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Policy Papers

  • 01.09.2014

    Ukrainian Machine Building: Strategic options and short term measures in view of trade disruptions with Russia

    (Code:PP_02_2014)

    Ukraine faces the possibility of major trade disruptions with Russia due to the current political tensions. The machine building sector is most exposed to the Russian market among all Ukrainian sectors, with 32% of output being exported to Russia. For this reason, the focus of the present paper is on this sector.

    The machine building sector is a major component of the larger manufacturing sector, contributing 25% to gross value added in the manufacturing sector and hence around 3.5% to the gross domestic product of Ukraine. It consists of six subsectors. 51% of output is produced by the three transport-related subsectors, the railway, aircraft/shipping and car industries. Manufacture of general machinery and equipment well as manufacture of electrical equipment are also relatively large subsectors of machine building, representing 27% and 16% of machine building output.

    The possibility of major loss of access to the Russian market would hit the sector hard, particularly as export diversification and productivity are low in most subsectors. The largest subsector, the railway industry, sells 82% of its total output in Russia and on the Ukrainian domestic market. Productivity in machine building is only two thirds of the national average, indicating a capital and technology deficit as well as suggesting problems with international competitiveness.

    In view of the possible loss of market access in Russia, the Ukrainian government has three strategic options: laissez-faire, conservation or modernisation. A pure market laissez-faire strategy would risk the loss of economic substance and potential, and is thus not advisable. But a state-centred conservation strategy is also not a sensible option, since it would not address the sector’s competitiveness problem. Instead, government should develop a modernisation strategy as an intelligent combination of market forces and government intervention. In such a way, government can contribute to the ability of the sector to redirect and diversify exports by facilitating investments, optimising public policy and setting incentives for firms to increase their competitiveness.

    Since such a strategy takes time to develop and implement, short run measures are needed in order to protect the economic substance and potential of the sector. Measures should be carefully designed in order not to counteract the competitiveness drive of the modernisation strategy. We identify government-assisted short term work schemes, public procurement schemes in selected goods useful for public infrastructure and an opening of the Ukrainian economy for FDI and joint ventures as short-run measures that should be prepared for the eventuality of massive restrictions to market access in Russia.

    Attached file  (290.8 kb)
    Authors:  Kovalchuk Artur, Naumenko Dmytro, David Saha, Ricardo Giucci
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