Rebuilding Ukraine’s wealth

16 April, 06:30 PM

Ukraine in future will have to rely on its economy, since Western charity will end, and we will have to start earning money ourselves.

When he was pushing the Russian forces of Peter Vrangel out of southern Ukraine in 1921, Nestor Makhno didn’t have a roadmap of establishing a state apparatus.

Vrangel, on the other hand, had such plans, and even succeeded in creating an independent Crimean state for a short while. Makhno prevailed on the battlefield and didn’t believe the poorly-irrigated, low-quality soil in the region could serve as an economic basis for a state.

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That’s why he decided to cede Crimea to the Russian troops advancing from Kuban in 1922 – at least they, much like Vrangel, had a political plan. Thus, Makhno remains a historical figure who mastered the art of war, but fell short in statecraft.

Let’s not repeat his mistakes. Let’s develop a vision for the future of our state, for the future of Ukraine. We have to prevent the coming post-war period from becoming another “mayfly” of Ukrainian sovereignty, and it will take our concerted efforts to achieve.

I describe the regime of Pavlo Skoropadsky, Vrangel’s state, Western Ukrainian People’s Republic as such “mayflies.” They all emerged suddenly, reached their zenith quickly, and promptly fell into oblivion.

After all, Makhno couldn’t have read Daron Acemoglu and James Robinson (the authors of Why Nations Fail), or draw upon the expertise of Niall Ferguson in the field of economic history, understanding its key principles and patterns. We have all that at our disposal.

It’s already clear that the post-war period will be extremely challenging for the Ukrainian economy.

It has undergone radical transformations, chiefly related to the labor market.

According to the UN, over four million Ukrainians have fled the country and have no clarity as to how they might try and rebuild their lives anew. Around 2.5 million of our citizens have left for Poland – a neighboring country somewhat similar to ours, but well-known to being conducive for Ukrainians put down roots.

Even within Ukraine, the labor force has shifted massively. Preliminary reports suggest that Kyiv lost half of its population and is reduced to 2 million people. The rest have bolted for other parts of the country, mostly the western regions. The capital has never before been as quiet as it is these days. The famously loud beltway is silent. Almost no people are riding the subway.

Western cities like Lviv, Ivano-Frankivsk, and Uzhhorod have taken in large numbers of Kyiv residents. This includes businesses relocating there, as well as individuals moving to western Ukraine. Much like Poland, the western regions of our country would like them to stay. Former residents of the capital bring with them a certain consumer culture, European experience, and aspirational living standards. Those are important factors for a modern economy.

Kyiv played an outsized role in Ukraine’s economy before the war. It has nothing to with companies there being somehow more productive than elsewhere. It was the case because at least half of Ukrainian businesses were registered there, endowing the capital with the lion’s share of our GDP, statistically. It was rather typical for a European country, but still led to some confusion among foreign investors when they were looking into the structure of our economy, the breadth of our consumer market.

It's reasonable to believe that the economies of Lviv, Ivano-Frankivsk, and Uzhhorod regions will become more productive with the influx of people from Kyiv. Richard Florida, a professor of urban planning, has shown that urban productivity crises lead to political ones. For example, productivity crises in “flyover states” in the United States led Donald Trump to the presidency in 2016. New York became the de-facto capital of U.S. east coast, and San-Francisco – of the Silicon Valley, precisely because people living there created productive economies, outpacing median national growth.

Ukrainian economist Pavlo Demchuk studied Ukrainian economy’s productivity and wrote a thesis on the subject at Rice University in 2013. One of the takeaways from his work is the comparison between eastern and western Ukraine. Both regions have low productivity; both regions have untapped potentials.

Eastern Ukraine is hampered by problems related to its human capital: poor healthcare, environment, workplace conditions, and education. Western Ukraine, on the other hand, is held back by a poorly structured economy. Demchuk concluded that both regions were convinced that they are “feeding” the country, while in reality Kyiv was doing that – having a concentration of half of Ukrainian companies.

Post-war economic recovery will become Ukraine’s true decentralization. Kyiv will no longer “feed” the country, since that was really done by regional agricultural powerhouses. Ukraine was “kept warm” by energy producing regions, while consumer culture was enabled by Nova Poshta’s elaborate logistical infrastructure.

This decentralization, which was first described in 2014 by Nobel laureate Roger Myerson, and then later promoted by former PM Volodymyr Hroisman, will now have a real chance to happen. And not just happen, but correct the flaws of the initial political decentralization launched by Hroisman in 2016.

While he tried to achieve the goal by redistributing fiscal and financial flows in the country, our post-war recovery will decentralize Ukraine via the geographical redistribution of the labor force. And its effects will be much more durable than those produced by centralized government efforts.

Another example is the vast Big Construction program of Zelensky’s administration. It soaked up billions in funding, but failed to produce meaningful GDP growth. The same mistake was made earlier by Canada’s PM Justin Trudeau during his first term in office, and former U.S. President Donald Trump. Both of them were listening to advisors repeating the “multiplicator effect” mantra (it suggests that for every dollar invested in infrastructure the economy grown by three dollars).

