_________________________________________________ Need to Know Something Fast? Try STRATFOR's Find Facts Service Visit http://www.stratfor.com/findfacts/index.asp Or e-mail [EMAIL PROTECTED] _________________________________________________ Global Intelligence Update Red Alert January 11, 1999 It is Time to Start Thinking About the Ukraine Summary: * Few people outside the region worry much about Ukraine. This will change in 1999. The Ukrainian question will be a major focus of international attention this year, creating stresses within Europe and between the United States and Russia. The issue: will Ukraine join the Russo-Belarus federation. We think economic forces will force Ukraine to federate with Russia. With this, Russian power will return to the frontiers of central Europe from the Black Sea to Carpathians to the Baltic. If Ukraine refuses to federate, Russia will not be able to reassert itself. If it does, there will be no buffer between NATO and greater Russia. The Ukrainian question is going to become front page news in the not too distant future, dwarfing Serbia and Iraq in significance, if not in violence. Analysis: We argued in our 1999 annual forecast that the fate of Ukraine would be one of the critical issues of 1999. We believe that Ukraine will rejoin Russia and Belarus in a Federation. This may not occur in 1999, but the process is already underway, and we believe it is very likely that Ukraine's return to the Russian embrace shortly thereafter. If and when it happens, it will reshape the geopolitics of Eurasia. Since Ukraine is not a nation that most people outside of the region think about very much, we think it useful to focus on it this week and to try to forecast its probable course. Let's begin by recapitulating why we think Ukraine will loom large among issues in 1999. Russia has reached the end of the reform cycle. It is experiencing a massive economic depression, has lost not only its global influence but also territories that Moscow and St. Petersburg ruled for centuries. This is not simply a matter of prestige, although the psychological effect of the loss of empire must not be dismissed, nor should the political consequences of the psychological crisis. Nevertheless, there are other, structural issues, primarily economic ones, which are driving things. The Soviet Union was never a particularly healthy economic entity. Nevertheless, more than most regions of the world, it was fairly self-enclosed. Until the late 1980s, the Soviet Bloc in general and the Soviet Union in particular were only marginally dependent on international trade or foreign investment. They existed as a virtual planet, separated economically from the general global economy. As a result, they lagged far behind the West in economic development. But while they lagged, they did not decline. Their economies and standards of living continued to develop, albeit unevenly, inefficiently, and far behind non-communist growth rates. This growth was due to the availability of secure markets, stable exchange rates, predictable cash flows within the boundaries of the Soviet Union and the communist trade zone called COMECON, which included most of communist Eastern Europe. A fully integrated regional economy, protected from the rest of the world by political, economic and monetary barriers, allowed for a sustainable if inferior rate of growth. The key to this was the availability of predictable markets in the region. The central assumption behind capitalism is that competition serves as a goad to maximize performance. Among nations, this theory manifests itself in the theory of comparative advantages. Every nation has a comparative advantage in some area. There are some things that each nation does best and if every nation sticks to it, then every nation will maximize its income. Competition forces a nation to find and stick to its comparative advantage. It is an excellent theory except in the case of nations whose advantage is insufficient to sustain a minimal, politically acceptable standard of living. When the borders of the old Soviet Union were thrown open, they now had to discover comparative advantages not in relation to each other, but in relation to Germany, France or the United States. The results weren't pretty. The expectation of western economists was that competitive pressure would compel former communist economies to become more productive. After a great deal of stress, this was true for countries like the Czech Republic, Poland and Hungary. These were the countries that had the greatest economic interaction with the West prior to the fall of communism, which meant that their economies had made necessary, if inadequate, adjustments. An influx of western investment allowed them to improve their industrial plant sufficiently so that, after a few years, they would enjoy sufficient competitive advantage to stabilize their economies and even begin to grow. Outside of the Baltic States, this process simply didn't occur in the rest of European Soviet Union. The amount of capital required to generate a competitive advantage that could sustain the Russian economy was greater than could be raised in foreign investment. As a