Replacing foreign aid: A macroeconomic plan B for Ukraine (and Europe)

The key message of the report was that, although Ukraine has many tools to achieve this goal, foreign aid is essential for meeting macroeconomic challenges. In line with that forecast, foreign aid3 has indeed played a critical role in keeping the Ukrainian economy running.

However, Ukraine now faces the danger that its economic and military aid from allies, notably the United States, will decline. This poses problems for the Ukrainian military and the Ukrainian economy. The immediate consequences of reduced aid may include acute problems with financing fiscal and trade deficits, which present the Ukrainian government with very painful trade-offs.

In this Policy Insight, we discuss some policy responses to ensure a sustained war effort despite reduced aid³. To be clear, we continue to believe that generous foreign assistance is essential, but we need to consider what Ukraine can do to close the gap created by insufficient aid. We also note that transferring Russian frozen assets to Ukraine can address the fiscal and trade deficits directly while reducing uncertainty over the medium term. If external aid does not materialise, Ukraine will have to mobilise resources internally to cover military spending over a long period of time.

The three fundamental challenges for Ukraine”s wartime economy are: (1) limited productive capacity and power generation that are constantly under Russian attack; (2) large fiscal deficits; and (3) large external trade deficits. We will cover each of these challenges in turn, but first we would like to present the economic case for European support of Ukraine.

Why help Ukraine?

Russia’s full-scale invasion of Ukraine in 2022 underscored the unpreparedness and exposure of the European Union to major security threats. These threats are now amplified by the evident ambivalence of the current US administration about its future role in NATO. While many current efforts centre on achieving a ceasefire in Ukraine and thus relieving immediate pressures, broader economic analysis of the costs and benefits of ensuring durable peace in Europe, as well as of alternative scenarios, is sorely lacking.

For example, typical discussions present possible choices as (i) giving Ukraine X amount of euros in military and economic aid versus (ii) stopping aid to Ukraine altogether. Framed this way, the “natural” choice for the public is to spend nothing on aid for Ukraine. However, this choice set is artificially restricted and fails to capture even the purely economic costs of a Russian win. In the interest of space, consider three such costs.

First, the menace of a victorious and aggressive Russia will force European countries to permanently increase defence spending by half or more. Europe is already moving in this direction, as the US pressures Ukraine to settle quickly with Russia. Even on current plans, France alone will add approximately €30 billion per year to its defence budget. If one adopts a ten-year policy horizon, this amounts to €250 billion extra spending in present value. On 3 March 2025, EU President von der Leyen announced a ReArm Europe package to the tune of €800 billion.

Second, security risks cast a long shadow over economic activity in general and specifically on the cost of capital. For the latter, the spectre of confrontation with Russia will manifest itself analogously to the so-called “Korean discount” (Korean firms have lower valuations relative to their US or European peers just because there is a risk that Kim Jong Un launches a war). Correspondingly, interest rates for European governments, firms, and households will include a security premium. To get a sense of magnitudes, consider again the case of France. The level of public and private debt in France is approximately 300% of GDP. If the cost of capital increases by even one basis point, France will have to spend an extra €1 billion per year on servicing its debt. In short, security risks can entail a large economic burden.

Third, a failed Ukraine will be a source of costly instability for Europe. The collapse of Yugoslavia, with waves of refugees, crime, guns, and other negative spillovers, provides an idea of what would come. But Ukraine is much bigger, and its political collapse would introduce qualitatively new challenges such as flows of nuclear materials and advanced military technologies (drones, missiles, and computer hacking, etc.). The cost of Ukrainian refugees alone is already immense (the EU cumulatively spent €125 billion on refugees from the war) and that cost will soar if many more millions – perhaps as many as 10 million – flee a country that is under permanent threat of Russian aggression.

