September 18, 2015

Ukraine’s ‘wormhole’ or ‘black hole’

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As Ukraine’s Parliament debates a constitutional amendment giving more autonomy to Donetsk and Luhansk under pressure from Western allies as part of the Minsk II ceasefire accord, it is useful to look ahead and examine what that would mean, at least in terms of post-conflict reconstruction and economic development of the Donbas. My intention is not to discuss the political or military dimensions of this issue, but to focus on what should be done and who ought to be responsible for rebuilding the Donbas and for funding and managing the reconstruction. Will that effort end in a “black hole” quagmire of corruption and Afghan-type “warlordism,” or serve as a useful economic “wormhole” for the future evolution of Ukraine’s economy?

A recent thoughtful article by Volodymyr Horbulin, one of Ukraine’s respected political commentators, introduced the image of the Donbas as an astronomical “black hole” – that is, a region that has such strong gravitational effects that nothing can escape from it. In essence, it would be a region that would become a bottomless pit for humanitarian aid and whatever other financial assistance is offered by global lending institutions. We have considerable evidence of such humanitarian black holes like Iraq and Afghanistan, and numerous failed states, where tens of billions of dollars of humanitarian aid are spent each year without any appreciable effects on diminishing poverty, despair or political instability.

Until recently, I had thought of the Donbas as a kind of a “wormhole,” which in astronomical terms is something akin to a shortcut between two separate points in the universe, or parallel universes. The Donbas is the wormhole that connects Ukraine to a post-Stalinist Russian state. The Donbas is a region that lives by its own rules, highly influenced by a corrupt Russian culture, and only tangentially linked to any of the common national political and cultural evolutionary processes. And, like Crimea, the Donbas was a net economic and political drain on Ukraine – a black hole.

In reality, in its present state, the Donbas, which includes Donetsk and Luhansk, should be considered a failed state, equivalent to Syria, Haiti, Yemen, Somalia, Congo, Libya and at least 10 others. So the fundamental question is how will political autonomy bring the Donbas back to normalcy. Before that question is resolved, there is the larger issue of post-conflict recovery and reconstruction. What are the priority reconstruction activities that need to take place immediately, and in the near-term? How will these decisions be made, and who will control the funding? Already, since early 2015, important international aid and lending institutions such as the World Bank and the European Investment Bank, have been preparing a plan for such an eventuality.

But the larger question is why should Europe or Ukraine have to pay for the destruction that was initiated and largely caused by the Russians? For the past two years, there has already been a great deal of humanitarian aid going to the Donbas region, mostly from U.N. agencies, the European Union and the U.S. Agency for International Development (USAID). That aid is grossly inadequate because it simply cannot keep up with the repeated destruction of basic infrastructure that provides the essential public services – hospitals, water treatment facilities, water pumping stations, communications systems and roads.

Mr. Horbulin, in his article “Chorna Dira” (Black Hole), argues that Crimea has now become an economic black hole for Russia, as well, especially in its current dire economic state. Russia clearly wants Ukraine to shoulder all the economic and social burdens of the Donbas conflict, and does not want to take any responsibility for the utter destruction of civil society. Ukraine, which is struggling to pay off its debtors and begging for every dollar from the International Monetary Fund (IMF) to stabilize its own currency, is in no position to financially support the reconstruction of the Donbas. It is questionable whether it’s even worth the money – other than for purely humanitarian assistance. Yet, that is what the lenders are requiring of Ukraine.

In fact, Mr. Horbulin goes a step further and claims that, for all intents and purposes, both Crimea and the Donbas no longer serve the economic interests of Ukraine, and that Ukraine has devised economic and trade strategies that no longer depend on the resources of those two regions. In other words, the immediate financial and capital costs, as well as investments, required to reconstruct the Donbas to restore it as an economically viable region would not pay off in longer-term economic growth potential. The Donbas would continue to be a drain on Ukraine’s economy.

One can debate the socio-economic consequences of neglect of the Donbas, but what is not debatable is the immense investment costs needed to bring it back to a viable economic state, or even to its former dilapidated status of regional development. Several recent post-conflict reconstruction needs assessments conducted by the World Bank and U.N. agencies have laid out the huge investments required to bring the Donbas back to its original state – which was not that advanced or desirable to begin with. That is one of the basic issues: whether to rebuild the infrastructure to modern standards or replace and rehabilitate to prior existing conditions, which were, in large measure, deplorable but at least functioning to provide very basic services.

The European Investment Bank (EIB) is providing Ukraine’s Ministry of Regional Development, Housing, Construction and Communal Services (MRD) a $200 million loan to conduct detailed assessments and a pragmatic implementation strategy, as part of an “Early Recovery Framework” to begin reconstruction of the Donbas. The contract was signed December 22, 2014. In addition, the Ukrainian government established a State Agency for Recovery of the Donbas (SARD). This agency will coordinate rebuilding efforts in the Donbas that are expected to cost billions of dollars over a period of more than a decade.

Nearly 3.5 million people in the Donbas region have been directly affected by the conflict, according to the United Nations. Of those, 2 million people have been displaced by the conflict, a third of whom left for Russia, while the rest are greatly stressing the social welfare capacities of local communities, exceeding the difficulties experienced by European countries that are struggling to cope with the migration of displaced Syrians.

Most of the major industrial sectors (coal, metallurgy, the chemical industry) in the Donbas are operating at 70 percent below capacity, while small and medium commercial enterprises are operating at 10-20 percent of capacity. There has been a comparable breakdown in social and health services, as well as basic public services such as transportation, wastewater treatment, municipal water supply, banking services and communications. It is comparable to the deplorable state of public services in Iraq two months after the end of the second Gulf War in 2003.

The proposed financial loan package is based on a “Recovery and Peacekeeping Assessment” (RPA) commissioned in 2013 by the EU, the U.N. and the World Bank. The first phase focuses on priority short-term recovery needs and social services, and rehabilitating critical infrastructure in the Donbas, such as hospitals, clinics, electricity, heating systems, water supply and wastewater treatment plants.

In reviewing this report, I believe that the RPA’s preliminary estimate of $1.5 billion for immediate recovery and reconstruction costs for Donbas seems very low, based on my experience conducting similar estimates for replacing critical infrastructure in similar situations in Iraq, Haiti and Afghanistan. In addition, there will be longer term infrastructure renovation costs in the tens of billions of dollars to bring them up to European standards, if Ukraine is to ultimately join the EU.

Understandably, the RPA study was accomplished under difficult conditions of constant ceasefire violations and in under three months. The report acknowledges that estimates are likely to rise as teams get better access to the damaged sites. Transport (roads, rail lines, bridges, commuter services), energy and health services alone will require well over $1 billion. Water and sanitation, social services, schools and other public buildings will require at least another $1 billion.

The key points, buried in the RPA document, are that the government of Ukraine is responsible for the recovery and reconstruction of the Donbas, and is expected to use its own financing, in addition to loans from international lending institutions. These are not grants, though. The loans, however generous the terms may be, must be repaid.

No contributions or reparations are required of Russia, however. There is no talk of a Russian “Marshall Plan” to assist the Donbas. Under the terms of the European Investment Bank loans, the Donbas will continue to be a wormhole, channeling corrupt Russian practices, and serve as a perpetual black hole for Ukraine’s scarce financial resources.

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