Ukraine may face deindustrialization after the war

It is necessary to fundamentally change the attitude of the state to industry and industrial policy

During the war, many industrial enterprises were damaged or destroyed, and the remaining ones are experiencing great problems with working capital, demand and logistics. In October-December, interruptions in the supply of electricity were added to this list. Ukrainian GDP in 2022, tentatively, decreased by 30.4%, while how much industrial production fell is unknown, as the State Statistics Service does not publish this data now. However, it is obvious that the decline in industrial production in Ukraine last year amounted to at least 30-40%, which threatens the post-war deindustrialization of the country.

Industrial policy-2022

Neither in the pre-war period nor during the war, Ukrainian authorities did not have a systemic industrial policy. As part of general business support in 2022, industrial companies could use various tools. However, the overall effectiveness of the implementation of these tools was low. For example, at the very beginning of the war, the authorities abolished VAT and duties on all imported goods, but since July 1, 2022, this decision has been abolished. In turn, the introduced single tax of 2% of turnover, which is planned to be canceled by the middle of this year, turned out not very effective for large backbone companies.

The program «Affordable loans 5-7-9%» also proved to be weak. Since the start of the program in February 2020, banks have issued 53,000 loans to businesses in the amount of UAH 166 billion. However, only UAH 10.9 billion of them went for investment purposes. Basically, within the framework of this program, anti-crisis loans (UAH 61.6 billion), for anti-war purposes (UAH 36.7 billion), refinancing of previously received loans (UAH 28.7 billion) and agricultural loans (UAH 25.7 billion) were issued.

However, in October 2022, the Cabinet of Ministers expanded the 5-7-9% program to cover enterprises destroyed or damaged by the war. A business can get a loan at 9% per annum for up to 5 years in the amount of up to UAH 60 million.

For the post-war recovery of the economy, it is important to adopt by-laws regarding industrial parks. At the beginning of September 2022, the Cabinet of Ministers exempted equipment for industrial parks (IPs) from import duty and import VAT. And even earlier, in the second half of June, the Verkhovna Rada accepted two draft laws providing for a number of new tax and customs benefits for industrial parks.

The relocation of enterprises can be considered a separate direction of industrial policy in the conditions of war. At the end of November 2022, more than 770 enterprises moved their activities to safer regions, more than 600 of them have already resumed work in a new location. At the same time, more than 50% of those relocated are trade enterprises, IT companies, etc. Only 30.2%, or about 230 relocated companies, belong to the processing industry.

Industrial perspectives

In general, no cardinal innovations in industrial policy can be expected in 2023 – the Cabinet of Ministers will focus on existing tools.

“The government, for its part, will continue to help the private sector. Concessional lending programs will continue, in particular for business resumption, the eRobota grant program, regulatory and fiscal incentives within Diya City, industrial parks and investment nurseries. We are also working on the continuation of the «economic visa-free regime» with the EU, improving logistics and new routes for the export of Ukrainian products,” notes Prime Minister of Ukraine Denys Shmyhal.

At the same time, in January, the Verkhovna Rada adopted bills No. 8298 and No. 8299 as a basis for supporting industry and business. The documents provide, in particular:

• exemption of import of equipment and components from VAT and duties – import into the country exclusively for own production (according to specific codes) without the right to alienate under any conditions earlier than five years from the date of their import into the customs territory of Ukraine;
• concessions on rent for the extraction of iron ore and water for the period of martial law;
• single tax benefits for IV group payers, etc.

At the same time, negotiations with the IMF regarding these bills have not yet been conducted and, most likely, the Fund will not support such innovations.

In addition, from January 1, the requirement for the level of localization for the production of certain groups of goods increased to 15%: urban and railway transport, municipal and special equipment, and power equipment. However, one should not overestimate the impact of this requirement in the conditions of war and the decline in the production of the listed products.

Deindustrialization: pros and cons

The war can become a trigger for the final decline of the role of industry in the country’s economy. Considering all the problems generated by the war, such an outcome of events in the post-war perspective is very likely.

“After the end of hostilities, the deindustrialization of Ukraine is quite possible. The Ukrainian industry is going through very difficult times due to falling demand, difficult exports, relocation, disruption of supply chains, rolling blackouts, blocking of tax returns, etc,” notes Andriy Ropitsky, CEO of the industrial park Bila Tserkva.

On the other hand, according to Dmitry Kisilevsky, Deputy Chairman of the Verkhovna Rada Committee on economic development, deindustrialization in Ukraine began long before the Russian invasion and even before the start of the war in 2014.

“If in 2007 we had a share of the processing industry in GDP of about 18%, then in 2021 it was already a critical 10%. The same goes for exports. In 2007, the share of the processing industry in exports was about 73%, and in 2021 – about 37%. That is, Ukraine has been gradually losing its industrial potential over the past 15 years – it has become more and more a country with raw materials, both in terms of GDP and in exports,” explains parliamentarian.

