Lessons of independence

It is common practice to sum up things on the eve of important historic dates. This year the most important historical Rubicon for this country is August 24, we will be celebrating the 20th anniversary of independence. Why did Ukraine opt for “wild capitalism” at the initial stage of its development? What managerial mistakes lead to the current situation, when only a small stratum of people feels economically and socially secure? Is the government following a right economic path today? These and many other issues are the subject of an interview with Professor Trokhym KOVALCHUK, Doctor of Sciences (Economics), Me-ritorious Figure of Science of Technology of Ukraine, and adviser on macroeconomic issues to ex-Prime Minister Yevhen Marchuk.

Mr. Kovalchuk, Ukraine is going to celebrate 20 years of its independence. This historically short period of time has seen a lot of events and processes which can be summed up with an absolute truth: “We are a State!” Two decades is quite a sufficient term to stop blaming “bitter legacy” and soberly assess our achievements in state building in general and economic development in particular.

“In this matter one should not go to extremes and paint everything in ‘Rembrandtesque colors,’ i.e., to paint too bleak a picture. With all downsides and mistakes in a historically short period of the existence of independent Ukraine, this period should not be unequivocally called a failure. It is not just a historical accident that we have had no domestic armed conflicts, possess a high intellectual potential, and have managed to keep territorial integrity and, after all, political sovereignty intact. Too many factors may have caused the loss of any of these gains – even all of them at once.”

In their daily routine, the Ukrainians are far less inclined to engage in political struggle than one can judge by TV and press reports. They are more concerned about the buying capacity of their own wallet and the prospects of having at least some kind of wellbeing.

“Yes, the living standards of a rank-and-file Ukrainian look, at first glance, even quite decent today if you are in a big city. Some external attributes, such as luxury estates on the outskirts, primary school children with cell phones, streets full of prestigious up-to-date cars, and shop windows with too expensive goods, may cause one to think it is prosperity. At the same time, what stands out against the background of the unhidden luxury of a small part of the people is total poverty of the Ukrainians – even of those gainfully employed. In the social dimension, a Kyivite and a resident of Polissia or Black Sea coast village differ so much as to seem to be living in different countries. This is a sign of ‘wild capitalism.’”

Was Ukraine doomed at the dawn of its independence to follow the road of “wild capitalism?” Was there a chance to choose a different way of development?

“As Den/The Day has been an impartial and, hence, very readable publication for many years, I will also try to answer your questions as much impartially as possible. This question literally prods me to say or even exclaim: ‘Yes, of course, there was a chance!’ But, in reality, a wish alone cannot cause anything to occur in society or in nature. You have to struggle for everything – first of all, for a chance to follow a civilized way of social development. Unfortunately, this did not happen. Ukraine embarked on the path of ‘wild capitalism’ from the very outset of independence.”

You are saying we have a “wild market.” At the same time, the state and the market cannot and must not be interchangeable categories. Am I right?

“I fully agree. It is the economy, not the state or a society, that can be market-oriented. For the state is quite an intricate system of political, organizational, managerial, socioeconomic, moral and ethical communications. The market is a toughly pragmatic phenomenon in its essence and nature, even though it is the most significant achievement of human civilization. It does not recognize such categories as ‘fatherland,’ ‘social justice,’ ‘patriotism,’ etc. It is the state that should care about these things by introducing a relevant ideology and pursuing an adequate economic policy.”

UKRAINE HAS A 120-BILLION-DOLLAR AGGREGATE DEBT

In other words, things are much worse. But still, what is the root cause of our economic failures?

“In my view, one of the weightiest and most effective factors that have caused the current problems is the mentality of temporariness typical of both big business and almost all the governments. The history of Ukraine’s governmental merry-go-round is ample proof of this. During the presidency of Leonid Kuchma, when he wielded almost unlimited powers, the real state of the national economy in fact depended on the prime minister. At the same time, if the head of government was unsatisfied, the president could replace him any time. Incidentally, he used this privilege all too willingly, often being guided by pure emotions. Therefore, fully aware of their temporary status, every cabinet would borrow a loan from ‘goodhearted’ neighbors, knowing very well that its ‘ruling period’ was short and it would be the next team’s headache to repay the loans (and not only them). Almost every borrowed dollar would in fact stop the production of an equal-value national product. Not a single cent of the hard-currency loans contributed to material production – all the funds were unwisely spent on current requirements or were used to top up the National Bank’s hard-currency reserves. (The rationale of keeping so vast a reserve outside Ukraine is highly questionable.) The owners of financial capital would in turn actively transfer it to offshore zones. In the long run, this brought about a situation when the accruement of domestic and, still worse, foreign debts had an extremely negative effect on the national economy.”

Some oppositional politicians are saying a financial default is imminent. What is the actual foreign debt situation now?

“Let us not tire the reader with figures. I will just say that Ukraine is now in a very difficult financial debt situation. Ukraine has a 120-billion-dollar aggregate debt, i.e., almost as much as the economy produces in a year. What I mean here is not the GDP, a parameter full of statistical ‘chaff,’ but the national income which is a more precise gauge of a yearly achievement.”

