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Ukraine, which produced missiles and airplanes, turned into a cornfield country

Author : Oleksiy Kushch

Source : 112 Ukraine

Today our economic well-being is 70-80 million tons of grain and 6-7 million tons of sunflower oil
11:00, 17 September 2020

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We often like to rate our competitors and rivals in the manner of Stalinist films, which portrayed the Germans from WWII as idiots and losers. We like to present Russia as a "failed state" with a repressive economy, while in the recent rating of competitiveness compiled by the World Economic Forum, the Russian Federation occupies 43rd position, and we - 85th, and in the ranking of ease of doing business The World Bank has the 28th position for the Russian Federation, and we have the 64th.

Not to mention the rating of economic freedoms, in which we are the most "unfree" country in Europe, because we are overtaken not only by Russia but also by "dictatorial" Belarus and "stagnant" Moldova. And our neighbors in the rating of "economic freedom" are Tunisia, Tajikistan and Bangladesh... This is a hard truth, which the "patriotic" experts will not tell. Although recovery begins with the correct diagnosis and determination of the patient's health status.

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Unfortunately, the current political "elites" do not notice the hidden truth so far: we are on the verge of emerging risks that, if quickly activated, may cause the loss of state sovereignty.

The resource curse - this is how the state of the countries is called, which, relying on rich mineral resources or popular mono goods, lost the tone of the national economy and, as a result, ended up at a broken trough, like the famous old woman from Pushkin's fairy tale.

The commodity curse is typical for countries that specialize in the extraction of minerals, such as oil, the production of intermediate goods, such as agricultural, the production of monoproducts, such as metal. The authorities must understand that: a) natural resources will sooner or later run out; b) prices for raw materials are subject to cyclical fluctuations and drop sharply during periods of global crises; c) a stake on the production of mono-goods, based on local absolute competitive advantages, can bring an increase in prosperity in the medium term, but is doomed to failure in the long-term time horizon.

Norwegian economist Erik Reinert, in his book How Rich Countries Got Rich and Why Poor Countries Stay Poor, has convincingly shown that the so-called vicious circle of poverty, or the ontological circle of evil, dooms some countries with colossal start-up opportunities to permanently settle down the "rings of poverty" to the bottom of the well of life. The main reasons are focus on mono-production with diminishing returns and misapplication of comparative advantage theory.

This theory was formulated back in the 19th century by the English economist David Riccardo and says that trade is profitable not only if it is based on absolute advantages, but also on the use of relative ones.

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With regard to Ukraine, this trap of poverty looks like this: since we have favorable conditions for agriculture, then we have absolute advantages in this industry compared to other countries, so we will focus on the production of corn, grain and sunflower oil, that is, raw materials mono goods with diminishing returns. But unlike goods with a high level of added value, there is no economies of scale in the output of agricultural products.

Thus, in the production of passenger cars, an increase in production volumes will lead to a decrease in costs, and in the agricultural sector and mining, on the contrary, each additional ton of wheat or a new ton of mined ore requires more and more costs: fertile soils are depleted, reserves are depleted.

What can lead to such imbalances in development as ours? Until 1960, Somalia's economy outstripped the quality parameters of South Korea. But the latter, thanks to the stake placed on the development of a creative and innovative economy (although an independent industrial policy was implemented before that), managed to break out of the vicious circle of absolute and relative advantages in the form of cheap labor and a stake on agriculture, and Somalia continues to search for them in such an exciting activity as "catching" other people's tankers.

Reliance on raw materials has led to the fact that the Ukrainian hryvnia has been sick with the "Groningen effect." The discovery in 1959 of the Groningen field in the Netherlands led to a short-term substitution of gas revenues for the development of other, more labor-intensive sectors of the economy. As a result, stagnation, unemployment, and a collapse of the national currency against the background of falling world prices for hydrocarbons. For a long time, the exchange rate stability of the hryvnia was "bought" not by the efficiency of our economy and its investment attractiveness, but by the growth of export earnings from the sale of raw materials, metal and agricultural products.

