poroshenko, ukraine, corruption
Ukrainian President Petro Poroshenko

How Western aid enables graft addiction in Ukraine

May 05, 2016
M. Steven Fish and Neil A. Abrams
This article was originally published in The Washington Post. Russia Matters is republishing it with permission of the authors.  

Over the past 25 years, Western donors have funneled billions of dollars into post-communist Ukraine, with two main goals: helping the country build a self-sustaining, competitive market economy, and laying the legal and regulatory groundwork for a law-governed state.

April 14 saw the appointment of yet another government dominated by insiders from Ukraine’s discredited post-communist establishment. This ended a political crisis sparked in February when Aivaras Abromavičius, the respected minister of the economy, resigned over persistent graft among his underlings.

Abromavičius’s resignation was just the latest confirmation that the hopes that accompanied the EuroMaidan movement of 2014 have crashed on the rocks of renewed asset-grabbing (see herehere and here). The gains from modest successes in economic reform have been washed out by impunity at the topalong with a lack of progress in civil service reform and movement toward a law-based state.

These developments prompt the question: Can Western aid actually support the cause of reform in Ukraine? Or is Western assistance enabling an entrenched elite to continue stealing and avoid building a functioning state? And what can social science research tell us about the answers to these questions?

Most Western aid is currently suspended pending a revival of the government’s economic reform program. Even so, the International Monetary Fund (IMF) already has cooperation with the government. Such a move would unlock further assistance from Ukraine’s other chief backers, namely the United States and the European Union.

This is a long-established pattern. Western governments and multilateral lenders have periodically suspended aid to Ukraine when signs of corruption and misrule became too glaring to ignore. But more often than not, the flow has resumed as soon as the government indicated an intention to mend its ways.

Only in rare instances have reforms gone beyond artful pandering to Western donors. The reason is simple: Since 1991, when Ukraine gained independence from the Soviet Union, a powerful political and business establishment has wielded uninterrupted control of the Ukrainian state. Not even popular uprisings in 2004 and 2014 or changes of executive power in 1994, 2005, 2010 and 2014 managed to dislodge this elite. The enduring influence of this class explains why Ukraine has yet to see the kind of reforms that could help create a functioning market economy or a state governed by the rule of law.

Ukraine’s elites deploy the courts and police to raid companies they covetExtortion, not public service, is the primary activity of state regulatory agencies. Even more damaging is the plundering of state assets. To be sure, the current government ended the practice by which private intermediaries reaped illicit billions from the exploitation of gas subsidies — at least for now. A previous government intermediaries in 2009 only for the scheme to return under the next administration.

The looting of state-owned companies by oligarchs and state officials, including figures close to the president and former prime minister, remains very much alive (see here and here). Privatizing these enterprises is no solution; if history is any guide, they will be sold to government cronies for a song (see herehere and here). Tax and customs fraud along with myriad subsidies have further enriched powerful insiders, hollowing out the state in the process.

Ukraine’s leaders might have constructed effective state institutions capable of preventing such plundering and fostered a market economy that can maximize tax revenue. But their virtually unlimited access to Western assistance has freed them from the need to do so. It has also heightened their interest in maintaining the status quo.

In September 1999, the IMF released a $184 million loan tranche. At about the same time, a presidential appointee allegedly stole $184 million from the state gas and oil monopoly, diverting $64 million to the president’s reelection campaign and keeping the rest for himself. In April 2015, the IMF, citing the government’s “bold economic program,” transferred $4.51 billion to the central bank, which used the money to support the country’s teetering commercial banks. But the largest recipient, oligarch-controlled Pryvatbank, reportedly siphoned $1.8 billion of the IMF funds into a maze of untouchable offshore accounts, according to Nashi Groshi, a non-governmental organization.

These are not exceptional cases; they are representative of the way the government works. For every dollar of aid that flows into the country, $6.25 illicitly flows out, according to figures from the OECD and Global Financial Integrity.

Social scientists have long analyzed the effect of aid on corruption and governance. To be sure, studies that have looked at the problem across large numbers of countries have collectively yielded inconclusive results. Some find that aid reduces corruption, others that it worsens corruption, and still others that it makes little difference at all.

Examining large numbers of countries together, however, can obscure important developments at the country and regional levels. For instance, studies of Cambodia and sub-Saharan Africa have found that aid enables leaders to steal and reduces their incentives to build effective states.

Aid to developing countries may in some cases be helpful. But the data suggest that only when aid comes with real strings attached, and is conditioned upon the law-abiding behavior of ruling elites, does it advance development.

How to make sure that the aid will not continue enabling Ukraine’s acquisitive elite? How to ensure that the results will be different this time around? These questions rightly occupy the attention of the donor community.

Ukraine’s benefactors face two options. The first is to resume assistance in the event that the new government puts forward a reform plan and passes some legislation recommended by donors. This is the approach the West has followed in the past.

The other option is to refrain from resuming aid until the coming to power of a truly new leadership that excludes most people with previous high-level government experience, save for reputable technocrats such as Abromavičius, former finance minister Natalie Jaresko, and central bank chief Valeriya Gontareva. This would mark a genuine change in Western policy, one based on the assumption that real, lasting reform is unlikely so long as Ukraine’s compromised political class continues in power.

This is the choice the IMF now confronts as it assesses whether to continue its $17.5 billion lending program.