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Our television screens and social media sites are filled with the images of death and destruction as the Russian army continues its devastating advance into Ukraine. How long this will go on, and with what human and material costs is still not known. But for the Ukrainian people and their country’s economy, the world is, truly, being turned upside down.
Before the Russian invasion of Ukraine on February 24, 2022, the Ukrainian economy was performing fairly well by a variety of official statistics. Price inflation had been declining modestly from nearly 11 percent in the middle of 2021 to an annual rate of 10 percent in January 2022. The rate of monetary expansion had been accelerating through most of 2021, but in January 2022, all the Ukrainian money supply measurements had modestly decreased compared to December 2021, suggesting possible diminished monetary pressures on prices.
Ukrainian Gross Domestic Product (GDP) had grown in the last quarter of 2021 at an annualized rate of nearly 6 percent, and was expected to grow at a reasonably good clip through 2022. The Ukrainian-Russian crisis of 2014 had resulted in Russia’s annexation of Crimea and the breaking away of parts of eastern Ukraine by Russian-supported separatists. The Ukrainian government’s deficit spending to cover military and other expenditures pushed the government debt to GDP ratio from 40 percent in 2013 to nearly 81 percent in 2016. But by the end of 2020, the debt to GDP ratio had declined to less than 61 percent, for a 25 percent decline over four years.
However, the Ukrainian government’s budget deficit in 2020 had equaled 6.1 percent of GDP compared to 1.9 percent in 2018 and 2.1 percent in 2019. And the government’s red ink had significantly continued in 2021. So even if this new war had not interfered, the government debt burden was likely to grow. With growing budget deficits to finance, the government would possibly have turned, again, to the Ukrainian central bank for the money to cover its expenditures in excess of taxes. This would have threatened to reverse the modest deceleration in price inflation.
Ukraine’s Uncertain Political and Economic Future
All of this has now been thrown out of the budgetary window with the war. Will there even be an independent Ukraine at the end of 2022? If it does exist, will it be a really independent country or a puppet state doing the bidding of Vladimir Putin? Will the territory of Ukraine be within the internationally recognized borders before the Russian attack, or will eastern parts of the country be cut off as permanent separate “people’s republics,” or be out-and-out annexed by Russia, as happened with Crimea in 2014?
By the time the military phase of the conflict comes to an end, how much physical destruction will have occurred as a constraint on postwar production and reconstruction? How many Ukrainians will have been killed or seriously injured or disappeared from the Ukrainian labor force due to the likelihood of millions of people going into prolonged or permanent exile in other parts of Europe and the world?
What will be the trade and investment climate and possibilities in a postwar Ukraine, again assuming it continues to exist as some type of separate country, real or puppet? A good part of the answer to this last question will depend on the extent and nature of American and European Union sanctions that remain imposed on Russia, and on whatever remains of Ukraine, if it’s anything other than a vassal state obedient to Moscow.
Will the people of a conquered Ukraine resign themselves to their Russian-determined fate and try to go about everyday life in the new circumstances? Or will there be an extended underground of resistance and sabotage? For several years following the end of the Second World War in 1945, groups of Ukrainian partisans continued armed resistance against the Soviet Union in the forests of western Ukraine. Will that type of determined resistance manifest again?
If a puppet regime is imposed in Kyiv, Ukraine’s economic future for a significant period of time will be determined by the degree to which Western sanctions are kept in place. The country’s economic prospects will be confined within the limited options and narrower opportunities as a vassal state within the political and economic orbit of Putin’s Russia.
Ukraine as Europe’s Submerged Nation in the Soviet Union
The worst scenario for the country and its people would be a repeat of what occurred in the aftermath of the First World War. After centuries under the rule of, especially, Imperial Russia and Austria-Hungary, Ukrainian nationalists declared their nation’s independence, like many other ethnic and linguistic groups were doing in central and eastern Europe in 1918 and 1919. But the Ukrainians, due to internal divisions, could not withstand the attacks of the conflicting armies of a reconstituted Poland trying to recreate a “greater Poland,” and Lenin’s Bolshevik forces overrunning parts of Ukraine while defeating the remnants of the anti-communist Russian military units.
The final outcome, after a peace treaty between Poland and Soviet Russia in 1921, was that the western part of the Ukrainian lands, including the city of Lviv, came under Polish control; the other two-thirds of the country, containing the capital city of Kyiv, fell under Soviet power. From 1921 to 1991, Ukraine remained a “submerged nation,” which under Soviet control suffered the death of millions of innocent men, women and children during Stalin’s forced collectivization of the land in the early 1930s. The Ukrainians suffered even more destruction in the Second World War, first from the invading German army in 1941-1943, and then with the return of Stalin’s rule at the end of the war in 1944-1945.
