Left behind: Ukraine's uncertain transformation.

• Author: Aslund, Anders

Ukraine has never been so close to an oligarchic system of power. We are witnessing the first stage of a coup d'etat that started inside the walls of parliament.

--Ukranian opposition leader Viktor Yushchenko, December 18, 2002

THESE DRAMATIC words reflect a developing political crisis in what is arguably the most delicately situated major country in Europe today. On the one hand, the oligarchic regime is becoming ever more authoritarian and President Leonid Kuchma ever more unpopular, with an approval rating hovering around 7 percent. On the other hand, political opposition and civil society have gathered strength, and new forces may soon come to power. The natural showdown is the next presidential election, scheduled for November 2004, but the preparations for that showdown will determine the outcome.

The West, and the United States in particular, cannot be indifferent to Ukraine's fate. It is the nexus between an expanding European Union, the Eurasian colossus of the Russian Federation and the northern Middle East. A stable and prosperous Ukraine facilitates interaction among its neighbors; a weak Ukraine creates a power vacuum that encourages rivalries. In a host of areas, Ukraine as a state could become a major contributor to global instability, from organized crime to WMD proliferation. (1) This is why safeguarding the future of Ukraine is critical.

Right now, however, everything appears to be up for grabs. Semi-democratic Ukraine could become a dictatorship or a fuller democracy. Though a market economy of sorts exists, and the country has seen three years of strong economic growth, this progress is not guaranteed: it could easily break down into a corrupt oligarchy. Western-oriented reformers argue that Ukraine must make its "European choice", but Ukrainian nationalists fear their country's independence will be subverted by a revitalized Russia. Pessimists fear that President Kuchma and the oligarchs are transforming Ukraine into another Belarus--that rogue, Soviet-style theme park that, as the last dictatorship in Europe, is as outmoded as it is outclassed by everything around it. Who will win? A decade hence, what will Ukraine be like? Perhaps the country's post-Soviet history can give us a place to begin in answering this question.

A Late Economic Transformation

DURING ITS first years of independence, Ukraine was preoccupied with nation-building, and little thought was devoted to economic policy. This was reflected in the election in December 1991 of Ukraine's first president, Leonid Kravchuk, formerly the Second Secretary of the Communist Party of Ukraine, who quickly changed his stripes when the old regime died. Though the jovial Kravchuk appeared a plausible nation-builder and mediator between the nationalist west and the Russified eastern part of the country, his economic philosophy could best be summarized as neglect. While a small number of operators made fortunes from the post-Soviet economic transition, general prosperity proved elusive, with a devastating rate of hyperinflation reaching more than 10,000 percent in 1993. The resulting economic free-fall provoked coal miners to strike and forced Kravchuk to call early elections. To his great surprise, he lost to Leonid Kuchma, the ultimate "red director"--the former manager of Ukraine's biggest armaments factory, who was viewed as a technocrat.

Kuchma undertook substantial economic reforms during his first year in power, leading to financial stabilization, but soon lost interest in marketization and privatization. As the interests of the old state managers dominated, economic decline continued, impoverishing the nation and forcing many to seek some measure of support from the growing underground economy. A handful of businessmen became billionaires by importing natural gas from Russia and foisting the bill on the government. In November 1999, Kuchma was re-elected thanks to a credible communist threat and heavy financing from the newly minted, billionaire oligarchs, who appeared to have bought the state.

The oligarchs proceeded to accumulate still more privileges as the rest of the economy descended into the doldrums of red tape and endless petty corruption. Ukraine soon achieved the worst economic performance of any post-communist state not plagued by war: Its official GDP per capita, which used to be higher than Russia's, declined steadily to half that of Russia. Oligarchic parasitism had driven Ukraine to the verge of external default.

Frightened by the Russian financial collapse of 1998, the Ukrainian oligarchs realized how desperate the situation was. Oligarchs, liberals and nationalists united in parliament and wrested control from the communists. They appointed Viktor Yushchenko, the highly-respected chairman of the Central Bank, as prime minister in December 1999 and charged him with saving the economy. Yushchenko named Yulia Timoshenko, at one time Ukraine's gas queen, deputy prime minister for energy. As a former oligarch who has fallen out with Kuchma, she knew all the tricks, and she took on the remaining oligarchs with full force.

In the course of four months, Yushchenko, Timoshenko and a handful of aides transformed Ukraine. They deregulated the economy, abolishing hundreds of decrees that had granted the oligarchs tax exemptions, subsidies or trade privileges. They enforced strict budget discipline, sharply reduced barter (an important means to extract tax rebates) and still managed to cut taxes. Yushchenko carried out a major land reform initiative and privatized many big enterprises, boosting the private share of the economy from about 50 percent to 60 percent. Timoshenko applied her unique knowledge as a former gas oligarch to clean out the energy sector.

The economic results were stunning. Ukraine's annual economic growth surged from 6 percent in 2000 to 9 percent in 2001 and remained above 4 percent in 2002. Exports from private enterprises in steel, textiles, agriculture, food processing and other light industries were the main engines of this growth. The budget was balanced, foreign debt was reduced from about 40 percent of GDP to about one-quarter of GDP, and prices and exchange rates stabilized. Millions of small and medium-size enterprises emerged. Ukraine's situation elegantly illustrates not only how damaging gradual market reforms can be, but also how radical market reforms can successfully revive a country.

Yushchenko had saved the country from default, but the oligarchs had only been diminished, not displaced. In April 2001, they ousted Yushchenko with the support of the communists and put a government of civil servants acting as caretakers in its place. Further economic reforms came to a halt, although existing ones were not reversed.

An Oligarchic State

DESPITE THE great distance traveled by Ukraine after the Cold War, no post-communist state today is more oligarchic. Initially, the clans were limited to the gas trade, but they have adapted and become regional conglomerates. Big business in Ukraine is even more entangled with the state than it is in Russia, and it is even more disposed to criminality. Today's Ukrainian...