Strengthening Economies in a Stormy and Fragmenting World

It’s a pleasure and an honor to be here in Kyiv, the city which has come to symbolize resilience, dignity and the enduring spirit of freedom. Kyiv stands not only as the heart of Ukraine but as a beacon of what it means to hold steadily to democratic values in the face of the immense challenge. As the great Ukrainian poet Taras Shevchenko wrote, “In our own house our own truth, our own strength, and freedom.”

Today Ukraine reminds all of Europe of this powerful truth. Our security and our prosperity rely on our unity and on integration with our neighbours. In the face of Russia’s unjustified war of aggression Ukrainians demonstrated extraordinary courage and resilience in defense of their country and its democratic values. 

We should not see Ukraine as a threat, we should see Ukraine as an opportunity, as a stimulus, as a shield and a catalyst. Keeping with the theme of the conference, I will try to reflect on recent history lessons that we’ve learned about strengthening and integrating economies in an increasingly stormy and fragmented world. The experience shows that closer ties with European neighborhood can provide a strong foundation for Ukraine to rebuild and emerge stronger. As geopolitical tensions rise and global supply chains fragment, the case for deeper regional integration, mutually beneficial to all, has never been as strong. Europe’s own journey of integration after the devastating WWII offers invaluable insights that can help guide Ukraine’s path forward.

Two key lessons stand out. First, deeper integration increases the potential reward but also raises the risks if it is not managed wisely. Sound domestic policy frameworks are essential to maximise growth and to safeguard stability. The second lesson is that benefits are not automatic nor permanent. Maintaining them requires continuous reform movement, and these reforms have to be tailored and properly sequenced in order to deliver benefits for people, since otherwise the appetite for reforms fades away.

Benefits of integration

Let’s have a quick look on the benefits of integrating in the fragmenting world. During the Cold war the iron curtain fractured the European community. Trade between East and West fell by nearly 50%. It was like imposing a nearly 50% tariff on any trade between East and West leading to immense welfare losses and isolating the Eastern block from global markets. But the transformation since Europe’s Eastern enlargement has been nothing short of remarkable. On average countries that joined the EU in 2004 have nearly doubled their GDP per capita over the last two decades. 

Critically, this was not just catching up from a low base. Between 2004 and 2019 the EU’s new member states saw their GDP per capita grow 32% more than comparable non-EU countries. The reason is deeper economic integration. Those who were already highly embedded into regional economy gained the most (e.g. Poland). While all new members experienced gains, countries with stronger integration into regional value chains recorded nearly 10 p.p. higher GDP per capita growth compared to their less integrated peers, regardless of geographic proximity. Technology and productivity spillovers made the difference. Our research at ECB shows that a 10% increase in productivity of Western EU firms translated into a 5% productivity gain in Central and Eastern European firms linked to those supply chains.

Thus, the case for regional integration is pretty clear. And in today’s increasingly fragmented geopolitical landscape it has become even more compelling. 

First and foremost, regional integration underpins growth. European economies are highly open thus the world splintering into rival blocks poses clear risk to prosperity. However, Europe’s most important trading partner is Europe itself. Around 65% of Euro area exports go to other European countries, including the UK, Norway, Switzerland. For Ukraine Europe too is the principal trading partner accounting for about 50% of its grade in goods in 2024. So by deepening economic ties and more closely linking neighbouring economies, we can reduce our exposure to external shocks. Rising trade within our region can help offset losses in the global market. 

The second benefit is that regional integration strengthens resilience. One consequence of geopolitical fragmentation is the realignment of supply chains towards trusted partners. Nearly half of the firms involved in external trade have already revised their strategies or intend to do so, including relocating part of their operations closer to home. While this trend reduces strategic dependencies, it can also raise labour costs. But large integrated regions can mitigate these costs by replicating many of the benefits of globalization at the regional level. Supply chains can be reorganized regionally allowing each country to specialize based on its comparative advantage within regional value chains. 

Ukraine stands to benefit significantly from these expanding networks and the EU stands to benefit from having Ukraine as a partner. Let me provide two practical examples. First is the automotive sector. Ukrainian firms today produce about 7% of all wire harnesses used in EU vehicles. As the automotive industry is shifting into the electrical dimension, which requires more complex wiring systems, Ukraine’s manufacturing base is well-positioned to scale up and play a much larger role in that value chain.

