We can't—or we won't?

Ukraine im­ports many sim­ple con­sumer items that could be do­mes­ti­cally man­u­fac­tured at a time when a large swath of Ukraini­ans is ei­ther job­less or does not have a steady source of in­come

The Ukrainian Week - - ECONOMICS - Olek­sandr Kra­mar

Ukraini­ans spend close to UAH 1 tril­lion on im­ports ev­ery year. Last year, of­fi­cially US $37.5bn was bought, although a good por­tion of im­ports is brought in on fixed con­tracts with ar­ti­fi­cially low prices or are sim­ply con­tra­band. What’s more of­fi­cial fig­ures from Derzh­stat show that the pro­por­tion of im­ports to Ukrainian-made con­sumer goods in re­tail net­works has tended to grow over the last 10 years. Where in 2005, the share of all im­ported goods sold by Ukrainian re­tail­ers was 29.5%, by 2013, it was up to 42.8%, nearly half again as much.

In the last two years, do­mes­tic prod­ucts have won back a tiny share of the mar­ket, inch­ing up from 57.2% to 58.1%. But when we con­sider that this tiny drop in im­ported goods took place at a time when the hryv­nia plunged to a third of its for­mer value, mean­ing that for­eign-made goods tripled in value, it’s clear that this rep­re­sents a se­ri­ous threat, not just to a rapid re­cov­ery, but to real growth in the share of Ukrainian-made goods in the fore­see­able fu­ture.

Cu­ri­ously enough, the share of crit­i­cal im­ports—en­ergy and raw ma­te­ri­als—has been shrink­ing year af­ter year, as has spend­ing on im­ported ma­chin­ery and equip­ment nec­es­sary to mod­ern­ize the coun­try’s econ­omy, while for­eign-made con­sumer goods have steadily strength­ened their po­si­tions on Ukraine’s do­mes­tic mar­ket. Re­plac­ing these goods with Ukrainian-made ones would have a ma­jor pos­i­tive im­pact on the coun­try’s econ­omy, which has con­tin­ued to de­cline—the vol­ume of goods and ser­vices pro­duced per capita re­mains well below both 1991 and 2008 lev­els. It would also pro­vide jobs for mil­lions of Ukraini­ans who are un­em­ployed to­day.

THE LOGIC OF IM­PORT SUBSTITUTION, UKRAINIAN-STYLE

The need for im­port substitution in Ukraine has no re­la­tion­ship with the idea of autarchy or self­suf­fi­ciency, which is com­mon of to­tal­i­tar­ian regimes that want to iso­late them­selves and op­pose the world around them. It should be based on com­mon sense and on a need to mit­i­gate the ex­ces­sive de­pen­dence of the do­mes­tic mar­ket on im­ports of an enor­mous range of con­sumer goods.

In 2015, Ukraine’s work­force, not in­clud­ing the oc­cu­pied ter­ri­to­ries, amounted to 19.9mn peo­ple of work­ing age—ex­clud­ing those who are study­ing or can­not work for health rea­sons—, and 0.7mn peo­ple of pen­sion­able age who were still work­ing (see Em­ploy­ment). The rest, one way or another, is sim­ply hid­den un­em­ploy­ment, which can cur­rently be es­ti­mated at about 10mn of able-bod­ied Ukraini­ans. The fact that they some­how man­age to find part­time, tem­po­rary or ir­reg­u­lar work for pay, which Derzh­stat, the sta­tis­tics agency, cat­e­go­rizes as “self­em­ployed” does not re­ally change the re­al­ity.

In the cur­rent eco­nomic sit­u­a­tion, set­ting up a green­field ex­port- ori­ented busi­ness is hard for small busi­nesses, and even for a good chunk of medium ones. This is es­pe­cially true if it in­volves en­ter­ing mar­kets that are dis­tant and not tra­di­tional for the par­tic­u­lar sec­tor. This process needs to be linked to get­ting Ukraine plugged into the global chains of transna­tional cor­po­ra­tions and to the

THE SHARE OF CRIT­I­CAL IM­PORTS—EN­ERGY AND RAW MA­TE­RI­ALS—HAS BEEN SHRINK­ING YEAR AF­TER YEAR, WHILE FOR­EIGN-MADE CON­SUMER GOODS HAVE STEADILY STRENGTH­ENED THEIR PO­SI­TIONS ON UKRAINE'S DO­MES­TIC MAR­KET

in­di­vid­ual suc­cess of big do­mes­tic busi­ness, and a por­tion of medium ones as well.

