The Ukranian Trilemma

The ongoing drama in Ukraine is rife with paradox. Russian special forces “liberated” Crimea without resistance and now uniformed gunmen who seem to be a mixture of locals and Russians have occupied key positions in the eastern region of Donbas, including police and municipal offices in Donestk, Slovyansk and Kramatorsk. Sentiments on the streets in these cities are split, but typically people seem to want looser relations with Kyiv and closer ties with Moscow. 

Ukraine can be said to be facing three challenges. Democracy dictates bowing to the will of the people; nationalism dictates resisting Russia; the exigencies of proximity, trade, and finance dictate economic intercourse with both Russia and Western Europe. 

Dani Rodrik, an economist at Harvard, published a book in 2011 called The Globalization Paradox. At the heart of his “paradox” is a trilemma between globalization, nationalism, and democracy. Ukraine since independence is a good example. In 1991, in a wave of nationalism rooted in the West and centered in Kyiv, Ukraine made history as the most important ex-Soviet state to secede. The spelling of Kiev was changed to Kyiv and universities adopted Ukrainian as their official language. At the same time, the best university, Kyiv-Mohyla Academy, long considered by Moscow a hotbed of nationalism was reopened.

The new nationalism was cloaked in democracy. The English-language Kyiv Post that we read as a source of restaurant and night-club tips also published editorials that were quite critical of President Kuchma who was alleged to have engineered the killing of a journalist found beheaded. Viktor Yushchenko, who after his later poisoning and disfigurement inspired the Orange Revolution against Kuchma, was Governor of the Central Bank and was idolized by my students, some of whom worked for him. But just before I arrived, the Deputy Governor was shot dead in the back of his head with a silenced pistol. Democracy and the rule of law clearly had its enemies. 

The third element of Rodrik’s trilemma, globalization, was playing itself out during that time, too. I was introduced to U.S. officers in mufti, there to “advise” the fledgling Ukrainian military. Jeff Sachs’s soon-to-be-disgraced Harvard Institute for International Development also employed many of our students. An implicit paradox of our program was that although we were avowedly educating a new elite to lead Ukraine, in truth the best and brightest of our students wanted nothing more than to move into a top U.S. PhD program with no plans to return home. 

Looking at contemporary Ukraine through the lens of Rodrik’s trilemma, we see a battle for democracy disturbingly confounded with sometimes-nasty nationalism of a neo-Nazi flavour. The very fact that it was a street battle, not an election that restored “democracy” is a contradiction in itself. And globalization seems to be at odds with democracy as well, with three large trading blocks—the Russian Federation (RF), the European Union (EU) and North America—each advocating a different agenda to help the Ukrainian electorate to decide how best to realize the governance they really want. 

The bald truth is that Western Ukraine looks west and Eastern Ukraine looks east, but both want independence from Russia. With wise face-to-face negotiation between their respective leaders, Ukrainians might in principle be able to work out a new and looser Ukrainian Federation that would remain politically independent but exploit obvious, win-win gains from trade with both the EU and the RF. 

Instead, the new Ukrainian leadership is mobilizing troops and badgering NATO for more arms. This strategy can only end in tears. Just as misguidedly, the new leadership (installed with the blessing of the United States and the IMF) is preaching bone-crunching austerity to pay back the foreign debt that was run up and squandered by the just-deposed kleptocracy. Indeed, Ukraine runs the risk of repeating the disaster that has been Greece: a messy default proceeded by blood in the streets. It is, of course, far better to negotiate debt relief early on but, at present, political barriers to that are daunting to say the least, since the creditors—Russia and Western Europe—are on the brink of a lose-lose sanctions war.

On March 25, the IMF announced a USD$14-18 billion rescue package to Ukraine, with a putative total of USD$27 billion contingent on commitments from others like the EU, World Bank, European Investment Bank, and European Bank for Reconstruction and Development. The problem with such “bailouts” is that they are not bailouts at all, but rather loans, and the IMF in particular (quite properly, as the world’s lender of last resort) never forgets and never forgives. Moreover the IMF demands “conditions” in return for the funds—many of them wise but some misguided. A wise precondition for the IMF’s disbursement was the abandonment of Ukraine’s currency peg. However, since mid-February, the hryvnia has dropped a dramatic 30 percent. This will help correct their 9 percent current deficit, or at least the trade part of it, but it will greatly exacerbate the hryvnia burden of their external debt, which is denominated in foreign currencies.

The ideal way to deliver relief to an economy with an unsustainable debt burden is not to lend it more money but rather to write off part of the debt. In the late 1980s and early 1990s, we learned that debt relief can be win-win: with both creditors and debtors ending up better off. The IMF and the United States organized commercial debt write-offs averaging about 45 percent for 23 middle-income countries—mostly in Latin America—and both banks and borrowers benefited. That lesson was largely ignored during the recent Eurozone crisis because there was no Paul Volcker, U.S. Treasury, or Bill Rhodes to mobilize the European banks so the German taxpayer was unduly burdened. In this case the U.S. Treasury is highly unlikely to inspire debt relief since Ukraine’s biggest creditor is Russia—not least Gazprom. So what to do? 

The immediate priorities should be threefold: avoid military confrontation and avert further annexation; proceed with and monitor the national election scheduled for May 25; and, crucially, replace the looming sanctions war with a trade, finance, and debt deal. 

On April 10 the IMF’s Managing Director, Christine Lagarde, intimated that it would take until early May to even submit the new loan package to her Board. She also hedged on debt relief because that would take much longer. The dismal reality is that money won’t be disbursed before the election in late May while Ukraine faces debt payments in June that it will not be able to meet. In fact Putin’s recent one-third hike of gas prices means that any new loan money would be bled back to Gazprom for current and past payments due. 

Brussels, Washington, Kyiv, and Moscow are scheduled to meet in Geneva on April 17. One bribe the EU might offer Putin in return for backing off from further annexation might be to pay off Ukraine’s debts to Gazprom and perhaps some parts of its other debts to Russia as well. And one way to persuade the populace of Eastern Ukraine that foreswearing federation with Russia could be in their immediate interest might be to offer them duty free imports, markets for their exports, loan guarantees for European investors into Ukraine, and easier visas for travel and jobs. 

Sanction wars and saber rattling are inevitably lose-lose. As economists, the central and sound lesson we can teach the world is that peace and prosperity flow from free trade, not the reverse.