Second example is the drone industry which has become one of the most advanced in the region. Drones are not only a critical component of modern warfare as you have so expertly demonstrated, but also a technology with substantial spillover effects in far-reaching dual use applications. Indeed, the country’s ambition to produce 4.5 million drones by 2025 has accelerated innovation in material sciences, battery technology, 3D printing, etc. These advances are already finding civilian applications in sectors such as logistics, agriculture, and emergency response. In sum, for both existing EU members and neighbouring countries such as Ukraine, regional integration is both a path to prosperity and an anchor in an increasingly fragmented world.

Risks of integration

As we examine the experience of countries that have used regional integration as a platform for growth and reform, we can learn at least two important lessons. First, if integration is not accompanied by the appropriate reforms, it can create new vulnerabilities, especially in the financial sphere. Financial integration often brings volatile capital inflows which can make it difficult to distinguish between sustainable growth and unsustainable excesses in real time. This can happen when productivity gains in tradable sectors such as manufacturing drive up wages in those sectors, which then spill over into higher wages in non-tradable sectors. This pushes up inflation. While this effect is a normal feature of catching up, it can make it very easy to mistake genuine convergence for economic overheating. If foreign capital is in fact driving financial imbalances such as unsustainable real estate booms, countries may exhibit the same pattern of rising wages and inflation masking underlying vulnerabilities. 

Another potential distortion is that capital inflows can significantly affect government fiscal positions by boosting tax revenues and creating the illusion of permanently greater fiscal space. This often leads to procyclical policies with governments increasing spending or cutting taxes during boom periods only to face fiscal stress when inflows reverse or growth slows. 

These two dynamics we have seen in the recent experience with integration. After the eastern enlargement in 2004, financial integration accelerated rapidly in 2004-2008. The new member states experienced an extraordinary surge in capital flows averaging over 12% of GDP annually which is twice the typical level of emerging markets globally.

Initially, these rapid capital inflows brought clear benefits. They expanded access to credit, fueled growth, and enabled much needed development. 

However, in many countries foreign capital was disproportionately channeled into consumption and construction booms while tax revenues rose sharply on the back of property transactions and buoyant domestic demand. This, unfortunately, led to widespread misallocation of private capital and inefficient public spending. Then, the global financial crisis struck and capital flows reversed sharply. Between December 2008 and May 2013, external bank liabilities in non-Euro area Central and Eastern european countries declined by an average of 27%, and in some countries by 50%.

Risk avoidance strategy

However, the risk associated with financial integration can actually be avoided. We see this because not all countries in the region were affected equally. Better performers typically shared two characteristics. First, they had clear policies to channel foreign investments into productive sectors. Strong industrial strategies, skilled workforce and integration into global supply chains helped direct this investment into manufacturing and tradable services sectors that in turn drive exports growth and are less prone to unsustainable booms and asset bubbles. 

Second, they maintained robust financial policy frameworks: tighter capital requirements, active macroprudential measures and countercyclical buffers strengthened the domestic banking sector and curbed excessive mortgage lending. These tools enabled these countries to absorb large capital inflows without creating destabilising imbalances. The lesson is clear: as countries integrate into the regions, strong domestic policy frameworks are critical to ensuring that capital inflows support long-term growth rather than generating financial instability or inefficient allocation. 

This insight is especially relevant for Ukraine today as it charts its path towards recovery. If reconstruction proceeds as planned, the country could attract significant capital inflows over the next decade. But without the right safeguards that capital risks being misallocated, undermining long-term productivity instead of strengthening it. There are very encouraging signs that you are learning from what has happened in the last couple of decades nearby. 

EU integration and reforms in Ukraine

The EU-Ukraine association agreement and DCFTA have already driven significant reforms in the financial sector. Ukraine’s banking regulation now aligns with 74% of EU standards covering critical areas such as capital adequacy, governance, and auditing. The NBU has adopted a risk-based supervisory model inspired by ECB single supervisory mechanism, markedly improving oversight. And despite unbelievably challenging circumstances, Ukraine is modernizing its capital market, consolidating exchanges, upgrading settlement systems, and strengthening regulatory enforcement to attract long-term investors. In that area you might teach us a few lessons.

The reforms that you are conducting are already delivering results. In 2023 Ukraine’s banking sector remained profitable and well-capitalized despite the ongoing war — an outcome that would have been unthinkable ten years ago. 

We know that progress is essential, especially in fiscal governance. Strengthening public investment management will be critical to ensure that reconstruction funds are allocated transparently and efficiently. And this is not about meeting external standards imposed by some institutions. It’s about ensuring that every Euro, every Hryvnia delivers a return for the Ukrainian people.

The necessity of constant reforms

Moreover, reforms cannot be treated as a one-time effort. They should be ongoing and sustained to ensure the benefits of regional integration since the latter are not automatic nor permanent and should not be taken for granted. Sustaining these benefits requires continuous reforms. Just as importantly, it requires that these reforms be conducted and framed in such a way that citizens see visible and tangible improvement in their daily lives. 

