Ukraine - financing its defence and development

With focus moving to prospects for peace talks on the Russo-Ukraine war it is worth noting that Ukraine’s long term sustainability beyond the current war will depend on security, financing and EU accession.

On security much of the focus has been on the importance of NATO membership. It is important to note that the on-going war is not the result of Ukraine’s supposed bid for NATO accession. The reality is that Russia annexed Crimea in 2014 and first militarily invaded Ukraine in that year when Ukraine had no realistic NATO accession perspectives. Back then Ukraine had non aligned status (effectively neutral). In fact, legacy still of its Soviet inheritance, its military doctrine was still anti Western - its military was focused on defending against an attack from the West. The lack of a threat to Russia from Ukraine was surely evidenced by the fact that Crimea was taken by Russian forces in a matter of hours with little resistance. Opinion polls, meanwhile, showed only single digit support for NATO membership back in early 2014. Opinion in Ukraine only avalanched towards supporting NATO membership as the previous neutral/non aligned status failed and because of Russia’s annexation of Crimea and subsequent invasion. The line also that Russia’s invasion of Ukraine was somehow a defensive move against prior and prospective NATO enlargement, and the threat therein to its own defence, is just a ridiculous claim. Waves of NATO enlargement to Central Europe actually brought reduced defence spending and the reduction in NATO military forces over the prior thirty years. NATO members were too quick to spend the peace dividend which they are now realising to their cost given the resurgent threat from Russia. Note there that the U.S. withdrew its last ground troops from Europe - its last tank forces in 2013, the year before Russia annexed Crimea. The British army, meanwhile, was reduced to its smallest scale since before WW1. Where was the actual threat to Russia? Without Ukraine’s current valiant defence NATO would have struggled to defend Europe against a Russian assault let alone launch an actual attack on Russia. And Moscow with its advanced intelligence capability was well aware of this.

The reality is that Putin launched the full scale invasion of Ukraine because he denied Ukraine’s very right to exist, had a problem with the decline of Russia as a power, and this war has been one of colonisation by Russia.

Now understandably because of Russia’s invasion, opinion in Ukraine has shifted to now support NATO membership. Ukrainians view membership as the best defence against future Russian aggression. It likely would be - we have learnt from this conflict that Putin is afraid of a direct conflict with a massively conventionally superior NATO. Unfortunately realpolitik in the West means that this is unlikely to be agreed by NATO members any time soon. US elections over the past week have surely laid bare the limited appetite in the U.S. to provide financing let alone U.S. troops for Ukraine’s defence. And in Europe, Germany seems happy to allow Ukrainians to lay down their lives in the defence of German, or European, values but not to allow Germans to do the same in exchange in Ukraine. This just reflects the moral bankruptcy of Germany which has for years appeased Putin while its political and business elites have been all too eager to take Putin’s forty pieces of silver - factors I think that contributed to the current war. They are significantly responsible for events over the past three years but now prefer to look the other way.

We are though where we are and the best perhaps that Ukraine can now hope for is to be given all the weapons by the West it needs to be able to defend itself - a kind of South Korean or State of Israel position. And brave Ukrainians have shown ample capability to defend themselves given the right tools.

But herein is where security and financing can interlink. Lets configure a solution where Ukraine is able to finance its own defence - not reliant on the drip drip of Western taxpayer funding. An obvious solution then is to transfer the full $330 billion in immobilised Central Bank of Russia assets in Western bank accounts. They can then use these to purchase the top and full spec of U.S. and Western defence equipment to enable them to outgun Russia. Support from the U.S. could be assured by making a nod to the U.S. political reality and creating a “Trump Ukraine Victory Fund” and pledging to spend hundreds of billions of dollars on U.S. defence equipment over say the next decade. This would secure hundreds of thousands of U.S. jobs keeping Trump happy.

Concern around the impacts of transferring immobilised RU assets on the dollar as a reserve currency would surely be overdone in Trump world. Which foreign country is going to risk pulling reserves out of the dollar and risk the ire of Trump who could easily respond with a barrage of tariffs and other threats. With the bulk of these assets in Europe Trump can just tell Europe to get it done if it cares at all about its defence. And surely Europe would now have an interest in massaging Trump’s ego by spending these funds in the U.S.

Assuming Ukraine is given the tools/resources to defend itself the country will still face a huge challenge in ensuring successful reconstruction. Indeed, experience in Iraq after the second Gulf war has proven that successful reconstruction and recovery is as important as winning the war. In Ukraine millions of troops will return home expecting improved lives. Failure to deliver could risk social and political instability which would be exploited in the future by Putin. Estimates of the economic damage to Ukraine from the invasion are huge. The World Bank in various studies with the Kyiv School of Economics has suggested something around the half a trillion dollars mark, and counting. President Zelensky recently suggested $800 billion in war related damages. Likely, and understanding of the absorption capacity of Ukraine’s $200 billion GDP economy, the annual cost is likely to be nearer to $50bn over the next decade at least. With funding defence assuming from immobilised  CBR assets then reconstruction should be the responsibility of Europe. However, the existing €50bn EU MFA provision for the period 2004-2007 is simply inadequate, providing a fraction of annual financing needs. The G7 has constructed a $50 billion facility (the Extraordinary Revenue Arrangement, ERA) from the interest stream on immobilised Russian assets but these underlying assets should be transferred to Ukraine, as noted above, to secure its defence. This will leave few resources for reconstruction. There is, in any event, fear that these underlying CBR assets might be transferred back to Russia as the price of any peace deal which would leave the whole ERA under funded. This simply cannot happen if the West is serious about adequately funding Ukraine’s defence and its post war deconstruction. The EU then needs to make a long term (€50bn pa) commitment to Ukraine’s long term financing. If it cares about its own security then ensuring the economic, social and political stability of Ukraine should be a priority and a $50 billion annual price tag when set against the $25 trillion European economy should be viewed as small change - 0.2% of GDP and one quarter of current European defence spending.

The last anchor of Ukraine’s longer term sustainability is EU accession. This is key to anchor reform and private investment into Ukraine - both being key to successful economic development and ensuing Ukraine can sustain its own defence. Why is EU accession so important? Well many have argued that Ukraine could benefit from being positioned as some kind of bridge between East and West, neither in the EU nor the Russian block. My retort is simple - that was Ukraine’s status between independence in 1991 and the Euromaydan in 2013-14 and it absolutely failed. It left Ukraine in a twilight zone between east and west where there was little reform or the rule of law. The result was the state was captured by oligarchs who rent sought and ripped the faces off the rest of the Ukrainian population. This resulted in periodic domestic revolutions - Orange in 2004, and Euromaydan in 13-14 but which kept social, political and economic stability fraught. The key proof of the failure of the past bridge status was the fact that Ukraine, Russia and Poland all had a per capita GDP of around $3000 in 1991 at the outset of the transition but by 2013, Poland and Russia had seen per capita GDP rise to $14,000 while Ukraine’s remained at $3000 or thereabouts. Ukraine was not working from its prior shackled status. Poland benefited from the EU accession anchor, Russia had the commodity cycle while Ukraine was in the twilight zone between East and West. Ukraine needs a new development status or anchor and it has to be EU accession - it worked for the rest of Emerging Europe and it will for Ukraine.