Ukraine Recovery Challenge | VOX, CEPR Policy Portal

Editors’ note: This column is part of the Vox debate on the economic consequences of war.

Military conflicts are associated with deep economic and human capital losses (Harrison 2022, Akbulut-Yuxel 2022). Economic impact depends on a number of factors: the area occupied by enemy forces, the intensity of bombings, and the destruction of human capital and physical infrastructure. These losses are multiplied by the length of combat operations and can have long-term effects. Ichino and Winter-Ebmer (2004), for example, see that Austrian and German children who were ten years old during World War II, or were involved in war through their parents, received less education than those in war-torn countries such as Switzerland. And Sweden. These individuals suffered a huge income loss of between 3% and 4% per year, almost 40 years after the war.

Russia’s recent invasion of Ukraine is unprecedented, as all military conflicts in the 21st century have taken place in countries with less developed human capital and physical infrastructure. Thanks to its educated workforce and good trade infrastructure, before the war Ukraine was one of the largest grain exporters in the world, dominating the global sunflower oil market and also among the steel producers. The devastation of more than 6.5 million refugees and an estimated 8 million internally displaced people in neighboring countries suggests that the disruption is extraordinary, even before anyone can get a reliable estimate of the actual loss of capital.

We anticipate potential economic losses in 2022, when it comes to spelling out the challenges in estimating this. First, the war presents a statistical challenge. As some territories fell into the hands of the enemy, local businesses and citizens stopped reporting to the statistics agency, even though their economic lives were interrupted. Ukraine has already faced this challenge: economic output data, including GDP flash estimates for the first quarter of 2022, were not created at the time of writing this column.

Second, the nature of Russia’s all-out offensive makes it difficult to compare with previous military conflicts. We use the invasion of Iraq in Kuwait in 1990 – where the Iraqi army inflicted heavy damage on Kuwait’s oil infrastructure – and the NATO intervention in Serbia in 1999 – where airstrikes were a major feature of the war, damaging electoral infrastructure – as impure proxies. The war in Kuwait has taken a heavy toll on the economy, with the country’s GDP falling by more than half as the oil-dependent country was set on fire by its retreating Iraqi army. The return, however, was rapid and Kuwait’s economy fully recovered in two more years (Figure 1). In the case of Serbia, the airstrikes did little to damage the economic infrastructure. The following year the economy recovered again, albeit after a long period of stagnation.

Figure 1 Actual GDP change in selected wars (percent)

(Year 0 is the first active year of a military conflict)

Formula: IMF, authors’ own calculations based on May 2022 agreed forecast for Ukraine.

Forecast for slow recovery

According to the baseline scenario compiled by a consensus forecast as of May 2022 (Focus Economics 2022), Ukraine’s real GDP is expected to decline by 36.5% in 2022 (Figure 1). These include a 39% reduction in personal costs, a push for supply, frustrated real disposable income and consumer confidence, and more than six million refugees fleeing the country. Investment has fallen to less than half where it was in 2021, mostly in areas of the country where it is still possible to replace capital goods. Despite a huge revenue deficit above 15% of GDP, government spending is expected to fall by 7% in real terms.

Externally, Ukraine’s GDP is expected to experience a strong 50% decline in exports, largely due to the closure of seaports by Russian naval blockades. Stocks of agricultural commodities that could provide some temporary support for GDP through increased inventory cannot be sent abroad. Imports are expected to fall by 45% in real terms, softening the fall in GDP.

The most disturbing feature of the consensus forecast is that economists do not expect a quick recovery, as happened in previous wars. Between 2023 and 2026, Ukraine’s real GDP growth should average 7.5%, meaning that five years after the Russian invasion, the economy is still 15% below its pre-war level (Focus Economics 2022). This is a pessimistic prediction when one compares this path to the post-war recovery of Kuwait or Serbia (Figure 1). The main reason for this prediction is the uncertainty of the end of the war in Ukraine, as there is still hostility in many parts of the country.

Some predictions are even more pessimistic. In particular, the economic activity forecast for 2022 has almost halved, with the World Bank forecasting a 45% actual GDP decline,1 Which includes the expectation of losing 50% of personal spending and exports falling to just one-fifth of their 2021 amount (World Bank 2022). The World Bank expects a slow recovery in the near term, with GDP growing by only 2% in 2023 and less than 6% in 2024. This means that the Ukrainian economy will still be about 60% of its pre-war level by 2025.

The challenge of recovery

As the war continues, physical infrastructure suffers further damage and one-third of Ukraine’s population is displaced from their homes for the fourth month. Estimates of the loss of physical capital have already come close to 100 100 billion,2 Or half of Ukraine’s pre-war GDP. For example, Ukraine’s largest steel mill (Mariupol) has already been destroyed, while the second largest steel mill was under heavy bombardment and is now under attack. These two mills accounted for half of Ukraine’s pig iron output in 2021. This means that Ukraine’s sector could gravitate upstream (iron ore), which means lower value for national GDP and some additional logistical challenges for the country. Now face to face

To make matters worse, before the war, Ukraine was already a country with a worrying population trend: an aging population and a dramatic decline in birth rates. The war has exacerbated these challenges, with 5 million women and children fleeing to high-income countries, where Ukrainians have been allowed local work permits. As the war continues, some of these refugees will find jobs and decide to settle abroad.