result, sudden competition threw the economies of Russia and most of the newly independent countries of the former Soviet Union into massive depression. The influx of western goods shattered domestic production in numerous industries. The influx of western investment shattered the native investment in infrastructure, while at the same time, being far too little to regenerate the native economies. Capitalism assumes that everyone has something that someone would want to buy. That may be true, but what if the price the market dictates won't sustain life? The solution in Western societies is welfare. What happens to a nation whose economy is so uncompetitive that it cannot generate sufficient wealth to sustain itself. That is the fate of the Third World. The answer there, if the country is small enough, is foreign aid, which can make the difference between starvation and malnutrition, if nothing else. But what do you do with a cluster of nations so large that outside help can't make a serious dent and whose competitive disadvantage is such as to cause more and more of their economy to disintegrate? Now, economists normally answer that you have to give the process time. And indeed, that may be the answer. But it has been six years since Russia was plunged into depression and the situation is getting worse, not better. There is no end in sight. That means that an entire generation of Russians will grow to maturity in increasing hopelessness and misery. In Russia the political clock is now ticking much faster than the economic clock. In retrospect, having lagged behind the West is not all that bad. >From a political standpoint, Russians are coming to regard the old situation -- low growth rates -- as preferable to the new one -- economic contraction with no end in sight. There is an obvious solution to the Russian, Ukrainian and Belorussian problems: re-enclosure, the re-creation of their virtual planet. The republics of former Soviet Union may not have enough to offer the West to prevent their economies from imploding. But isolated from Western products and Western capital, they do have advantages relative to each other. They may not be able to build autos as well as Western car companies, but few Russians can buy those cars anyway. They do have the ability to build pretty bad cars and sell them to each other. A Lada isn't a Mercedes, but at least they can build them and maybe afford them. At the very least, building Ladas for a captive market would stop the economic free fall. Of course, the small segment of society that has profited from its ability to steal and sell assets to the West is appalled at this prospect, although there are few in the West that are still buying or investing. Also appalled are Russian economists who attended conferences in the West. Joining them are Western economists. But for the rest, the idea of enclosure is increasingly appealing. Even the most committed reformer has to admit that most of European Soviet Union is not likely to be able to reach competitiveness in any significant industry in any reasonable time to stop the economic free fall. Therefore, both Communists and nationalists in Russia are taking seriously the idea of defaulting on Western loans, ending the convertibility of the ruble, controlling private holdings of dollars and other hard currencies, and thereby rebuilding an economic wall between Russia and the West. In short, the idea is to create a new ruble bloc, much like the old one. The issue, of course, is who will be behind the wall. Belarus is committed. But Ukraine is the key. Ukrainian agricultural production in particular is critical to the policy of enclosure. Without Ukraine, Russia will have to import agricultural products from outside its bloc, undermining its ability to construct a virtual planet. With Ukraine included, there is a real possibility of creating a sustainable union. Without Ukraine, it becomes nearly impossible, and Russia will continue its free fall. Thus, with a Belarus-Russian unification agreement completed, Russia turns its eyes to Ukraine. Ukraine is torn. There is a real nationalist sense in the Ukraine. Western Ukraine is largely Roman Catholic and deeply distrustful of Russian Orthodoxy. Although not as discriminated against as the Moslem republics by the Soviets (Khruschev was a Ukrainian), there is a legacy of exploitation and resentment there. Ukraine would dearly like to be included in the West and many Ukrainians are distrustful of Russian Pan-Slavic fantasies. At the same time, the most optimistic projection on the Ukrainian economy is that it may not fall much more than 1 percent in 1999. This is probably a pipe dream. The Communists and their allies, who tend to favor some sort of re-federation, hold 1/3 of the Parliament. With elections coming in October, 1999, it looks as though, even if they don't take the Presidency, they will be the king-makers. Now, unlike Russia, where nationalists can form an alliance with Communists, Ukrainian nationalism cuts against Communism. This limits the Communists' influence in the Ukraine more than in Russia, where nationalism and Communism are natural allies. Nevertheless, with the economy in