Frozen conflict brings economic stagnation to Ukraine’s Donbas region

Seven years on from the outbreak of hostilities in the east of Ukraine, a once-economically vibrant region is mired in economic stagnation, with little prospect of respite. 

There is still shooting in Donbas. Most evenings, soldiers on either side of the contact line – the 472 kilometre-long “border” separating Ukrainian government-controlled territory from Russia-backed separatists – take potshots at each other across the buffer zone, using mortars, howitzers, ATGMs and tanks. Residents have learned to live with this. But just as worrying as the threat of stray shells is the severe economic decline of the entire region. 

The conflict has wreaked havoc on Ukraine’s economy as a whole, with the government recording contractions of 6.6 per cent and 9.8 per cent for 2014 and 2015 respectively. Inflation soared, reaching a peak of 61 per cent in April 2015. Exports to Russia, Ukraine’s biggest trading partner, plummeted by 35 per cent. With large parts of its eastern territories occupied by separatists, Ukraine has physically lost access to vast resources. 

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Seven years since the conflict began, over 13,000 people have lost their lives (including at least 3,000 civilians). Supply and market links have been shattered. Vital infrastructure has been abandoned or damaged. Entire communities have sunk into poverty – some have disappeared entirely. Businesses, both large and small, have gone under and investors are reluctant to risk capital in such a volatile environment. The situation is even worse in separatist-controlled territories which are kept afloat by billions of US dollars of Russian aid. 

The war itself is in stalemate. The Ukrainian military isn’t strong enough to retake the Russia-backed territories, while the separatists (or their handlers) show little intention or capability of advancing beyond the current contact line. This absence of a decisive victory creates the economic quagmire affecting all of Donbas: neither full scale war, nor peace.

Instead, Donbass is mired in perpetual uncertainty and stagnation.

Donbas was long considered the most “cosmopolitan” part of Ukraine. Since vast coal reserves were discovered in the 19th century, workers poured in from all over the Russian empire, and later the Soviet Union. Holding the bulk of Ukraine’s vast mercury and coal reserves – the second and seventh largest in the world, respectively – it was a prime location for industrialisation. 

Independence hit this region hard. Between 1993 and 2013, Donetsk and Luhansk lost 18.3 and 21.6 per cent of their populations, respectively (Ukraine as a whole saw a 12.5 per cent decline in the same period). Industry declined and young people began migrating to bigger cities, raising the average age of Donbas. 

As such, even prior to the war, the industrial hub of Ukraine had to be held afloat by billions of US dollars in subsidies from the government. In 2012, these amounted to about 1.7 billion US dollars, nearly four per cent of Ukraine’s state budget. 

Lost economic output

Despite this, the region still had among the highest economic outputs in Ukraine. Prior to the conflict, Donbas accounted for a quarter of Ukraine’s exports and 15 per cent of capital investment. However, despite nominally higher wages than in the rest of the country, this didn’t always translate to better conditions for people actually living in Donbas. 

Life expectancy was two years below the national average – Ukraine was also the world leader in fatal mining accidents. Wage arrears were the worst in the country. Density of pollution was six times higher than the national average. Levels of violent crime, drug addiction and HIV infection were among the highest in the country – and Ukraine has long been among Europe’s leaders in opiate use and HIV transmission. 

The conflict made the economic situation deteriorate. Industrial production contracted by 60 per cent in Donetsk Oblast and 80 per cent in Luhansk Oblast. By 2017, exports from the region had fallen to 10 per cent of Ukraine’s total – down from 25 per cent just three years prior. In separatist-controlled parts of Luhansk Oblast alone, 25 plants and factories and 41 mines were closed. Those which remained reduced their output. Consequently, unemployment in the region is significantly higher than the national average – last year, it stood at 14.5 per cent in Donetsk and 15.2 in Luhansk, compared to the national average of 9.2 per cent. 

It wasn’t only big enterprises which suffered. Large parts of Donbas were depopulated. More than 1.4 million people are registered as internally displaced – many more have gone abroad. Large parts of Donetsk were depopulated and the market shrank. Two major international airports in Donetsk and Luhansk were closed and the political shift away from Russia forced producers to look for new markets, not always successfully. 

Rita has owned a nail salon in central Sloviansk since 2008. Sloviansk and its neighbouring city of Kramatorsk were the site of the first major battle of the war. Her business was closed from April 2014 – when separatists entered Sloviansk and occupied it – until September, two months after the city had been retaken by the Ukrainian military. For Rita, the war was a major turning point in her business.

“It was like starting again,” Rita says. “Many people left. Some to Russia, some to Crimea, some to western Ukraine. I’m still in contact with many of these girls and most of them don’t intend to come back. [The years] 2015 and 2016 were especially hard.”

Rita’s business was physically unharmed during the battle – but not everybody was this fortunate. 

Oleh owned a car repair shop which was used as a fighting position by separatists. Although he had fled Sloviansk with his family when it came under occupation, he returned to find the bricks heavily eroded from bullets. The fighters occupying the building had also made holes in the walls to shoot through. The roof had a gaping hole. Most of his equipment was missing.

