Mr. Chairman, I would like to thank you for this opportunity to speak on an important topic. In my view, no political event in Europe this year is more important than Ukraine’s presidential elections next October. They amount to two clear-cut choices between democracy and dictatorship as well as between a Western and Eastern geopolitical orientation.

The United States is well liked and highly influential in Ukraine. The U.S. can do a great deal to influence that country’s choice. The main objectives for U.S. policy on Ukraine should be to support democracy. If only democracy is secured, Ukraine is most likely to choose a Western geopolitical orientation.

As a matter of disclosure, I first visited Ukraine in 1985 and have kept in close touch with the country ever since. I worked as an economic advisor to the Ukrainian government from 1994 to 1997, and I have continued to follow its economic and political development.

Recent Economic and Political Developments

To make sense of recent developments in Ukraine, it is probably most illuminating to start with its economic metamorphosis. It is been transformed from moribund to a highly dynamic economy which has undergone swift structural developments since 2000. For the last four years, Ukraine has enjoyed an average growth rate of 7.3 percent a year, and growth seems to be accelerating. For the last year, three other economic indicators are also telling. Industrial output surged by 16 percent, machinebuilding output by as much as 36 percent and exports by a whopping 28 percent. The Ukrainian economy is not only dynamic, but it is also rapidly becoming more sophisticated and integrating into the world economy.

These recent economic developments stand in sharp contrast to the 1990s. Until 1999, Ukraine underperformed even other post-Soviet economies, while a handful of tycoons or oligarchs made fortunes on government subsidies and regulations. In Soviet times, Ukraine’s GDP per capita was slightly higher than Russia’s, but it has slipped to less than half of Russia’s. Yet, eventually, macroeconomic stabilization, liberalization and privatization took hold, and a market economy was formed. The real breakthrough occurred in 2000, when a new government under Prime Minister Viktor Yushchenko carried out momentous market reforms, slashing subsidies to oligarchs and leveling the playing field. Since then, Ukraine’s state budget has been close to balance and inflation under control. About two-thirds of national income is produced by private enterprises. Yushchenko’s deputy Yuliya Tymoshenko minimized subsidies in energy. In revenge, the oligarchs ousted both of them after slightly over a year. Even so, sound market economic reforms have continued. From this year, a flat personal income tax of 13 percent has been introduced.

The whole nature of Ukraine’s business changed. Until 1999, Ukraine’s dominant businessmen were shady commodity traders, who made more money on the government than on the market. Today, these traders have been replaced by real companies. Ukraine’s four largest enterprises are healthy metallurgical corporations, namely System Capital Management and the Industrial Union of Donbass in Donetsk, as well as Interpipe and Privat in Dnepropetrovsk. Ukraine has comparative advantages in steel production, and steel accounts for nearly 40 percent of Ukraine’s exports. Light industry and food processing have developed well for years, and trade has come of age. Recently, machinebuilding has taken off. Ukraine also has an impressive computer programming sector. Many sound corporations of all sizes are also flourishing on a competitive market, although the bureaucracy is deeply corrupt and the rule of law not very stringent.

My contention is that, with such a strong competitive market economy, Ukraine needs to make very serious political mistakes to fail. Unfortunately, that cannot be excluded. Whereas the economy is modernizing at great speed, the political system is pretty retrograde.

To understand Ukraine’s economy and politics, one must comprehend its oligarchic groups, which remain the political and economic base of the country. The three most important oligarchic groups are regional: the Donetsk group, the Dnepropetrovsk group and the Surkis-Medvedchuk group in Kiev. These groups are both economic and political. At present, the strongest group by far is the Donetsk group. Its leader is Rinat Akhmetov, a businessman who owns System Capital Management, Ukraine’s biggest corporation, focusing on metallurgy. Prime Minister Viktor Yanukovich and the Deputy Prime Ministers for energy and finance also hail from the Donetsk group. Its parliamentary faction, the Regions, has some 65 members out of a total of 450. The second most important group is the Dnepropetrovsk group, whose business leader is Viktor Pinchuk, who owns the metallurgical company Interpipe. Its party, Labor Ukraine, has about 40 parliamentarians and is led by the Chairman of the National Bank, Serhiy Tyhypko. Pinchuk owns three TV channels. The Kiev businessman Hryhoriy Surkis and President Kuchma’s chief of staff Viktor Medvedchuk form the third group, which is much more state-oriented. Unlike the other groups, it has not developed normal private enterprises as yet. Medvedchuk controls the three biggest TV channels, and he plays a great role in law enforcement. Their United Social Democratic Party comprises some 40 parliamentarians. President Leonid Kuchma rules by playing off these and other less important oligarchic groups against one another.

