Graft, red tape, addiction to cheap gas kept Ukraine from fulfilling post-Soviet potential

The Associated Press

View on Independence Square, the epicenter of the country's current unrest, Kiev, Ukraine, Thursday, Feb. 20, 2014. Fierce clashes between police and protesters in Ukraine's capital have shattered the brief truce Thursday and an Associated Press reporter has seen dozens of bodies laid out on the edge of the protest encampment. (AP Photo/Efrem Lukatsky)

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By DAVID McHUGH, AP Business Writer

The battle in Kiev is, in large part, a fight for the country's economic future — for better jobs and prosperity.

Ukraine's protesters want to pry their country away from Russian influence and move closer to the European Union. A look at neighboring Poland, which did just that, suggests why.

The two countries emerged from the collapse of the Soviet Union two decades ago in roughly similar economic shape. But Poland joined the EU and focused on reforms and investment — and by one measure is now three times richer than Ukraine.

Ukraine, on the other hand, sank in a post-Soviet swamp of corruption, bad government and short-sighted reliance on cheap gas from Russia.

Per capita economic output is only around $7,300, even adjusted for the lower cost of living there, compared to $22,200 in Poland and around $51,700 in the United States. Ukraine ranks 137th worldwide, behind El Salvador, Namibia, and Guyana.

Protests broke out in November after President Viktor Yanukovych backed out of signing an agreement with the EU that would have brought the economy closer in line with European standards. After violent protests resulted in scores of deaths, the government and the opposition signed an agreement on Friday. But it is unclear whether it will succeed in providing a stable government that can heal the rifts and improve the economy.

It didn't have to be this way, experts say. Ukraine has a large potential consumer market, with 46 million people, an educated workforce, and a rich potential export market next door in the EU. It has a significant industrial base and good natural resources, in particular rich farmland.

How did things go so wrong? Here are the main reasons.

OLD INDUSTRY: Ukraine did little to move away from Soviet-era industries producing commodities such as steel, metals and chemicals. Former communist state companies, often privatized to politically connected figures, relied on cheap gas from Russia and growing demand from the world economy for their raw materials.

That helped Ukraine's economy grow rapidly from 2000 to 2008, but reduced pressure to modernize.

When the world economy fell into a crisis in 2008, demand for Ukraine's raw materials plunged. Then in 2009, Russia significantly raised the price of its gas supplies, further pulling the rug from underneath the country's export industries.

Pekka Sutela, an economist at Finland's Lappeenranta University of Technology who has extensively studied post-Soviet economies, calls the gas-based export boom "the Ukrainian curse."

"The economy was able to grow without making the necessary changes," he said.

GAS FOLLIES: Ukraine's state gas company, Naftogaz, charges customers only about 20 percent of what it pays for imported Russian gas. That means the government spends about 7.5 percent of the entire economy's output each year on a massive home heating subsidy aimed at keeping voters happy. That results in large budget deficits that the government must borrow to cover.

The International Monetary Fund tried to help Ukraine through its post-crisis troubles, with loan packages in 2008 and 2010. Each time, the IMF turned off the money tap after Ukraine refused to follow policy requirements including raising gas prices or cutting back sufficiently on generous government salaries and pensions.

CORRUPTION: A recent World Bank study of the economy cited "pervasive" corruption as a major factor holding back the economy. At street level, businesses are subjected to arbitrary treatment by officials and demands for bribes. Higher up, there is widespread public skepticism over the fortunes amassed by the connected, known as oligarchs. In particular, attention has focused on the career of Yanukovych's son Oleksandr, a dentist who according to Forbes Ukraine has amassed a $510 million fortune through various business enterprises.