An economy that stopped growing, and the three reasons why

The Ukrainian economy stopped growing in 2013. There was no crash, no bank run, no external default — output simply flattened, and it did so while the government was still describing the situation as a temporary external headwind.

It was not temporary and it was not primarily external. Three structural causes explain most of it, and each had been visible for years.

Commodity dependence

Ukrainian exports were heavily concentrated in steel, iron ore, chemicals and grain — products whose prices are set globally and over which the country has no influence.

Steel in particular had been the engine of the 2000s expansion. When global steel prices fell and Chinese capacity expanded, the entire model lost its driver. There was no adjustment available on the Ukrainian side because the sector's competitiveness rested on cheap energy and depreciated Soviet-era plant rather than on anything that could be improved quickly.

An export base of this shape gives you fast growth when commodity prices rise and stagnation when they do not. The 2000s looked like a Ukrainian success story and were substantially a commodity cycle.

Investment drought

Gross fixed capital formation was far too low to sustain growth. The reasons were the familiar ones: unreliable courts meaning contracts could not be enforced predictably, unclear property rights, a tax administration that treated large taxpayers as a revenue source rather than a base to protect, and a banking sector that was not lending productively.

Domestic capital that could have been invested was substantially held offshore instead. That is a rational individual response to those conditions and a collective disaster.

The credit channel

Banks were lending to related parties and to the state rather than to enterprises. A mid-sized company with a viable expansion plan could not obtain term financing at a rate that made the plan work.

This is the least visible of the three causes and possibly the most damaging, because it means the economy could not reallocate capital toward whatever was actually growing. An economy without a functioning credit channel cannot restructure itself; it can only run the businesses it already has.

What it implied

The three causes reinforce each other. Commodity dependence discourages the diversification that would reduce commodity dependence. Weak institutions suppress investment, which keeps productivity low, which keeps the country dependent on commodity exports.

Breaking that requires simultaneous action on courts, banking and property rights — which is precisely the reform agenda that had been recommended and deferred for a decade, and precisely the agenda that only became politically possible when the fiscal position collapsed entirely.

The reading for a business

Stagnation of this kind is not a reason to avoid a market; it is a reason to understand which part of the market you are exposed to.

The sectors that continued growing through the stagnation — food processing, retail, IT services, agriculture — were those serving domestic consumption or exporting something other than commodities. The sectors that stalled were those tied to the old industrial base.

That divergence has held ever since, and it is the single most useful sectoral distinction to make when assessing this economy in any year.

Related in this archive

• When the growth number is worse than it looks: reading the composition instead
• The last year of the old model: a review written at the end of one era
• An old balance-of-payments problem, and why it kept coming back
• Ukraine Annual Review 2013: the year the model ran out

An economy that stalls without a dramatic event shows up first in the order book: through 2012 and 2013 enquiries for new projects fell while maintenance enquiries rose, and that always says the same thing — nobody is expanding. We noticed the investment drought months before the macro data did. The earliest indicator of stagnation is postponed purchasing decisions.