But his­tor­i­cally, the suc­cess of Ukrainian SMEs, es­pe­cially those that are start-ups, has the best chances when started pre­cisely with win­ning a share of the do­mes­tic mar­ket. This gen­er­ally in­cludes both set­ting up new green­field man­u­fac­tur­ing and trans­fer­ring part of a part­ner’s tech­nol­ogy and man­u­fac­tur­ing fa­cil­i­ties to Ukraine un­der var­i­ous forms of col­lab­o­ra­tion, be it on a co­op­er­a­tive or a li­cense ba­sis. Once a busi­ness is suc­cess­ful on the do­mes­tic mar­ket and has de­vel­oped some “mus­cle,” such do­mes­tic firms can also try en­ter­ing for­eign mar­kets.

This kind of strat­egy should go hand in hand with the process of Euro­pean and global cor­po­ra­tions set­ting up sub­sidiaries in Ukraine and should play the key role in pro­vid­ing a new, pop­u­lous layer

of in­de­pen­dent lo­cal busi­nesses. Bet­ting ex­clu­sively on the pro­duc­tion ca­pac­i­ties, es­pe­cially ex­port ori­ented ones, of transna­tional cor­po­ra­tions or on tolling schemes is dan­ger­ous in the long run: since such cor­po­ra­tions are not tied to Ukraine in any way ex­cept for re­li­able f lows of prof­its from their fa­cil­i­ties here, they will be the first to move those fa­cil­i­ties to another coun­try the minute the global sit­u­a­tion changes.

PROMIS­ING NICHES

Ukraine con­tin­ues to be a ma­jor ex­porter of semifin­ished cast­ing prod­ucts that it is hav­ing an ev­er­harder time sell­ing, at the same time as fin­ished steel prod­ucts with a much higher added value are be­ing im­ported in grow­ing vol­umes. What’s more, these sup­pli­ers are from coun­tries where the cost of la­bor in the steel in­dus­try is far higher than in Ukraine (see Im­ported met­al­ware). Mean­while, the coun­try’s steel mag­nates, aka oli­garchs, are in no hurry to ex­pand the scale of pro­cess­ing in their fa­cil­i­ties, which has led to grow­ing un­em­ploy­ment in the in­dus­trial belt of Ukraine’s southeast.

More re­cently, Ukraine has been in­creas­ing its ex­ports of light in­dus­trial goods and fur­ni­ture to Euro­pean mar­kets on the ba­sis of toll man­u­fac­tur­ing. Cloth­ing sold abroad in 2015 alone reached nearly US $500mn, and a few hun­dred more mil­lion in fur­ni­ture, toys and sports equip­ment was shipped out. Sta­ble de­mand for these Ukraini­an­made goods tes­ti­fies to the highly com­pet­i­tive ca­pac­i­ties of do­mes­tic en­ter­prises in fill­ing or­ders. Nev­er­the­less, the share of im­ports of light in­dus­trial prod­ucts re­mains dom­i­nant on the do­mes­tic mar­ket.

In­deed, the share of Ukrainian-made cloth­ing out of cloth has col­lapsed from 23.3% to 5.7% in the last 10 years, the share of knits has plunged from 16.9% to 4.1%, and the share of footwear has dropped from 9.3% to 1.1%. Even the mar­ket for stock­ings and socks, where do­mes­tic man­u­fac­tur­ers re­main among the strong­est in light in­dus­try, the share of im­ports has jumped from 41% to 60% in the same pe­riod. Based on their of­fi­cially de­clared value, which is typ­i­cally ar­ti­fi­cially re­duced to cut down on im­port duty, cloth­ing and ac­ces­sories alone worth US $340mn were im­ported in 2015, plus another US $193mn in footwear.

Ukrainian mak­ers of cos­met­ics and per­fumes are also sharply los­ing mar­ket share, los­ing 33% over the last 10 years, down to 30.5% and 19.8% of the to­tal mar­ket for these goods. And yet, the vol­ume of im­ports of cos­met­ics, per­fumes, per­sonal care prod­ucts like soap, sham­poo and tooth­paste was over US $470mn, even at the height of the eco­nomic cri­sis in 2015.

