Victory Is Close: Economic Reconstruction Is Urgent

The development of the economy in wartime requires a clear state strategy, a coordinated systemic state economic policy, its targeting on specific indicators of qualitative or quantitative changes.

Our strategic goal is to turn Ukraine into a strong European country with powerful industry, developed small and medium-sized businesses, with an economy that generates a significant part of added value and attracts labor resources and financial capital.

However, the war and related economic problems create significant obstacles to achieving the goal, namely, economic activity has significantly decreased in the country, and risks to macroeconomic stability have increased.

The two main problems of the current economy of the country are the following:

• Low performance. As a result of the war, the country has largely lost its production potential, millions of jobs have been lost, logistical routes for business have become more complicated, the cost price has increased, and there is a shortage of labor resources due to their departure for the needs of the front and migration abroad. As a result, the production of real GDP decreased by 30% compared to the pre-war level, and the negative gap between potential and actual GDP widened.
• High risks for currency stability. The country's balance of payments is reduced to a significant deficit, which is covered only thanks to non-market international aid. Excluding international aid, the deficit amounts to 13 billion dollars. for the first half of 2023, and in general since the beginning of the war — almost 50 billion dollars. The main reason for the deficit is the negative trade balance, which reached $17 billion in the first half of this year. Compared to the pre-war period, imports have increased by 22%, while exports have decreased by 25%. Import dependence of the economy exceeds 50% of GDP, which is 10 percentage points higher than the pre-war indicators.

Both problems are intertwined: the fall in productivity of the real sector reduces the supply of domestically produced goods, which increases the economy's need for imports and leads to currency risks.

Therefore, in the current conditions, there is no other alternative than to revive the national production potential, to stimulate investments in job creation.

War generates risks that cannot be offset by market incentives. There is no such market profitability that would interest business to invest in production that could be destroyed by war. Without government incentives, labor, production, and financial resources will gradually leave the economic territory of a warring country.

The pre-war proportions of development and placement of productive forces have been broken and, in some cases, cannot be restored. A new State Spatial Development Strategy should be defined, which would consider new territorial schedules regarding the labor market, natural resources, and other components of productive forces. Strong regions mean a strong center.

The economic development strategy is a strategy for the productive redistribution of the country's available resources and international aid for the purpose of restoring and increasing the country's production potential, creating jobs. Action tactics should include a set of appropriate tools of various directions of economic policy in order to make this process of redistribution as effective as possible.

Such a strategy can be based on:

• Increasing the redistributive role of the state, strengthening the accumulation of internal resources of the economy through the mechanism of state finances for their allocation in priority directions. Point support of business activity, balancing of the general level of taxation.
• Elimination of contradictions between different directions of economic policy in the process of achieving the single goal of economic recovery. Monetary, fiscal, and structural policies should be synchronized as much as possible.
• Decreasing the cost of borrowing resources in the economy. The cost of the credit resource should be adequately comparable to the expected profitability of future business projects.
• Aggressive investment attraction policy. Compensation from the state for criteria investors at the expense of future tax payments. New adequately paid jobs are the basis of domestic demand.
• The priority of supporting investments in the production of products with a high share of added value, in the localization of the production process and import substitution projects. Such productions increase the multiplier effect of investments and reduce the risks of currency instability in the long term.
• Development and planning of territories considering the available natural and labor resources in the regions. Increasing control over the use of funds by local bodies for the purpose of economic recovery.
• Expanding Ukrainian manufacturers' access to foreign trade markets. Preferential access to the powerful markets of developed countries will make it possible to increase the attractiveness of investments in Ukrainian enterprises. The duty-free trade regime with the EU expires in June 2024 and needs to be updated and expanded.
• The launch of the state system of guaranteeing investment insurance against military risks, which includes financing from international donors and reinsurance from global insurance companies.
• Investments in education, training and retraining of personnel. It is necessary to program the future change of generations in accordance with the country's investment priorities. Many war veterans will need retraining to find work.
• Objective communication of progress in reforms for international partners. Successes of Ukraine in the implementation of reforms are often underestimated in the international arena. Ukraine has already implemented a number of market reforms, but new institutions need new qualified personnel, which is hindered by the war.