With the end of the Soviet Union in 1991, Ukraine declared its independence. For the last thirty years, the country has experienced the dream that has been dreamed by many Ukrainians for centuries: being an independent nation-state. But, now, Putin’s Russia threatens to remove Ukraine, again, from the political map of the world, as happened in 1921 at the hands of Lenin and his Soviet government.
Ukraine’s Prewar Imperfect Political System
Independent Ukraine has not been a model of a perfectly functioning political democracy, nor has the government always respected the civil liberties of every citizen. Corruption has abounded. Privileges and favors to various individuals and interest groups have been freely meted out. Fiscal mismanagement has always been present, and price inflation has sometimes been high and erratic due to the Ukrainian central bank’s willingness to turn the handle of the monetary printing press to finance the government’s spending needs.
But whatever the political imperfections, economic regulatory hurdles, and monetary and fiscal abuses, freedoms of the press, speech, religion, and association have been fairly reasonably practiced in recent years. On the Freedom House’s index for overall respect for political rights and civil liberties in countries around the world, Ukraine got 61 percent out of a hundred. Not close to Germany’s 94 percent, or the UK’s 93 percent or even Poland’s 81 percent, among some other European countries. But Ukraine appeared to be a shining example of a politically free society compared to, say, Russia with a score of 19 percent out of a hundred, or Belarus with only 8 percent.
Ludwig von Mises’s Gold Standard Proposal for Ukraine
Whether at least part of Ukraine survives as a free and independent country when this war ends, or whether that will have to wait until some time in the future, Ukrainians will have to plan for the reconstruction of their economy at some point in the future. The economic policy agenda for such a reconstruction is at least partly at hand, and can be found in the writings of the Austrian economist, Ludwig von Mises.
Mises, interestingly, was born in Lviv in 1881, when it was then known as Lemberg in the old Austro-Hungarian Empire. He served as an artillery officer in the Austrian Army during World War I, seeing action on the eastern front against the Russians. After Lenin’s Bolshevik government signed a separate peace with Imperial Germany and Austria-Hungary in February 1918, Mises was sent to the part of Ukraine that fell under Austrian occupation. He was assigned as officer in charge of currency control, with his headquarters in Odessa. Mises served there for most of the spring of 1918, until he was ordered back to Vienna as an economic expert with the Austrian general staff until the end of the war in November 1918.
In the summer of 1918, shortly after returning to Vienna, Mises prepared a policy paper offering “Remarks Concerning the Establishment of a Ukrainian Note-Issuing Bank.” It was an outline of the institutional rules to be followed by a Ukrainian central bank under a gold standard. (In Selected Writings of Ludwig von Mises, Vol. 2, pp. 23-29)
All bank notes issued and outstanding, Mises said, should be at all times covered with gold reserves or foreign exchange redeemable on gold to one-third of the bank’s liabilities. Bank assets in the form of secure, short-term loans should back the remaining two-thirds of the notes in circulation. Mises admitted that there might be particular historical and institutional circumstances that would have to be taken into consideration in setting the conditions under which certain types of borrowers might have access to the lending facilities of the Ukrainian central bank. But what was crucial for Ukraine to have a sound monetary system were ample gold reserves for redemption on demand; also essential were limits on the term structure of loans made by the central bank to make sure it was always, ultimately, able to meet its obligations to maintain a functioning gold standard.
Establishing a gold standard in Ukraine, or anywhere else in the world today seems highly unlikely. Governments value too highly their ability to access fiat money for their deficit-covering purposes, and for central banks to have the means by which to try to influence borrowing, spending, and employment through monetary and interest rate manipulations. But Mises’s central point was that unless there are institutional rules and checks on a central bank to prevent it from arbitrarily changing the quantity of money and credit in the economy, the danger of serious price inflation and the booms and busts of the business cycle will always be present.
Mises’s Economic Agenda for Postwar Reconstruction
An outline of a Ukrainian postwar agenda for economic reconstruction is to be found in a series of monographs, essays, and lectures that Mises delivered in the early 1940s after his escape to America from war-torn Europe in 1940. Much of Europe was being destroyed in the conflict between Nazi Germany and the Allied powers. When the war was finally over, the task of rebuilding a broken Europe would be immense. (See, Selected Writings of Ludwig von Mises, Vol. 3: “The Political Economy of International Reform and Reconstruction”.)
