Monday 14 April 2014 8:53 pm

Ukraine fatally weakened by failure to embrace real capitalism

IN the dreadful communist days, Ukraine and Poland used to be equally poor. The former was part of the Soviet Union, and Poland was one of the USSR’s satellite nations, belonging to the Warsaw pact.

In 1990, both countries had roughly the same GDP per capita – their economies were eerily similar. A quarter of a century later, everything has changed: Poland’s GDP per capita is now 3.3 times greater than Ukraine’s. It’s a tale of two economic models, and a central reason why Russia – a waning world power desperate to cling on to its historic zone of influence – has felt able to bully Ukraine in such a shocking way.

The numbers are astonishing: Ukraine’s GDP per capita is now $3,867, according to the World Bank; Poland’s is $12,710. Poland has transformed the quality of life of its citizens, something that has not happened in anything like the same way in Ukraine, which has been grossly mismanaged for years.

The big difference is that Poland has pursued free-market policies, reducing the size of its state, introducing a strict rule of law and respect for property rights, privatising in a sensible way, avoiding the kleptocracy and corruption that has plagued regimes in Kiev, and embracing as much as possible Western capitalism, technology, modernity and innovation.

Of course, there have been mistakes: Poland’s tax system remains far too oppressive, the red tape is too strict and the bureaucracy still too redolent of the bad old days, the labour market is excessively regulated, parts of the population rejects elements of the new order and the country remains relatively poor, which explains why so many of its most ambitious folk have moved to the UK and elsewhere.

But Poland has been one of the great success stories of the post-communist era, whereas Ukraine, tragically, has been one of the great failures. Even Belarus has performed better. Ukraine has followed Russia’s lead, and in doing so has wasted the past 24 years.

There, is of course, an alternative explanation: Poland has been in receipt of large-scale subsidies from the EU, unlike Ukraine. But I don’t buy it. Foreign aid at best makes only a small difference to economic growth – and at worst retards development by creating a culture of dependency, propping up value-reducing projects and fuelling corruption. So yes, Poland now boasts shiny new infrastructure it wouldn’t otherwise have; but this doesn’t explain why its economy has performed more than three times as well as Ukraine’s. And until the present crisis, Ukraine benefited from cheaper energy prices, as part of its uncomfortably close relationship with Russia – an even greater subsidy, but one that merely staved off total collapse.

Ukraine’s population has also fallen dramatically, from 51.89m in 1990 to 45.49m in 2012, while Poland’s has risen from 38.11m to 38.54m. Geopolitical weakness often stems from economic under-performance – and that is all too tragically the case with Ukraine today.

Good news: the Treasury’s new dynamic model is making waves. The traditional model doesn’t sufficiently account for supply-side effects: it calculates the tax impact on demand, but not on incentives to work, invest or save. It exaggerates the negative fiscal impact of tax cuts and downplays the deleterious effects of tax hikes.

HMRC has already published an analysis of the dynamic effects of corporation tax; it has now applied its peer-reviewed model to the fuel duty cuts since 2010. It finds that the tax reductions will increase GDP by 0.3-0.5 per cent in the long-term and that increased profits, wages and consumption reduce the “cost” (in terms of the reduced revenues for HMRC predicted by the usual static model) by 37-56 per cent. One can quibble with details and assumptions, but this is a great step in the right direction. More, please.
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