But merely dumping cash into infrastructure doesn’t suddenly make the economy grow rapidly. Even Joe Biden admitted as much, launching his infrastructure plan to create jobs, rather than to stimulate the economy.

Infrastructure investment should be done differently. Instead it should focus on improving regional interconnectedness, which, in turn, will produce economic growth via symbiotic effects.

In my opinion, traditional economic infrastructure investment shouldn’t be the main thrust of our future recovery. Not to mention, the responsible enterprise – Ukravtodor – is hardly up to the challenge, being limited in its ability attract capital and investments due to some peculiarities of its balance sheet and status.

Instead, I’d suggest we invest heavily into the sectors of our economy that can grow rapidly and have long suffered from systemic under-investment.

One such example would be healthcare. Investing into public and private healthcare produces powerful second-order effects. It improves human capital – something that prevented the economy of Donbas from reaching its full potential. State clinics are also in dire need of new equipment, or they will soon be reduced to mere offices with family doctors.

In April 2021, I injured my leg while running, and needed minor surgery. It could have been done in a public hospital, but with some discomfort – it was difficult to even move the date of the procedure up. Far from being wealthy, I still turned to private clinic, that performed the procedure quickly, using modern equipment, and the doctor gave me a quick overview of how human legs work.

Besides medical services, Ukrainian pharmaceutics could become a growth driver and give us a presence on international markets. For instance, the UK, the United States, and Canada have a huge demand for ketamine.

In Ukraine, ketamine is classified as a hallucinogenic drug, and is mostly used for anesthesia for veterinary purposes. It’s produced by a factory in Kharkiv. Western medicine uses ketamine to treat depression in terminally ill patients in palliative care. Ketamine production could be a major opportunity for Kharkiv and other domestic pharma companies – Darnytsia, Farmak, Borschahivskiy Pharmaceutical Plant.

Our agriculture also has a great outlook, provided we properly invest in its modernization. After the war, drone operators will be looking for jobs in great numbers. They could be employed by agricultural companies that need people with those skills to monitor crops, and analyze weather conditions and soil quality.

Ukrainian investors have often overlooked the farming potential of Donbas, focusing on the fertile soils of Cherkasy, Poltava, and Ternopil regions. But the soil in Donbas is pretty decent – its potential has been highlighted by World Bank reports. With cities like Mariupol having had their industrial capacities decimated by the war, banking on agriculture could pay out big time for economic growth in Donetsk and Luhansk oblasts.

The reputation of our IT sector was somewhat damaged by Russian cyber-attacks when it comes to cybersecurity. Nevertheless, digital innovation in the Ukrainian banking remains very advanced, outpacing even the United States. The reason PayPal remains so dominant there is because U.S. banks couldn’t develop in-house payment systems akin to Ukraine’s Privat24. In their recent report, the Federal Reserve described the market of U.S. banking apps as underdeveloped.

Developing technological solutions for the global financial markets is a marvelous opportunity for Ukrainian software engineers. Their products are already well-regarded in Scandinavian and Eastern European countries. Now is the time to compete for new markets, creating jobs in Ukraine and generating global demand for IT graduates from universities in Kyiv and Lviv.

Following the coupling of the Ukrainian and EU power grids, we are presented with opportunities to export energy generation to Europe. To capitalize on them, we would have to invest in new power plants – solar, wind, and nuclear, including modular nuclear power plants designed in the UK.

Electricity production auditing and automation is another area that could use some attention. Anyone who has ever dug into the operations of Ukrenerho knows how challenging it is to precisely monitor the production and transmission of large quantities of power along power lines, accounting for resistance, and so on. Developing new, more efficient materials for power lines would be a major scientific breakthrough.

Import substitution is something Ukraine ought to work on as well. Localizing the production of consumer goods – from lightbulbs and coffee cups, to Christmas tree ornaments and phone chargers – things Ukraine has grown used to importing, should be a priority for investors.

I’ve outlined but a handful of suggestions about how Ukraine’s post-war recovery could be made to reflect the changes Ukraine has undergone due to the Russian invasion. Naturally, attracting investment isn’t trivial, and takes the efforts of various investment agencies, coupled with the momentum of Ukraine’s Foreign Ministry. Ukrainian diplomats should have presentations that persuasively describe the prospects of investing in the country’s economy; they have to be able to “sell” this bright future to potential investors.

Ukraine’s ability to ask or even demand the West for support won’t last long. Sooner or later, Ukraine will have to rely on strictly economic arguments in its relationship with the West, both in the questions of EU membership and weapons supplies. Without a plan for economic recovery, Ukraine won’t be able to convince the world that it has really changed after the war.

It’s clear to me personally that Ukraine has changed. The old world, where Ukraine prioritized marketing and promotion over the quality of goods and services is still around, but it’s gradually fading. Ukraine’s future lies in the real economy, in ensuring that what Ukraine has to offer the world is competitive.

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