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‘Is Ukraine on the Path of Shock Therapy?’

Victory for Ukraine is not just about defeating Russia but avoiding the path Putin’s country has taken with its economy, write Gerhard Schnyder and Simon Deakin

Ukraine’s President Volodymyr Zelensky. Photo: American Photo Archive/Alamy

Is Ukraine on the Path of Shock Therapy?

Victory for Ukraine is not just about defeating Russia but avoiding the approach Putin’s country has taken with its economy, write Gerhard Schnyder and Simon Deakin

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Western media has recently reported that Ukrainian President Volodymyr Zelensky is now fighting two wars: one with Russia and another one with corruption in his own country.

Indeed, in the middle of the war in Ukraine, Zelensky has launched an anti-corruption campaign that has led to some of his closest allies – including Deputy Head of the Office of the President Kyrylo Tymoshenko – leaving office; and some of his former supporters among the business elite having their houses searched.

Investigative journalists had uncovered various cases of high-level corruption regarding public procurement in the middle of the conflict and Zelensky will have been worried that aid money and military support may stop flowing from the West if he does not stomp out such behaviour in his closest circles. He was quoted as explicitly stating that corruption prevented Ukraine’s rapprochement with the European Union.

To some extent, the President’s anti-corruption campaign can be seen as a continuation of Zelensky’s de-oligarchisation policy predating the war, which aimed at cutting back the power of the country’s richest and most powerful businessmen. The war has very considerably weakened Ukraine’s oligarchs, both financially and politically, to the extent that it seems unlikely that they will still have any role to play in Ukraine once the war is over. 

The anti-corruption drive and de-oligarchisation are actively supported by the West and may make a rapprochement with the EU easier once peace is restored. But there is a risk that some of the institutional reforms Zelensky’s Government is undertaking will have the opposite effect; that they will move Ukraine away from Europe and the West.

There are already signs that certain actors in Ukraine are using the situation to impose a radical economic reform agenda, which can only be described as a reheated version of the ‘shock therapy’ Western experts inflicted on Russia after the fall of the Soviet Union in the 1990s.

This is the very same approach to economic reform that has transformed Russia into an autocracy. Following the Russian invasion last February, Columbia Law Professor Katharina Pistor argued that the seeds for an aggressive and authoritarian Russia were sowed during the Yeltsin years.

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Under the influence of Western advisors, Boris Yeltsin used the extraordinary power given to him to impose a reform agenda that followed the libertarian mantra coming out of American universities and international financial institutions – that of putting market liberalisation above institution creation or democracy building.

On this account, ‘rolling back the state’ through mass-privatisation, price liberalisation, and unconditional opening of trade borders, was all that was needed to create a free market economy. Democracy would follow automatically.

Yet, by 1993, Yeltsin’s shock therapy had let to mass demonstrations in Moscow’s streets and the constitutional crisis of October 1993, during which the then President ordered tanks to shell the Parliament building. During the clashes between demonstrators and police, between 187 and 1,500 people died.

Yeltsin’s victory over Parliament led to the adoption of a new constitution three months later, which removed many checks and balances on executive power. When he anointed Vladimir Putin as his successor, Russia was set on the path to go from a fledging democracy to an authoritarian regime.

Ukraine could be vulnerable to repeating the same error of putting its trust in markets at the expense of democracy and people’s rights.

Spurred on by economists writing in Western media outlets, the Ukraine legislature recently passed laws removing core labour protections from more than two-thirds of the workforce. The laws were introduced under the guise of emergency measures. According to economists, they are needed to ensure flexibility for firms operating under wartime conditions. However, the measures were first proposed prior to the current conflict by a Ukrainian NGO, which was set up by former Georgian President Mikheil Saakashvili with the support of Ukrainian employers’ associations and a USAID programme.

Since being removed from office in Georgia, Saakashvili has become a Ukrainian citizen and an influential personality. He was appointed to the International Advisory Council for Reforms, set up by then President Petro Poroshenko. He trained at New York’s Columbia Law School, one of the key institutions in the so-called ‘Law and Economics’ approach, which has strongly influenced the post-socialist reforms of the 1990s.

In 2005-6, Georgia under Saakashvili, implemented one of the most radical anti-labour reforms in the world. Through his influence, the radically anti-labour ideas of US economists appear to have now spread to Ukraine.

The justification of the reforms is that by cutting back on worker rights, with firms free to hire and fire at will, economies will become more adaptive to shocks and grow more quickly. But is this actually the case?

One benchmark, the Cambridge Leximetric Datasets, shows that Ukraine’s recent reforms represent one of the steepest declines in labour rights of any country since 1970.  They are comparable to changes made in only a few other places: the UK in the early 1980s; New Zealand in the 1990s; and the former Soviet Republic of Georgia in the 2000s.

Evidence for beneficial economic impacts from labour market deregulation is difficult to find. There may be a short-term increase in employment as firms take advantage of lax labour laws to take on more workers but, over the medium-term, looser labour protection is correlated with less innovation, lower productivity and reduced employment

Firms under no legal pressure to treat workers fairly are less likely to invest in training and upskilling; while workers without job security are less willing to share tacit knowledge, critical for innovation, with their employers.

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Weakening labour rights – which often goes hand-in-hand with strengthening ‘capital rights’ (the rights of shareholders to ‘hold managers to account’) – also leads to a fall in returns to labour, in the form of lower wages, and an increase in returns to capital, in the form of increased dividends and share buybacks. This is not surprising: as workers’ bargaining power is reduced, they are less able to press for wage increases to match productivity or keep up with price inflation. Correspondingly, shareholders have used their new powers to press firms to prioritise dividends over not just wages but also investment .   

What is more surprising perhaps is that tilting the balance of power in favour of capital over labour is correlated with a range of negative health outcomes including higher infant mortality. Inequality – and not just poverty as such – leads to health morbidities, such as obesity and mental illnesses, associated with insecurity and stress .

Ukrainian policy-makers are, of course, free to make their own laws but the current course in terms of labour regulation may have unintended consequences.

In due course, in a period of post-war reconstruction, Ukraine will need to show that it is able to comply with international labour standards which are increasingly a condition of participation in the global trading system. The new anti-labour law may also create tensions with the EU, with European trade unions having already pointed out that the legal changes are incompatible with the terms of the EU’s accession process and the European Convention on Human Rights (ECHR). 

Above all, prominent Western economists seem not to have learned the lessons of ‘shock therapy 1.0’ and continue to peddle the outdated and largely evidence-free view that ‘radical liberalisation of markets’ – including ‘dramatically loosened labour market regulations’ – is a cure for anything, including the appalling emergency in which Ukraine currently finds itself.

Professor Gerhard Schnyder is Director of the Institute for International Management at Loughborough University London. Professor Simon Deakin is Director of the Centre for Business Research at Cambridge University. The research underlying this article has received funding from NORFACE (grant No. 462-19-080 project)

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