Thursday, May 29, 2014

Ukraine is a Prize Neither Russia Nor the West Can Afford to Win | Brookings Institution

Authors' Note: This article is based on a section of our paper, “Beyond the Sanctions: Russia, the West, and Ukraine.”

Almost forgotten in the discussions of the conflict between Russia and the West is what happens to Ukraine. The answer to that question, like so many other problems, depends on how much each side is willing to pay for their preferred outcome. It is important therefore to understand the costs of the potential outcomes for Ukraine and how those costs will be apportioned between Russia and the West.

The West sees itself as defending Ukraine against Russia, and since it won’t wage military war against Russia it has two main ways to do that, both economic. The first is to shore up Ukraine’s huge economic vulnerabilities, mainly by helping Ukraine pay its bills and plug its deficits. The IMF has pledged $17 billion to that end, the EU a nearly equal sum. The second way the West is defending Ukraine is to levy economic sanctions against Russia to deter it from further aggression.

From Russia’s standpoint, things are more complicated, but in the end there, too, it comes down to economics. Russia sees Ukraine as a front in a war being waged by the West against Russia. Through its actions in Ukraine, Russia is telling the West to stop using the country as a staging ground for operations against Russia. Russia sees sanctions as a yet another weapon in the West’s war. Russia knows it is far inferior to its adversaries in terms of economic size and strength (the combined GDP of Russia’s NATO and EU adversaries is roughly 15 times that of Russia’s), so it has opted not to engage in tit-for-tat responses to Western sanctions. Instead, it resorts to “asymmetric” measures. It looks for weak spots. One obvious such weak spot is Ukraine’s economy. The Russia attitude is, if the Western coalition wants to use Ukraine against us, let them see how much it will cost.

It is clear to most observers that the West would not be able to defend Ukraine economically from a hostile Russia. Russia is in a position to do far more damage than the West can defend against or repair. It’s always true that it’s easier to undermine a country economically than to build it up. It’s easier to destabilize than stabilize. It is perhaps less evident that the West would have a very hard time stabilizing the Ukrainian economy even if Russia weren’t around to make mischief. The simple fact is that Russia today supports the Ukrainian economy to the tune of at least $5 billion, perhaps as much as $10 billion, each year.

When we talk about subsidies, we usually think of Russia’s ability to offer Ukraine cheap gas — which it does when it wants to. But there are many more ways Russia supports Ukraine, only they are hidden. The main support comes in form of Russian orders to Ukrainian heavy manufacturing enterprises. This part of Ukrainian industry depends almost entirely on demand from Russia. They wouldn’t be able to sell to anyone else. The southern and eastern provinces of Ukraine are dominated by Soviet-era dinosaur enterprises similar to Russia’s. They were all built in Soviet times as part of a single, integrated energy-abundant economy. They could be sustained only thanks to the rents from Soviet (overwhelmingly Russian) oil and gas. Russian subsidies have continued to maintain the structure in the post-Soviet era. Because most of these subsidies are informal, they do not appear in official statistics. (In fact, not even Putin talks about them, though it might be to his advantage to do so, because acknowledging the existence of hidden Russian subsidies to value-destroying Ukrainian enterprises would expose the fact that the same thing goes on, on a much greater scale, with their Russian counterparts. They, too, are not producing real value.)

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