Ukraine's Economic Rise

Anatoliy Kinakh , Mark Medish January 31, 2007 Washington, D.C.
Summary
The only effective economic reforms in the Ukraine will come through the free market system. Increasing the value of its workforce and improving the pensioner system should not come through populist measures.
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Anatoliy Kinakh
Chairman of the Committee on National Security and Defense of the Verhovna Rada of Ukraine

The purpose of my trip to Washington is to provide the policy making community here with real information about the political situation in Ukraine, and in doing so, build our bilateral relations.  I spent today meeting with my counterparts on Capitol Hill, discussing issues of national security and reaffirming Ukraine’s commitment to the fight against global security threats such as international terrorism and drug trafficking.

My presentation here, however, will focus on the development of Ukraine’s economy.  Overall, our economy has had a very successful year.   Growth was 7% on the year thanks in part to our efforts to strengthen the rule of law and the help of the US in repealing Jackson-Vanick and granting us market status.

That said, inflation grew more than expected, 11.6 percent, due in large part to the increase in the price of natural gas.  And while this increase in gas prices and subsequent growth of inflation mirrors global trends, it makes obvious the ever-present need to reform and restructure Ukraine’s economy, building the infrastructure for free and fair markets.

Especially as Ukraine prepares to enter the WTO—which I hope will happen later this year—we need to increase the competitiveness of our economy.   This means attracting capital to increase technological innovations and the sophistication of the means of production.  Most importantly for Ukraine, it also means increasing energy efficiency and conservation.

Last year foreign direct investment increased twofold, but there are still several key sectors of the economy that fail to attract the attention of investors.  Agricultural production is one such sector, and the government is working hard to make the changes necessary to attract investment.  The government has reformed the land code and is in the process of enacting a series of laws that will make the sale of land possible by January 1, 2008.  The government is also working hard to reform the high-tech sector.   Our top priorities in this sphere are space technologies, aircraft building, and energy technologies.

Of course, Ukraine has a very complicated situation in the energy sphere.  We come at this challenge from a very principled position, building off the belief that energy relations should be conducted in a transparent market without monopoly pressure coming from any side.  Ukraine has a very important role to play in the energy security of Europe: 80 percent of all natural gas, about 120 billion cubic meters annually, that goes from Russia and Central Asia to Europe travels through Ukraine.  Ukraine has ratified the EU’s energy charter, and supports the energy security bill that was enacted by the US Congress.

We strongly believe that energy should not be used for political purposes, and insist on this principle in our negotiations with Russia and other energy partners.  Our stake in global energy security and in the transition to transparent energy relations is not small as 70 percent of the energy consumed in Ukraine is imported.  In light of this, we support the creation of fair and transparent relations between producing and consuming countries.

Last but certainly not least among our economic priorities is the development of medium and small business.  The government is working to create a hospitable environment for entrepreneurship because it is convinced that these businesses are the key to creating a middles class.  This middle class in turn will serve as a bulwark not only of the economy but also of democracy.  Thus, this task takes on more than just a pragmatic meaning; it also carries a moral weight.

In helping these struggling sectors to prosper, we face many systemic challenges, but two are most urgent.   First, the government needs to change the way it relates to business.  It has not accepted all of the principles of a free-market economy, implementing measures that run counter to its logic.  The effects of this are clearly seen in the grain market.  Last year, Prime Minister Yanukovich introduced new requirements for the licensing and export of grain.  We all love Ukraine, and want to see its people fed, but food security cannot be achieved by contradicting market principles.  Indeed the results of the PM’s hasty policy are all too clear: over-flowing grain bins filled with rotting grain, broken contracts, and ships with empty cargo holds.  We are in dialogue with the cabinet right now to resolve this matter, but the president and the business community have made it clear that the current situation and the way the government acts toward business are unacceptable.

The second challenge presents itself in the reformation of the judiciary.  Many judicial decisions still do not adhere to the law, but are rather the result of lobbying.  This creates an environment where investors are uncertain about the security of their assets as those in power seek to “redistribute wealth” in their own favor.  We are working to stabilize the situation and have introduced a number of laws towards that end.  During the first half of the year, the National Security and Defense Council with the active participation of the parliament, cabinet and president will be reviewing the problem and will form a plan to strengthen the judiciary. Strengthening the rule of law will make Ukraine more attractive to foreign investors.


