Impact of the Russia-Ukraine war on the economic welfare of Ukraine (2014-2021)

Размещено на http://www.Allbest.Ru/

Taras Shevchenko National University

Impact of the Russia-Ukraine war on the economic welfare of Ukraine (2014-2021)

Kyrychenko Ye.M.

Introduction

Ukraine's economic welfare has been continuously threatened by political uncertainty, external shocks, and military conflict since its declaration of independence. The 2014 Russia-Ukraine war disrupted domestic production, generated a massive state debt, reaching 80% of the country's GDP in 2016, triggered galloping inflation, and eroded national wealth. Estimating the impact of the war on Ukraine's economic welfare is crucial for developing government policies that can effectively support economic recovery and modernisation. This estimation can be done by analysing changes in national assets, budget expenditures, data on income distribution, and data on war damages.

Main Text

National wealth comprises all assets accumulated by households within the country. Assessment of Ukraine's structure of national wealth is taken from the World Bank's Wealth Accounts database, where all the values are measured at market exchange rates in constant 2018 US dollars, using a country specific GDP deflator. The latest 2018 estimates from the Wealth database revealed that Ukraine's national wealth comprised 59% of produced capital, 30% of human capital, 12% of natural capital, and -1% of net foreign assets [1]. Graph 1 shows that Ukrainian economy lost almost all its wealth generated during 2000-2012. As of 2018, Ukraine possessed 2.47 trillion USD in national assets, only 50 billion USD more compared to 2000. Net foreign assets have never played a significant role in Ukraine's wealth structure and have proved insufficient since 1995. Chronically low foreign investment suggests that external financing is unlikely to compensate for the lack of capital resources needed for technological upgrading, unless Ukraine makes progress on the EU integration to reassure investors of the optimistic scenario. In general, Ukrainian model of economic development is unsustainable, meaning that Ukrainians consume national wealth faster than generate it.

Graph 1. Source: compiled by the author based on Wealth Accounts data [1].

Due to the loss of territories, capital, and people, the whole economy has shrunk in size. Table 1 shows that the outbreak of the Russia-Ukraine war in 2014-2015 inflicted a significant fall in domestic consumption, which was fostered by sharp increase in the key policy rate. The exports of goods and services dropped in 20152016 and remained below the pre-war levels. Increased public expenditure in 2015-2018 was attributed to growing military spending financed by cutting social welfare programs. Consumption levels stabilised in 2016 at the cost of expensive external borrowing.

Table 1

Ukraine: GDP Structure (in billion USD, constant 2015 prices)

Source: compiled by the author based on the UN data [2], [3].

Spillover effects of war have exacerbated the weaknesses inherent to Ukrainian economy. One of them is extreme capital deficiency accompanied by negative FDI flows, meaning that Ukraine faces significant challenges in accumulating enough capital investment for the postwar reconstruction and technological modernisation of its key industries (Graph 2). Since the Great Recession of 2007-2009, Ukraine has been experiencing shortages of capital funds needed to maintain and improve basic infrastructure: railways, bridges, power and nuclear plants, etc. Negative values of changes in inventories in Table 1 also indicate this shortage.

Graph 2. Source: compiled by the author based on the UN data [2].

Manufacturing industry, the main contributor to Ukraine's GDP, is the biggest concern. During 2014-2015, Ukrainian manufacturing industry faced recession and undercapitalisation caused by the loss of CIS markets, reorientation of trade toward the EU, and increased energy prices due to the occupation of coal mines in Donetsk and Luhansk regions. Although heavily subsidised, Donetsk and Luhansk ranked 1st and 5th in volumes of industrial production of goods and services, accounting for 25% of Ukraine's total in 2013. Before Russian occupation, their gross regional product constituted 14% of Ukraine's GDP [4].

