‘We don’t want to produce the next oligarchs’

Economist Jan Pieter Krahnen on designing an effective ‘Marshall Plan’ for Ukraine

In late April, the Centre for Economic Policy Research (CEPR), a network of hundreds of economics researchers from around the world, published a new report on the future reconstruction of Ukraine’s economy. While the organization released its first “Ukraine Reconstruction Plan” in March 2022, its new recommendations are significantly more detailed and reckon with the harsh realities of the grinding, years-long slog the war has become. Meduza special correspondent Margarita Lyutova spoke to one of the report’s key authors, Jan Pieter Krahnen, a finance professor at Goethe University Frankfurt and a member of the German Federal Finance Ministry’s Academic Advisory Board. Meduza shares an English-language summary of their conversation.

Even the most optimistic forecasts for the future of the war in Ukraine acknowledge that the weeks and months ahead will be difficult; while the U.S.’s latest military aid package has begun to arrive, the long delay in its passage allowed Russia to make key gains on the battlefield. While President Volodymyr Zelensky said Friday that Ukraine had largely managed to stave off Russia’s latest offensive in the Kharkiv region so far, he warned it may be just the first of several waves.

With the war’s future as uncertain as ever and any semblance of a peace agreement still a distant prospect, discussions of how to approach the reconstruction of Ukraine’s economy may seem premature. According to economist Jan Pieter Krahnen, however, if the country wants to avoid past mistakes and make the most of postwar investments, it’s now “high time” for policymakers to begin strategizing.

As Krahnen and his co-authors argue in CEPR’s new report, Ukraine’s Reconstruction: Policy Options for Building an Effective Financial Architecture, Ukraine can’t simply count on foreign grants and one-time investments to rebuild its economy after the war. For one thing, it’s no longer clear that enough money is forthcoming to even begin this process.

“In the early days of the war, it was not a big topic. ‘Of course this money will come,’ [we thought]. ‘We have the E.U., we have the U.S., we have Germany, France, etc.’ There were enough donors, in a way that seemed to add up to big sums,” Krahnen tells Meduza. He continues:

But as time goes on, the support has dwindled a bit. And despite my expectation that there will be significant amounts of money available, these amounts will by no means be enough to cover the investment outlays that will be necessary not only to rebuild physical infrastructure in the country that has been destroyed but also to bring the economy up to speed.

For this reason, according to Krahnen, the grants and loans that will be available to Ukraine after the war will not be enough to make the country “competitive with other European economies” or to “orient the whole Ukrainian economy in a stronger sense than before towards its Western neighbors.” Instead, accomplishing these goals will require what Krahnen and his colleagues refer to as “building back better,” a process that he says will entail restructuring the corporate sector as well as the agricultural, energy, and raw materials sectors, among others. And for this, he explains, the available grant funding will not suffice.

“So there is a demand to access the market for private investment,” he tells Meduza. “And this is a global market. In a certain sense — price-wise, information-wise — it’s an integrated global market where Ukraine is competing with the U.S. and other countries for funding.”

To attract the “big pension funds, big institutional investors, big banking groups, and asset managers that might put their money where they think the return is,” Krahnen says, Ukraine needs to make its market attractive enough. Broadly speaking, he explains, this will require “onboarding international money and channeling it to good firms.”

But this is easier said than done. “To make a system a trusted system is one of the hardest exercises I can think of,” Krahnen says. “Much of my academic life was actually concerned with [the question of how to] establish what we call incentive alignment — in other words, [ensuring that] people to whom we hand over money will do what they have claimed to do and what we expect them to do. How can we ensure this?”

This question, according to Krahnen, is key to whether Ukraine’s postwar economy will succeed. While this may sound abstract, he says, it’s “essentially what institution-building everywhere in the world is all about.” And while economists and policymakers do have an arsenal of tools for ensuring trust and confidence in a market, creating the institutions this requires takes time.

“You need to create a legal framework that is suitable for such an endeavor,” he says, continuing:

You need to have institutional variety, diversity, an institutional setup that is competitive among [institutions] but still accountable to investors, owners, [and] lenders. [This] needs to be done now in order to be ready for delivery one or two years from now. And all of our suggestions should be read as an attempt to formulate conditions for such a sustainable financial system.