Ukraine is a country in swift development, and the transformation of the oligarchic groups might be seen as one of the keys to development. Privatization and the leveling of the playing field means that in both Donetsk and Dnepropetrovsk enterprises have becoming more independent from one another, and they have become competitors.

They are also facing competition from other groups, which are independent or support opposition parties. Therefore, their status as oligarchic groups is becoming tenuous, but they still have their political parties, which hold about half the seats in parliament and the government, and they control media, too. Although they are rivals, they still gang up against the democratic opposition. Moreover, the Surkis-Medvedchuk group is hardly modernizing, but rather digging into the state administration, notably law enforcement.

The Ukrainian parliament is a rather curious creation. Virtually all of Ukraine’s businessmen are members of the parliament, which serves as their meeting place. It is frequently stated that about two-thirds of the Ukrainian parliamentarians are dollar millionaires, and the Ukrainian parliament might actually appear more reminiscent of the New York Stock Exchange than the U.S. Congress. One reason for all these businessmen sitting in parliament is that parliamentarians enjoy legal immunity, but their often large corporate interests mean that they are easily subject to repression from various state inspections of their enterprises. Another reason for their presence in parliament is that government interference in business remains excessive.

Ukraine possesses a strong and reasonably well-organized political opposition. The democratic opposition is mobilized around West-oriented former Prime Minister Viktor Yushchenko, who leads the center-right bloc Our Ukraine, which holds just over 100 out of the 450 seats in the parliament. In addition, the like-minded block of Yuliya Tymoshenko and the Socialist Party of Olexander Moroz have about 40 more seats. The eight oligarchic party factions supporting President Leonid Kuchma can barely mobilize a majority. The communists hold 65 seats, and independents hold the balance.

In the latest parliamentary elections in March 2002, no less than 70 percent of the votes went to the opposition to Kuchma in the proportional part of the elections. The oligarchs succeeded in getting almost half the seats through elections in one-man constituencies, where money plays a greater role. Surprisingly, the oligarchic parties have legislated a political reform this year. They have adopted a new electoral law, which makes the next parliamentary elections in 2006 entirely proportional, which will presumably undermine the oligarchic representation, while reinforcing the center-right and communist parties.

Another intended part of the political reform proposed by the oligarchs was to reduce the power of the President, while enhancing the power of the Prime Minister and the Parliament. The obvious purpose was to reduce the power of the President, in case the next president would not be the oligarchs’ man. Their apparent assumption that they might lose the presidential elections underscores that these elections are a real opportunity for the opposition. In spite of an alliance with the socialists and the communists, who favor a parliamentary system out of principle, the oligarchs failed to mobilize the required two-thirds majority, as Our Ukraine and the Bloc of Yuliya Tymoshenko opposed the amendment to the Constitution.

President Kuchma persuaded the Constitutional Court to give him the right to run as a presidential candidate for a third time although the Constitution allows for only two five-year terms. The excuse was that the Constitution was adopted in 1996, two years after Mr. Kuchma’s first election. Even so, it appears unlikely that Mr. Kuchma will try to run again, because a solid majority opposes him. His opinion poll rating does not reach higher than 7 percent.