Related: Ukraine imposes special import duties for coal, diesel fuel, liquefied gas

In this context, we should recall the so-called Rybczynski theorem (US economist). According to it if the endowment of some resource increases, the industry that uses that resource most intensively will increase its output while the other indus­try will decrease its output. The relative factor intensity is measured by the ratio of factor use in each industry. This model gives no place for industries that meet the needs of the domestic market; they simply cannot withstand competition for resources and money with "factor" directions of development. There is no place for complex mechanical engineering, not to mention innovative areas.

The Russian Federation faced the same risks at the beginning of the 2000s when prices for hydrocarbons were growing rapidly and it seemed that natural gas and oil would only increase in price. But, as Herman Gref once said, the Stone Age ended not because the stones ended, in the same way, the "oil age" ended not because of the depletion of oil reserves, but as a result of the development of technologies. First, cheap American "shale" appeared, and then there was a revolution in consumption patterns, mainly due to the development of "green energy" and the production of electric vehicles. This technological revolution also significantly limited the growth potential of "lateral branches of energy evolution" in the form of biofuels, in particular with the use of rapeseed and corn.

Russians owe their present survival in large measure to one person. And this is not about Putin, but about the former Minister of Finance of the Russian government, Alexei Kudrin.

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In 2013, the structure of state budget revenues was allocated to oil and gas and non-oil and gas revenues in a 50/50 proportion. In 2018, non-oil and gas revenues amounted to 54%, and oil and gas revenues, respectively, fell to 46%, that is, the Russian Federation has managed to reduce its budget dependence on raw materials by 4% in five years.

In a certain way, this was facilitated by the model of "non-oil and gas deficit", which consisted in determining the difference between budget expenditures and its revenues (excluding oil and gas). According to Russian legislation: "The non-oil and gas deficit of the federal budget is the difference between the volume of federal budget revenues excluding oil and gas revenues of the federal budget and revenues from the management of the Reserve Fund and the National Welfare Fund and the total volume of federal budget expenditures in the corresponding financial year."

The size of the non-oil and gas deficit itself is clearly regulated - it cannot exceed 4.7% of the GDP projected in the corresponding financial year. The non-oil and gas deficit of the federal budget calculated in this way "is financed by the oil and gas transfer and sources of financing the federal budget deficit."

This system made it possible to create a certain buffer on the way of unproductive expenditure of oil and gas revenues, as happened during the Soviet era in the 1970s-1980s. The system of non-oil and gas deficit can be compared with the system of conditional financial "reservoirs" when the country's reserve funds are formed (during the period of high world oil prices) due to the income from the sale of oil and natural gas, the resources of which are actively spent to support the economy and social sphere during the time of crisis periods (when world oil prices fall).

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The system of reserve funds itself was created on the initiative of Russian Minister of Finance of the Government Alexei Kudrin. The doctrine of social welfare introduced in Norway was taken as a model. Let us remind you that in this Scandinavian country the oil industry indicators are up to 20% of GDP, and the share of oil revenues in the structure of the state budget is 45%. Norway has created the State Oil Fund, which has accumulated more than $ 1 trillion, and the income from the operation of which is distributed to the personal accounts of Norwegians (at birth, about $ 3,000 is credited to it, and by old age, $ 100,000 can be accumulated). A significant part of the Norwegian oil fund is invested in stocks (60%), part - in financial instruments with fixed income, mainly bonds (35%), and about 5% - in real estate.

The Russian model is, in fact, an adaptation of the Norwegian doctrine of social well-being to Russian realities. This is a fairly simple system: the indicator of the non-oil and gas deficit is financed by an oil and gas transfer, that is, tax revenues received from oil and gas production. These fees include two main groups of revenue: mineral extraction tax and export duties. In the event that world energy prices grow and revenues from oil and natural gas production exceed the established indicator, the excess financial revenues are not used to increase budget revenues (in surplus), but are transferred to the reserve fund, which is designed to smooth out fluctuations in oil and gas revenues and compensate for financial deficits with a fall in world oil and gas prices.

If the prices for oil and gas have risen so much that they allowed not only to finance the oil and gas budget transfer and the planned replenishment of the reserve fund, but also to receive surplus funds, then these excess financial resources are to be transferred to the National Welfare and Development Fund, whose mission is not only to cover possible cash budget gaps (as in the case of the Reserve Fund), but also ensure the future growth of pensions and social benefits for Russians. Thus, a two-tier system of financial stability was created in Russia, a kind of double liquidity buffer in case of a possible crisis: at the first tier, a Reserve Fund appeared, which should cover the budgetary revenue deficit in the event of a fall in energy prices.