Clearly, these three costs – and there are potentially many others – dramatically outweigh the costs of supporting Ukraine and avoiding the consequences of its defeat. Furthermore, history (e.g., Ilzetzki, 2025) teaches us that investment in European security will create jobs, reduce strategic dependencies, and fund innovation – key objectives outlined in the Draghi Report (European Commission, 2024).

In short, the multiplier for investments in defeating Russian aggression may be as high as 10 – that is, every euro invested in Ukraine today will save 10 euros for the EU in the future. Decisive support for Ukraine can avert a historical geopolitical disaster in Europe and beyond, but even in narrowly economic terms, it is the best investment the EU can make.

Productive capacity

Ukraine faces shortages of workers, mismatches in the labour market, blackouts, uncertainty, and Russian missile and drone strikes. The National Bank of Ukraine estimates that, given the destruction of productive capacity and occupation of territory to date, output is currently close to potential. If accurate, this means that further demand-side stimulus cannot create much output without inflationary pressures. Hence, economic policy should concentrate on the supply side of the economy.

We favour a comprehensive and ambitious strategy:

•  loosen bottlenecks in logistics (ports, border-crossing lanes, etc.);
• ensure a stable supply of electricity (add and repair generators and protect existing facilities);
• help people move, retrain, and find jobs in the new economy (this also necessitates social support to encourage working and retraining);⁴
• encourage labour force participation by women and other marginally attached groups (by setting up safe daycare facilities and schools and tax exemptions on earnings of disabled persons or retirees returning to the
  workforce);
• de-risk economic activity (using war insurance, public–private partnerships, risk sharing and joint ventures with foreign entities);
• reallocate businesses and production to safer parts of western Ukraine and decentralise production (for more details, see Dombrovskis et al., 2024);
• clarify who can be drafted into the army and who can obtain deferment;
• deregulate economic activity;
• attract back workers who have emigrated abroad;
• further digitalise the economy;
• improve management of assets seized from Russian owners and collaborators.

As discussed in Dombrovskis et al. (2024), attracting Ukrainian refugees back to the country should be net-revenue positive; that is, returning people should bring more income to Ukraine than the cost to the Ukrainian government. (One can expect that retirees and children are net-revenue negative.) With this objective in mind, Gorodnichenko and Gros (2025) propose a “reinsertion” programme to increase labour supply and stimulate Western companies to invest in Ukraine. Specifically, the German government could provide a bundle of insurance and funds for training Ukrainians currently living in Germany but interested in finding a job in a German factory in Ukraine. Linking reallocation to a job in Ukraine could solve labour shortages in Ukraine, relieve pressure on public finances in Germany, and minimise the financial burden for the Ukrainian government.

Although Ukraine’s economy faces binding capacity constraints, some sectors could expand even in the short run. Firms in the military defence sector report that their capacity to produce drones is currently only 40% utilised. Although the Ukrainian government may not have resources to contract with these firms to their full capacities, Ukraine”s allies can pay for drone deliveries directly (for example, the Dutch government pledged to spend €700 million on drone production in Ukraine). Apart from addressing the need to replace US military kit and create a “drone line” for Ukraine”s defence, this approach promotes production upscaling and self-reliance in Ukraine, delivers defence capabilities cheaply, and recognises that Ukraine is a critical part of Europe’s defence perimeter.

An urgent priority is to assemble timely and accurate economic data on available resources and needs in the economy. Currently, it is difficult to assess the degree of mismatch in labour and capital markets. Exchanges and private aggregators provide an incomplete picture. Although prices help move resources towards better uses, the process can be accelerated by government guidance so as to generate more output. For example, labour force surveys, suspended owing to the hostilities, should be resumed as quickly as possible.

While focusing on expanding productive capacity, we do not consider policies that abandon the market economy and rely on government direction to allocate resources. That is to say, we rule out forced labour and official production quotas. Mobilisation can take a variety of forms (for example, the government can take direct control over the economy as in the USSR or Nazi Germany during World War II). However, the Ukrainian context calls for market-based allocation mechanisms, which are more likely to provide cost-effective solutions that do not overburden the state’s capacity, exacerbate corruption, or promote black markets.

