inflation was under control. But strict monetary policy also meant that salaries were unpaid or delayed, welfare payments slashed, and pensions postponed.

As his successor, Kravchuk chose Iukhym Zviahilsky, a “Red director” from the politically important Donbas. Reflecting the conservatism of his caste and supported by the president, the new prime minister reintroduced rigid state controls and halted privatization. He raised subsidies to factories and especially to collective farms, where many of Kravchuk’s supporters lived. These huge expenditures by the government led to a catastrophic burst of hyperinflation: in 1993 prices surged by over 10,000%. Although salaries also rose, they could not keep pace with prices. Consequently, goods remained unsold, production sank even further, and the specter of unemployment or underemployment emerged. Another painful effect of hyperinflation was that, in one fell swoop, it wiped out the savings of millions of frugal, hard-working citizens. Especially hardhit were the elderly who had carefully set aside funds for their retirement. Thus, within a year, millions in Ukraine became virtually penniless.

While masses plunged into poverty, the well-placed elite used the fiscal chaos to accumulate tremendous riches. Some well-placed officials simply transformed Communist party funds and property into private holdings. Others accumulated wealth in more roundabout ways. For example, factory directors obtained, with the help of old Communist party colleagues, huge government loans or subsidies, ostensibly to keep their enterprises in operation.

Practices of this sort were feasible only if one occupied high positions or had the right connections. Indeed, connections were more important than capital. They resulted in the rapid transformation of the most intrepid members of the old Soviet nomenklatura into incredibly wealthy oligarchs. However, unlike the robber barons of early capitalism, these new “captains of industry” acquired their wealth by undermining rather than expanding the economy. Kuchma policies

In 1994, the key element in Kuchma’s election platform was his commitment to improve the economy. Almost immediately after taking office, the new president announced a program of radical reforms. It included privatization of state property, elimination of subsidies to unprofitable enterprises, liberalization of prices, reduction of social expenditures, and stabilization of the currency. The heart and soul of the reforms was privatization: it was assumed that the sooner government-owned enterprises passed into private hands, the faster market conditions would begin to operate. After a slow start, small-scale privatization – which included shops, restaurants, and service facilities – accelerated, and by mid-1997 about 90% of Ukraine’s 45,000 small enterprises were privatized (at this time, Poland had two million).

The appointment of Ievhen Marchuk as prime minister in 1995 signalled a retreat to a more gradual approach. The new prime minister insisted, however, on limiting subsidies and salaries. Wages declined to $55 a month, among the lowest in the cis (in the Baltic countries the comparable figure was $200, in Russia it was $140). Unemployment rose inexorably: the government claimed that it was about 10%, but reliable estimates put the rate at about 33%. This figure did not reflect the large percentage who were on pay-rolls but were not being paid or who were indefinitely furloughed from their jobs. Social tensions mounted and so did conflicts between Kuchma and Marchuk. In what was fast becoming a standard response to frustrating problems, Kuchma dismissed his prime minister. His place was taken by Lazarenko, a leading member of the Dniepropetrovsk clan, which was the traditional recruiting ground of the Soviet and post-Soviet Ukrainian elite. Kuchma himself was one of its products. Soon over two hundred of the top positions in government were occupied by members of the Dniepropetrovsk clan, to the great dismay of the rival Donetsk clan. When Lazarenko was implicated in corruption, he was replaced by another Dniepropetrovsk product, Valeri Pustovoitenko. It seemed that responsibility for reforms lay in the hands of the unreformed.

Unable or unwilling to control its growing deficits, the government sought to increase its income. It raised taxes, especially on business activity, to astronomical heights. In many cases, businesses were expected to pay a 90% tax. The result was that much privately conducted economic activity moved underground. This shadow economy grew so rapidly that, by some estimates, it was close to half of the GDP. However, much of it remained in oligarchic or “Mafia” hands. Since it did not pay taxes, this budding sector was of little help in alleviating government deficits. Furthermore, much of the illegally acquired wealth was sent, for safe-keeping, outside of the country, resulting in a massive flight of capital. Some estimates placed the amount sent abroad in the $25–50 billion range, a sobering indication of the scope of the illegal, parasitical operations carried out by the rapacious oligarchs. Meanwhile, given the corruption, exorbitant taxation, and stifling regulation, Ukraine had extreme difficulties in attracting foreign investors. In 1997, foreign direct investment was only $27 per capita in Ukraine, compared to $48 in Russia, $250 in Poland, $696 in the Czech Republic, and $1376 in Hungary. Finally, the country faced a cash drought. One of the few bright spots on the dreary economic horizon was the successful introduction, in 1996 and thanks to the able efforts of Viktor Iushchenko, head of the National Bank, of a new and relatively stable currency, the hryvnia.