“Even with insurance, I couldn’t cope with this financially and I had to close,” says Oleh. He now works as a mechanic in Kyiv and drives taxis in his spare time. 

Abandoned by Ukraine

Rita says that she felt abandoned by her government.

“I didn’t see any bit of help from my government during the battle in my city,” she says. Although Rita’s nail salon was closed for over five months, she continued paying taxes. “They forced me to pay, even though we were closed… they gave a slight break in the form of a slight reduction in pension tax, but that’s it. Other than that, we paid the same taxes as the rest of Ukraine. Imagine, we returned to a destroyed city. My daughter was starting first grade and we’d had no income for half the year.”

Although Sloviansk is about an hour’s drive from the contact line, the economic decline is readily apparent. Many of Rita’s acquaintances shut down their businesses and left the city permanently. Closer to the frontline, where you can actually hear the exchanges of gunfire, some small towns and villages are virtually depopulated.

Numerous checkpoints on every road leading in and out of Donbas also choke the economy and greatly slow the flow of commerce. People queue, often for up to three hours in these checkpoints. Soldiers on both sides are regularly reported to be rude, aggressive and unsympathetic. 

The economic situation is even worse in separatist-controlled territories, where a sizable chunk of the remaining population are pensioners. The economy has been monopolised by separatist-owned enterprises and salaries plummeted in the first year of the war, although they have been steadily increasing since.

The economy is held together by billions of US dollars per year from Russia and is based entirely on cash, with virtually no working ATMs. Consequently, an average of 650,000 people cross over to government-held territory every month, often to withdraw cash. Many others – in fact most who cross – are known as ‘pension tourists’ – receiving pensions from separatists authorities and augmenting this with Ukrainian government pensions. 

Today, Donbass has made little progress in economic recovery. Between 2014 and 2018, foreign direct investment has been under one per cent of Donbas’ GDP. Investors balk at having to devote resources to an area where artillery exchanges occur daily. Furthermore, there is always the nagging fear that things could escalate again – the ferocity of the first 12 months of the conflict is still etched in residents’ minds. Because of this, the economy struggles to develop and was particularly badly affected by the Covid-19 pandemic. 

According to an anonymous source within an international organisation, firms also have low confidence in regional educational institutions to equip graduates with the relevant skills in emerging sectors. Thus, the ICT industry which Ukraine has been banking on following its recent successes in the field, is still underdeveloped in the region. 

Some international organisations have been involved in attempting to stimulate the economic recovery of the region. USAID has helped establish IT clusters in Kramatorsk and Mariupol, the two biggest cities in government-held Donbas. In Mariupol, there is a fully-fledged start-up incubator, the 1991 Start-up Development Centre (founded in 2012). The Danish Refugee Council has a Livelihoods programme, which gives cash grants to small businesses in the region – this programme was expanded after the Covid-19 pandemic. Rita has a pending application for this programme. “Covid was more difficult than the war for my business,” she says. 

In 2019, on President Volodymr Zelensky’s initiative, Mariupol also hosted the Mariupol Investment Forum, attracting diplomats and business representatives from all over the world. No fewer than 12 deals were agreed during the forum, with over one billion US dollars pledged. 

Some entrepreneurs have managed to adapt to the situation. Settlements on the Ukrainian side of the contact line are now full of places offering beds to stay in for the constant flood of ‘pension tourists’ from separatist-controlled territory. Close to the frontline, businesses cater to the soldiers. Alcohol and prostitution generate particularly large amounts of profit. Some people have set up food stalls near checkpoints – at one crossing between the warring sides, there is even a sushi stand. 

No solution in sight

However, there is no solution to Donbas’s economic malaise which precludes the resolution of the conflict. As long as lives and vital infrastructure are haunted by the spectre of war, the conditions for sustained and broad-based economic growth cannot be met. Although the most recent ceasefire agreement of July 2020 has seen a marked decrease in violence – 2020 saw 138 civilians killed or wounded, compared to 167 in 2019 and 604 in 2017, according to the United Nations Office for the Coordination of Humanitarian Affairs (OCHA) – the ‘frozen’ conflict only further mires the region in stagnation. 

And even with a swift resolution to the conflict, there is still a long, long way to go before Donbas can properly recover. A report by the Vienna Institute for International Economic Studies estimates the minimum cost of reconstruction at 21.7 billion US dollars. Ukraine cannot afford this.

A military solution is out of the question. The separatists and their backers have no interest in letting the status quo change. The Ukrainian military simply does not have the capacity to retake the lost territories. Besides, this would cause an even greater degree of death and suffering. 

Reconciliation has been hampered by political considerations. Many in Ukraine believe all the ‘decent people’ have left the separatist-controlled territories. This widespread belief implies that all who are left are traitors or people lacking transferable skills. The Ukrainian government is in no particular hurry to reintegrate such demographics. 

What little progress may have been made has certainly been set back by the Covid-19 pandemic. Now, Donbas remains more vulnerable than any other part of Ukraine. Economic stagnation and population decline is forecast to continue at faster rates than the rest of the country. A peaceful resolution to the conflict which would allow Ukraine to again exercise its sovereignty over its whole territory looks no closer than it was five years ago. It may yet be a very long time before Donbas can recover its economic might.

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