Sergiy Nikolaychuk on the Economics of War

Rabbit Hole: In macroeconomics, there’s the classic trade-off between “guns and butter” – between spending on defense versus spending on civilian goods. In wartime, of course, the pendulum swings more towards guns. But how are you balancing between the two now?

SN: The task of budget management lies with the minister of finance, the government in general, and with the parliament. Military expenditure is definitely their major priority, and all sources of the economy are being directed to this area, as is needed. Meanwhile, we also understand that we have to support the population and maintain social expenditures. We also need to try and launch the economy in areas where it is possible – in relatively calm regions. We rely heavily on international support to accumulate resources and finance these expenditures. But of course, military expenditures are currently the main priority.

Rabbit Hole: How are you allocating the foreign aid Ukraine is receiving?

SN: First of all, this crucial financial support helps us to fill the budget gap. The deficit has expanded given very, very high military expenditures and the sizeable drop in revenues. During the last few months, our budget deficit was close to $5 billion, around $1.5 billion per month, and we finance this with the support of our international partners. Some of this support is also targeted to social needs. Usually, our partners do not want to finance military expenditures because of difficult geopolitical considerations. So we try to finance our military expenditure from internal sources, as much as possible.

Rabbit Hole: In an interview in this magazine, Israeli military expert Azar Gat spoke of the importance of economics to war. He said: “The winner in all the great power wars over the past two centuries was the richest. It is the economy that determined the winner in all of them. The ability to produce weapons fast, in large quantities, and high quality, was the decisive factor.” Do you agree with this assessment?

SN: I would agree to an extent, but I also believe that other factors are important. First of all, there is the moral motivation and the values of the military forces. In our case, it’s very clear that Ukrainian forces are extremely motivated in defending their own lands. But Russian troops are fighting mostly because of the orders of their leadership. That difference in motivation could be crucial.

However, coming back to the question of economics, international financial support is very important. Frankly, at the start of the war, our forces were not compared as well as the Russians. But every day we see that international support for Ukraine and our forces is growing. We are very thankful for that. If we just compare Ukraine and Russia, Russia definitely has a bigger economy and much higher potential when it comes to military spending. But with international support, and our high levels of motivation, I believe we will win.

Rabbit Hole: How is the central bank supporting the war effort?

SN: There are a few ways that we can support the budget directly. Actually, before the war, during the pandemic crisis, many emerging market central banks joined the central banks of advanced economies to provide quantitative easing and support budgets. In the past, we have had very bad experiences with such mechanisms: our crisis of 2014-15 was partly caused by helicopter money from the central bank to the budget, so we are usually afraid to do that. But the war changed everything. We have to balance the need to achieve financial stability with the need to support the government’s crucial expenditure. Since the beginning of the year, we have provided the government with 225 billion Ukrainian hryvnias, which is something like $7.5 billion, to cover around a month and a half of budget deficits. Our response to the war is designed to help fund military expenses.

Rabbit Hole: Accordingly, do you see yourself as squared-off against the Russian central bank, and, if so, how do you plan to beat it?

SN: Nowadays, I don’t think we can compare ourselves to the Russian Central Bank. In our view, the Russian state is now the main terroristic organization in the world – and the Central Bank is definitely part of this state. Before the war, we considered Russian central bankers as very experienced, professional, and technocratic. But since the war, we now believe Russian central bankers to be part of a terroristic state.

Rabbit Hole: The World Bank has projected Ukraine’s economy will shrink by 45.1% this year, and that Russia’s will shrink by 11.2%. How would you assess the relative strengths and weaknesses of the Ukrainian economy and the Russian one?

SN: First of all, I must emphasize that we are not fighting with economic figures, but with military forces. Of course, our economy is struggling a lot because of the invasion, and even more so because of terroristic actions – like bombing civilian areas, or shelling shopping centers. Given this destruction, the destruction of infrastructure and loss of revenue, our economy is definitely suffering a lot. But we are completely sure that, with international support, it will ultimately be Russia that has to pay for these disruptions. In the longer-term, with economic reforms anchored in membership of the European Union, our economy will be able to regrow. Russia, on the other hand, now faces a decade of regression. The next 10 years will be dedicated to a complete regress from globalization as its economy is forced to localize. These are our main strengths compared with the Russian economy.