The Euro Economy

It’s 2015 and Ukraine has much in common with the famous cartoon from the 1950s. Like the Wile E. Coyote, its economy ran over the hill and is now suspended mid-air, treading on air. Inflation is upwards of 25%, foreign currency reserves are melting away to prop up a tumbling currency, the GDP contracted by 6.5% in 2014, the budget is running a deficit in the billions and international credit agencies awarded its bonds the infamous “junk” rating. Moreover, Ukraine is fighting a losing war in the East, which costs some €5 million per day. Caught in this mad dash and gasping for air, the coyote just keeps on running without looking down. Can Ukraine’s economic decline be stopped?

The IMF, the European Union, Germany and Washington have all pledged to prop up Ukraine with enough funds to see the country through 2015. John Kerry, the U.S. Secretary of State visited Kyiv on February 5th to discuss the economy and the Fund is expected to pay a visit in the coming week and talk about a bigger bailout than the $17 billion already agreed upon last year. But these funds will likely act as loan guarantees or budget debt financing, and not towards stimulating economic growth.

What’s more, the conditions attached to the disbursement of such packages (like the scrapping of the 86% gas subsidy for households and the cutting of pensions) will likely inflict pain on the country’s already impoverished and war weary population. Federica Mogherini, the EU foreign policy chief, said that Brussels would continue to “hold Kyiv’s feet to the fire” over accepting the conditions of economic aid.

Unfortunately, the IMF is still relying on the same shock treatment and austerity strategies that have proven time and time again their ineffectiveness. Back in 2012, the Fund even released a note where it recognized that it had seriously misjudged the fiscal multiplier effect, which implied that austerity has had a more damaging effect on GDP growth than had been assumed. For many liberals, this was celebrated as an implicit acknowledgment that supply-side economics are bound to fail, yet, two years on, Western policymakers are still arguing that austerity is the only game in town.

For Ukraine, pushing through tough austerity policies while a war is going on in the East would only add insult to injury. What the country now needs is to devise growth-based strategies that will seek on one hand to reign in rampant corruption (a factor that would only exacerbate in the face of belt tightening) and on the other to promote structural reforms that will stop the economic nosedive.

Targeting both areas can be achieved in one fell swoop: a redistributive tax policy that would follow the Robin Hood principle: take from the rich and give to the poor. In 2012, the fifty wealthiest oligarchs accounted for a staggering 85% of the GDP. Let that number sink in for a moment. How can a country that has the economic climate to produce at least 15 billionaires could have teetered on the verge of bankruptcy, even before the Euromaidan? The crony capitalism and rent-seeking behaviour associated with these “businessmen” has led Anders Aslund of the Peterson Institute to describeUkraine as a “competitive oligarchy”. Therefore, the current crisis offers the best chance of breaking their hold over the state.

A structural reform that would hit the oligarchs and increase budget revenues would be one targeted at bringing to light the shadow economy. For that to work, the tax code should be completely reformed and a progressive tax system on profits should be enacted, along with complementary measures. Back in 2013, Oleksandr Klymenko, Ukraine’s former tax minister, had railroaded through legislation that cracked down on tax evasion in the export sector with the goal of increasing by $1 billion yearly state revenues. As Klymenko recently admitted on CNN, his plans were not fully implemented before the Euromaidan took hold of the country, but the current Yatseniuk administration has continued some of his reforms.

Sadly though, Kyiv policymakers have so far been following the austerity logic imposed by international creditors and have not done enough to properly put the brakes on the syphoning of state assets at the hands of oligarchs. Ten per cent of public employees will be laid off, coal-mines will be closed, and education and health care will be partially privatised.

When announcing the package, Yatseniuk dropped the anvil on the battered Ukrainian population “Don’t cry. Don’t be afraid. Don’t ask for anything”.


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