The loss of territories in Donbas, industrial heartland of Ukraine, laid the foundations for deindustrialisation throughout the country, primarily hitting steel, iron and electricity production. Over the past two decades, the growth of industrial production in Ukraine averaged -2.41%, falling to a record low of -53.7% in March 2022 [5]. The annexation of Crimea in 2014 also had a severe negative impact on the economy. Based on 2016 research by Zoryana Olekseyuk and Hannah Schurenberg-Frosch, the annexation contributed to depletion of natural and financial resources, decreased economic productivity, fallen FDI inflows, disrupted production chains, and business closures across Ukraine. Empirical estimates showed that the welfare and GDP losses of Ukraine constituted 7% and 4% respectively, while Russian welfare and GDP gains from the annexation were small but positive: 0.89% and 0.42%, respectively [6]. The authors discovered that negative effects from annexation were compensated by welfare gains from DCFTA agreement with the EU, reaching 7.45%. However, the research doesn't consider economic losses in annual terms, which, according to the Centre for Economics and Business Research (Cebr), account for up to $8.3 billion [7].

The compensatory effect of the DCFTA agreement has somehow smoothed the loss of Russian and CIS markets forcing domestic industries to reorient their production to the West. However, the integration effect was not enough to compensate for the trade losses, as Ukrainian exports have not grown ever since. Imports have also decreased compared to the pre-war levels (Table 1).

External borrowing during 2014-2017 covered the gap between rising state expenditures and decreasing revenues. These years were marked by active negotiations between Ukrainian Finance Minister Natalia Yaresko and the IMF. In 2015, Ukraine's state debt hit a record 80% of the GDP but gradually decreased due to challenging debt restructuring and partial write-off process (Graph 3).

Graph 3. Source: compiled by the author based on the IMF data [8].

Ukraine managed to avoid default by restructuring its foreign debt through the reissuance of Eurobonds totalling $15 billion with a 7.75% coupon rate [9], [10]. As of November 2023, the total amount of outstanding bonds issued in 2015 constituted almost $10.6 billion USD including 3 billion USD Eurobond (ISIN XS1303929894) with zero-coupon rate. Creditors also received VRI or GDP warrants. During 2017-2021, the Ministry of Finance continued to issue Eurobonds in both US and EUR currencies with different maturity dates, ranging from the short term to as far as 2041. The total outstanding value of Eurobonds as of November 2023 was 2.25 billion EUR and 19.7 billion USD [11]. Therefore, before the full-scale invasion by Russia in 2022, Ukraine was already heavily indebted and highly dependent on external financing.

Assessment of budget expenditures. The drop-down in budget expenditures presented in Table 2 suggests that Ukraine could hardly be called a welfare state, given the low government priorities in financing education, housing, healthcare, and spiritual and physical development during the period of 2014-2021. The share of expenditures on education was significantly cut from 6.7% in 2014 to 4.3% in 2021. Expenditures on housing almost reached zero. Healthcare expenditures only raised in 2019 as a response to the spread of COVID-19. Despite the share of public expenditures on pensions remaining unchanged (15-16% from 2014 to 2022), their proportion in households' incomes significantly decreased from 27.1% in 2013 to 17.9% in 2021 (Table 3). On the contrary, military expenditures were growing steadily from 2.89 billion USD in 2013 to 5.9 billion USD in 2021, accounting for 1.6% and 3.2%, respectively, according to the data from the World Bank. The introduction of proportional 1.5% military tax in August 2014 put additional pressure on the household incomes. According to the Ministry of Finance of Ukraine, the total amount of military tax collected since August 2014 amounted to 132 billion UAH in 2021 [12]. Therefore, Ukraine was gradually transforming into a warfare state with militarised economy, despite active military actions mainly taking place in 2014-2015.

The most striking was the record fall of the interbudgetary transfers, which served as the primary sources of funding for regional, district, and self-governed municipalities. The decrease in transfers from 30.4% in 2014 to 5% in 2022 occurred under the state decentralisation reform, which encouraged local communities to find alternative sources of funding. Consequently, budget decentralisation measures caused a significant lack of capital investment and deepened inequalities in regional development.

war ukraine politics economic recovery modernization

Table 2

State budget expenditures in Ukraine by functions (2014-2021)

Source: compiled by the author based on the data from the State Statistics Service of Ukraine [13].