To enhance allocation of scarce resources, prices should reflect supply and demand conditions. Of course, fluctuations in prices can create uncertainty and hardship that can undermine solidarity in Ukrainian society. Price rises are essential, however, to signal excess demand and stimulate the economy to increase supplies. This is particularly important in the context of electric power generation, as the country is projected to experience electricity deficits of 5% or more in 2025 and likely beyond (more than 50% of electricity power generation has been destroyed by Russian missiles). Although the government increased the price of electricity by 60% in 2024 to bring the price closer to cost recovery levels, planned and unplanned blackouts due to shortages of electricity continue to inhibit economic activity. To balance protection of the population and improvement in efficiency, Ukraine can rely more on nonlinear tariffs, where some amount of electricity is sold at a stable price that corresponds to a moving-average cost of electricity but the marginal kWt of electricity is priced to reflect market conditions.

In short, economic policy should do everything it can to expand capacity and use multiple policy levers to support the supply side of the economy.

Fiscal deficits

Since the beginning of the full-scale invasion, Ukraine has been running fiscal deficits on the order of 30% of GDP. Although the deficit is projected to stand at 19% of GDP in 2025 and then to decline modestly over time, Ukraine is unlikely to cover it without foreign aid. At the same time, Ukraine can make a number of changes to reduce its dependence on aid. In a nutshell, this would require raising taxes and controlling nondefence spending. This is obviously a painful combination in the best of times, but geopolitical developments may force Ukraine to take radical steps.

Limited capacity on the supply side points to the importance of shifting the demand mix from private to government demand. With total available resources roughly fixed (the economy is projected to grow 3-4% over the next year, which is not enough to fully replace outlays that are now covered by foreign aid), the government has to induce the private sector to cut its spending to free up resources for defence production. This means that (1) taxes must be raised, and (2) households and firms should be given incentives (possibly via financial repression) to channel their savings into government bonds. Because the increase in taxes will be matched by a corresponding increase in government spending, any potentially contractionary effects of higher taxes on the economy will be mitigated.

Raise tax rates

A fiscal policy including higher taxes is most likely to generate a durable foundation for the war effort. Taxes on consumption (VAT, excise) are particularly effective. They are easier to enforce than direct taxes. In addition, they discourage consumption and encourage investment and saving (allowing the government to borrow more from the private sector).

Progressive income taxes are another potential source of revenue. A “war surcharge” on high incomes and luxury items (e.g., expensive imported cars) can be applied, although these taxes are harder to enforce in an economy with a history of tax evasion. In addition to raising more revenue, progressive taxation can improve social cohesion by showing the government’s resolve to distribute the tax burden fairly.

Broaden the tax base

Closing tax loopholes and eliminating tax evasion are further important sources of revenue – “private entrepreneurs” (ФОП) engaged in illegal gambling, evading import duties, and selling counterfeit tobacco products offer obvious examples of practices that the government should combat. The authorities should improve tax enforcement and increase penalties for tax evasion.

The high cost of tax administration is a perennial source of complaints from the business community. It also pushes more of the economy into the shadows and creates opportunities for tax evasion. Simplifying tax administration can generate more resources for the government⁵.

Control non-defence government spending

Given limited resources and defence spending dictated by the imperatives of the war, the government needs to control (and conceivably even cut) non-defence spending. For example, given the massive relocation of people, there should be opportunities to consolidate government services in depopulated areas. Suspending indexation of pensions and other social payments can release more resources. Postponing development projects (maintenance of roads, renovations, etc.) can free up resources in the short run.⁶ More competitive and transparent public procurement can drive down the costs for the government. Utility tariffs and other regulated prices can be adjusted toward cost-recovery levels to reduce the drain of public funds and to encourage more efficient use of energy and other resources. Subsidised credit can be targeted at new investment rather than working capital. New spending programmes (including tax breaks and subsidies) should be put on hold or at minimum have a corresponding source of funding revenue. The government should preserve (and if needed, install) proper corporate governance of state-owned enterprises because they are large sources of waste. In a similar spirit, anti-corruption agencies should continue their watchdog activities to minimise graft and inefficiency.

