Anders Åslund Ukraine: What Went Wrong and How to Fix It Anders Åslund BESET BY RUSSIAN MILITARY AGGRESSION and the legacy from its years of economic mismanagement, Ukraine faces an existential crisis that has also roiled the politics of Europe. Yet there is a glimmer of hope and opportunity for this tormented country. In 2014 Ukraine carried out free and fair elections of a new president and parliament. With this democratic foundation, Ukraine can shape its future and return to economic and political stability. In this book, one of the world’s leading experts on Ukraine offers its new leadership a strategy for reform. Anders Åslund maintains that the country’s fundamental problem is corruption and poor governance, which requires radical reform of the state from the top down. He calls for the cleansing of the judiciary and law enforcement, including the abolition of the many intrusive inspection agencies, which use a regime of licenses, permits, and certifications to squeeze the lifeblood of the economy. The book also advocates cuts in wasteful public expenditures and deregulation to promote growth—but it also calls for international financing spearheaded by the International Monetary Fund. The European UKRAINE Union and the United States must also help. The book focuses extensively on the energy sector, which Åslund argues is the biggest source of top-level corruption and wasteful subsidies and should be reformed with a unified system of energy prices determined by the market, not government. Åslund also details a series of reforms in education and health care. To assure Ukraine’s success, the European Union must assume the role of anchor of the country’s democratic and market economic reforms. ANDERS ÅSLUND is a leading specialist on economic policy in Eastern Europe, especially Russia and Ukraine. Since 2006, he has been a senior fellow at the Peterson Institute for International Economics. He also teaches at Georgetown University. He has been deeply engaged in Ukraine since 1985, having served as an economic advisor to its government in 1994–97. In 2004 he cochaired a United Nations Blue Ribbon Commission for Ukraine and a similar International Commission of Independent Experts in 2009. He was one of the founders of the Kyiv School of Economics and cochaired its board of directors (2003–12). He is the author of 14 books, including How Capitalism Was Built: The Transformation of Central and Eastern Europe, Russia, the Caucasus and Central Asia (2007, 2013), How Ukraine Became a Market Economy and Democracy (2009), and Russia’s Capitalist Revolution: Why Market Reform Succeeded and Democracy Failed (2007). He has also edited 16 books, including Economic Reform in Ukraine: the Unfinished Agenda (2000), Revolution in Orange (2006), and The Great Rebirth: Lessons from the Victory of Capitalism over Communism (2014). Åslund was the director of the Russian and Eurasian Program at the Carnegie Endowment for International Peace, founding director of the Stockholm Institute of Transition Economics, and professor at the Stockholm School of Economics. He earned his doctorate from the University of Oxford. USD $25.95 UKRAINE What Went Wrong and How to Fix It 1750 Massachusetts Avenue, NW Washington, DC 20036-1903 (202) 328-9000 Fax (202) 659-3225 Cover Photography: © Oleg Pereverzev/Demotix/Corbis www.piie.com Cover Design by Peggy Archambault Peterson Institute for International Economics PetersonJacket_UKRAINE.indd 1 3/31/15 6:25 PM Anders Åslund UKRAINE What Went Wrong and How to Fix It Peterson Institute for International Economics Washington, DC April 2015 Anders Åslund UKRAINE What Went Wrong and How to Fix It Peterson Institute for International Economics Washington, DC April 2015 Anders Åslund is a leading specialist on Cover Design by Peggy Archambault economic policy in Eastern Europe, especially Cover Photo by ©Oleg Pereverzev/Demotix/Corbis Russia and Ukraine. Since 2006, he has been Printing by Versa Press a senior fellow at the Peterson Institute for International Economics. He also teaches at Copyright © 2015 by the Peterson Institute Georgetown University. for International Economics. All rights reserved. No part of this book may be repro- He has been deeply engaged in Ukraine since duced or utilized in any form or by any means, 1985, having served as an economic advisor electronic or mechanical, including photo- to its government in 1994–97. In 2004 he copying, recording, or by