Yanukovich has fled the capital yesterday and a new government is on the way. The territorial integrity of Ukraine is not (yet?) secured and many unknowns are still out there. Given that the political turmoil of the last weeks will dwindle down to a stable transition to a new government, what would the economic prospects of Ukraine be?
Before we go any further, it is good to anchor ourselves in a framework: we don't want to start speculating things out of nowhere. We need strong foundations to make assumptions so they'll be both more credible and likely to happen than the forecasts of the milkman. In other words, we need some modelling to guide our thoughts.
The first equation that can help us here is the composition of GDP:
GDP = Consumption + Investment + Government spending + trade balance
Let's take a look at what trends could affect these components.
Consumption: The low level of private debt will not hinder consumption. The climate of uncertainty now prevailing should discourage savings and possibly the holding of liquidity as inflation might be a threat (it is too early to tell as of now).
Investment: The climate of uncertainty will definitely deter investment, at least in the short term. In the medium term, an improvement of the stability perspective and a likely accession agreement with the EU should provide a good business environment that will attract foreign investment.
Government spending: Now that the economic racket of Ukraine has failed, Ukrainian officials are turning to the IMF and reforms it demands for a loan to be made. In November 2013, the deal breaker of an IMF loan was the gas subsidy to households: the IMF demanded that it be gradually abolished in a way that would be affordable by the least well-off Ukrainians. Ukraine's debt-to-GDP ratio was around 40% at the end of 2013, well below the debt levels of Germany (80%), France (93%) or the U.S (106%). Structural reforms does not imply austerity and I do not expect government spending to go down significantly, if at all.
Trade balance: Economic sanctions are to be expected from Russia. Although they could be downright official sanctions, they most likely will take place as non-trade barriers that will shut Ukrainian exports off the Russian market. Expect a surge of interest in standard compliance and hygiene inspections from Russian authorities. In 2010, 25% of Ukrainian exports were destined to Russia, making it a major partner. The new political situation will force Ukrainian companies to seek new trade partners and will lower Ukrainian output until companies find new trade partners, most likely in the European Union.
Thus, looking at the composition of GDP, we might expect some domestic stagnation coupled with a drop in exports, yet no economy-breaking catastrophe. In a few years, Ukraine is most likely to be on a growth path higher than its current one due to an improved business environment.
Let's use my custom blog-simplified (the simplification allows for the main mechanics to be working yet spares mathematical rambling that doesn't add much to the big story) Mankiw-Romer-Weil version of the Solow growth model as a basis for further analysis. Let's see in what direction the different variables will change.
GDP = (Physical capital)*(Worker education)*(Workers)
Physical capital: Although the physical destruction on the main square of Kiev is impressive, little physical capital destruction has actually happened outside skirmish areas. The amount of physical capital destroyed is insignificant. After a few years of investment scarcity coupled to a stabilization of the investment environment, foreign investment should drive a build-up of Ukrainian capital.
Worker education: With the political situation in Ukraine stabilizing, no brain exodus is to be expected. The conflicts were concentrated in a few areas of the capital city and a climate of country-wide civil war was not reached. If anything, expect a marginal movement of educated Ukrainian nationals coming back their home country.
Workers: The death count of the clashes over the last few months vary between 30 and 200 - clearly not much in a country of 45 million inhabitants. The number of workers hasn't suffered any significant change with the latest events.
According to this last growth model, the Ukrainian prospect is far from disastrous: it will go through an adjustment period and will get back on the track.
Ukrainians should concern themselves with providing a business environment and sensitive structural reforms, including slashing gas subsidies that indirectly benefit Russian Gazprom, to get Ukraine back on the track. The EU benefits from a stable neighborhood and Ukraine will most likely need a new trading partner. Reaching an accession agreement (it was ready to be signed in late 2013 yet the Yanukovich government preferred to attempt an economic racket) will be a win-win historic outcome for Europe and, above all, Ukrainians.
Before we go any further, it is good to anchor ourselves in a framework: we don't want to start speculating things out of nowhere. We need strong foundations to make assumptions so they'll be both more credible and likely to happen than the forecasts of the milkman. In other words, we need some modelling to guide our thoughts.
The first equation that can help us here is the composition of GDP:
GDP = Consumption + Investment + Government spending + trade balance
Let's take a look at what trends could affect these components.
Consumption: The low level of private debt will not hinder consumption. The climate of uncertainty now prevailing should discourage savings and possibly the holding of liquidity as inflation might be a threat (it is too early to tell as of now).
Investment: The climate of uncertainty will definitely deter investment, at least in the short term. In the medium term, an improvement of the stability perspective and a likely accession agreement with the EU should provide a good business environment that will attract foreign investment.
Government spending: Now that the economic racket of Ukraine has failed, Ukrainian officials are turning to the IMF and reforms it demands for a loan to be made. In November 2013, the deal breaker of an IMF loan was the gas subsidy to households: the IMF demanded that it be gradually abolished in a way that would be affordable by the least well-off Ukrainians. Ukraine's debt-to-GDP ratio was around 40% at the end of 2013, well below the debt levels of Germany (80%), France (93%) or the U.S (106%). Structural reforms does not imply austerity and I do not expect government spending to go down significantly, if at all.
Trade balance: Economic sanctions are to be expected from Russia. Although they could be downright official sanctions, they most likely will take place as non-trade barriers that will shut Ukrainian exports off the Russian market. Expect a surge of interest in standard compliance and hygiene inspections from Russian authorities. In 2010, 25% of Ukrainian exports were destined to Russia, making it a major partner. The new political situation will force Ukrainian companies to seek new trade partners and will lower Ukrainian output until companies find new trade partners, most likely in the European Union.
Thus, looking at the composition of GDP, we might expect some domestic stagnation coupled with a drop in exports, yet no economy-breaking catastrophe. In a few years, Ukraine is most likely to be on a growth path higher than its current one due to an improved business environment.
Let's use my custom blog-simplified (the simplification allows for the main mechanics to be working yet spares mathematical rambling that doesn't add much to the big story) Mankiw-Romer-Weil version of the Solow growth model as a basis for further analysis. Let's see in what direction the different variables will change.
GDP = (Physical capital)*(Worker education)*(Workers)
Physical capital: Although the physical destruction on the main square of Kiev is impressive, little physical capital destruction has actually happened outside skirmish areas. The amount of physical capital destroyed is insignificant. After a few years of investment scarcity coupled to a stabilization of the investment environment, foreign investment should drive a build-up of Ukrainian capital.
Worker education: With the political situation in Ukraine stabilizing, no brain exodus is to be expected. The conflicts were concentrated in a few areas of the capital city and a climate of country-wide civil war was not reached. If anything, expect a marginal movement of educated Ukrainian nationals coming back their home country.
Workers: The death count of the clashes over the last few months vary between 30 and 200 - clearly not much in a country of 45 million inhabitants. The number of workers hasn't suffered any significant change with the latest events.
According to this last growth model, the Ukrainian prospect is far from disastrous: it will go through an adjustment period and will get back on the track.
Ukrainians should concern themselves with providing a business environment and sensitive structural reforms, including slashing gas subsidies that indirectly benefit Russian Gazprom, to get Ukraine back on the track. The EU benefits from a stable neighborhood and Ukraine will most likely need a new trading partner. Reaching an accession agreement (it was ready to be signed in late 2013 yet the Yanukovich government preferred to attempt an economic racket) will be a win-win historic outcome for Europe and, above all, Ukrainians.
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