If Ukraine’s public debt were channeled into long-term investments, could it be considered a positive phenomenon?

“That is the point. One should focus not so much on the size of hard-currency debts as on the efficiency of their utilization. The International Monetary Fund is the chief lender of hard currency for us. Our state was forced to sign cooperation memorandums with it, which forbid us to channel the borrowed funds into the real sector of the national economy. This is why the accrued hard-currency debts are producing a negative effect. Paradoxically, the agreements on the granting of new loans, especially by the IMF, are being touted as an outstanding achievement, as if it is not clear that these loans are not charity but a common commercial operation, in which the creditor first of all pursues his commercial interests. By offering the so-called credit aid, the IMF can thus dictate rather tough demands about the shaping and pursuing of economic policies in this country. This kind of ‘cooperation’ with the IMF openly shows the clear signs of neocolonialism. And the public considers the claim of Serhii Tihipko that cooperation with the IMF is ‘a positive signal for foreign investors’ as a cynical mockery of reality.”

AN UNPRECEDENTEDLY OPEN ECONOMY WAS A FATAL POLITICAL MISTAKE

But these loans do not go to the budget.

“You are right. The so-called IMF and World Bank hard-currency loans are deposited on target-oriented NBU accounts, their sole purpose being to top up NBU hard-currency reserves. But the hard-currency reserves of the Ukrainian state (a staggering amount of almost 38 billion dollars) are kept on foreign accounts as US securities. Some of them are shoeing today the signs of ‘trash.’ The Ukrainian head of state ought to look into the conditions of the placement and utilization of hard-currency funds. The information he would receive, provided it is unbiased, would be not so rosy, to put it mildly.

“As for a likely menace of financial default, I will say a paradoxical thing. This would play in the hands of the national economy. The point is that, under these conditions, the so-called foreign ‘investors’ will have to make serious concessions and considerably liberalize the current tough hard-currency requirements. Let us recall Argentine which carefully heeded IMF advices, only to announce financial default in the long run. After severing contacts with the IMF, that country was soon among the top 20 economies of the world. Should the Ukrainian financial system continue to pursue the customary debt policy, it will go in for systemic default. It is not even a forecast but just a description of the actual course of not-so-distant events. An unprecedentedly open economy is a fatal political mistake of the previous years. The latest comments of Mykola Azarov at last show a long-awaited more sober approach to what was considered necessary and beneficial cooperation with the parties to the Washington Consensus.”

Still, I would like to know if independent Ukraine may have an optimistic scenario for, say, the next few years.

“Everything depends on the current government and, first of all, on the president of the country. I have no doubts that he is striving to radically change the situation for the better. There are some encouraging steps in sight. For example, the Basic Principles of the Domestic and Foreign Policy were mapped out and adopted in an extremely short time, as were the Budget Code and the Tax Code. It is difficult to overestimate the legal power of these juridical instruments and their impact on economic development.

“Fully aware that the newspaper space is very limited, I will briefly point out a few more ideas which are very important for a more successful progress in the coming years. Incidentally, they need no budgetary expenses to be put into practice. On the contrary, if they were realized, the government would greatly improve this country’s monetary situation.

“I will allow myself to note one of the obvious reserves which, under the pressure of foreign ‘advisors,’ are not being taken into account and are pictured in a distorted light. I mean the claim that inflation is ‘the ultimate evil’ which we must fight uncompromisingly and fiercely. Besides, the amount of money in circulation is considered the main cause of inflation. This brings forth the money issue phobia, i.e., the fear of putting into circulation as much national money as necessary under the Basic Principle of the Domestic and Foreign Policy.”

Do you mean the Ukrainian government should drop the strategy of maximum monetary restrictions?

“I mean just this, for, in reality, this kind of loans and ‘investments’ are only beneficial to foreign speculative capital. Moreover, we are ignoring the world practice which has worked out a criterion that determines a money mass which is sufficient to make an economy effective. It is the so-called monetization ratio (M2 to GDP). As of mid-2011, the money mass of our state was at best around 50 percent by this criterion. In other countries, this important index is as follows: 65 percent in Germany, 69 percent in France, 89 percent in the UK, 110 percent in the US, 116 percent in Japan, and 160 percent in China. As we can see, the countries with a sustained economic development are adhering to the key principle of the economy being filled with a sufficient mass of money. Conversely, Ukraine has artificially created a hryvnia shortage based on a forcibly imposed fear of inflation. As a result, the money shortage is being actively made up by means of foreign hard-currency loans.”

But inflation can provoke quite serious problems…

“Of course, money issue harbors a certain potential danger. But the potential danger of, say, electricity does not at all mean that we should stop using it everywhere. Money is the ‘oxygen’ of an economic body and a normal monetary circulation is its ‘capillary and vascular system.’ An artificial restriction of the money mass’s access to the economy will in fact trigger the paralysis of the latter. For this reason, the national monetary system of this country is in an emergency condition. Incidentally, it is inflation that eats up the money that is kept at home instead of being invested in entrepreneurial projects or at least placed onto banking deposits. In other words, inflation is a ‘scavenger’ of sorts, which trims the unused money mass.