At the same time, now the government has largely given priority to supporting the agro-industrial complex, rather than industry. The industry is still supported at the level of announcing intentions and actions, with an eye to the future. According to First Deputy Prime Minister – Minister of Economy Yulia Sviridenko, Ukraine will focus on the development of industries that will provide the greatest export effect in the direction of the growth model. The government has identified steel sector, agro-industrial complex with a high level of processing, military and aerospace technologies, IT and military-tech based on IT solutions as priority areas.

Such intentions can only be welcomed, but the industry needs to solve its problems here and now, but there is little real progress with this. In addition, it is clear that it is impossible to develop the IT sector without its own industrial base for which it will work.

What to do?

Experts emphasize that for the development of the industry it is necessary to use a set of tools and incentives that have shown their effectiveness in other countries. According to Dmitry Kiselevsky, such tools can promote the creation of industries even during the war:

1. War risks insurance;
2. Access to long and cheap money;
3. Compensation of expenses for capital investments in the processing industry through taxes;
4. Stimulating the export of the processing industry;
5. Expanding the use of localization in public procurement;
6. Development of industrial parks.

“The sector of the military-industrial complex needs and will need special attention. Here, the state must transform from a passive observer to a demanding and capable customer. There is a rule proven by practice: if a state does not buy military products of its own producers, then other states will never do it either, ”adds Dmitry Kiselevsky.

According to Andriy Ropitsky, Ukraine has all the prerequisites for a new wave of industrialization:

1. Partial stabilization of the situation in the industry. According to a recent survey of 200 companies, 45% of them continue to work, as before the war, or work partially – 42%. Among those businesses that continue to operate, the top 5 areas of activity include construction and the production of goods. Producing companies have suffered significant losses in revenues and reduced output, but they are optimistic about the timing of reaching pre-war levels of production in the coming years. In particular, in order to resume production, domestic companies can receive assistance in relocating capacities within the country, and international organizations such as USAID, GIZ and others are considering the possibility of allocating additional grant assistance for the construction of production and storage buildings. Enterprises that do not plan to relocate, and there are more than 60% of them, can count on financial support under the 5-7-9% program, which was expanded to include enterprises destroyed during the war;
2. State support of the domestic producer. To restore the destroyed infrastructure and housing, a huge amount of building materials, energy and heating equipment will be required. It is difficult and unreasonably expensive to import the entire required volume of products. Thanks to the localization law, the local component in the cost of raw materials, materials, components, assemblies purchased at public expense should be at least 15%. This support mechanism will give impetus to the development of the processing industry, attract investment and create about 60,000 new jobs.
3. Nearshoring and entry of Ukrainian-made goods to European markets. European producing companies, having learned from the experience of the COVID-19 lockdown, remember how vulnerable the supply chains of components and finished products from China or India can be. The process of nearshoring – the placement of European plant’s branches in Ukraine – will only intensify over time, given Ukraine’s course towards joining the EU.

Post-war situation

Now in Ukraine, due to the war and the destruction of industries, there is a large-scale replacement of Ukrainian products with foreign goods. Thus, after the end of the war, we will talk not only about the restoration of lost production, but also about the need for Ukrainian producers to return their lost positions in the domestic market.

What will be the process and nature of the post-war recovery of the country’s economy – no one knows yet, but it is clear that this should take place already at a new technological level.

“Communication with Ukrainian industrialists shows that they see no point in restoring what was destroyed to the pre-war level. Now we need to restore everything so that production has development prospects – enterprises of a higher level will be created in terms of technology, quality, production organization,” says the CEO of UParks and Industrial Management Company Valeriy Kyrylko.

Also, Ukraine needs to move to a different level of location of enterprises, in particular, to the formation of industrial clusters that will provide a competitive cost of production.

“Since Russia and Belarus have compromised themselves with war crimes and can no longer be reliable trading partners, Ukraine can set up their exports to the EU countries for a total of $37 billion. In the next five years, Ukraine may become a regional producing hub,” Andriy Ropitsky adds.

At a time when European companies are considering the possibility of transferring their capacities, even despite military risks, Ukraine remains an attractive place to locate production due to its skilled, cheap labor and relatively low construction costs.

“After the war, funds will pour into Ukraine to restore the economy. Many Ukrainian companies are counting on this. At all international venues, including at the conference on the post-war reconstruction of Ukraine in Lugano, they say the same thing – after the onset of peace, Western funds and investors are ready to invest in Ukraine,” sums up Valeryi Kyrylko.

Unfortunately, many experts do not share this optimism. International business and investors carefully look at local conditions and preferences provided by various states and regions. The renaissance of industrial policies and policies to support the localization of production began in pre-Covid times. Ukraine has always lost in this battle for the producer – not a single international investor has been able to implement a large industrial project over the past 10-15 years (let’s recall the notorious example of Black Iron, which was never able to build a mining and processing plant in Kryvyi Rih, and the VW concern, which did not choose our country to accommodate production). Without a conceptual change in the state’s approach to industrial policy and industrial development, Ukraine has very little chance of a post-war recovery.