Ukraine’s Lost Trade Opportunity

New York - The European Union announced earlier this month that it has agreed with Ukraine to delay implementation of the Association Agreement between the two sides until the start of 2016. Most observers view this as a concession to Russia.

di Christopher A. Hartwell

New York - The European Union announced earlier this month that it has agreed with Ukraine to delay implementation of the Association Agreement between the two sides until the start of 2016.

Most observers view this as a concession to Russia since the deal marked the Westward turn that triggered Moscow’s interventions in the first place. But whatever its international significance, delaying the deal is also a domestic mistake for Kiev.

The Ukrainian government risks losing a rare opportunity to rescue Ukraine from its economic failures of the past two decades. The Maidan revolution and ouster of former President Viktor Yanukovych at the end of 2013 was sparked by Mr. Yanukovych’s decision at the last minute to turn Ukraine away from its path in the direction of European integration and back toward Russia.

While there is little reason to think that joining the European Union is the goal of many Ukrainians - they don’t need anyone else to tell them what their bananas should look like - the public clearly wanted to be less in Russia’s thrall.

Mr. Yanukovych’s attempted turn also meant that the sputtering economy and corrupt political machine that had been in place since before Ukraine was an independent country was not going to reform anytime soon.

The country needs a “big bang” along the lines of that undertaken by its neighbor Poland 25 years ago. After contracting 14.2% in 2009 as a result of the global financial crisis, Ukraine struggled to recover, with anemic GDP growth of only 0.2% in 2012.

Now, due to the political instability compounding the already-existing economic malaise, GDP is projected to contract by 9.0% in 2014. Clearly there is no shortage of reforms to complete.

Bolstering the protection of private property and allowing the sale of agricultural land would be a huge first step toward creating a real market economy. De-monopolizing large sectors of industry and slashing the bloated public sector would also turn Ukraine into a state where business success is less predicated on who you know and more on what you do.

One of the most critical reforms would be liberalizing trade, an area that is plagued by corruption, nontariff barriers and administrative hurdles. The World Bank notes that Ukraine is the 148th easiest country in the world to export to or import from, more difficult than such free-trade stalwarts as Libya, Syria and Yemen, despite years of EU assistance in customs management and border controls.

The ubiquitous need for stamps and signatures to engage in commerce is comparable to Russia, which is 157th in the world in the same trading-across-borders category. EU authorities said that postponing implementation of the Association Agreement would give Ukrainian industry more time to adjust, but this is a fallacy.

If implementation of the trade deal is delayed much longer, a vital chance to open to the world would fade away, perhaps forever. Even for advanced countries, trade liberalization is a tough reform, as evidenced by the resilience of the EU’s protectionist Common Agricultural Policy.

The benefits of trade are dispersed, while their costs are often borne by smaller segments of the population, usually those in uncompetitive industries. Lobbying by these segments often leads to suboptimal trade outcomes for all.

In the Ukrainian case, there is an additional lobby that will push back against trade liberalization, and that is the legion of bureaucrats who benefit from corruption. From the street policemen to the president’s office, corruption has burrowed into the heart of the body politic.

Free trade, by eliminating opportunities for rent-seeking, helps to strike at administrative corruption. A country that doesn’t choose “winners” by fiat leaves firms to spend less time influencing politicians and more time doing business.

Fewer controls at the border mean fewer chances for an official to collect a little something extra from a permit or license. Poland’s experience shows that the chance to break the back of corruption passes rapidly, however, with only a small window of time to implement needed reforms.

Former Polish Deputy Prime Minister Leszek Balcerowicz called this time “extraordinary politics,” the rare moment where everyone is in agreement about what is to be done and when the normal give and take of political bargaining is suspended.

This time does not last forever, and the window has already begun to close for the no-longer-new Poroshenko government in Kiev. As Ukrainian Prime Minister Arseniy Yatsenyuk admitted recently, the government has not delivered on many of its promises over the past six months.

Political infighting doomed earlier hopes for reform after Ukraine’s Orange Revolution, allowing Mr. Yanukovych to come to power. So avoid further slippage, the Ukrainian government must insist that implementation of the trade pact with the EU not be delayed.

And if the EU cannot help integrate Ukraine into the world economy, Ukraine must liberalize unilaterally and wipe away the vestiges of the command-and-control system that has crippled it for too long.

It may lose some territory to its large neighbor to the East, but if it fails to reform, it will have also bargained away its soul. Mr. Hartwell is president of the Center for Social and Economic Research in Warsaw. This is the first of a series of two features on the Ukrainian economy.

(Source: The Wall Street Journal)