Excluding data from temporarily occupied territories of Donetsk and Luhansk regions and the Autonomous Republic of Crimea.

Based on the data from State Statistics Service of Ukraine, the main sources of income for Ukrainian households remain wages, pensions, stipends, and social benefits [14]. The share of income received from entrepreneurship and self-employment remained very low, despite wholesale and retail trade being one of the key contributors to the GDP, accounting for 17% of the total GDP in 2020 [2]. The portion of average monthly income spent on utilities (gas, water, electricity, fuel, housing) grew up from 9.5% in 2013 to 15.6% in 2021 (Table 3). It should be emphasized that household incomes were not growing in real terms, but were largely eroded by inflation. From 2013 to 2021, the share of household spending on food and non-alcoholic beverages varied between 46-50% of their average monthly income, while only 1% was allocated to education, and less than 2% on recreation and culture [15].

Table 3

Source: compiled by the author based on the data from the State Statistics Service of Ukraine [14].

Assessment of income distribution. The World Bank defines lower middle-income economies as those with a GNI per capita between $1,036-$4,045. As a low-middle-income economy under the World Bank classification, Ukraine faces the same inequality challenges as the rest of the developing world. In the 1990s, Ukraine belonged to countries with high inequality rates (the Gini index was almost 50 in 1995). Economic growth of 2000-2004 boosted household incomes and pushed the average Gini index down to the 0.2-0.3 threshold. The Great Recession of 2007-2009 also contributed to greater equality among Ukrainian population, mainly hitting the incomes of the top 10%. However, the outbreak of the Russia-Ukraine war in 2014 caused higher polarisation of Ukrainian society, widening the gap between the bottom 40% and the top 10% of Ukrainian elite.

The patterns of income distribution in Ukraine were built based on the decile data from the World Income Inequality Database (WIID) [16]. The latest available data for Ukraine encompasses the period of 1968-2020. Decile groups result from ranking all individuals according to income and dividing them into ten equal social groups, each presenting 10% of population. Table 4 below presents the shares of income by 10 decile groups during 2013-2020. Incomes of all decile groups were negatively affected by the outbreak of the Russia-Ukraine war in 2015, except for the top 30% (deciles 8-10). The share of the top 30% slightly increased compared to the 2013 pre-war levels at the expense of other groups, mainly those in the middle of the distribution (deciles 4-6).

Table 4

Ukraine: Shares, of income, by decile groups (2013-2020)

Source: compiled by the author based on the WIID data.

Table 5 shows calculated rich/poor ratios and Gini index for 2013-2020. The higher the ratios, the higher the inequality. The Palma ratio offers an alternative to the Gini index and traces income inequality between the poorest bottom 40% and the wealthiest top 10%. Based on the values obtained, income inequality between the rich and the lower-middle class was growing in Ukraine.

Table 5

Ukraine: Rich/poor ratios in 2013-2020

Source: compiled by the author.

Graph 4 below shows historical data for the Gini index in 2007-2020. Overall, the Russia-Ukraine contributed to growing income disparities, benefiting the top 30% of Ukrainian population in 2014-2020. On the contrary, the bottom 10% were socially unprotected against extreme poverty due to decreased government support.

Graph 4. Source: compiled by author the based on the WIID data [16]

Effectiveness of government policies. To the author's mind, Ukraine's economic strategies of 2004-2015 (“Through European Integration”) and 2020-2023 (“National Economic Strategy - 2030”) have proven to be inefficient, as they did not comply with the UN's SDGs and failed to protect the nation's well-being during the war. Inadequate assessment of political and economic risks associated with war, accompanied by weak policy responses to the war shocks, led to depletion of national wealth, natural and capital resources, widening income inequality, growing poverty, and social stratification. Furthermore, irrational use of scarce resources and mismanagement of public funds suppressed household incomes, thereby affecting the economic wellbeing of the population.

