Rebuilding Ukraine: how will policy-makers shape the country after the war?

There is no singular roadmap for Ukraine’s economic recovery. Rebuilding will require policies that are informed by a deep understanding of the country’s strengths and weaknesses. They should not seek to return to the pre-war status quo.

Ukraine's post-war recovery will be unique. The country faces the devastating consequences of Russian aggression, which add to the existing problems of a formerly socialist developing economy. Overcoming these challenges will require a great deal of time, money and effort.

In the first year since the full-scale invasion on 24 February 2022, the Ukrainian economy lost 30-35% of GDP (see Figure 1). This is the largest drop in economic activity that the country has experienced since independence and it will take years to recover from it.

Even after the war, Ukraine is likely to experience serious labour market shortages caused by the exodus of refugees. The memory of the war will also have a lasting effect on the country's investment appeal.

Figure 1: Ukrainian GDP growth

Source: International Monetary Fund (IMF)

These problems will require creativity from the country’s leaders. The good news is that Ukraine is capable of recovering.

With the right planning, Ukraine can shift its focus, turning disadvantages into opportunities. Ukrainian policy-makers should emphasise labour productivity growth – and use the aftermath of the war as a chance to modernise the economy and state apparatus, including implementing low-carbon production, improving the energy intensity of the economy, and using advances in information technologies and fintech to improve government services. In other words, the objective is to achieve all the structural changes that other European countries have been going through for years in a short period of time.

What strengths can Ukraine draw on?

Ukraine is a resilient nation. Despite a pre-war image of being a corrupt and institutionally weak country with a serious lack of state capacity, Ukraine has demonstrated its ability to cope with even the most difficult of challenges.

The first months of the war were a real stress test for the state machine and wider society. But it was at this point that one of Ukraine's greatest strengths emerged. Despite the panic and risk that the state may collapse, the Ukrainian government was able to take contrarian but important steps to stabilise the economy.

In the first weeks of the conflict, the government cut taxes substantially, reducing the income tax rate from 18% to 2%, abolishing VAT and customs duties on imports, and removing duties on fuel.

These policies contributed to a fall in budget revenues (in March 2022, the authorities only managed to collect 36.7% of the monthly planned tax) and a growing deficit. But it was steps such as these that helped to ensure food security, to slow down inflation, and to provide Ukrainian companies with a financial cushion for the months of most active fighting, after which most of the temporary measures were lifted.

In March 2022, 79% of businesses in Ukraine were idle or on the brink of shutdown, but by the end of the year, this figure had been reduced to just 32%. Given the scale of the destruction caused by the war, this is a remarkable achievement.

Similarly, Ukraine was able to avoid bureaucratic failure. Most public services have remained accessible to the population, primarily due to the high level of digitalisation that has proved effective since the Covid-19 pandemic. Currently, the Diia portal, through which most public services are provided, has over 100 different documents, procedures and permits that can be accessed remotely.

The number of users of the portal has grown from 14 million before the invasion to 18.6 million today. The fact that more than half of the adult population already uses digital tools will allow the state to implement welfare programmes more effectively in the future, to provide better services, to prevent corruption and, at the same time, to reduce the number of officials.

Immediately after the outbreak of hostilities, the government used the Central Bank of Ukraine's identity verification system – which relies on the client registers of all Ukrainian banks (both state and private) – to provide virtually all Ukrainian citizens with a single digital identity document. This was an important initiative as many refugees and internally displaced persons (IDPs) were unable to pick up their usual documents when they moved.

Further, all services for registration of IDPs, financial assistance and job searches were digitised immediately. This avoided the queues at state agencies and lengthy processing procedures that were observed in the first phases of the armed conflict that took place in 2014-15. For example, through Diia, 1.4 million people have been granted IDP status. This equates to almost half of those forced to leave their homes.

These examples show the flexibility of Ukraine’s state apparatus and its ability to react quickly to crisis situations, often using non-standard and unconventional tools. None of the strategic industries of Ukraine, such as the banking system, logistics, telecoms or public services, have been put out of business. Without such an adaptable state, this might not have been the case.

This experience is likely to reinforce Ukraine’s existing strengths and advantages, such as its geographical location. Located at the crossroads of transport routes from Europe to Asia and from the Scandinavian countries to the Mediterranean region, Ukraine is of strategic importance for international trade.

It has 18 seaports, one of Europe's longest roads, and is home to the 15th longest railway system, which still operates without interruption despite continuous attempts by the Russian military to destroy it.

The war may offer an opportunity for Ukraine to bolster its status through trade partnerships, including with the European Union (EU). Ukraine's candidate status for EU membership, obtained on 23 June 2022, opens up new forms of cooperation.

In particular, Ukraine has access to the benefits of the Instrument for Pre-Accession (IPA) – a special EU fund aimed at developing transport infrastructure, protecting the environment, enhancing regional cooperation, improving the quality of human capital and activating economic development mechanisms in pre-accession countries.

Given the importance of these sectors in future reconstruction, the partnership with the EU will be an additional source of funding for rebuilding the country.

What are Ukraine’s weaknesses?

Ukraine experienced the largest recession in its history in 2022, losing nearly a third of its GDP. The country has experienced previous recessionary periods in different ways: in 2014-15, associated with the war and lower commodity prices; and in 2020, because of the pandemic.

In neither case did the rate of economic recovery exceed 4%, ranging between 2.44% and 3.49% of GDP growth. If we assume that in periods of growth, the Ukrainian economy grew by 3% on average, recovery after the war would take 13 years. To avoid being set back by a decade, the country would need to achieve record economic growth. Achieving this will require overcoming a number of challenges.