“Just on the eve of this interview, I wrote down some quotes from the memoirs of Ludwig Erhard, an outstanding statesman and macroeconomist of postwar Germany. As an architect of the postwar reforms, he played the most notable role in a breath-taking revitalization of the totally ruined German economy. Here is his unequivocal conclusion: ‘There is no cause-effect relationship at all between inflation and the money in circulation. Inflation can only be caused by the fact that there may be incomes from the activities that are of no real use for the economy… It is deflation that first of all hinders the process of restoration in an economy that depends on private initiative.’ But deflation is a tightly-pressed inflation. In other words, it is approximately the same as to remove a pressure gauge from the steam boiler and cherish the illusion that no steam is being fed and the boiler will not burst.”

CHEAP LABOR IS AN ESSENTIAL DRAWBACK OF UKRAINE

Your generalization is an interesting food for thought. What do you think is the next factor for the revitalization of Ukraine’s economy?

“An important reserve for revitalizing the national economy and speeding up the long-awaited modernization is the impartial appraisal of such an important financial instrument as budget deficit. The myth of an utter necessity to maximally restrict and reduce the budget deficit in fact poses a threat to the country’s national interest and security. Incidentally, this is one of the conditions for the IMF to grant hard-currency loans to Ukraine. What is being ignored here is the fact that over the past few years the developed countries have been planning rather a high level of budget deficit: 12 percent in the UK, 10 percent in the US, 7 percent in Russia, and even more. A historical overview convincingly shows that almost always, whenever a certain country saw an accelerated economic growth, its budget had a deficit and, on the contrary, the intention to overcome the deficit at any price quite often cut short the upward trend in economic growth. A 7-to-10-percent budget deficit is absolutely necessary for the economies that tackle, as Ukraine does, some difficult socioeconomic, environmental, and other manmade problems. The IMF demands that it be cut down to 3-4 percent. This means the national economy will be unable to earn at least several hundred billion hryvnias. And the government will have to cover this money deficit by means of foreign loans.

“The transition to a new pattern of public relations is connected to the recognition of the fact that the main social problem in Ukraine is the level of wages, i.e., the problem of overcoming the poverty of the gainfully employed people. It is impossible to solve the problem of poverty among the broad masses without a radical reform of the wages policy. But to explain does not mean to justify. In this connection, one of the most urgent tasks for legislators is to make sure that wages perform their restorative and stimulating functions. Cheap labor is an essential drawback, rather than an advantage, of Ukraine. A considerable increase in, first of all, hourly wages will lead to the growth of the nominal wages, which will in turn boost Pension Fund contributions. The growth of pensions should be objectively based on the growth of wages rather than on arbitrarily-set pension increments.

“I could also name some other urgent measures. For example, territorial reform is an arch-topical problem. I do not mean the so-called administrative-territorial reform that only provokes administrative chaos and again reproduces the mentality of temporariness. It is wrong to continue to disregard the current territorial fragmentation, which calls for an excessive number of local government organizations that swallow budgetary funds without taking into account the interests and requirements of the local populace. In essence, the current line of executive authorities is not from bottom to top, as it should be according to civilized criteria, but the other way round – from top to bottom. All such a system can do is take away. This should be put an end to, after all.”

In what way can this be done?

“In my opinion, it has long been extremely necessary to optimize the territorial setup of Ukraine. It will be noted that the name of our state derives from the idea of our native land. Incidentally, the root word in the name of the Ukrainian state is ‘krai’ [area, territory – Ed.]. The current situation demands that it is time to switch from small oblasts to integrated territories. The optimum model is when 24 small oblasts give way to eight powerful territorial-administrative entities. This pattern of territorial reform will help build a clear-cut system of executive authorities, consolidate financial resources, and considerably reduce the bureaucratic apparatus and, hence, the extent and potential of the now rampant corruption. This kind of territorial optimization will considerably intensify and diversify the inner regional links, radically reduce the number of depressed regions, and eliminate the wide gaps in socioeconomic development.

“In more concrete terms, the state of Ukraine might have the following territorial setup: the Autonomous Republic of the Crimea, Donetsk Territory (Donetsk and Luhansk oblasts), Carpathian Territory (Lviv, Ivano-Frankivsk, Chernivtsi, and Zakarpattia oblasts), Kyiv Territory (Kyiv, Kirovohrad, Cherkasy, and Chernihiv oblasts), Podillia Territory (Vinnytsia, Khmelnytsky, and Ternopil oblast), Polissia Territory (Volyn, Rivne, and Zhytomyr oblasts), Dnipro Basin Territory (Dnipropetrovsk and Zaporizhia oblasts), Black Sea Basin Territory (Odesa, Kherson, and Mykolaiv oblasts), and Sloboda Territory (Kharkiv, Sumy, and Poltava oblasts).

“I can only forecast that it is not today or tomorrow this country will opt for these radical changes. But it is sure to do so. This will be the beginning of a true Ukrainian renaissance.”