There is also tremen­dous po­ten­tial for im­port substitution in the fuel and en­ergy com­plex (FEC). This year, Ukraine will likely spend US $6-7bn on this. The process of sub­sti­tut­ing nat­u­ral gas has been go­ing on for sev­eral years now and has been given a real boost by in­creas­ing the price for do­mes­ti­cally ex­tracted gas to im­port lev­els. Mean­while, to in­crease the share of do­mes­tic re­fin­ing, this is the best time to take ad­van­tage of the situ- ation as the world mar­ket for black gold un­der­goes a ma­jor re­dis­tri­bu­tion. The idea would be to of­fer one or more oil-pro­duc­ing coun­tries that would like to push Rus­sia out of the Euro­pean mar­ket to part­ner in an oil re­fin­ery project with con­sid­er­able depth of re­fin­ing in Ukraine.

FLOUR­ISH­ING WITH THE FARM SEC­TOR

Even as Ukraine has jus­ti­fied claims to sta­tus as an “agri­cul­tural su­per­power,” it re­mains a ma­jor im­porter of a slew of food­stuffs with sig­nif­i­cant added value. Fully 16% of its fresh veg­eta­bles,

nearly 25% of its canned veg­eta­bles, 40% of its fruit pre­serves, and 55% of the fresh fruit sold in su­per­mar­ket chains all come from abroad. Sim­i­larly, 55% of pack­aged cof­fees and 30% of teas are im­ported, along with 23% of spir­its and 35% of wines, shares that have dou­bled and tripled over the last 10 years.

This mas­sive trend to­wards more and more im­ports of food is in the face of con­sid­er­ably higher prices com­pared to do­mes­tic prod­ucts and is again a re­flec­tion of how Ukrainian pro­duc­ers are ig­nor­ing spe­cific seg­ments of this mar­ket. Ukraine is thus a ma­jor im­porter in the food busi­ness: ex­tracts and essences of cof­fee and tea worth US $134.4mn; pure ethanol worth US $122.8mn, beers and wines worth US $85mn, choco­late worth US $70.5mn, pro­cessed veg­eta­bles worth US $46.6mn, ready-made sauces and spices worth US $45.5mn, and feed for live­stock worth US $144mn. At the same time, a sig­nif­i­cant share of im­ported fresh veg­eta­bles, worth US $48.8mn, is in part due to a do­mes­tic green­house busi­ness that is un­der­de­vel­oped, while im­ports of ap­ples and pears worth over US $23mn is re­lated to un­der­de­vel­oped in­fra­struc­ture for keep­ing such pro­duce in Ukraine.

With en­ergy con­ser­va­tion on the rise, new op­por­tu­ni­ties for im­port substitution are be­com­ing avail­able, in­creas­ing de­mand for en­ergy-sav­ing equip­ment over tra­di­tional ver­sions sub­stan­tially. For in­stance, in 2015, cen­tral heat­ing fur­naces worth US $37.9mn were im­ported to Ukraine, as well as US $31.4mn worth of ra­di­a­tors, and US $23.6mn worth of high- ef­fi­ciency light bulbs. This grow­ing mar­ket of­fers op­por­tu­ni­ties to set up lo­cal man­u­fac­tur­ing, which is good for both existing man­u­fac­tur­ers and new ones, specif­i­cally to set up co­op­er­a­tion with for­eign com­pa­nies. Nor is much be­ing done to take ad­van­tage of the po­ten­tial to set up lo­cal pro­duc­tion of durable con­sumer goods, such as house­hold ap­pli­ances, com­put­ers, tele­phones and smart­phones, and pas­sen­ger cars.

At the same time as the sec­tor for out­sourced IT ser­vices has been boom­ing for the last 10 years, the share of com­puter tech­nol­ogy, pe­riph­er­als and soft­ware be­ing pro­duced do­mes­ti­cally col­lapsed al­most en­tirely, go­ing from 22.5% in 2005 to a mar­ginal 0.8% in 2015. Even at the of­fi­cially de­clared prices in im­port con­tracts, for­eign com­put­ers, mo­bile phones and spare parts were worth US $1bn in 2015. An ad­di­tional US $660mn worth of elec­tron­ics were im­ported. In the last decade, the share of au­to­mo­biles as­sem­bled in Ukraine has plunged from 23% to 8%, with US $824mn worth be­ing im­ported in 2015 alone. Rub­ber tires and tire cas­ings worth over US $250mn are brought into Ukraine from abroad ev­ery year.