The first challenge relates to workers, following the large-scale emigration of people from Ukraine. Over eight million Ukrainians were forced to flee to other countries in Europe after the invasion, according to the latest figures from the United Nations High Commissioner for Refugees (UNHCR).

Of these, around 4.8 million have been granted temporary protection status, indicating their desire to stay abroad during active hostilities. Although surveys show that 77% of refugees plan to return, their decision to do so is likely to depend on the pace of economic recovery. Even under optimistic scenarios, Ukraine will inevitably face a shortage of personnel (especially skilled workers) once the fighting stops.

Despite record high levels of unemployment (from 10.3% to around 26%, according to the Central Bank of Ukraine), a number of regions are already facing staff shortages. For example, in the western regions of Ukraine, where many companies have been relocated, the labour market had already recovered to 90% of its pre-war level by January 2023 and the search for new employees was becoming more difficult.

If this trend continues, companies in Ukraine will face a choice: not to increase business activity, which would be bad for the pace of economic recovery, or to raise wages, to compete not only with local employers but also with foreign firms. This, in turn, may lead to higher inflation (in the case of active recruitment) and discourage investment by companies because of ever-increasing payrolls.

This problem has already affected some of Ukraine's neighbours, such as Poland, which used Ukrainian migrants to cover a deficit of domestic workers. The policy has kept wages from skyrocketing, providing Polish companies with a cheaper labour force, increasing their profits. Thanks to this compensatory mechanism in both high- and low-skilled sectors, the country has managed to secure additional growth of 0.3-0.9% annually.

Ukraine also has a problem when it comes to financial capital. For years, the small size of the economy has dictated conditions for Ukrainian companies: many have focused on foreign markets, while the state has concentrated primarily on foreign direct investment (FDI). Access to credit has remained low, with Ukrainian companies perceived as too risky by foreign loan markets.

If Ukraine only has access to domestic capital – as has been the case in previous years – reconstruction of war-torn facilities will be slow. The country will also be unlikely to reach the level of business activity necessary to achieve the desired growth rates.

Coping with risks and seizing opportunities: how can Ukraine succeed?

In the current situation, Ukraine risks ending up in a ‘grey zone’ of the global economy. At worst, the economy could be left with shattered infrastructure, significant social problems and bleak prospects following the conflict. The shadow of war, in turn, may be a barrier for investors because of the potential risk of new aggression.

To overcome these risks, as well as the direct economic consequences of war, Ukraine needs to exploit its available opportunities. Current estimates of direct and indirect losses to Ukraine from Russian aggression range from $564 billion to $600 billion.

As of December 2022, the total amount of documented damage to Ukraine’s infrastructure was estimated at $137.8 billion (at replacement cost). These are monstrous figures. But they do offer some hope for the rapid development of the country's economy.

Rebuilding could mean modernising. Most of Ukraine's major enterprises or industries, which have suffered in one way or another from the aggression, have gradually become uncompetitive due to obsolete technology, high energy intensity and a lack of funds for their development.

From this place, economic recovery, provided it is based on a ‘build back better’ approach, could hasten the modernisation of Ukraine – a process that many other countries have been going through for years already.

For example, the Ukrainian steel industry has been hit hard. This includes the loss of two of its biggest factories in Mariupol: Azovstal and Illich Steel. But these firms were already massively behind their European counterparts. Preliminary estimates show that the implementation of ‘best available techniques’ in this industry – which is necessary to adapt to the European market and global environmental standards – would require an investment of $6.6 billion from Ukrainian companies.

All else being equal, it would take 30 years before Ukrainian industry could adopt the technologies that have existed in the EU for 15 years. Rebuilding the steel industry after the war might offer a chance to accelerate this catch-up.

This pattern applies to more than just steel. In general, Ukraine’s modernisation would not only rehabilitate enterprises to meet modern needs – making them more competitive in foreign markets – but could also kick-start the process of the re-industrialisation of Ukraine with a focus on labour productivity growth. The latter factor will be a solution to the problem of human resources, among other things.

What about reparation payments from Russia? As it stands, several countries are considering using frozen Russian assets to cover losses from the aggression. This includes the EU, which has frozen more than $300 billion in assets belonging to the Central Bank of Russia, and a further $30 billion connected to oligarchs with close ties to Vladimir Putin.

A joint framework guaranteeing the efficient use of these funds would not only compensate for Ukraine’s losses, but could also help to restructure the Ukrainian economy after the war.

Post-war, Ukraine has a chance to solve some of the systemic problems that have persisted throughout its 31 years of independence. If it is able to do so, it will emerge from the war not only stronger in security terms, but also more resilient and economically developed. To seize this chance, Ukraine's policy-makers should already be working on the pre-conditions for reconstruction.

First and foremost, they must prepare a new institutional framework. Ukraine can draw on existing successes, particularly the country’s rapid and effective digitisation. This has made bureaucracy more efficient and doing business easier. Digital solutions also greatly reduce corruption, which has always been seen as a major problem.

Second, Ukraine should focus on raising productivity and modernising production as a key driver of economic recovery. This will not only solve the problem of labour shortages, but it will also help to facilitate Ukraine's greater integration into the global economic community.

Where can I find out more?

Building a Post-war Ukrainian Economy: Position paper on the Fast State strategy for Ukrainian Recovery by Dmytro Natalukha and Jagjit Chadha.
How to Organise Aid: Research on potential funds and priority targets for Ukraine's reconstruction by Barry Eichengreen and Vladyslav Rashkovan.
The Labour Market in Ukraine: Rebuild Better: A study of the impact of Russian aggression on the labour market in Ukraine and its consequences, prepared by Anastasia Giacomo, Tito Boeri and Oleksandr Zholud.