Outsourcing some government functions (for example, helping internally displaced people) to international and foreign agencies such as the Red Cross can reduce the pressure on public finances.

Social support is essential for the maintenance of unity. Hence, Ukraine must maintain social programmes, but such support should be carefully targeted. Programmes should be focused on helping specific disadvantaged groups rather than providing non-targeted assistance to the entire population. One can expect greater efficiency from cash transfers than from fixed bundles of goods, although direct provision of goods and services (food, shelter, etc.) may still be needed for specific groups that experience particularly difficult hardships.

Manage government debt and assets

Encouraging business and households to hold government debt is of paramountimportance. Real returns on government debt appear to be sufficiently attractive tosavers now, but the conventional sources of funding such as banks are largely exhausted – the projected net borrowing of the Ukrainian government for 2025 is effectively zero. Thus, the main focus should be on direct outreach to savers (a public campaign,default options to allocate a fraction of income automatically into government bonds,enhancing access to government bonds, marketing to the Ukrainian diaspora abroad, mounting a campaign equivalent to Israel bonds in the United States). It is important to lock in interest rates by extending the maturity of outstanding debt. In the event of acute financing difficulties, the authorities could opt for more radical solutions, like financial repression.

Extending a comprehensive standstill on external debt payments is essential.

Although Ukraine is unlikely to bring in significant revenue from privatisation or the sale of mining rights, the government should continue working in this direction to generate revenue and inward investment. Furthermore, effective use of nationalised firms is central not only for generating revenue for the government but also for utilising their assets for the defence industry.

Printing money

Seigniorage is unlikely to be a durable source of revenue.⁷ First, revenue from printing money is small in dollarised economies because firms and households switch away from the local currency. Ukraine has a history of dollarisation, so such a switch would happen quickly in an environment of higher inflation. Second, to extract large resources from printing money, the government has to repeatedly generate surprise inflation. As people adjust their inflation expectations progressively upward, this ultimately results in hyperinflation, which is deeply damaging and not economically or socially sustainable. Hence high surprise inflation can give only a temporary increase in government revenue. Third, high inflation is unlikely to make credit more accessible – quite the contrary. There is no shortage of liquidity in the banking sector, and in practice the high cost of credit stems from other factors (war risks, poor protection of creditor rights, etc.). Inflation will make the real cost of credit even higher (risk premia will increase due to macroeconomic uncertainty), thus inhibiting economic growth. Fourth, printing money does not resolve the external trade imbalance. If anything, it will result in burning through foreign exchange reserves by encouraging illicit capital flight. Finally, inflation is a regressive tax, even more so than a consumption tax, since the relatively poor probably have more of their wealth in cash. As a result, inflation can undermine national unity and the willingness of Ukraine to resist Russian aggression.

With the prospect of a long war, the (high) risk of the economy being ravaged by high inflation outweighs the (minor) benefit of seigniorage revenue. We therefore strongly advise against reliance on seigniorage as a significant source of revenue for the government.

The external trade deficit

Ukraine is running a persistent trade deficit. War is certainly a prime factor (it means limited ability to export, blockades, and the destruction of domestic oil refineries, necessitating fuel imports). Hence, economic policies alone cannot eliminate the deficit. But they can mitigate the problem. We consider three such policies: adjusting the exchange rate, applying capital controls, and removing export bottlenecks.

Adjusting the exchange rate

The hryvnia should be allowed to adjust in response to trade imbalances and aid flows. The current regime of managed floating should help absorb shocks and adjustments at least in part. The hryvnia should be allowed depreciate gradually to improve the trade balance and help stimulate the economy.⁸ To minimise macroeconomic uncertainty and runs on the currency, the National Bank of Ukraine should smooth short-term fluctuations and allow two-sided variations (i.e., the hryvnia might either appreciate or depreciate on any given day). The central bank should not use reserves to resist trends affecting the exchange rate. Foreign exchange reserves should be used only to
cover structural deficits that arise from financing war-related needs of the government or critical imports (e.g., generators).

