Beyond Saber Rattling: Who Bails Out Ukraine?

The crisis over Ukraine is quickly becoming a geostrategic conflict. As Vladimir Putin maneuvers to restore Russia’s right to behave with a superpower’s impunity – particularly in its own backyard – the West pushes back.

But economic forces also have shaped this confrontation, especially Ukraine’s record as the world’s worst-performing industrial economy over the last 20 years.

It was popular discontent with this disastrous performance that drove the recent dissent. This, in turn, triggered a bloody response from Viktor Yanukovich. His response consolidated the opposition – and ultimately cost Yanukovich his job.

Beyond this week’s political and military maneuvers, the outstanding question is: Who will bail out the Ukrainian economy? Russia, or the EU and the United States? A bailout will be the price of drawing Ukraine into one of the two trading systems on offer.

Stated simply, Ukraine is the economic equivalent of a failed state. After gaining independence in 1991, the country moved briefly to liberalize its economy along the same lines as most of Eastern and Central Europe.

However, Ukraine soon jettisoned its reforms in favor of the state-oligarch model also evolving in Russia. Some twenty years later, Ukraine’s GDP has shrunk 30%.

Keeping poor company

Even Russia’s sorry economy is 20% bigger than it was in 1991. Meanwhile, Poland’s economy, which looked much like Ukraine’s in 1991, grew 130% over the same period.

Ukraine’s economic performance has been so terrible and for so long that its sovereign debt issues are now considered the equivalent of junk bonds.

Even before the crisis, Ukraine’s credit rating was worse than Greece’s — no small feat. And it was no better than that of Argentina, a global financial pariah for its mismanaged debt defaults and summary expropriations of foreign-owned companies.

Ukraine’s debts soon come due, with some $15 billion in sovereign bonds maturing this year and another $15 billion in 2015. With a current account deficit equal to 8% of its GDP, Ukraine cannot pay off and refinance those debts without large-scale aid — some $20 billion to $25 billion — and affiliating itself with a larger trading system.

Which way to turn?

An economic and trade alliance with Russia would deliver the bailout, but with little prospects of improving the underlying economy.

The EU and the United States (through the IMF) also are prepared to provide the bailout, if the Ukrainian government will accept far-reaching economic reforms. The EU-US/IMF reforms should lead to better economic times down the road.

But they also would mean more short-term hardships for ordinary Ukrainians. That’s why Yanukovich sided with Putin: He feared that he would lose his grip on power if times got even worse. Of course, he lost power anyway.

With a new, pro-Western government in charge in Kiev, Ukraine’s fate may well lie in the hands of Europe and the United States. Their choice is simple to state, if difficult to execute: Do they put sufficient economic and diplomatic pressure on Putin, to convince him to pocket his own bailout – and let the West pick up the pieces?