As its financial troubles mounted, Ukraine turned to the International Monetary Fund (IMF) and the World Bank for help. As a result, its foreign debt began to grow: in 1992, foreign indebtedness was a relatively insignificant $1.4 billion, but by 1998 it shot up to $12.5 billion. Meanwhile, the IMF, troubled by the lack of reforms, became increasingly hesitant about providing new loans or rescheduling debt payments. To make matters worse, rising energy costs pushed Ukraine’s debt to Russia even higher. By 1999, Ukraine faced the real danger of bankruptcy. The appointment of Iush-chenko as prime minister in December 1999 raised hopes that this highly regarded banker would resume the stalled reforms. Another hopeful sign was a 5.6% rise in the GDP, the first since independence, in early 2000. But the parasitical dominance of the oligarchs in the Ukrainian economy limited the optimism.

Agriculture, traditionally a key sector of the economy, also continued its steep decline. Between 1990 and 1997, gross agricultural production decreased by 44%. Quite simply, agricultural production became economically unfeasible because the cost of production rose, due mainly to soaring energy prices, six times faster than what the produce could be sold for. Reformers hoped that the liquidation of the collective farm system, privatization of land, and encouragement of private farming would revitalize this crucial area of the economy. But many more opposed the abolition of the collective farms than supported it. For the left, privatization of land was anathema and, in parliament, it used every means possible to block it. The powerful collective farm directors feared it because private landownership would undermine their power and income. And the peasants, who had once so fiercely resisted collectivization, proved to be surprisingly reluctant to abandon it. In 1997, out of approximately 4.6 million agrarian workers, Ukraine had only about 35,000 independent farmers. A country that possessed the richest farmland in Europe faced the possibility of importing food to feed its population.

Even when measured against the poor performance of most other former Soviet republics, the attempted economic reforms in Ukraine were highly disappointing. Granted, the task of transforming a highly developed, planned economy to a complex market economy was extremely difficult, especially in a country that had practically no capitalist institutions and traditions. Nonetheless, Ukraine’s leaders bore the responsibility for the incompetence, vacillation, and lack of commitment that characterized their efforts.

Kravchuk failed to realize the importance of economic reform. When problems arose, he attempted to resolve them by using clearly discredited Soviet methods, thereby making matters even worse. Initially, Kuchma’s efforts were promising: he focused his attention on the economy and opted for radical change. But his long-term goal of introducing market conditions ran afoul of his short-term goal of maintaining inefficient enterprises and limiting unemployment. Unwilling to impose short-term pain, he failed to achieve long-term gain. As his approach to reform became ever more gradual, Ukraine’s transition process appeared to grind to a halt, mired in a stagnating situation that was neither a planned nor a market economy but that had the worst elements of both. Fear spread that the so-called Ukrainian way, which called for “a socially oriented market economy,” was actually leading the country into a semi-permanent, painful state of economic stagnation, similar to that which existed in numerous Third World societies.

Clearly, opposition to reform was strong. The leftist-controlled parliament repeatedly frustrated the president’s economic program. At the same time, the new oligarchs, who financed electoral campaigns, realized that a prolonged, indecisive transition provided them with the best opportunities to enrich themselves. The stifling bureaucracy was also antagonistic because reforms called for the deregulation of the economy, and this meant fewer opportunities to supplement their meager salaries with bribes. Finally, large sections of society, especially the elderly, longed for a return to the security of Soviet times. In short, the political base for radical economic reforms was simply lacking, and the political will among the leadership to enforce reforms was also absent.