The Significance of the Ukraine-Russia Economic Relationship

Russia is a natural benchmark for all discussions about Ukraine. The countries are similar in many ways, both in their history and in their current development. After communism, both have undergone an oligarchic phase. In Ukraine it still lasts, while it has ended with the reinforcement of the state in Russia. Because of earlier reforms, Russia has a stronger economy.

In the 1990s, the relationship between Russia and Ukraine was dominated by the gas trade, which consists of Ukraine’s importation of natural gas from Russia and the large Russian transit of natural gas through Ukraine’s pipelines to Europe. Each year, a small number of Russian and Ukrainian gas traders made a few billion dollars on this trade at the expense of their governments and populations. After the Ukrainian energy reforms in 2000 and the change of management of Russia’s gas monopoly company Gazprom in 2001, these malpractices have been brought under control. While the trading arrangements are still nontransparent, their implications are much less damaging.

The main features of Ukrainian-Russian economic relations have instead become trade and investment, while pipelines remain important. With the big liberalization of the Ukrainian economy, large foreign investment occurred in Ukraine, primarily from big private Russian business groups. In particular, four different Russian oil corporations bought four large Ukrainian oil refineries, and two large aluminum companies were also purchased. More recently, Russia’s two largest mobile phone companies have bought the two leading mobile phone companies in Ukraine, and two different Russian groups have been buying up Ukrainian public utilities. By and large, Russian investment in Ukraine has been economically and socially beneficial. Because of earlier market reforms in Russia than in Ukraine, the Russian companies have tended to be more commercially and legally advanced than their Ukrainian competitors, and they have greatly helped the revival of the Ukrainian economy. The oil companies are a case in point. They have sharply raised production at the Ukrainian refineries, developed a network of modern gas station, and they have driven down gas prices through competition.

The trade relationship between Russia and Ukraine has been troubled. Ukraine’s share of trade with Russia has persistently fallen and has now reached one quarter of Ukraine’s foreign trade. Part of this decline has been an economically justified adjustment, but part of it has been caused by mutual protectionism. Formally, Ukraine and Russia are supposed to have free trade with one another according to an agreement between all twelve members of the Commonwealth of Independent States from 1993. In reality, free trade has frequently been violated. Whenever Ukrainian enterprises were particularly successful in their sales to Russia of, for instance, steel pipes, vodka or chocolate, Russia raised severe trade barriers. Ukraine did the same to successful Russian exporters to Ukraine. The problem with the CIS trade arrangement is that it contains no arbitration or penalty mechanism, so the agreements are not really implemented. Rather than trying to solve this problem, Russia has proposed one new trade arrangement after the other, which have remained little but formalities. Ukraine has regularly turned these initiatives down.

Last year, however, Russia came up with a new nebulous initiative called a Common Economic Space, designed for Russia, Ukraine, Kazakhstan and Belarus. Initially, it is supposed to be a free trade area, and then to become a customs union, and ultimately even a currency union. The Ukrainian public and government were divided over this new agreement. The dominant faction in the government decided to adopt it, and it was recently ratified by the Ukrainian parliament. The government argued that it was important for political relations with Moscow, that it would facilitate trade with Russia, and that it would not harm Ukraine’s Western integration. The opposition and a minority within the government opposed the agreement’s far-reaching plans and feared that it would block Ukraine’s integration with Europe, the WTO and NATO. The immediate effect has been a substantial increase in Ukrainian exports to Russia by 30 percent last year, as the Russian and Ukrainian economies are being reintegrated. This is especially true of the swiftly expanding machinebuilding industry.

To solve their problems with mutual trade, however, both Russia and Ukraine need to join the World Trade Organization (WTO). The WTO possesses the necessary trade agreements and an arbitration mechanism, and it can pass deterring penalties. Both applied for membership in the WTO in 1993, but for many years neither country pursued WTO membership seriously. Now, both countries are close to joining. The Common Economic Space idea has been a serious distraction, but since it does not solve any problems in principle, both countries have as great a need for WTO membership. If Ukraine would join the WTO before Russia, it would be able to resolve all its trade problems with Russia, because Russia would then have to negotiate with Ukraine to gain WTO membership.

