The Road to Recovery: Ukraine's Economic Challenges and Opportunities

The Ukrainian economy has lost over 30 percent of GDP in the year following Russia’s invasion in 2022. According to the Ministry of Finance, this is the largest loss in economic activity that the country has experienced since independence in 1991. The Ukrainian government is working desperately to regain economic growth. This is not the first recession that the country has encountered as it previously faced recession in 2014-15 as a result of the conflict in Donbass which resulted in the lowered prices of goods. Ukraine again faced a recession in 2020 due to the COVID-19 pandemic. However, in both of these instances, the rate of economic recovery did not exceed 3 percent on average. According to the Economics Observatory, Ukraine is estimated to need 13 years before its economy can recover if the growth rate continues at 3 percent. This means, that the country will need to achieve a record economic growth rate of at least 4 percent to avoid being set back by a decade. Achieving this will require overcoming numerous challenges.

Further exacerbating the situation is the large-scale emigration of people from Ukraine due to the war.  Approximately six million Ukrainians were forced to flee to other countries in Europe after the invasion, with nearly a quarter of those who moved abroad still remaining uncertain of whether they would return after the conflict ends. Around 4.7 million have registered for temporary protection status and an estimated 77 percent stipulated that they plan to return, but their return will depend on the pace of economic recovery. Even under optimistic scenarios, Ukraine will face a shortage of personnel, especially skilled workers, once the war ends.

Yet there is still hope as the Ukrainian economy has demonstrated to be just as resilient as its people. Despite the continued fighting, the country’s economy has started to stabilize. A large reason for this positive development is the government’s policy to reduce income taxes as well as VATs on imports and taxes on fuels, slowing down inflation and supporting Ukrainian businesses while active fighting continued.

Most public services have remained accessible to the population throughout the course of the conflict, primarily due to the high level of digitalization that has proved effective since the Covid-19 pandemic. Currently, the Diia portal, through which most public services are provided, has over 100 different documents, procedures, and permits that can be accessed remotely. Since 2020, the level of use of public e-services – such as the Diia app and web portal – have increased by 63 percent as of 2022. The fact that over half of the adult population of Ukraine already uses digital tools will enable the state to implement welfare programs more effectively in the future, provide better services, prevent corruption, and, at the same time, reduce the number of officials. These examples show the flexibility of Ukraine’s state apparatus and its ability to react quickly to crisis situations, often using non-standard and unconventional tools. None of the major industries, such as banking, logistics, the IT sector, or public services have been put out of business. Without these adaptations, this might not have been the case.

As mentioned before, the Ukrainian government has been able to help resolve some bureaucratic issues and reduce corruption by digitizing major services in the country. Corruption is a major problem Ukraine continues to struggle with. As Ukraine continues to receive aid for postwar development, it is crucial that Ukraine be held accountable for the prevention of corruption with regard to the aid money. It is important to note that in 2021, Ukraine was ranked the second-most corrupt country in the world, ironically behind Russia. There is a concern that the elite members of the Ukrainian government could take advantage of the inflow of aid and reconstruction money. Kyiv should create a system where the government is financially responsible for receiving and using the money only on postwar development. Corruption in Ukraine is still an important issue that needs to be resolved in order to facilitate reconstruction and recovery.

It is important for international development partners to be aware that even anti-corruption digital solutions can be susceptible to corruption. There is a risk of potential misappropriation of funds, whether they are public or provided as international technical assistance. Improper use of technology itself is also a concern. Various issues may arise, from unnecessary procurement of expensive IT equipment to unexplained “maintenance works on the source code” that may be fictitious or rendered at inflated prices. Often, pricing of the software development or maintenance can become problematic, and labor hours spent on “bug-fixing” can be hard to verify. Double billing (for the equipment already paid for through the state budget) and nepotistic selection of vendors are other ways that an anti-corruption digital solution may end up mired in unethical practices.

Rebuilding Ukraine also means modernizing the country, as it still grapples with the Soviet legacy that can be found in most of its sectors. Further magnifying the challenges in modernization and reconstruction, most of Ukraine's major enterprises or industries, which have suffered from the war, have become uncompetitive due to obsolete technology, high energy intensity and a lack of funds for their development. Thus, Ukraine’s economic recovery will  require both reconstruction and modernization. One example of this is Ukraine’s steel industry which has suffered the loss of two of its biggest factories in Mariupol. The implementation of modernizing this industry would require an investment of $6.6 billion from Ukrainian companies. Additionally, Ukrainian industries would take time to adapt the technologies that have existed in the EU for many years. In general, Ukraine’s modernization would not only repair and allow businesses to meet modern standards, which would make them more competitive in foreign markets, but it would also begin the re-industrialization of Ukraine and allow for more economic growth.

Another critical challenge that Ukraine is facing is that of labor. Despite high levels of unemployment (around 26%), many regions are already facing labor shortages. In the western regions of Ukraine, where many companies have relocated, the labor market had already recovered to 90% of its pre-war level by January 2023 and the search for new employees was becoming harder. If this continues, companies in Ukraine will likely face a choice to not increase business activity, which would be bad for the pace of economic recovery, or to raise wages in order to compete with both local employers and foreign firms. This may lead to higher inflation (in the case of active recruitment) and discourage investment by companies because of increasing payrolls. This problem has already affected neighboring countries, such as Poland, which has used Ukrainian migrants to due to a deficit of domestic workers.

Ukraine needs to use its available opportunities to overcome these risks, as well as the direct economic consequences of the war. Current estimates of direct and indirect losses to Ukraine from Russian aggression in February 2022 range from $564 billion to $600 billion. As of January 2023, the Kyiv School of Economics estimated that the total amount of documented damage to Ukraine’s infrastructure had increased to $138 billion. Recovery is expected to take at least a decade, if not more, and the total cost is estimated to be between $411 billion and $1.1 billion. This number is larger than the Marshall Plan, which helped rebuild multiple European nations after World War II. Despite the cost of postwar recovery (both financially and in time), there is some hope for the rapid development of Ukraine’s economy. Several countries have also considered using frozen Russian assets to cover losses from the aggression. The EU has frozen more than $300 billion in assets belonging to the Central Bank of Russia, and $30 billion connected to oligarchs with close ties to Vladimir Putin. Efficient use of these funds would help compensate for Ukraine’s losses and help restructure the Ukrainian economy after the war.

Though its Reconstruction, Ukraine now has a chance to address some of the critical challenges and problems that have existed throughout its 31 years of independence. In addressing these, the country has the opportunity of not only strengthening its security and sovereignty, but it also can strengthen and further develop its economy in order to meet its full potential across its sectors such as agriculture, information and communication technology (ICT), energy, and more. Ukraine will also be more attractive to Western investment as well. Ukraine's government is expected to be working on the pre-conditions for reconstruction. Most importantly, it must prepare a new institutional framework to bolster its reconstruction efforts and move it closer to EU accession. Ukraine can use examples such as the rapid and effective digitization of government services in the country. This has made bureaucracy more efficient and doing business easier. Digital solutions also help reduce corruption, which has always been seen as a major problem. Second, Ukraine should focus on raising productivity and modernizing production as a key driver of economic recovery. This will not only solve the problem of labor shortage, but it will also help to facilitate Ukraine's greater integration into the global economic community.

Mark Volynski