Ukraine’s Secret Turnaround

When the president of a country is accused of ordering a journalist to be murdered – which is what rumors concerning Ukraine’s President Leonid Kuchma do – it is hard to imagine that country as being on the mend. Yet Ukraine is. From 1991 to 1999 it experienced steady economic decline but in 2000 it suddenly recorded 6% growth, which accelerated to 9% in the first half of 2001. Having dithered over piecemeal reforms for years, the country suddenly launched a standard radical reform program. The curious thing is that such reforms had become politically possible. Russia’s financial crash of August 1998 opened the door to real reform because, in its wake, Ukraine approached default and this imposed austerity on the government. Cynicism and apathy shattered. A broad coalition of centrist and right-wing parties came together in late 1999 to put Ukraine right. Improvement followed swiftly. Their choice for Prime Minister was Viktor Yushchenko – the only hero in Ukraine's first decade of independence, earned through his provision of a stable currency by his work as the country’s long-serving Central Bank Chairman. As Prime Minister, Yushchenko began to reform on a broad front, and fast. Curiously, his main agent of reform was Yulia Timoshenko, one of the wealthiest of Ukraine’s powerful oligarchs, who launched a ferocious assault on her competitors. Yushchenko forced the profligate Ukrainian establishment to tighten its belt, pushing the budget into a slight surplus. Contrary to a purported need for fiscal stimulation, austerity presaged growth, as extra state funding had in the past disappeared into the pockets of the oligarchs. A balanced budget leveled the playing field for business, boosting competition and thus production. For years, everyone cried about Ukraine's failure to collect state revenues, but its treasury was, in reality, collecting too much money – about 40% of official GDP, far more than in the US. These high taxes were not paid by the oligarchs but by small and medium-size entrepreneurs who were also extorted to pay large bribes to bureaucrats. Therefore, Yushchenko preceded fiscal sanitation with substantial tax cuts. A simple fixed tax for single entrepreneurs gave life to millions of enterprises, and bribe-seeking business inspections were combated by all means. With smaller businesses beginning to grow, Yushchenko turned his attention to the oligarchs. The art of being an oligarch is to have government decisions twisted so as to make state property and wealth legally yours. Yushchenko moved to clean up government decision-making routines, which the oligarchs had notoriously shaped in their own interests. Stealing a signature from the Prime Minister was no longer possible. Quietly, Ukraine’s government privatized many large enterprises. Before 1999's presidential elections, Ukraine’s leading oligarch Grigory Surkis seized one quarter of the regional electricity distributors. Parallel to this, President Kuchma's son-in-law Viktor Pinchuk gained ownership of five big metallurgical companies. In 2000, Ukraine sold four major oil refineries to three different Russian oil corporations and one to Kazak Oil, and so on. Suddenly, once masterless industrial giants had concrete owners who wanted to make money. Beneficial effects came swift. Privatized Ukrainian steel producers began a major export drive. Foreign oil companies boosted oil refining in Ukraine, making the country self-sufficient in expensive oil products and slashing the oil import bill. Because foreign oil companies cannot claim government subsidies, the oligarch who lived high on import subsidies (Alexander Volkov) is no longer a force. Ukraine’s electricity distribution was an economic absurdity. Generators were public, and distributors extracted payment from final customers, but often in barter, avoiding payments to state-owned generators. The total unpaid bills exceeded one billion US dollars a year. When Surkis arose as the owner of so many regional distributors, Deputy Prime Minister for Energy Yulia Timoshenko forced Surkis to pay his bills as well as taxes in real money. Oligarch Ihor Bakai stated a couple of years ago that all the really rich in Ukraine made their money on gas imports from Russia, which is true of Bakai, Volkov, Timoshenko, Surkis, and Pinchuk. In complex deals, managers of Russia’s Gazprom and a few Ukrainian oligarchs split about $3 billion a year. Yet it was Timoshenko who systematically undermined and destroyed this murky business before her fellow oligarchs forced her out of the government and had her arrested for alleged corruption. In particular, Timoshenko forced Bakai out of business. Alas, Timoshenko was ousted before she could reform the coal industry, which is profoundly criminalized by state subsidies. The coal industry, led by the governor of the Donetsk region and the head of the Tax Service (!), comprises the third major group of oligarchs alongside Pinchuk and Surkis. The others have been devastated by reforms. Ukraine’s tale is not over, but amazing reforms have been achieved despite its murky politics, and nothing succeeds like success. Even though Ukraine’s newspapers and television journalists remain subservient, people learn about these changes, and even in Ukraine’s truncated democracy, the views of ordinary people now matter. So, in a land where most leaders are perceived as crooks, an honest leader stands tall. Earlier this year Yushchenko was ousted by a coalition of left and right forces in the parliament acting in concert with President Kuchma, who was anxious to cut Prime Minister Yushchenko down. Out of power, however, Yushchenko is becoming more and more popular. In semi-reformed societies, postcommunist or developing, oligarchies that abuse the state are the biggest problem. They can, however, be broken through competition. Rather than compromise with them, reformers must learn to pit oligarchs against each other to foster competition, which is what Yushchenko did. When everything has gone wrong in a country, economics becomes simple. It’s politics that remains hard.