The Outlook for Ukraine after the Presidential Elections

Hardly anybody doubts that the presidential elections on October 31 will take place and be a watershed in modern Ukrainian history. It is commonly recognized as the most important political event since Ukraine’s national independence in December 1991. The stakes are high:

  • Democracy or authoritarian rule;
  • Russian or Western geopolitical orientation;
  • Cleaning up of Ukraine’s pervasive corruption;

At present, the two dominant candidates are likely. The democratic center-right candidate will be former Prime Minister Viktor Yushchenko, who is the Chairman of the Center-right bloc Our Ukraine. He will most likely be supported by the Bloc of Yuliya Tymoshenko as well. Together these two political forces represent about one-third of the popular vote. Yushchenko’s main opponent will be Prime Minister Viktor Yanukovich, who is the leading politician from Donetsk. Yanukovich was recently nominated as the candidate of all the oligarchic factions, which gathered the support of one-quarter of the electorate in the last parliamentary elections. In addition, the communist leader Petro Symonenko is likely to run as always, with a steady electorate of barely twenty percent. Other candidates will be minor. The real drama will presumably be a duel between Yushchenko and Yanukovich. So far, Yushchenko is far ahead in all opinion polls, but Yanukovich is gradually catching up. In a free and fair election, Yushchenko is likely to win, but the government is using all means to skew the election to the advantage of its candidate. The only way in which Yanukovich can win is by credibly depicting Yushchenko as an extreme Ukrainian nationalist.

In their political activities, the regime-friendly oligarchs are driven by several concerns. Partly, they are defensive. They are all worried about losing their booty if a new government comes in, and they fear retribution. They suspect that they would lose out to big businessmen who are supporting the opposition, being well aware of how much hardship they have caused their enemies. Yushchenko has tried to console them with public statements that no revenge will be taken and that no redistribution of property will ensue. Partly, they are offensive. Some oligarchs hope to continue benefiting from state largesse and property, but that does appear less important. In short, the oligarchs prefer to have a state that serves as their client, and they have little interest in democracy.

The resources that are being mobilized for the presidential elections are truly enormous. A common assumption is that the total election funds will amount to $200-300 million, that is, more than President Bush’s current election campaign, although Ukraine’s GDP in current dollar comprises merely half a percent of the U.S. GDP. This money will largely be put up by big businessmen in Donetsk and Dnepropetrovsk. In order to deter businessmen from providing financing to the opposition, the State Tax Inspection and the state prosecutors often undertake selective actions against such businessmen.

Two oligarchs control Ukraine’s six main television channels, leaving little media for the opposition or independents. Foreign radio stations – the BBC World Service, Radio Free Europe/Radio Liberty and Voice of America – still play a vital role in Ukraine. The best current information is provided by internet sites, often supported by Western financing. One independent media outlet after the other has been closed down. Various excuses have been used, such as licenses, tax violations and excessive libel penalties. The government’s domination over media is tempered by a solid popular distrust of, and disinterest in, official media. Ukrainians are well aware of their government trying to manipulate them.

In the parliamentary elections in March 2002, there were many irregularities, but the ultimate results appear to have been reasonably representative in most of the country. The big exception was the Donetsk region, where vote rigging was blatant. The fear is that the “Donetsk model” will be applied in the whole country this time around. Ukraine has a large number of regional and local elections, which are spread out over time. The authorities appear to try to manipulate them ever more, by disqualifying opposition candidates, prohibiting the public appearance of opposition candidates, or through fraudulent vote counts. It appears as if they are intent on systematically denigrating elections so that fraud becomes the standard by the time of the presidential elections.

The regime is by all kinds of innovative means trying to stop the opposition from holding meetings. The utilization of public premises is widely blocked, and even electricity is being turned off. A number of special police forces are being used for a variety of repressive actions. A few journalists and politicians die under mysterious circumstances, mostly in traffic accidents or purported suicides, each year. Although the methods are crude, the repression is comparatively mild, and it does not deter the opposition or the population much.

