Robert Samuelson March 12, 2013

It’s a stunning comparison that, in some ways, explains everything about the crisis in Ukraine. Back in 1990, average per-person incomes in Polandand Ukraine were roughly equal, about $8,000 in each country. By 2012,they no longer were, reports economist Anders Aslund of the PetersonInstitute. Poland’s per-capita income had jumped to about $18,000;Ukraine’s had dropped to $6,000.

These figures make it easy to understand why so many Ukrainians want closerties with Europe — and why Vladimir Putin feels threatened. It’s notjust geography and history. The hope is that adopting Europe’s more open economic and political system will promote faster economic growth andmore freedom. If this happens, Russia might suffer by comparison. Poland is again instructive. In 1990, its per-capita income was a third lessthan Russia’s; by 2012, it was one-fifth greater.

Putin’s successful campaign to persuade deposed Ukrainian president ViktorYanukovych to reject a sweeping trade agreement with the European Union — which seemed a done deal — involves far more than trade. For Putin,it’s an act of political self-preservation. The point is to keep Ukraine weak and thereby prevent it from embarrassing Russia. But, ironically,Putin’s aggressive response may ultimately backfire.

Although Russia may acquire Crimea, Putin may not be able to keep Ukraine inMoscow’s economic orbit. Just the opposite: The crisis may haveaccelerated efforts to reorient Ukraine westward. For starters, the E.U. decided to go ahead and give Ukraine the trade concessions in the agreement trashed by Yanukovych. The E.U. estimates the annual benefits for Ukraine at500 million euros ($700 million). Meanwhile, the severity of the crisisis forcing Ukraine to address comprehensive reforms sooner rather thanlater.

The economy is dismal. It’s been in recession since mid-2012. Last year’s budget deficit was about 9 percent of the economy (grossdomestic product), and “we believe they may be hiding some losses inoff-budget accounts and state enterprises,” says economist Ondrej Schneider of the Institute of International Finance, a think tank funded by banks and financial service firms. The currentaccount deficit — a broad measure of trade — also reached roughly 9percent of GDP last year. To pay for imports, Ukraine is draining itsforeign exchange reserves of dollars and euros. They may be as low as$13 billion, says Schneider. That’s down from $38 billion in 2011 andequals only a few months of imports.

Ukraine desperately needs a loan to cover imports, including for Russian natural gas, and to make international debt payments. Putin initially pledged $15 billion, but now Russia probably won’t lend any more than it already has ($3 billion). Although the United States has pledged $1 billion and the E.U.at least $15 billion, most of that money would require Ukraine to reach an agreement with the International Monetary Fund. The IMF would insist on policy changesbefore giving approval and contributing its funds to the pot.

One target would be lavish energy subsidies. In 2012, they reached 7.5 percent of GDP, reports the IMF. These huge government subsidies bloat both the budget deficit and thecurrent account deficit, because low prices “encourage one of thehighest energy consumption levels in Europe,” as the IMF notes.

What really needs transforming is Ukraine’s economic culture. Corruption issaid to be endemic, from getting a driver’s license to signing majorbusiness contracts. The Peterson Institute’s Aslund says that the“Yanukovych family” may have diverted as much as $10 billion for itself. Ukraine also needs to modernize its economic base. It remainsexcessively dependent on communist-era heavy industry, particularlysteel.

It’s a tall order that may not succeed. Many vested interests have a stakein the status quo. But the crisis that stalks Ukraine also createspressures for fundamental change. There’s a short and long game here.Putin may win the first. It’s less clear that he’ll prevail in thesecond.

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