In conclusion, I would like to say a few words about the current political environment in Ukraine.  On January 1, 2006 six new constitutional provisions were implemented, which significantly redistributed power between the various branches of government in favor the cabinet and parliament.  The changes were enacted in a haphazard fashion without implementing or revising the laws that dealt with the technical aspects of these provisions.  No laws on the new role of the president or the cabinet of minister have been enacted, and there are no new laws that spell out in detail the relationship between these branches of government.

It is important for the political elite to come together to fix these deficiencies and create a balance of power between the branches of government.  All of the branches of our government should have clearly defined limits on their authority.  The Orange Revolution confirmed that the people of Ukraine want a government based on this principle, and I am doing everything I can to bring their wishes about.

Ukraine recently celebrated its first 15 years of independence.  Those first years have witnessed many changes in our region.  The EU is evolving with many of our neighbors in Eastern Europe becoming members.  Russia, Azerbaijan, and other countries in the CIS have also dramatically changed.  In this dynamic environment, Ukraine cannot lose time in developing a transparent and democratic political system, and I believe that with the determination and ingenuity of the Ukrainian people such a system is within our reach.  


Q & A:

Q: How do these political developments affect the economy? Specifically, what impact does the competition between the president and cabinet have on the economy?  What are the risks and what is the way forward?

As I said there are certainly many systemic problems that can’t be tackled by either the cabinet or president alone. Their resolution requires a unified effort. Such issues as the integration of Ukraine into EU and the world economy, economic competitiveness, tax reform and investor protection can only result from a consolidated effort between the parliament and president.

Unfortunately the necessary level of unity does not exist in Ukraine’s current system, leading to the loss of opportunities.  For example, we had a chance to join WTO in 2006, but the Rada lacked the political will to enact a series of laws to make it possible, and as a results Ukraine’s strategic interests suffered.  There are currently 15 anti-dumping cases against Ukraine being reviewed around the world, and WTO membership would have increased our ability to defend our interests in those cases.

We were also on course to sign a Nato Membership Action Plan at the Riga summit this last fall, but the so-called anti-crisis committee lacked the power and will to do that. We lost that opportunity as well.  Unequivocally, when the government is not unified on strategic interests the country suffers.

Q: Energy is a very important if not the most important theme when it comes to Ukraine’s economy.  From your experience as a leader of Ukrainian industry, can you comment on how the Ukrainian economy and Ukrainian business people have been responding to the increase in energy prices?

Ukraine supports market relations in the energy sector, but does not want to see market shock therapy.  Rather, we want to see a gradual increase in prices, and have tried to convince our partners that this is the most prudent course of action.

Ukraine’s GDP requires a great deal of energy consumption.  Coal and ore mining, chemical refining, and electricity production constitute 60 percent of GDP.  Energy consumed in Ukraine in 2.3 times higher when compared with other countries with similar GDPs in the region. Thus, we have to work diligently on energy conservation and efficiency, but the necessary technological innovation requires both time and investment.

Meanwhile, as of January 1, 2007 the average price for gas increased 70 percent.  On the border of Russia and Ukraine, 1000 cubic meters of gas costs $130 dollars. With the transportation fees and shipping fees the average price for enterprises and businesses is $160 per 1000 cubic meters.

We understand that the growth of prices is inevitable, and realize that we need to swiftly adapt the economy of Ukraine to these increasing prices.  Of course, foreign investment is important to bring this about, and thus we need to create an environment hospitable to that investment.

At the same time, in our negotiations with Russia, we insist on gradual price increases, but will not sell off our strategic industries to maintain those gradual increases.  Therefore, Ukraine is trying to diversify its energy resources, seeking partners in Central Asia and working closely with other countries, like the EU and US to bring this about this greater diversification.

It is important for us to adapt quickly and not allow the current situation to negatively affect business.  It is also important to recognize that the problems we face are our own.  It is only our will and initiative that can solve them.

Q: Many studies have verified the rapid growth of drug resistant Tuberculosis and HIV/Aids infection in Ukraine.   But because of the lack of political unity, public health programs have suffered.  Some of my colleagues at the World Bank are having trouble conducting their public health activities in the country because of bureaucratic “red tape.”  I wonder if this is an area that the fighting parties can cooperate on, if only because viruses do not care about politics.  Can you comment?

Thank you for an important question.   In 2006, when I was secretary of the National Security and Defense Council, we looked into health problems including TB, HIV/Aids, and those that are related to Chernobyl.  After that meeting, the president issued a decree to implement measures to stem the problem—measures which we are currently carrying out.

When I return to Ukraine, I’ll look into the problem with the World Bank program.  I agree that all parties should unite on such issues, and it just further illustrates my point that the population suffers when government is divided.