Do­mes­tic SMEs are more than ca­pa­ble of sub­sti­tut­ing with their own prod­ucts in these mar­kets by work­ing with for­eign man­u­fac­tur­ers of equip­ment un­der li­cense, which would es­tab­lish an area of po­ten­tial op­er­a­tions for hun­dreds of new SMEs and gen­er­ate tens if not hun­dreds of thou­sands of new jobs.

Mean­while, Ukraine’s farm sec­tor is cur­rently de­vel­op­ing based on the wide­spread im­port of tech­nol­ogy, equip­ment, fer­til­iz­ers, seed, and plant pro­tec­tion means. Even in cri­sis-rid­den 2015, over US $2bn of this kind of goods was im­ported ac­cord­ing to of­fi­cial data. In fact, some seg­ments are nearly en­tirely de­pen­dent on im­ports, which not only sug­gests that the do­mes­tic mar­ket is be­ing com­pletely ig­nored, but also rep­re­sents se­ri­ous risks to sta­ble growth in Ukraine’s AIC, although it is the largest and one of the most promis­ing sec­tors in the do­mes­tic econ­omy. In the fer­til­izer mar­ket, which is worth US $708mn, there is a Rus­sian-Be­laru­sian mo­nop­oly on a slew of po­si­tions, es­pe­cially potas­sium, phos­phates and potash­phos­phate com­pounds. Yet, as the do­mes­tic farm sec­tor con­tin­ues to grow, it will need this kind of prod­uct in greater vol­umes.

What’s even more promis­ing is the mod­ern­iza­tion and re­place­ment of de­pre­ci­ated farm equip­ment and ma­chin­ery, with­out which the sec­tor’s po­ten­tial will never be reached. In 2015, farm

THERE NEEDS TO BE A WELL-THOUGHT-OUT, HIGH QUAL­ITY POL­ICY FOR KEEP­ING PEO­PLE IN­FORMED AND FOR TRAIN­ING PO­TEN­TIAL EN­TREPRENEURS, MAN­AGERS AND PRO­DUC­TION WORK­ERS FOR FU­TURE IM­PORT SUBSTITUTION PROJECTS

equip­ment worth some US $600mn was im­ported, in­clud­ing US $229.3mn in trac­tors, US $106.6mn in grain har­vesters, US $70.4mn in seed­ers and mow­ers, and US $22.4mn in plows and har­rows. To­day, the mar­ket for this equip­ment is al­ready highly com­pet­i­tive. For in­stance, Be­larus and the US are jock­ey­ing for top place in sup­ply­ing trac­tors, with each of them boast­ing around 25% mar­ket share, fol­lowed by sup­pli­ers from sev­eral EU coun­tries—the Nether­lands, Ger­many, France and Poland—and China. The Ukrainian mar­ket is clearly a good one to in­vest in, as its po­ten­tial for dy­namic growth is al­ready ev­i­dent. Clearly, some of these man­u­fac­tur­ers might be pre­pared to set up pro­duc­tion lines in Ukraine and to grad­u­ally ex­pand their mar­ket share of lo­cally-made parts.

GET OVER YOUR COM­PLEXES

There is a wide­spread and dan­ger­ous max­i­mal­ism in Ukraine to­day, where im­port substitution is be­ing re­jected be­cause do­mes­tic pro­duc­ers are not

able to of­fer ei­ther ex­clu­sive or in­no­va­tive prod­ucts that are bet­ter than the best analogs else­where in the world or at least at their level. This kind of at­ti­tude has al­ready caused Ukraine con­sid­er­able harm as it treads wa­ter in­dus­tri­ally. Mean­while, a slew of Asian coun­tries that just 1020 years ago were in worse shape than Ukraine man­aged to get their hands on li­censes and tech­nolo­gies to pro­duce items that were de­vised in de­vel­oped coun­tries and are not the lat­est any more. This en­sured them rapid ex­pan­sion of man­u­fac­tur­ing ca­pac­i­ties, more jobs and higher in­comes for their cit­i­zens, which in turn stim­u­lated a wealth­ier con­sumer mar­ket and more mus­cu­lar busi­ness. In a coun­try where ef­fec­tively ev­ery sec­ond adult has no of­fi­cial job, lo­cal­iz­ing just about any kind of man­u­fac­tur­ing that can sub­sti­tute for im­ports would be a great boon.

