The last year of the old model: a review written at the end of one era

The model that governed the Ukrainian economy from the early 2000s had four load-bearing parts. By the end of 2013 all four were failing simultaneously, and reviewing them together shows why what followed was structural rather than accidental.

The four parts

Commodity exports as the growth engine. Steel, iron ore, chemicals and grain generated the foreign exchange and the industrial employment. Global steel prices and Chinese capacity expansion removed the engine, and no policy on the Ukrainian side could restore it.

Cheap imported energy as the industrial subsidy. Heavy industry was competitive largely because energy was priced below the level a market would set. That arrangement required a political relationship to sustain, and it made the entire industrial base a hostage to the terms of that relationship.

Household tariff subsidy as the social contract. Gas and heating for households were priced far below cost, with the difference absorbed by the state and by accumulating debt at the state gas company. This was the largest single fiscal drain, the largest source of arbitrage, and the reason energy consumption per unit of output stayed among the highest in Europe.

A fixed exchange rate as the confidence anchor. Defended with reserves, presented as national credibility, and increasingly detached from the underlying external balance.

Why they failed together

Because they were connected. The export engine generated the foreign exchange that financed the imports; the cheap energy made the exports competitive; the subsidised tariffs required fiscal space that the export revenue provided; and the fixed rate was sustainable only while the external accounts were manageable.

Remove the first and the rest lose their support in sequence. Export revenue falls, the external deficit widens, reserves are spent defending the rate, the fiscal space for the subsidy disappears, and the state gas company's losses become sovereign debt.

That is not four separate problems. It is one structure reaching the end of its life.

What was not wrong

It is worth being precise, because the failure of the model does not mean everything was failing.

The agricultural sector was growing and had barely begun to realise its potential. The IT services industry was expanding rapidly with no state involvement of any kind. Food processing and retail were building genuine businesses serving domestic demand. The workforce was well educated and cheap by European standards.

Everything that was working was working outside the old model, and everything that was failing was part of it.

What the review indicated

That the adjustment ahead was not cyclical. A cyclical downturn is followed by a recovery to the previous configuration; a structural exhaustion is followed by a different configuration or by nothing.

The specific measures that would be required were all identifiable in advance: tariffs to cost recovery, a floating rate, banking sector resolution, and an export reorientation toward the sectors that were already growing.

All four arrived within eighteen months, none of them by choice.

The transferable observation

An economic model that depends on a single input price staying favourable is not a model, it is a position. It will perform well for as long as the price holds and it has no answer for when it does not.

The question worth asking of any economy — or any company — is which of its advantages would survive the loss of its cheapest input. Where the answer is none, the arrangement is more fragile than its results suggest, and the results are what conceal the fragility until it arrives.

Related in this archive

• An economy that stopped growing, and the three reasons why
• When the growth number is worse than it looks: reading the composition instead
• An old balance-of-payments problem, and why it kept coming back
• Ukraine Annual Review 2013: the year the model ran out

You know a model is exhausted not from one indicator but from all of them stopping at once. I have seen it at company scale too: sales stall, margins narrow, collection lengthens, and it all happens in the same quarter. What is called for at that point is not working harder but changing the model — and that is the hardest decision to accept.