The correlation matrix below aims to give an overall assessment of whether sustainable economic policies adhered to by Ukrainian governments in 2013-2020 contributed to Ukraine's economic welfare. Despite correlation not always means causation, it is a valuable exploratory tool, which helps to find potential relationships between economic indicators. The data was taken from the World Bank database at current US dollars for 2013-2020. The chosen macroeconomic indicators and their corresponding abbreviations are listed in Table 6. These are key performance indicators reflecting the progress made towards strategic goals expressed in the National Economic Strategy - 2030, such as improvement of the business environment, attraction of Foreign Direct Investment (FDI), industrial development, and eradication of poverty. Table 7 displays the correlation coefficients between them.

Table 6

Indicators of economic development

Source: compiled by the author

Net national savings are negatively correlated with the GNI indicators since Ukraine is a net borrower and is highly dependent on imports. Net foreign investments and the index of economic complexity also have an inverse relationship with GNI, showing that Ukraine experiences increased capital outflow, and its low economic complexity negatively affects income generation. The correlation coefficient between total external debt and GNI is high and positive, suggesting that Ukraine relies on external borrowing to ensure its economic growth. However, the growing debt burden has negative implications for economic welfare in general.

Table 7

Correlation matrix of Ukraine's indicators of economic development (2013-2020)

Source: compiled by the author.

Conclusions

Whereas the costs of war were escalating, the nation's economic welfare was dramatically decreasing. The Russia-Ukraine war during 2014-2021 led to diminishing economic welfare through depletion of national wealth, militarisation of economy, raising inequalities in income distribution, growing state debt, and suppressed household incomes. Ukrainian economic policy largely failed to respond to war shocks to ensure economic stability and preserve national assets. During the war, the government's income redistribution policy led to a widening income gap between the bottom 40% and the top 10% of Ukraine's population.

References

1. The World Bank. 2023. Wealth Accounts Database. Accessed November 30, 2023.

2. The National Accounts Section of the United Nations, Statistics Division. 2023. Downloads. Accessed November 30, 2023.

3. National Bank of Ukraine. 2023. NBU Key Policy Rate. Accessed November 30, 2023.

4. Simon Saradzhyan. 2022. Donbas: What's Ukraine Losing-Industrial Hub, Breadbasket or Both? July 7. Accessed November 30, 2023.

5. Trading Economics. 2023. Ukraine Industrial Production. Accessed November 30, 2023.

6. Olekseyuk Zoryana, Hannah Schuerenberg-Frosch. 2016. Ukraine's unconsidered losses from the annexation of Crimea: What should we account for in the DCFTA forecasts? April 14. Accessed November 30, 2023.

7. Cebr. 2022. Ukraine's unconsidered losses from the annexation of Crimea: What should we account for in the DCFTA forecasts? London: Centre for Economics and Business Research. Accessed November 30, 2023.

8. International Monetary Fund. 2023. Ukraine Datasets. Accessed April 18, 2023.

9. Ministry of Finance of Ukraine. 2019. Ukraine returned to the euro debt market after a 15-year hiatus. June 14. Accessed November 30, 2023.

10. Taras Kotovych. 2015. Bond Market Insight. Debt restructuring: Ukrainian version. 8 December. Accessed November 30, 2023.

11. Ministry of Finance of Ukraine. Eurobonds. Accessed November 30, 2023.

12. Minfin. 2023. Ukraine: Military tax. Accessed November 30, 2023.

13. Minfin. 2023. State Budget of Ukraine. Accessed November 30, 2023.

14. State Statistics Service of Ukraine. 2023. The structure of household income resources. Accessed November 30, 2023.

15. State Statistics Service of Ukraine. The structure of total household expenses. Accessed November 30, 2023.

16. United Nations University World Institute for Development. 2022. World Income Inequality Database - WII. Accessed November 30, 2023.

Размещено на Allbest.Ru