On top of the loss of quantitative human capital, there is a huge risk of qualitative deterioration in human capital. The loss of learning by Ukrainian children is of particular concern: Ukraine will add substandard to its workforce because of the war-related (and before that, coward-created) learning disruptions. These losses are estimated at $ 90 billion (Angrist et al. 2022), or about the same as the actual capital losses so far.

Aqbulut-Yuksel et al. (2022a) show that exposure to war in childhood negatively affects not only cognitive abilities, but also long-term mental health. The increase in a standard deviation from the devastation caused by war in the first five years of a person’s life is related to a decrease in the standard mental health score of about 10% during the 60’s and 70’s. This translates into a 3.3 percentage point increase in the likelihood of diagnosing clinical depression. Similar evidence of the adverse mental health effects of the war on children has been found in survivors of the Vietnam War. Vietnamese wartime children, especially girls, who were exposed to war before their adolescence, are more likely to have functional limitations in their day-to-day activities than adults (Akbulut-Yuksel et al. 2022b).

About $ 200 billion is needed to recover the human and physical capital lost in the war, assuming the war is over now and there will be no further damage to infrastructure. This amount is equivalent to the pre-war annual GDP of Ukraine and can only be financed through foreign aid. Post-war Ukrainian and international organizations need to focus on economic recovery as well as human capital recovery at the same time and with the same urgency.

The process of joining the European Union will play a central role in the recovery. A strong post-war recovery requires a strong EU-led effort that allows most Western European economies to recover after WWII (Vonyo 2019). An outline of a possible recovery program is given in Baker et al. (2022) A recent VoxEU e-book. The program can be structured in two phases: rapid restoration of critical infrastructure and services to revive basic functions of the economy and government; And re-establishing the foundation for sustainable growth. The latter includes a significant focus on human capital savings. These stages have different demands. For example, strong macroeconomic stability should be included in the first phase to ensure that market-based processes can begin to allocate resources to the post-war economy.

The local banking sector will play an important role in the recovery of Ukraine. Extensive banking sector reform has been a major breakthrough in Ukraine, with the results showing itself well in times of epidemics and war challenges. Post-war recovery is a good opportunity to attract international investors to the banking sector as part of the larger challenge of rebuilding the country.

The second step will be to improve the institutional environment for growth. The most obvious possibility is to create a carbon-free economy, both as a way to coordinate investment for the future but also to show how to reduce dependence on fossil fuels. Entire cities, including Kharkiv, Mariupol and Chernihiv, need to be rebuilt, and this presents an opportunity to use energy-efficient building design and urban planning.

If the war continues in the coming months, the cost of reconstruction will skyrocket, as one-third of Ukraine’s population spends more time away from home, children fall behind in their learning and stop running businesses. New methods are needed to assist in recovery, and funding will be much needed.

References

Akbulut-Yuksel, M (2022), “The Unaccounted Long-Term Health Costs of War on Children in War”, VoxEU.org, 10 May.

Akbulut-Yuksel, M, E Tekin and B Turan (2022a), “WWII Blues: The Long-Term Effect of War on Mental Health”, Miami.

Akbulut-Yuksel, M, Z Zimmer, S Pandey and TK Toan (2022b), “The Untold Story of Children in War: Results of the Vietnam Health and Aging Study”, Miami.

Agrist, N. S. Jankov, P. Goldberg and H. Patrinos (2022), “Loss of human capital in Ukraine”, VoxEU.org, 27 April.

Baker, T. B. Eichengreen, Y. Gorodnichenko, S. Guriev, S. Johnson, T. Milovanov, K. Rogoff and B. Wader de Mauro (2022), A blueprint for the reconstruction of UkraineA VoxEU.org ebook, CEPR Press.

Focus Economics (2022), “Consensus Forecast CIS Plus Country”, 10 May.

Harrison, M. (2022), “The Economic War and Mancur Olson: Insights for the Great Power Clash”, VoxEU.org, 25 March.

Ichino, A and R Winter-Ebmer (2004), “Long-term educational costs of World War II”, Journal of Labor Economics 22 (1): 57-87.

Vonyo, T (2019), “Recovery and Reconstruction: Europe after WWII”, VoxEU.org, 21 November.

World Bank (2022), “Ukraine’s macroeconomic outlook”, 17 April.

Endnote

1 https://thedocs.worldbank.org/en/doc/d5f32ef28464d01f195827b7e020a3e8-0500022021/related/mpo-ukr.pdf

2 https://bank.gov.ua/ua/news/all/kolonka-volodimira-lepushinskogo-ta-artema-vdovichenko-dlya-forbes-ukraine-pro-fizichni-vtrati-ekonomiki-ukrayini-vid-viyni-rozvyazanoyi -RussieU

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