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Date: Sun, 10 Jan 1999 17:33:27 -0600 (CST)
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Subject: Weekly Analysis -- January 11, 1999
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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.
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