free fall, the pressure to protect the Ukrainian economy is tremendous. And since protecting Ukraine inevitably means joining with Russia, there is natural pressure to rejoin. January 17 will be seen as a critical date in Ukrainian history. Foreign investment in Ukraine has just about disappeared. The Ukrainians, like the Russians, are really not able to repay their foreign debt. The only hope for any sort of restructuring is the International Monetary Fund. About $2 billion in help had been promised but was stopped because the Ukrainians were unable to come up with a plan to collect taxes, a prerequisite for IMF help. On January 17, an IMF delegation will travel to Kiev. They will check on progress on the tax issue, as well as examine other fiscal issues. If they approve of what they see, they may release the money. The problem is that it makes no difference, because the $2 billion is trivial. It will take care of some immediate problems, but as with the IMF and the Russians, the structural, competitive issues are so deep that ten times that money wouldn't make a difference. However, if the IMF doesn't ante up, it will create a situation in which the pro-western factions inside the Ukrainian government, including Ukrainian President Kuchma, will lose all credibility. The forces arguing for reversing the modest privatization that have taken place, for defaulting on Western debt, for returning to central planning, will have few barriers to power. In our view, whatever happens on January 17, Ukraine cannot survive economically as an independent state. Its comparative advantages are such that the Ukrainian economy will continue its implosion indefinitely. The issue is simply the degree of bitterness with which the Ukrainians will recoil from the West. We expect that the West will pressure the IMF to be more forthcoming with the Ukrainians and the process will be delayed. But in the end, Ukraine, like Russia and Belarus, will have to recreate the virtual planet and enclose their economies. Ukraine imports nearly half its goods from Russia, including critical energy supplies. Russia accounts for about a quarter of its exports. No other nation, including Germany, comes close. Most important, the only real hope for increasing exports is in the former Soviet Union. Ukrainian goods are not going to do very well outside that very special bloc. If Ukraine rejoins Moscow and Minsk, the heart of the European Soviet Union will be recreated. Moscow's reach will now extend to the Romanian, Hungarian, Polish and Slovak borders. Hungary and Poland are now all but NATO members. Moreover, the Slovak and Romanian economies are in borderline conditions -- on the border between the ability to compete and the need for enclosure. Certainly, they are ripe for Moscow's manipulation. In addition, Ukraine, once within the Russian fold, increases Russian control of the Black Sea, and secures Moscow's flanks as it reasserts itself in southern Russia and in the Caucuses. Thus, Ukraine is the necessary condition for creating a sustainable Russia. It also re-opens geopolitical opportunities that were closed for the Russians by the breakup of the Soviet Union. For Ukraine, the real question is simple: what is the alternative? The current situation is untenable economically. There is no real hope for a solution to its economic problems from the West. Ukraine simply cannot exist in the competitive environment it has been thrown into. Retreat is really the only option. The Ukraine question poses a profound challenge for Europe. Seeking to revive the Gaullist dream of blocking American power, France is engaged in political flirtation with Russia and is unlikely to challenge the growth of Russian power. Germany, dependent on a secure Poland and deeply involved in the rest of Eastern Europe, does not want to see a return of Russia to its old borders. Germany is clearly motivated to support an independent Ukraine. Therefore, the Ukrainian question will challenge Western European solidarity, posing the first serious foreign policy challenge to a unified Europe. France will back Moscow. Germany will back nationalists in Kiev. Since the Europeans still haven't figured out how to forge a unified foreign policy, the coming Ukrainian crisis could pose real hazards for a united Europe. We predict that the world will hear a great deal about Ukraine in 1999. We believe that the end result, if not in 1999 then shortly thereafter, will be a federation of Ukraine with Belarus and Russia. This will be the preface to more aggressive Russian empire building. We frankly do not see any long-term possibility for pro-Western reform in Ukraine. This reunification will reshape Eurasian geopolitics once again. ___________________________________________________ To receive free daily Global Intelligence Updates, sign up on the web at http://www.stratfor.com/mail/, or send your name, organization, position, mailing address, phone number, and e-mail address to [EMAIL PROTECTED] ___________________________________________________ STRATFOR, Inc. 504 Lavaca, Suite 1100 Austin, TX 78701 Phone: 512-583-5000 Fax: 512-583-5025 Internet: http://www.stratfor.com/ Email: [EMAIL PROTECTED]
