The company Ukraine keeps

December 3, 2013

This is a guest post by Julia Gray, assistant professor of political science at the University of Pennsylvania. – Erik Voeten


Ivan Sekretarev/Associated Press

Familiar scenes are appearing in Ukraine: protesters in the main square, rallying cries from opposition figures, hand-wringing from the West and not-so-veiled threats from the East. This may seem like a repeat of the Orange Revolution of the mid-2000s, which was billed as a historic moment. Back then, Ukraine was choosing between a future that linked it to Europe and a past that entrenched it with the Soviets.

But what’s really at stake this time? Ostensibly, it’s a choice between a customs union with Belarus, Kazakhskan, and Russia on the one hand, and closer cooperation with the EU on the other. That closer cooperation would at present take the form of an Eastern Partnership (something Ukrainian President Viktor Yanukovich scuttled at a summit on Nov 29). This makes it sound as though Ukraine would potentially have a lot to gain economically from picking one option or the other.

What’s interesting, however, is that material gain is only part of the story. Ukraine has been a member of the World Trade Organization (WTO) since 2008, and the WTO gives it sizeable market access to all the countries mentioned above. True, the proposed deals would allegedly give it more. But Ukraine already signed what Brussels calls a “Deep and Comprehensive Free Trade Agreement” with the EU in 2008 (negotiations were concluded in 2012). And it’s already been a member of various post-Soviet economic integration schemes since the early 1990s. It’s therefore unclear that economics are what’s making this story so prominent now.

Instead, what’s primarily in the balance is Ukraine’s image. The company a country keeps can change its reputation, as I’ve argued. Reputations can, of course, translate into material gains – greater access to capital on financial markets, if portfolio investors perceive you to be more likely to honor your debt obligations.  I’ve shown that international agreements can often serve as a seal of approval  to portfolio investors.

This particular case is no exception. Caught between one club it doesn’t particularly want to join (the Russian-led customs union) and another that won’t let it come much closer (the EU), Ukraine is currently taking heat from both sides as well as in the international press. Tying itself to the EU might make Ukraine look more attractive on the international front in the long term, but if Russia cuts Ukraine off, the short-term economic consequences could be devastating – particularly since it’s far from clear that Ukraine can get any closer to the EU than it already is. At the same time, any further crackdowns on protesters will only make them seem less like a country that belongs in Europe.

And with Ukrainian debt at around $60 billion set to mature by July 2015, access to international capital is crucial for the country. This fall, several ratings agencies –  including Moody’s, Standard & Poor and Fitch— all downgraded Ukraine’s credit rating close to default. One economist reckons that Ukraine needs up to $25 billion to cover outstanding sovereign debt payments as well as to inject cash into the economy. Reputational benefits aside, the EU simply wasn’t offering enough to Ukraine to offset the economic considerations.

The irony is that for now, Ukraine probably has more to gain economically from closer ties to the east than the west, even if the reputational benefit of being linked to the EU might help them in the long run. Ukraine is the breadbasket of central Europe, but the EU’s scheme of agricultural subsidies means that there isn’t a lot of room for Ukrainian food exports. Ukraine also has around $20 billion in loans at Russian state banks; worse relations with Russia would likely put that financing at risk. It’s also important to remember that Russia and Ukraine have long had a contentious relationship over gas, and angering Russia would certainly only deepen those troubles. Ukraine currently exports around $17 billion worth of goods to Western Europe and $16 billion to Russia — but if the Russian export market is cut off, it would hit around 1/5 of Ukraine’s GDP.

So Ukraine has nowhere to go – or at least it faces a difficult balancing act. Much has gone wrong on the domestic front, including political turmoil and possible human-rights violations, such as the the jailing of Yulia Tymoshenko. But it bet on Europe, and now the threat of immediate economic losses loom larger than the possible reputational or future material benefits of the EU. Furthermore, Ukraine is in its fabric a split country. Its western regions naturally gravitate to the West, while the Russian-speaking eastern part has more in common with its eastern neighbors. And no matter how strongly many Ukrainians feel connected to the West, the Ukrainian economy is intertwined with Russia. So regardless of who is in power, it is difficult for officeholders to “choose” the West without alienating at least part of the citizens as well as damaging the economy – particularly when the immediate material gain from doing so may be slight.

When Ukrainians took to the streets almost a decade ago, they probably thought they were choosing a future that put them more firmly in line with Western Europe. But the current government probably sees that it’s gotten as far as it can feasibly go down that road. EU enlargement is not likely to materialize any time soon, and Russia is happy to make life worse for Ukraine in any way it can. Particularly for countries in transition such as Ukraine, navigating the company they keep on the international stage can be a delicate endeavor – but it’s one that has important consequences.

 

 

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Andrew Gelman · December 2, 2013