One of the most important factors in the Ukrainian presidential elections is Russia. In the parliamentary elections in March 2002, President Putin and his chief of staff engaged personally in publicized meetings with the leading oligarchic representatives and the communist leader. At present, official Russian media are overwhelmingly positive on Prime Minister Yanukovich, the leading oligarchic candidate, and highly critical of Yushchenko and Our Ukraine. The official Russian position will have significant influence in Russophile eastern Ukraine. In the last elections, Russian political advisors played a major role, but to judge from the election results their utility appears to have been muted. Russia can use all kinds of means to influence the outcome of the presidential elections. Given the regression of democracy in Russia, Russia is unfortunately likely to oppose democracy in Ukraine. Russian businessmen active in Ukraine will also play a major role in the elections, but their role is not obvious. In the last elections, they tended to support individual candidates belonging to different parties, making sure that they had reliable lobbyists in different factions. This time around, they are likely to be pressured by the Russian government to support the oligarchic candidate, but, given the current Russian government campaign against big businessmen in Russia, their real interest might be to limit the influence of the Russian state in Ukraine. Therefore, the Russian businessmen might be the wild card in the forthcoming Ukrainian elections.

Until recently, Russia appeared more democratic than Ukraine, but today democracy appears to have much better odds in Ukraine than in Russia. Ukrainian media are far worse than Russian media, and the methods of repression in Ukraine are somewhat cruder than in Russia. Even so, Ukrainian society appears more open than Russian society. The fundamental reason is that Russian power has been consolidated in the centralized law enforcement apparatus. That is not true of Ukraine. Ukrainian state power is not yet consolidated in the security police, because President Kuchma has skillfully played off various groups against one another. The oligarchic groups remain politically much stronger in Ukraine, and their system is quite competitive. Another contrast to Russia is that the Ukrainian opposition is strong and structured. Nor are Ukrainians taken in by government-controlled media. Furthermore, Ukraine does not suffer from any imperial hangover, and it is much closer and largely sympathetic to the West. At present, Ukraine may be described as semi-democratic in the sense that the opposition has a real chance of winning the presidential elections, but we can harbor no illusion that the elections will be free and fair. There is a substantial chance that these elections will mark Ukraine’s definite democratic breakthrough. That is what the U.S. should work for.

Economically, the outlook appears much more obvious. Ukraine is on a great growth trajectory of about 8 percent a year. Its growth is based on private ownership, macroeconomic stability, competitive domestic markets and an open economy. Ukraine is swiftly being integrated into the world economy. Very serious mistakes have to be made to stop this economic growth, which is characteristic of the post-Soviet region.

Usually, corruption falls with economic growth, more open government, increasing foreign trade and democracy. If Ukraine becomes a full-fledged democracy, corruption is likely to decline faster than if it becomes more authoritarian, but because of the strong economic growth corruption is likely to dwindle in any case.

The Current State of U.S.-Ukraine Relations

Beside Russia, the U.S. has persistently been the country that has devoted the greatest interest to Ukraine. The Unites States is well liked in Ukraine, and every statement in Washington about Ukraine, such as this hearing, is carefully scrutinized in Kyiv. For the U.S., a great deal is at stake. Two aspects of Ukraine’s current developments are of fundamental importance to the United States.

  1. Will Ukraine become a democracy or an authoritarian state?
  2. Will Ukraine integrate with the West or not?

The U.S. can do a great deal in both regards. Ukraine is tied to democracy through a large number of international agreements, notably to the United Nations, the Organization of Security and Cooperation in Europe (OSCE) and the Council of Europe. Publicly, the Ukrainian government strongly professes the values of democracy, and it has repeatedly committed itself to such values in agreements with the U.S. The U.S. can and should insist on the Ukrainian government honoring all its international commitments with regard to democracy.

