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Economic decay fuels Ukraine's unrest

| Saturday, Feb. 22, 2014, 12:01 a.m.
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A man presses against the side of a van carrying the body of Ustim Holodnyuk, 19, who was killed in fighting between anti-government protesters and police, after a funeral procession through Independence Square on Feb, 21, 2014 in Kiev, Ukraine.
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An anti-government protester sleeps behind a barricade on Kiev's Independent square on February 21, 2014. Ukraine's leader and opposition on February 21 signed a deal to end the splintered country's worst crisis since independence after three days of carnage left nearly 100 protesters dead and the heart of Kiev resembling a war zone. President Viktor Yanukovych's dramatic decision to hold early elections and form a new unity government was met with caution by the tens of thousands gathered on central Kiev's main square for a protest that began exactly three months earlier.

The battle in Kiev is, in large part, a fight for the country's economic future — for better jobs and prosperity.

Ukraine's protesters want to pry their country away from Russian influence and move closer to the European Union. A look at neighboring Poland, which did just that, suggests why.

The two countries emerged from the collapse of the Soviet Union two decades ago in roughly similar economic shape. But Poland joined the EU and focused on reforms and investment — and by one measure is now three times richer than Ukraine.

Ukraine, on the other hand, sank in a post-Soviet swamp of corruption, bad government and short-sighted reliance on cheap gas from Russia.

Per capita economic output is only about $7,300, even adjusted for the lower cost of living there, compared with $22,200 in Poland and about $51,700 in the United States. Ukraine ranks 137th worldwide, behind El Salvador, Namibia, and Guyana.

Protests broke out in November because President Viktor Yanukovych backed out of signing an agreement with the EU that would have brought the economy closer in line with European standards. It is unclear whether the agreement reached on Friday will succeed in providing a stable government that can heal the rifts and improve the economy.

It didn't have to be this way, experts say. Ukraine has a large potential consumer market, with 46 million people, an educated workforce and a rich potential export market next door in the EU.

How did things go so wrong? Here are the main reasons:

Old industry

Ukraine did little to move away from Soviet-era industries producing commodities such as steel, metals and chemicals. Former communist state companies, often privatized to politically connected figures, relied on cheap gas from Russia and growing demand from the world economy for their raw materials.

That helped Ukraine's economy grow rapidly from 2000 to 2008, but reduced pressure to modernize.

When the world economy fell into a crisis in 2008, demand for Ukraine's raw materials plunged. In 2009, Russia significantly raised the price of its gas supplies, further pulling the rug from underneath the country's export industries.

GAS FOLLIES

Ukraine's state gas company, Naftogaz, charges customers only about 20 percent of what it pays for imported Russian gas. That means the government spends about 7.5 percent of the entire economy's output each year on a huge home heating subsidy aimed at keeping voters happy. That results in large budget deficits that the government must borrow to cover.

The International Monetary Fund tried to help Ukraine through its post-crisis troubles, with loan packages in 2008 and 2010. Each time, the IMF turned off the money tap because Ukraine refused to follow policy requirements including raising gas prices or cutting back on government salaries and pensions.

CORRUPTION

A recent World Bank study of the economy cited “pervasive” corruption as a major factor holding back the economy. At street level, businesses are subjected to arbitrary treatment by officials and demands for bribes. Higher up, there is widespread public skepticism over the fortunes amassed by the connected, known as oligarchs. In particular, attention has focused on the career of Yanukovych's son, Oleksandr, a dentist who according to Forbes Ukraine has amassed a $510 million fortune through various business enterprises.

Ukraine ranked 144 out of 175 countries in the 2013 corruption perception index compiled by Transparency International, an anti-corruption group.

RED TAPE

Business advocates say owners sometimes prefer paying bribes to obeying regulations and taxes that are so complicated and burdensome that they would be out of business if they complied. The country's complex business tax laws require 390 hours a year to comply with and take 54.9 percent of profits. That put Ukraine 164th out of 189 countries in ease of paying taxes in a World Bank survey.

BROKEN FINANCES

Ukraine's finances are in such bad shape that it will have trouble paying its debts this year without outside help. With continuing deficits, it faces borrowing needs of between $7 billion and $10 billion this year. Its poor prospects mean it's unlikely to be able to borrow more on bond markets.

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