Foundation for Effective Governance Ukraine, Kiev, 23-F Kudryavskaya Str., tel: +380 44 501 41 00, fax: + 380 44 501 41 05

feg@feg.org.ua

www.feg.org.ua, www.debaty.org

Increasing government spending will prevent the 2nd wave of crisis in Ukraine

At the end of January, at the World Economic Forum at Davos, world leaders discussed

one of the major problems of 2012: the approaching second wave of the global economic

crisis. Recognized international organizations expect a slowdown in economic growth

both in developed countries and in fast-growing economies. One of the most serious

problems - European debt crisis - revealed that the future of the Euro and the European

Union are at risk. Cuts in government spending are seen as one of the ways to mitigate the

effect of the economic crisis. In the end of January, twenty-five countries of the EU

pledged to balance their budgets, although previous attempts to do so triggered social

protests in Greece, Italy, Belgium, and other countries. On the contrary, in Ukraine there is

a strong possibility of an increase in government spending caused by the country’s

preparation for the parliament elections. Economists do not have a single opinion on

which budget policy can prevent the crisis. History has shown that cutting government

spending caused recession and hindered the economy’s revival after a crisis. On the other

hand, increasing government spending often failed to solve the problems of a country’s

economy.

What should the Ukrainian government do as we face the second wave of the global

economic crisis: spend more or save more?

A country has two options to

mitigate impact of economic

crisis: to cut or to increase

government spending

Arguments FOR

An increase in public spending will boost domestic demand and preserve jobs, which is

especially important before the crisis. The economic slowdown in Ukraine’s trade partners

will result in lower demand for Ukrainian goods and services. Ernst&Young estimates that

the Euro zone crisis will reduce Ukrainian exports to the EU by 10-15%. To make up for

this loss, the Ukrainian government can stimulate the demand for Ukrainian goods within

the country. The increased share of government contracts will prevent decline in output,

jobs and investment activities at a time when the national economy is particularly

vulnerable. State support has helped many developed countries to stop the recession. In

France in the 1990s, subsidies from the government stopped the economy from going into

a steep slide after the fall of export.

Increase in government

spending will result in GDP

growth

Larger spending on the economy’s strategic sectors will improve the country’s

competitiveness and make it more resilient to global crisis. Many years of underfinancing

of railways and roads, energy, utilities and other infrastructure has led to a situation in

which the poor condition of these sectors hampers not only the country’s economic

growth, but also its global competitiveness. In Ukraine, 38% of heat and power plants are

more than forty years old; 25% of heat is lost in the networks, 70% which are more than

ten years old. Government financing of medicine, education and the social security system

is an investment in human capital that is necessary for future growth. A cutback of

spending in these sectors now may aggravate the consequences of the economic crisis and

will make Ukraine’s sustainable long-term economic growth impossible.

Increased government

spending will make economy

resilient to crisis

Foundation for Effective Governance Ukraine, Kiev, 23-F Kudryavskaya Str., tel: +380 44 501 41 00, fax: + 380 44 501 41 05

feg@feg.org.ua

www.feg.org.ua, www.debaty.org

Arguments AGAINST

Budget cuts today will help to accumulate and preserve resources that the country will

need to fight the consequences of a new economic crisis. The government must save for a

rainy day; in the face of a crisis, it will need money to support strategic industries and the

unemployed. The budget deficit will increase, and it will be difficult and expensive to

finance it by external loans. Ukraine already pays a lot to serve its foreign debts. In 2012

only for this purpose government will spend UAH 8 billion, which is almost one-third of

the budget deficit. Business in Ukraine already faces a slowdown of lending activities by

European banks subsidiaries because of Euro zone problems. If the crisis builds up,

Ukraine will be ranked peripheral to Spain or Italy in the need for financial support.

Reduced government

spending will save money to

combat the consequences of

the crisis

Increasing government spending will inject extra money into the economy, boosting the

demand for goods and services, not only those made in Ukraine, but also those that are

imported. If Ukrainian manufacturers cannot build up their production in time to meet this

increased demand, budget money will be spent on imported goods and eventually distort

the balance of payments. It was the balance of payments deficit that resulted in the

devaluation of the hryvnia from 5 to 9 hryvnias per 1 dollar in 2008. Another, and even

worse, consequence is the increase in prices. Studies show that in Ukraine a 10% increase

in social payments results in a 0.5% growth of inflation. Both steps will damage the

economy and exacerbate the impact of a crisis.

Increased government

spending may trigger

inflation and rise in imports

The problem of government spending on the eve of the second wave of the global economic crisis will be discussed

during the public debate on February 28, 2012. The event will be held by the Foundation for Effective Governance in

partnership with London-based Intelligence Squared. ____________________________________________________________________________________________________________________________________

Statistics

Macroeconomic indicators for selected countries

Ukraine Greece Spain Italy Latvia Germany

2008 2009 2010 2010 2010 2010 2010 2010

GDP Growth, % 2.3 -14.8 4.2 -4.5 -0.1 1.3 -0.3 3.5

GDP growth forecast for 2012, % - - 2.5 -1.1 -1.7 -2.2 2.7 0,5-1

Exports of goods and services, ratio to GDP 47 46 50 22 26 27 53 47

Imports of goods and services, ratio to GDP 55 48 53 30 28 29 54 41

Current Account Balance, ratio to GDP -7 -1 -2 -10 -4 -4 4 5

FDI net inflow, bln USD 11 5 6 2 25 10 0 46

Average CPI, % 25.2 15.9 9.4 4.7 2 1.6 -1.2 1.2

Total Government Gross Debt, % GDP 21 35 40 142 60 119 40 80

Total reserves, bln USD 32 27 35 6 32 158 3 216

Fitch rating В+ В- B CCC AA- A+ A+ AAA

Source: http://www.economywatch.com/economic-statistics, World Bank, IMF

Expected external public debt payments in 2012 - 2014, bln UAH

2012 2013 2014

Public debt 23.0 43.0 34.2

Debt payment 15.0 35.6 28.0

including International Monetary Fund 7.0 22.8 24.3

Debt service 8.0 7.5 6.3

including International Monetary Fund 2.4 1.9 0.9

Publicly guaranteed debt 34.4 41.2 34.1

Debt payment 24.8 31.6 26.4

including International Monetary Fund 23.0 27.8 7.2

Debt service 4.9 5.1 3.5

including International Monetary Fund 1.6 1.8 0.4

Source: Draft Law of Ukraine on State Budget for 2012