information storage cochaired a United Nations Blue Ribbon or retrieval system, without permission from Commission for Ukraine and a similar the Institute. International Commission of Independent Experts in 2009. He was one of the founders of For reprints/permission to photocopy please the Kyiv School of Economics and cochaired contact the APS customer service department its board of directors (2003–12). at Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923; He is the author of 14 books, including How or email requests to: [email protected] Capitalism Was Built: The Transformation of Central and Eastern Europe, Russia, the Caucasus Printed in the United States of America and Central Asia (2007, 2013), How Ukraine 17 16 15 5 4 3 2 1 Became a Market Economy and Democracy (2009), and Russia’s Capitalist Revolution: Why Library of Congress Cataloging-in- Market Reform Succeeded and Democracy Failed Publication Data (2007). He has also edited 16 books, including Åslund, Anders, 1952– Economic Reform in Ukraine: the Unfinished Ukraine : what went wrong and how to fix it / Agenda (2000), Revolution in Orange (2006), Anders Åslund. and The Great Rebirth: Lessons from the Victory of pages cm Capitalism over Communism (2014). “January 2015.” Includes bibliographical references. Åslund was the director of the Russian and ISBN 978-0-88132-701-4 Eurasian Program at the Carnegie Endowment 1. Ukraine—Politics and government—1991– for International Peace, founding director 2. Ukraine—Economic policy—1991– of the Stockholm Institute of Transition 3. Ukraine—Military policy. 4. Ukraine— Economics, and professor at the Stockholm Social policy. 5. Political corruption—Ukraine. School of Economics. He earned his doctorate 6. Social change—Ukraine. 7. Crisis manage- from the University of Oxford. ment in government—Ukraine. PETERSON INSTITUTE FOR 8. Yanukovych, Viktor. I. Title. INTERNATIONAL ECONOMICS DK508.848.A53 2015 1750 Massachusetts Avenue, NW 947.7086—dc23 Washington, DC 20036-1903 2014042507 (202) 328-9000 FAX: (202) 659-3225 www.piie.com Adam S. Posen, President Steven R. Weisman, Vice President for Publications and Communications This publication has been subjected to a prepublication peer review intended to ensure analytical quality. The views expressed are those of the author. This publication is part of the overall program of the Peterson Institute for International Economics, as endorsed by its Board of Directors, but it does not necessarily reflect the views of individual members of the Board or of the Institute’s staff or management. The Peterson Institute for International Economics is a private, nonprofit institution for the rigorous, intellectually open, and indepth study and discussion of international economic policy. 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Contents Preface xi Acknowledgments xv Map xix I A Strategy of Radical and Comprehensive Reform 1 Introduction: Ukraine on the Precipice 3 What Went Wrong 4 Something Happened on the Road to Vilnius 9 A Strategy for Economic Reform 10 A Vision for Ukraine in 2020 16 2 Why Ukraine Can and Should Opt for Radical 17 Reforms Now What Are Putin’s Intentions? 18 Why This Time Is Different in Ukraine 22 Most Relevant Reform Prototypes 25 The Power of the Oligarchs Has Declined 26 The Threat of Populism Is Also on the Wane 32 The Alternative: Financial Meltdown 35 3 Ukraine Needs Europe as a Model and International 37 Anchor Europe as an Anchor for Modernization 37 The Dream of Europe 40 European Neighborhood Policy and Eastern Partnership 42 European Association Agreement 43 Growth through Integration into the European Supply Chain 46 Will Ukraine’s European Integration Proceed? 51 Ukraine Needs a Marshall Plan 53 II What Went Wrong 4 Nation Building But Little Reform, 1991–2010 59 Leonid Kravchuk: Preoccupation with Nation Building, 60 but Political Chaos, 1991–94 Hyperinflation and Output Collapse, Breeding Rent Seeking 61 and Oligarchs, 1992–94 Complicated Relationship with Russia 67 The Orange Revolution: Political Chaos Again, 2004–10 68 Stalemate over Reprivatization, 2005 72 Resolution of a Severe Financial Crisis, 2008–09 73 Conflicts with Russia over Gas and NATO 75 5 The Yanukovych Regime: The Ultimate Predation, 79 2010–14 Oligarchy Restored 80 Brief Economic Reform in 2010 82 Ever Worse Economic Policies Leading to Stagnation 83 Capitalism in One Family 88 Corruption at the Top Level Reaches a New Apogee 91 The