Lessons from Germany

Krahnen says that while the CEPR’s new report has been met with reservations from the National Bank of Ukraine and the European Bank for Reconstruction and Development (EBRD), its recommendations seem to have resonated with Germany’s Federal Finance Ministry. According to him, that’s no coincidence: the report includes an entire chapter dedicated to Germany’s experience with the Marshall Plan and the lessons it holds for Ukraine.

“The major insight of our chapter on the Marshall Plan is that it’s not the amount of money that made the Marshall Plan successful, because that wasn’t that much after all,” he says. “But the money […] was used in Germany to build institutions rather than directly funding some infrastructure project, [in which] you do it once and it’s gone.”

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Krahnen and his colleagues propose the creation of a bank in Ukraine analogous to Germany’s KfW, which was established as part of the Marshall Plan and is now the country’s second-largest bank. “[KfW] does a lot of policy work,” he explains. “For instance, we have this energy transition— something that needs a lot of support money to be viable on the household level and on the firm level.” While KfW helps finance projects like these, it’s not responsible for finding good projects or conducting due diligence; instead, “they just do refinancing of the banks for extending the loans that they give to the client.”

While Ukraine already has a number of state-owned banks, Krahnen says that what the CEPR is proposing is a “state-owned bank [that would] get rid of all the others: “The bank we are suggesting would not be a commercial bank that competes with other commercial banks. […] What we suggest is a state-owned bank that channels international money into the banking sector as such and follows certain conditionalities, certain principles [governing] where this money should be spent,” he explains.

While the proposal might sound on its face like a push for more centralized control of Ukraine’s economy, Krahnen says that the opposite is true: privatizing the country’s existing banks and replacing them with a Tier 2 bank — an institution whose only clients are other banks — would help Ukraine develop a more market-based economy.

According to Krahnen, this system would avoid turning the new bank into a bottleneck of red tape by leaving client selection and monitoring responsibilities with the Tier 1, customer-facing banks, while minimizing corruption and perverse incentives through mechanisms such as co-lending.

“[This] means we only put Tier 2 bank money where the Tier 1 bank also puts their own money,” he says. “That’s a mechanism to ensure that the bad projects will not be targeted with this money.”

Reviving the banking sector

Ukraine’s banking system was in poor shape even before the war. According to Krahnen, the country’s banking sector is plagued by non-performing loans (NPLs) while also containing an “unmatched” volume of government bonds. The result is an aggregate balance sheet with approximately half of its assets “sitting there doing nothing in the economy,” he says.

“The proposal that we’re making in this report is to unfreeze, so to speak, bank balance sheets, and make them useful for the recovery,” Krahnen explains.

To accomplish this, the report’s authors propose obligating state-owned banks to sell their debt to a newly-created “bad bank” — an institution specially designed to isolate and liquidate Ukraine’s NPLs — within 10 years. The banks would also be required to find private owners.

“Since privatization is so delicate in many Eastern European countries, [...] we do not claim to have a silver bullet that solves it,” Krahnen notes. “But we would say [to the banks]: ‘Take care, give yourself time, use all the expertise you can get to build stable ownership groups.’ We don’t want to produce the next oligarchs.”

Political considerations

When it comes to specific infrastructure restoration projects, such as the reconstruction of a power plant, Krahnen says, the EBRD is largely capable of handling the process. The new development bank that he and his colleagues are proposing would in some ways act as a competitor to the European bank — and, according to him, it opposes the idea for this reason. But Krahnen sees the competition as a positive outcome.

“My own take is that such a national development bank would empower Ukraine to participate more strongly in what they favor and what they don’t favor,” he explains. “[...] If you externalize too much of your financial architecture, you will lose control, in a democratic sense, of what’s going on in your country.”

It’s also important to build up Ukraine’s domestic banking infrastructure to protect it from the risk of outside banks abruptly leaving the country, according to Krahnen. “In the end, foreign institutions are governed by their own bottom line,” he says. “And if this bottom line is in trouble for reasons completely unrelated to Ukraine, these banks would go home.”

At the same time, the economist adds, there are good reasons to include foreign institutions in the oversight process:

In a country where international investors fear corruption and interference from different sides, you would like to tell them: “Don’t fear too much interference here, because we’ve constructed an institutional setup that doesn’t make that so easy.” And this is the best we can do: we can hand over control to an outsider, or at least part of that control. And if we trust the outsider, we can more or less trust the result in that country.

Interview by Margarita Lyutova. Summary by Sam Breazeale.