To successfully rebuild Europe, the postwar world would have to be one of work, saving, and investment to, first, rebuild all that was gone, and then to build on that for a more prosperous life than had prevailed before the outbreak of the war in 1939. Or as Mises, expressed it, “It is the duty of honest economists to repeat again and again that, after the destruction and the waste of a period of war, nothing else can lead society back to prosperity than the old recipe – produce more and consume less.” Mises went on:
The distinctive mark of a sound economic policy is that it aims at the establishment of a durable system resulting in a continuous improvement of the nation’s wellbeing. There can hardly be imagined a worse principle of government than that of the short-run policies of the last decades . . . A policy that, indifferent about tomorrow, strives after ephemeral success and carelessly sacrifices the future is not progressive but parasitic . . .
“There is but one means to improve the economic wellbeing of a whole nation and each of its individual citizens: The progressive accumulation of capital. The greater the amount of capital available, the greater the marginal productivity of labor and, therefore, the higher the wage rates. A sound economic policy is a policy that encourages savings and investment and thereby the improvement of technical methods of production and the productivity of labor.
The Need for Secure Property Rights and Entrepreneurship
Mises argued that fundamental to a peaceful and prosperous future was a change in ideas away from various forms of collectivism and political paternalism to “an ideology that could lead us to a perfect free market economy.” Property rights need to be recognized, secured, and protected against not only private plunderers but, more importantly, against the confiscating and regulating hands of government.
This was essential not only to induce the domestic incentives for work, saving, investment and entrepreneurial creativity, but also to create the domestic institutional confidence to successfully attract and secure both direct foreign private investors and financial lenders from abroad. Only in this way could a war-recovering country – like Ukraine will be – accelerate reconstruction and increase production and productivity, so as to not be dependent only on the possibilities from domestic savings and scarce resources in that postwar environment.
There has to be both a respect for and the free market latitude given to entrepreneurs and the entrepreneurial spirit out of which arises progress and prosperity. As Mises said, looking over the wreckage left by the war in Europe, “If there is any hope for a new upswing it rests with the initiative of individuals . . . The entrepreneurs will have to rebuild what the governments and the politicians have destroyed.”
Ending the Politics of Envy and Economics of Redistribution
This also means, Mises said, that the politics of envy and government redistribution must be put aside. Who shall be left to be taxed in any “tax the rich and subsidize the poor” scheme in a setting in which war has made practically everyone a “have-not, when the focus of economic policy should be to foster capital formation, not wealth redistribution.” In the type of postwar setting in which Ukraine will find itself, Mises’s words remain no less true today: “There is no other recipe than this: Produce more and better, and save more and more.”
Taxes need to be low, predictable, and non-disincentivizing. Property rights need to be secure, protected, and free from the intervening and regulating hand of government. A politics of envy and political pandering to special interest groups has to be set aside, so profit-seeking, market-directed entrepreneurs can be confident and at liberty to peacefully and productively go about the work of producing what consumers want and investing in more, new, and better capital to raise the standards of living of all over the longer run.
Trade between nations needs to be free and unrestricted so all might benefit from gains from specialization in a global system of division of labor. The doors of Europe have been thrown open to Ukrainian refugees in the generous and charitable spirit of offering shelter and safety to those escaping from Putin’s dreams of “making Russia great again.” When the shock and sorrow die down, there should be no fear of a free movement of people, alongside a free movement of goods and capital. Hands, just like money and commodities, move where they can be most profitably and productively employed to the long-run betterment of all, everywhere. This, too, was part of Mises’s program for international peace and prosperity.
The Need for a Radical Change in Ideas to Economic Liberty
According to Mises, “What ranks above all else for economic and political reconstruction is a radical change in ideologies. Economic prosperity is not so much a material problem; it is, first of all, an intellectual and moral problem.”
Putin’s foreign policy of conquest, or Ukraine’s pre-war domestic politics of corruption and favoritism, or America’s political economy of seemingly unending budget deficits and growing debt, are the practical outcomes of an ideology of plunder. The idea is that taking is superior to exchanging; that coercing is better than reasoning and persuading; and that forced association is as moral as relationships based on voluntary agreement. It is the immorality of force versus the ethics of liberty.
War dramatically brings out the difference between these two opposing conceptions of social life. Out of this conflict and at some time in the future, Ukrainians will have to not only rebuild their country, but decide which of these two ideologies will be the foundation for their country’s future. The better one would be Ludwig von Mises’s proposed ideology of a “perfect free market economy.”
First published at: AIER.
Photo by Joost J. Bakker IJmuiden, Attribution 2.0 Generic (CC BY 2.0).