Q:  I am interested in your thoughts on Ukraine’s position toward Turkmenistan.  On one hand, you have the legacy of the Orange revolution and a commitment to support democratic principles.  On the other hand, you are dependent on Turkmen gas, and therefore, cannot alienate their ruling elite.  To what extent do you think the Turkmen opposition’s relations with Ukraine threaten its energy interests? How should you balance energy security with your ideals of democracy and human rights?

Turkmenistan is an important partner.  Ukraine consumes on average 73-75 billion cubic meters of gas a year, and at least 40 billion of that comes from Turkmenistan.  We also have a very serious level of investment in Turkmenistan.  It is important for us to deepen our bilateral relations.  Unfortunately, due to divisions in the government during the last couple of year, our bilateral relations have suffered.

At the same time RosUkrEnergo has come to monopolize energy imports from Turkmenistan to Ukraine.  We now have to depend on the monopoly of this private, very opaque company.  RosUkrenergo has also tried to make inroads into our domestic market lately, which is completely unacceptable because it would further increase the dependence of Ukraine.

We need to renew the agreements signed between Russia and Ukraine in 2000 and 2001.  They spelled out a reciprocal relationship between Russia and Ukraine in the energy sphere: Ukraine was obliged to transport gas to EU, and Russia, in turn, was to provide Ukraine access to natural gas from Central Asia.  It is important for us to renew these agreements, in order to for us to have direct conference with Turkmenistan with out any commercial intermediaries.

I won’t comment on Turkmenbashi.  He is not among the living so it wouldn’t be ethical.  But Ukraine needs to establish ties with the new government.  What happened to the Turkmen opposition in Ukraine was simply a provocation and was counter to the interests of Ukraine.  A third party, which I will not name, profits from this provocation.  We are conducting an investigation of these events with representatives from Turkmenistan. It will be open and transparent.

Q: I want to ask more about how the current political situation affects the economy.  In particular, how does/will the current constitutional crisis affect the economy?  Will you please more generally comment on the current crisis?   On the one hand, Yushchenko is pushing for further reform.  He says that he is pleased with the earlier reforms, but wants to add to them.  Meanwhile the Council of Europe and the Venice Commission among others have stated the last changes to the constitution were void from the beginning because they were adopted illegally.  What is going on?

I stated my view earlier that it was done in a haphazard way without a clear vision, and without laying out the necessary separation and definition of powers of the various branches of government.  These amendments, of course, were adopted in 2004 to make possible a “civilized” and democratic presidential election, and were not the product of consensus.

A constitution has to unite people; a constitution should not be changed to alleviate short-term political problems because it is the supreme law.    It is necessary to end the tug of war between the president and parliament right now and create a stable balance of power.

This tug of war not only negatively affects the economy; it lowers the overall ability of the government to act and harms its legitimacy.  Nonetheless, I am against repealing previous amendments.  They have already become an entrenched part of the law.  We are currently working on creating a constitutional committee, where the parties involved—the president, parliament and government—can unite their efforts, and improve upon the current provisions.  It is necessary for this process to be successful.  Just like the fight against infectious diseases, the creation of a sound legal basis for our country is something that all sides should be able to agree upon.

Q: My first question is about social programs and the social sphere. The number of retires has been increasing in the last three years. What has the government to prepare for the increase in pensioners?  Next, about immigration, what steps is the government taking to attract Ukrainians working outside of the country back to Ukraine?

We have a very complicated demographic situation.  The population of Ukraine as of January 1, 2007 was about 47, 000,000.  In comparison, in 1990 the population was about 51,000,000.  It decreases by about 350,000 people a year both through the loss of workers across the border and the imbalance between deaths and births.

It is thus important to improve social programs in our country, including maternity care and the pension program.  We have done a lot in the last two years to solve these problems in the social sphere.  Pensions and salaries have increased by 25 percent.  Despite that, the average salary in Ukraine as of January 1, 2007 is about $175.  By the end of the first quarter of 2007, we predict that it will increase to about $200.

We need to increase the value of our workforce, and improve the pensioner system, but not through populist measures.  Rather, the only effective reforms will come through the logic of the free market system, through the increase competitiveness of our economy.  This gets to your second question:  the only way to attract Ukrainians back to Ukraine is to continue to work on the economy. 

About the Russia and Eurasia Program

The Carnegie Russia and Eurasia Program has, since the end of the Cold War, led the field of Eurasian security, including strategic nuclear weapons and nonproliferation, development, economic and social issues, governance, and the rule of law.

 
Source carnegieendowment.org/2007/01/31/ukraine-s-economic-rise/2qef
 

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