  1. Sometimes, U.S. authorities protest when independent media are being closed down, but it could be done more firmly and at a higher official level.
  2. The Ukrainian government uses the State Tax Inspection as its main agency of repression. Businessmen who support the opposition have been extensively investigated and harassed. The U.S. Ambassador to Kyiv, John Herbst, has rightly protested, but again these abuses should be given more high-level attention.
  3. Both the U.S. and the EU have protested sharply against the aggravated malpractices in regional and local elections, but again more high-level attention would be useful.
  4. The big test will be the presidential elections on October 31. International election observers are accepted. The U.S. can do a great deal to make sure that the actual elections are free and fair.

In the course of this year, little is as important in U.S. policy on Europe as democracy in Ukraine.

The second aim for U.S. policy on Ukraine is its integration into the West. Ukraine is already a member of most international organizations, including the IMF, the World Bank, the OSCE and the Council of Europe. The three remaining organizations of relevance are the WTO, NATO and the European Union.

  1. For the U.S., the first interest is to have Ukraine accede to the WTO as soon as possible. Few obstacles remain. The main outstanding U.S. demand is that Ukraine adopt a new and more stringent law on intellectual property rights. With little doubt, Ukraine will adopt such a law after the presidential elections regardless of their outcome. Second, the U.S. should recognize Ukraine as the market economy it is, which is of importance for how the U.S. treats Ukraine in anti-dumping disputes. Third, strangely, the Jackson-Vanik Amendment to the U.S. Trade Law of 1974 about the freedom of Jews to emigrate from the Soviet Union still applies to Ukraine, although it is not the Soviet Union and Jews have no complaints about any problems emigrating from Ukraine. This anachronism should just be abolished.
  2. Ukraine has a close cooperation with NATO, which is likely to proceed further.
    In March 2003, the oligarchic majority in the Ukrainian parliament, with partial support from Our Ukraine, voted for sending some 1,600 Ukrainian troops to support the U.S. in Iraq. President Kuchma’s obvious purpose was to improve Ukraine’s poor relations with the U.S. The troop presence in Iraq is very unpopular in Ukraine, and several Ukrainian soldiers have died. Ukrainian troops participate in various peacekeeping efforts in former Yugoslavia, as well.
  3. Since 1996, Ukraine has officially asked for membership in the European Union, but it has been cold-shouldered by the EU. Yet, the democratic opposition is much more committed to its “European Choice” than the government is. Recently, the President of the European Commission, Romano Prodi, repeated his statement that the EU has no plans for letting Ukraine become a member of the EU. Although Ukraine is now the neighbor of three EU countries (Poland, Slovakia and Hungary), it has a minimum of agreements with the EU. In particular, its trade access to the EU is very limited, as Ukraine primarily exports such sensitive goods as steel, foods, chemicals and textiles. Moreover, the possibilities for Ukrainian citizens to travel west have been sharply reduced with the enlargement of the EU to countries that previously did not require visas for Ukrainian citizens. It would be desirable that the EU open its markets to Ukraine through a free trade agreement, but a natural EU demand is that Ukraine first become a member of the WTO.

Regardless of other policies, the U.S. needs to help build up a cadre of well-educated Ukrainians who understand Western economies and politics. For this purpose, a larger number of scholarships need to be given for doctoral degrees at U.S. universities.

Oddly, the U.S. administration has devoted great attention to whether an unused small pipeline from Odesa in southern Ukraine to Brody in western Ukraine will be utilized in that direction, or whether it will be turned around, taking Russian oil from the north to the south instead. Given that Ukraine has a sound competitive oil market, this does not appear to be a question of major U.S. interest.

The current dilemma in U.S. policy toward Ukraine may be sharpened as a choice, on the one hand, between the relative importance of Ukrainian troops in Iraq, and democracy in Ukraine, on the other. Recently, President George W. Bush wrote a letter to President Leonid D. Kuchma, thanking him profusely for sending Ukrainian troops to Iraq. Meanwhile, mid-level State Department officials are complaining about a variety of abuses of democracy in Ukraine. No observer can draw any other conclusion than that troops in Iraq supersedes everything else. This balance in U.S. policy toward Ukraine needs to be redressed.