Applying capital controls

Given limited reserves and enormous uncertainties, the National Bank of Ukraine has no choice but to retain comprehensive capital outflow controls. The Bank should refrain from any relaxation of existing capital controls. Because Ukraine is effectively cut off from global financial markets, and significant foreign direct investment in the country is unlikely due to the war, distortions from capital controls are smaller than otherwise. Capital controls should also help the government to borrow at a lower rate. For the foreseeable future, foreign exchange reserves should not be used to help private (domestic and foreign) businesses repatriate dividends or other forms of capital. In grave conditions, a short list of critical imports should be reintroduced to help control outflows of foreign currency.

Eliminating export bottlenecks

Reopening of the big Odesa ports unlocked export opportunities. While the government should continue to work on increasing the capacity of seaports, land-based routes are important for diversification and market-access reasons. Here, there is scope for enlisting Ukrainian refugees and the Ukrainian diaspora in export-oriented joint ventures.

Concluding remarks

Although the Trump administration has halted military and economic support to Ukraine, the fundamental calculus is largely unchanged. The economic resources of the EU, the UK, Norway, Canada, Japan and other allies of Ukraine are collectively an order of magnitude greater than those of Russia. There is a growing understanding in Paris, London, Berlin, and other European capitals that the Russian war in Ukraine is a direct and existential threat to the European project, to European security, and to the very ideals of democracy. There is good reason to expect that Europe and others will fill economic and military shortfalls due to US withdrawal. At the same time, the American policy reversal shows that, no matter how deserved assistance to Kyiv may be, Ukraine needs to prepare for all contingencies, including delayed or reduced disbursements of aid from its allies in the face of continued Russian aggression. To paraphrase French President Emmanuel Macron, the future of Ukraine’s fate should not be decided in Moscow, Washington, Budapest, or even Brussels.

References

1. Becker, T., B. Eichengreen, Y. Gorodnichenko, S. Guriev, S. Johnson, T. Mylovanov, M. Obstfeld, K. Rogoff and B. Weder Di Mauro (2022), Macroeconomic Policies for Wartime Ukraine, CEPR Rapid Response Economics 2.
2. Dombrovskis, V., M. Obstfeld, I. Sologoub, Y. Gorodnichenko, T. Becker, A. Fedyk, G. Roland, and B. Weder di Mauro (2024), “Stimulating growth in Ukraine and policies for migrants” return”, CEPR Policy Insight 132.
3. Gorodnichenko, Y. and D. Gros (2025), “Ukraine Refugees: From Temporary Protection to Encouraging Return to Support the Ukrainian Economy”, EconPol Forum 1/2025: 38-40.
4. European Commission (2024), “The future of European competitiveness: Report by Mario Draghi”.
5. Ilzetzki, E. (2025), Guns and Growth: The Economic Consequences of Defense Buildups, Kiel Report 2.

Authors

1. Torbjörn Becker, Stockholm Institute of Transition Economics
2. Barry Eichengreen, University of California, Berkeley and CEPR
3. Yuriy Gorodnichenko, University of California, Berkeley and CEPR
4. Sergei Guriev, London Business School and CEPR
5. Simon Johnson, MIT and CEPR
6. Tymofiy Mylovanov, Kyiv School of Economics, University of Pittsburgh and former
7. Minister of Economic Development, Trade and Agriculture of Ukraine
8. Maurice Obstfeld, University of California, Berkeley and CEPR
9. Kenneth Rogoff, Harvard University
10. Ilona Sologoub, VoxUkraine
11. Beatrice Weder di Mauro, CEPR and Geneva Graduate Institute