In this context there are two risks to watch out for. First, the institutional reform momentum can fade and it fades particularly if the economic benefits do not follow quickly. Deeper regional integration typically begins with aligning framework conditions such as legal systems, regulation, public administration. These areas often improve rapidly. But for the economic gains to materialize, domestic entrepreneurs, households, foreign investors must respond to the new incentives created, which takes time.

In the long run evidence suggests that countries with initially weaker institutions benefit the most from adopting higher standards. In the short run, if people see only the efforts and not the payoff of this effort, public support for further reforms will weaken putting long-term convergence at risk. 

The second risk is that a structural shift in the economy may weaken the link between integration and economic convergence over time. The integration of goods’ market has traditionally driven convergence almost automatically as FDI flows to the countries with lower land and labour cost, supply chains relocate and lower-income countries benefit from technology transfers. 

This will remain an important mechanism even in the era of supply chain reshoring. But countries can no longer rely only on this mechanism as much as they did in the past. Future growth in intra-EU trade is expected to depend increasingly not on goods but on services, particularly digital services. Research shows that service sector activity tends to concentrate in more affluent urban areas that exhibit the hallmark of the knowledge economy: tertiary education rights, well developed technology and science sectors, and robust digital infrastructure. 

This means that deeper integration alone will not guarantee broad-based convergence across all regions. Over time, countries will need to invest more in education, skills, and digitalization to ensure that they can build a high level of human capital and leverage that under the integration paradigm. Maintaining the path of convergence is therefore not as easy and straightforward as it was before. But slowing down the reforms will not be the answer, especially in the shock-prone world that we face today. 

Additionally, there is a clear link between strong institutions and economic resilience. Our research indicates that during the pandemic, regions with lower institutional quality experience (all else equal) an additional GDP per capita decline of around 4 p.p. compared to the top ten regions with the highest quality of government. 

Ukraine’s competitive advantage and new geopolitical realities

As our economies are increasingly buffeted by global turbulence, institutional backsliding risks creating a vicious circle: repeated shocks can undermine economic convergence and further erode public confidence in the reform process. Thus, the best way for countries to sustain reform momentum is to recognize the importance of maintaining public support and as much as possible pair governance improvements with a focus on sectors where they have a clear competitive edge and where deeper integration with the region can unlock significant and rapid growth opportunities. In this way citizens will feel the benefits of reform more quickly and more widely. 

I contend that Ukraine is well positioned to put this into practice. Its IT sector is already relatively strong. IT services exports reached nearly 7bn USD in 2023 making it one of the country’s leading export sectors despite the war.

Ukraine produces around 130 000 STEM graduates each year exceeding that of Germany or France, and it ranks them among the top 5 countries globally for 35 IT professions. Successful IT clusters are active in several cities, and major foreign firms, including Apple, Microsoft, Boeing and Siemens have established their R&D operations in Ukraine. The dynamic defense tech ecosystem is also taking shape with Ukrainian startups attracting almost $0.5 billion of funding in 2024 surpassing many of their peers across Central and Eastern Europe. Experience from countries like Israel suggests that such a foundation can enable a country to emerge as a broader technology hub in the years ahead.

If Ukraine stays on course of institutional reform and continues to adapt its economy to new opportunities despite the stormy environment, it can emerge as a vital engine of growth and a key contributor to the region’s future.

Ukraine stands at the pivotal moment facing the horrible hardship of war, the challenge of reconstruction and the opportunity of deeper regional integration. In a world marked by shifting geopolitical realities such integration offers a clear path to recovery and lasting prosperity. This is good for Ukraine and for Europe. The recent history of regional integration shows not only its immense benefits but also the importance of managing transitional risks through robust policy frameworks. It also underlines the need to sustain reform over time by ensuring that its benefits are felt by the people. 

I’m confident that you will be able to fully realize its economic potential turning the upheaval of today into the foundation of a dynamic future. As Ivan Franko, one of Ukraine’s greatest poets, wrote. “Even though life is but a moment, and made up of moments, we carry eternity in our souls”. This enduring spirit captures the resilience and potential of Ukrainian people and its economy. The spirit that will continue to drive advancement and renewal in the years ahead.

I was the first managing director of the IMF to visit Ukraine ever in 2015. I’m now the first president of the ECB to visit Ukraine in 2025. I hope it will not take ten years for me to be the first former ECB president to attend as a special guest the governing council of the ECB in Kyiv.

Thank you very much.