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National Welfare Fund is at the second level, which must accumulate resources for the future increase in the living standards of Russians. The goal-setting of the funds also determined their directions of use. The reserve fund is exclusively financial resources allocated to cover the deficit of oil and gas transfers. It is under the operational management of the Ministry of Finance for planning budget payments. And the National Welfare Fund is systemic state reserves that are not spent on current needs but are used to make public investments and implement the tasks of national industrial policy and stimulate the economy, in particular, to finance large infrastructure projects.

That is why, during the crisis of 2014-2015, the most significant outflow of funds was suffered by the Reserve Fund, whose resources were used to cover budget cash gaps. If in February 2008 the resources of the Reserve Fund amounted to $ 125 billion, then as of December 2017 they decreased to $ 17 billion. And the State Duma of the Russian Federation adopted a law according to which its funds were transferred to the National Welfare Fund.

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The dynamics of the resources of the National Wealth Fund also in a certain way corresponds to the resistance of the Russian economy to external price and financial shocks. As of February 2008, the assets of the Fund were $ 32 billion, or 1.9% of GDP. By 2013, the Fund's resources were systematically growing, the extremum amounted to $ 88 billion, or 4% of GDP. But after 2014, an outflow of the Fund's funds began, which led to the fact that its resource base decreased to $ 59 billion, or 3.4% of GDP (June 2019). Then the assets of the Fund skyrocketed to $ 122 billion, or 7.5% of GDP.

And now imagine that the Russian Federation would not have carried out a tax maneuver when fiscal fees from oil and gas production were reoriented from export duties to domestic consumption, as well as would not have created a two-tier system of reserve funds and would not have introduced a rule of non-oil and gas deficit when conducting state budgeting. The profits from the sale of oil and gas, obtained before 2013, would be eaten up and distributed among the oligarchs, and today the country would be on the verge of economic collapse.

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blue line - food and commodity, red line - machinery and equipment

Ukraine's external trade rate

Few people noticed, but in 2020 a significant event might occur – the share of food and agricultural raw materials in the structure of our exports will quite possibly exceed 50% of total export flows for the first time in history. This is the apogee of the current economic policy, which is beautifully packaged in the term "grain and brains."

Today, the most important items in our export are grain and sunflower oil. Ukraine has lost its positions among the top ten countries in the world in metal smelting, having dropped to 12-13th positions, having even surpassed Vietnam and is about to lose to Taiwan. Today our economic well-being is 70-80 million tons of grain and 6-7 million tons of sunflower oil. A country producing missiles and airplanes has turned into a churn country and a cornfield country.

Related: Ukraine exported grain for $7,2 billion in 2018

Now let's imagine that the "grain age" will end soon. We should not forget that the laws of the world economy operate inexorably: high prices and demand lead to the development of alternative technologies and the subsequent cyclical collapse. And then Ukraine may face colossal risks, when prices for grain and sunflower oil drop sharply, and there will be no more opportunities to revive the national industry.

Something similar happened once with the Commonwealth. If in the 17th century Dutch merchants bowed to the gentry and in Poland printed engravings "grain pays," then in the 18th century, after the opening of new international trade routes, the gentry themselves bowed, and on the engravings, they began to write: "grain does not pay."

A similar situation was observed in Egypt in the 19th century, when the local ruler Ismail Pasha attracted huge external loans, taking advantage of the favorable world price environment for cotton. But the civil war in the United States ended and with it cotton from the southern American states entered the market, crashing price quotes. As a result, Egypt actually came under the direct control of external creditors ("the Khedive debt commission") with the "European Cabinet" and control over the country's debts, customs, and tax authorities by foreigners.

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Our current "political elites" are too greedy and overly focused on getting immediate benefits. They are interested in sowing rape, corn, wheat, or sunflower another hundred thousand hectares of arable land and repatriating the received billions to their offshore accounts. They, like Polish nobles, are ready to lease the country to play the future of their country at parties with a national anthem, mummers, and bottles of champagne, each costing ten minimum pensions in their country.

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