For 2014, the
IMF assesses the actual size of the deficit at 10.1 percent of gross domestic product.
However, the
deficit might even become larger, perhaps approaching 15 percetn of GDP if off-budget
items are included as the International Monetary Fund estimates the financial deficit of Naftogaz alone
this year at 7.6 percent of GDP.
Such a deficit magnitude cannot possibly be
closed by raising already-falling tax revenues. Neither can it be closed by
non-inflationary financing given the sharp increase in the risk-premium for
sovereign debt which is skyrocketing from 40 percent of GDP in 2013 to 68
percent of GDP according to the current base case IMF projection. In more
pessimistic scenarios it is even higher, possibly exceeding 100% in the
worst-case.
Under
a favorable scenario about an early resolution of the conflict in the east, the IMF currently considers the financial position to be sustainable.
However, under the current
existential threats to Ukraine, that scenario may not materialize and the
present budgetary position will not be financially sustainable. For the sake of national security, Ukraine must
cut its public expenditures sharply. This is no longer a matter of finances,
but an issue of national survival. Ukraine’s aim should be to cut public
expenditures by 10 percent of GDP within one year if total default and monetary
chaos is to be avoided.
At
53 percent of GDP in public expenditures expected by the IMF in 2014, Ukraine’s
public expenditures are far too high. That leaves only one alternative to
closing the gap; namely extensive budget-cutting. If nothing is done to
plan such cuts, they will happen anyway brutally by sequester as eventual lack
of revenues to cover expenditures will lead to “forced-closing” in the form of freezing
and random cuts. Across-the-board cuts
are the worst possible outcome.
Hence we recommended that a strategy of budget-cutting
focusing on the least desired public expenditures be developed immediately.
Such cuts would also facilitate badly-needed structural reforms, notably energy
reforms and subsidy elimination.
Ukraine
has no realistic choice but to focus on extensive expenditure cuts.
It is also
consistent with Ukraine’s medium-term strategy of reducing the size of
government to stimulate economic growth.
With its current budget expenditure
share of GDP of 53 perent of GDP, Ukraine
stands out among comparable countries as having an extremely high government
share in the economy. While several countries in Western Europe have similar
shares they have a far higher level of economic development.
The best comparable countries appear to be
the Baltic countries that have public expenditures of 34-38 percent of GDP. The
best standard for Ukraine appears to be Lithuania that has public expenditures
of 34 percent of GDP, the highest economic growth in Europe and yet has far
better social benefits than Ukraine.
In
the current situation, it is both unrealistic and undesirable to raise public
expenditures outside of the most pressing military spending.
Instead, the
government needs to focus on cutting big and inappropriate public expenditures
that can be cut fast.
A number of big items stand out.
The first is energy
subsidies that will probably amount to 10 percent of GDP in 2014 according to the
latest IMF calculations.
This is totally
unjustified as such high subsidies make Ukraine weaker in all regards – more
dependent on Russian gas, producing less gas itself, and consuming more gas.
Instead the Ukrainian government should eliminate these subsidies as soon as
possible by normalizing Ukrainian energy prices while giving the poorest half
of the population full cash compensation.
The
second big cut should be directed to the old Nomenklatura. Many of their
privileges are hidden in the uniquely high public pension expenditures of no
less than 18 percent of GDP. Special pensions alone amount to 4 percent of GDP.
The
third category of spending that should be checked is public procurement that
was the prime boondoggle of the Yanukovych government after energy. With a
total public procurement of 10 percent of GDP, half of this amount could be
saved if the standard kickback under Yanukovych was 50 percent as is widely
reported.
Another
area of opportunity for cuts is related to superfluous regulation and
bureaucracy. If wisely done, the cuts will fall most heavily on areas where
corruption opportunities abound. For example, a substantial percentage of
superfluous inspection agencies should be abolished and their cadres laid off.
Finally,
many expenditure items comprise subsidies allegedly intended to help low-income
population, but are highly inefficient because they are also being provided to
those with high incomes. Indeed such subsidies are well-known to have the effect
of regressive as opposed to progressive budget policy.
In
this way, Ukraine can in one year cut public expenditures of at least one-tenth
of GDP without anybody but vested interests suffering. At the same time, one of
the benefits would be that the tax-burden-including social taxes – can be
reduced considerably with a consequent stimulus to economic activity. The
unified social contribution should be cut to 25 percent to encourage the
emergence of private business in the official economy.
Reductions
of this magnitude will mean positive results in terms of higher economic
welfare of the Ukrainian nation, better state finances, greater equity, and
higher economic growth.
Authors:
Daron Acemoglu, Professor of Economics, Massachusetts Institute
of Technology, Boston, USA;
Anders Aslund, Senior Research Associate, Peterson Institute,
Washington, USA;
Kakha Bendukidze, Chairman, Free University, Tbilisi, Georgia;
Oleh Havrylyshyn, Adjunct Professor, George Washington
University, Washington, USA;
Basil Kalymon, Professor Emeritus, Ivey Business School, Western
University, London, Canada