Here, we also have to con­sider another “com­plex” that is com­mon among Ukraini­ans, and that is prej­u­dice against goods made in their own coun­try as be­ing ipso facto worse than any im­ports. This cre­ates an il­lu­sion that Ukraini­ans them­selves are un­able to pro­duce any­thing of sub­stance and there­fore have no right to a de­cent liv­ing stan­dard and lifestyle. Those who ac­tu­ally buy “Made in Ukraine” prod­ucts ve­he­mently dis­agree with this po­si­tion.

THE ROLE OF THE STATE

The bot­tom line is that im­port substitution can­not pos­si­bly take place us­ing tra­di­tional mea­sures such as pro­tec­tion­ism based on dis­crim­i­na­tion or pro­hib­i­tive im­port du­ties. Ukraine’s in­ter­na­tional com­mit­ments and its enor­mous de­pen­dence on ex­ports mean that the coun­try’s do­mes­tic sup­pli­ers would run into se­ri­ous prob­lems. Ar­ti­fi­cial pro­tec­tion would also have a long-term neg­a­tive im­pact on the over­all com­pet­i­tive­ness of the do­mes­tic econ­omy.

On the other hand, the gov­ern­ment can pro­vide in­cen­tives for im­port substitution by sup­port­ing com­pa­nies in those sec­tors where they can quite eas­ily com­pete on the do­mes­tic mar­ket with for­eign sup­pli­ers. It can also in­flu­ence out­side sup­pli­ers by in­cen­tiviz­ing the es­tab­lish­ment of lo­cal pro­duc­tion fa­cil­i­ties, start­ing with sim­ply as­sem­bling fi­nal goods and even­tu­ally in­creas­ing the level of lo­cal man­u­fac­tur­ing.

For in­stance, the gov­ern­ment can of­fer leas­ing and cred­it­ing pro­grams to its cit­i­zens and com­pa­nies reg­is­tered in Ukraine that only cover the assem­bly or pro­duc­tion of goods in coun­try. It can also of­fer hryv­nia- de­nom­i­nated loans on the same terms and con­di­tions that for­eign com­peti­tors get them. Tax hol­i­days for new busi­nesses or for new projects by existing firms are pop­u­lar form of in­cen­tive. Fi­nally, red tape needs to be min­i­mized so that is­sues re­lated to per­mits, land al­lo­ca­tion, util­ity hook-ups for new pro­duc­tion fa­cil­i­ties and so on are han­dled quickly and ef­fec­tively.

Last but not least, there needs to be a wellthought- out, high qual­ity pol­icy for keep­ing peo­ple in­formed and for train­ing po­ten­tial en­trepreneurs, man­agers and pro­duc­tion work­ers for fu­ture im­port substitution projects. All too of­ten, po­ten­tial en­trepreneurs and em­ploy­ees alike have no idea how to make things hap­pen for them­selves with­out em­i­grat­ing. At a cer­tain stage, it makes sense for the state and in­ter­na­tional foun­da­tions and or­ga­ni­za­tions that have re­sources for this pur­pose to pro­vide funds to in­vite man­agers and other spe­cial­ists from abroad to con­sult and share knowl­edge for the nec­es­sary pro­duc­tion fa­cil­i­ties to be launched and es­tab­lished in Ukraine.

And there’s more that can be done: the gov­ern­ment can also build green­field fa­cil­i­ties, man­age them un­til they are prof­itable, and then sell shares on the stock mar­ket or auc­tion off en­tire com­plexes. Any money earned can be rein­vested in re­peat­ing the same scheme to de­velop im­port-sub­sti­tut­ing man­u­fac­tur­ing. In the end, all these mea­sures and others that have not been men­tioned should be used alone and in com­bi­na­tion for the max­i­mum pos­si­ble im­pact.

Do­mes­tic pro­duc­tion of many prod­ucts to re­place sim­pler im­ports or im­ported goods that are in se­ri­ous and grow­ing de­mand—through de­vel­op­ing the farm sec­tor and en­ergy con­ser­va­tion, mod­ern­iz­ing in­fra­struc­ture, and so on. By pro­vid­ing jobs and adding con­sumers with cash to spend will in­crease de­mand in­ter­nally and ex­pand the do­mes­tic mar­ket con­sid­er­ably, which will, in turn, in­crease GDP and tax rev­enues in the bud­gets of var­i­ous lev­els of gov­ern­ment, and gen­er­ate more jobs in the ser­vice in­dus­tries. The mul­ti­plier ef­fect is po­ten­tially enor­mous for Ukraine.

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