All these factors are all the more important for Ukraine, but it has patently failed to utilize its opportunities.
In 1989, Ukraine had a gross domestic product per capita that was 10 percent higher than Russia’s. Today its per capita GDP is barely one-third of Russia’s at current exchange rates. Even more worrisome, it is only one-third of Turkey’s GDP per capita, because unlike Ukraine Turkey jumped on the bandwagon of European economic integration concluding a customs union with the EU.
Ukraine’s convergence with Europe is not happening, and the country lingers at a mere 8 percent of the GDP per capita of the euro area. It is laudable that Ukraine joined the World Trade Organization in 2008, but now it has to proceed.
At this time, Ukraine should boom from outsourcing of production and services from the EU. In the 1990s, Central Europe took off because of outsourcing from Germany. Similarly, in the early 2000s, Estonia, Latvia and Lithuania boomed due to outsourcing from Sweden and Finland.
In recent years, Bulgaria and Romania have been major beneficiaries of European outsourcing. Bulgaria had foreign direct investment exceeding one quarter of GDP for a few years before the global financial crisis, while Ukraine’s foreign direct investment amounts to 3-4 percent of its tiny GDP.
Ukraine needs a far-reaching agreement with the EU on free trade, institutional reforms and technical assistance. Sensibly, Ukraine started such negotiations in 2007, and they concluded negotiations on a deep and comprehensive free trade agreement of some 1,000 pages last fall.
Incredibly, President Viktor Yanukovych has preferred the jailing of former Prime Minister Yulia Tymoshenko, former Interior Minister Yuri Lutsenko and other former top officials over the already concluded Association Agreement with the EU.
But the EU is not only an economic union. It is also a political union with democratic values.
Incredibly, President Viktor Yanukovych has preferred the jailing of former Prime Minister Yulia Tymoshenko, former Interior Minister Yuri Lutsenko and other former top officials over the already concluded Association Agreement with the EU. Ukrainian courts are obviously dependent on the government, and the legal proceedings have been a joke, clarifying that this was the president’s personal choice.
Moreover, the inert EU cannot possibly reverse its firm position on Yanukovych. Does the president really want Ukraine to be treated like Belarus by the EU?
Ukraine’s door to the EU is locked until Yanukovych releases Tymoshenko, Lutsenko et al.
In July 2010, Yanukovych’s government concluded a two-and-a-half-year standby agreement of $15 billion with the International Monetary Fund. A brisk reform wave of several months ensued, and the two first quarterly tranches of a total of $3 billion were disbursed in the second half of 2010.
An IMF mission in February 2011 agreed on four major prior actions with the Ukrainian government for further funding. The two most important were pension reform and gas price rises. Much delayed, the Ukrainian government carried out a substantial pension reform.
But it has done literally nothing about the gas prices. Unacceptably, the Ukrainian government subsidizes the importation of Russian gas, paying $450 per 1,000 cubic meters, while it pays only $57 per 1,000 cubic meters for domestically produced gas.
Not surprisingly, domestic Ukrainian gas production is stagnant, while it could double if a normal price was offered. Ukraine is wasting 4.5 percent of GDP on gas subsidies, which only breed corruption and waste. Sensibly, the IMF has refused to finance such outrageous waste.
The situation is pretty simple and obvious. At present, Ukraine consumes about 60 billion cubic meters of gas a year. Of this, two-thirds is imported from Russia and one-third is produced domestically. With normal prices, gas consumption should fall by one-third to some 40 billion cubic meters within a few years, which could all be produced in Ukraine.
This could be done within five years, as Poland and Slovakia have shown. Such actions only require the political will to go against the gas barons, but they form one pillar of the current regime. The IMF understands this, and IMF money is out of question until Ukraine’s gas policy changes.
As always, when the Ukrainian government has spoiled all other options, Russia remains its last hope. Ukraine has pursued repeated negotiations about the January 2009 gas agreement, which it considers so criminal that it has imprisoned Tymoshenko for it.
Yet it has not revoked this agreement, which was previously a standard procedure. Nor has it achieved any changes, while virtually all the European customers of Gazprom have received substantial alleviations.
This arouses the suspicion that important members of the Ukrainian regime obtain considerable benefits from this flawed agreement and may want to distort it even more. Usually, we learn how officials have made money on Russian gas some time after the event.
Given that the gas transit system has poisoned Ukraine’s economy and politics for the last two decades, the country might be better off without it.
Russian President Vladimir Putin is no fan of Yanukovych or his gas traders, but his $20 billion gas deal with Belarus last November suggests the contours of a possible deal with Ukraine. The three key elements would be that Russia takes over at least half Ukraine’s gas transit system in return for Ukraine buying Russian gas at much lower prices and receiving substantial credits from Russian state banks.
The total value of a three-year agreement could be in the order of $20 billion. Yet, Putin would also demand that Ukraine joins the Russia-Belarus-Kazakhstan Customs Union, which would close Ukraine’s door to free trade with Europe.
Ukraine does not need such an agreement, and Yanukovych insists that he prefers free trade with Europe to the Russian customs union.
Given that the gas transit system has poisoned Ukraine’s economy and politics for the last two decades, the country might be better off without it. Let Russia build its wasteful South Stream and clean up Ukraine from its gas corruption!
This article by Anders Aslund, a senior fellow at the Peterson Institute for International Economics, was first published in Forbes magazine.