State resources are limited; this increases the relevance of point policies for their use in priority areas of recovery. International aid can largely offset the country's financial needs for recovery, but its receipt is non-market and depends on the goodwill of our partners. Also, the national banking system retains a significant resource for financing reconstruction, however, the high cost of credit funds makes their wide use in the investment process impossible.

The state has a wide arsenal of policy tools capable of stimulating the creation of new jobs and generating a multiplier effect in the economy:

• special economic zones or taxation regimes for specific types of activities or regions;
• grants for startups and innovations;
• risk guaranteeing;
• tax subsidies for the amount of investment costs;
• tax preferences for investment imports;
• state investments in new jobs in priority activities;
• public-private partnership, primarily in the field of infrastructure;
• state guarantees for loans and compensation of loan interest rates;
• state order for the purchase of goods and services;
• nationalization of a systemically important business threatened with bankruptcy;
• stimulation of import substitution and localization of production;
• stimulation of production conversion;
• solving problematic issues of logistics and transport infrastructure;
• resolving problematic energy supply issues.

Special attention should be paid to tax incentives. Ukraine needs balancing of the general level of taxation, standardization of the system of taxation rates considering the existing practices in the EU, point support of investments in priority areas.

Institutional maturity is an important component of a successful market economy. The rule of law, minimization of corruption, and strong democracy expand the possibilities of large-scale attraction of private domestic and foreign investment. Therefore, institutional reforms in the state administration system should be continued. However, it is worth understanding that their significance in a war-weakened economy is secondary to direct government incentives.

To maintain the conditions of macroeconomic stability, it is important to eliminate the risks of a currency crisis. Measures to strengthen the balance of payments can be divided into two categories: administrative and structural. Administrative measures include strengthening restrictions and control over the movement of capital, operations with foreign currency, return of export proceeds, as well as constant work with partners to provide Ukraine with international financial assistance. Structural measures include tools to support the competitiveness of the real sector, state initiatives for the development of logistics and transport routes for export. Such measures make it possible to strengthen the fundamental resilience of the economy to currency shocks and have a medium-term effect.

The fixed exchange rate regime and currency restrictions should be maintained for the period until the market balancing of demand and supply for foreign currency in the country is restored. Fixing the exchange rate has a positive effect on the predictability of business activities, promotes investment imports, and facilitates integration processes into the EU. A premature return to flexible exchange rate formation in the absence of stable market inflows of currency will threaten the emergence of a currency panic. A fixed exchange rate regime is compatible with an independent interest rate policy and an inflation targeting regime, provided certain restrictions on capital movements are maintained.

The country also needs a long period of negative real interest rates. The expected investment profitability of business projects must exceed the basic cost of loan capital. Otherwise, the loan funds will remain in the banking system. The government also needs cheap borrowing to actively support the economic recovery. A war economy society should not prioritize income redistribution in favor of financial intermediaries.

Summarizing what has been said, the strategy of structural restructuring of the economy of Ukraine should be based on an active and purposeful state policy of job creation.

The redistributive role of the state in the economy should be strengthened in order to ensure the possibility of effective concentration of the necessary resources in priority areas.

The launch of new productions will allow to effectively lock the money supply in the new added value and generate related tax revenues, which is especially important in the conditions of a high fiscal deficit and an increase in emission funds in the economy.

To support the recovery, it is important to start the process of bank lending to the economy. Lowering the base cost of the loan resource and special lending support programs will contribute to both the improvement of financial intermediation and the restoration of monetary transmission.

An important resource for recovery is international support. It is expected that it will be provided both in the form of direct financial assistance and in the form of preferential access to the commodity markets of partner countries. The integration of Ukraine into the EU and the continuation of structural reforms will contribute to the inflow of private foreign capital into the country.

Increasing the productive circulation of money in the economy and increasing competitive production will make it possible to avoid the risks of a currency crisis or inflationary spirals.

The creation of jobs will also be an incentive for the return to Ukraine of people who were forced to leave Ukraine as a result of hostilities. Retired military personnel will need decent employment. State retraining programs will help reintegrate soldiers into a peaceful and productive life in the rear. Therefore, adequately paid jobs will not only preserve the labor potential of the nation, but also protect the society from social tension.

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