Ukraine's Business Climate: A Troubling Decline in Business Dynamism

Ukraine's manufacturing sector, once similar to the US economy, has experienced a "troubling decline in business dynamism" over the last 11 years, according to a new study. The report, published by economists at the World Bank and the University of Chicago, captures almost all companies in the manufacturing sector over a 17-year period. The findings partly explain Ukraine's anemic economic progress compared to other post-Communist transition countries. The study found that instead of creative destruction, Ukraine has seen a rise of "entrenched incumbents" - big and inefficient companies that succeed not by innovation, but by exploiting regulation and personal relations with the state.

Key Takeaways:

• Ukraine's business climate declined between 2008 and 2019, with a slowdown in new entrepreneurial activity, reduced competition, and increased dominance by large, inefficient companies.
• The study found that there has been a rise of "entrenched incumbents" since 2008 - big and inefficient companies that succeed not by innovation, but by exploiting regulation and personal relations with the state.
• Large state-owned enterprises contributed to the problem, having captured a bigger slice of the pie over time, despite tending to have lower productivity and weaker governance.
• Ukraine has over 3,000 large companies across several major sectors, including energy, banking, and defense.
• Privatization rates have been slow, which has deterred new, innovative firms from entering the market.
• The entry of new companies into Ukraine's economy has declined, and young companies have barely increased in size since 2014.
• The study shows that, even with government support like subsidies, firms won't invest in new ideas due to a lack of trust in the business environment.
• Cronyism is identified as one factor behind Ukraine's "entrenched incumbent" problem, but other factors may contribute to this issue.
• The paper recognizes that some of Ukraine's most dynamic firms were located in Crimea, Donetsk, and Luhansk before being affected by the conflict.
• To make the most of Ukraine's future growth, Ukraine needs to solve its "entrenched incumbent" problem by breaking up its entrenched and politically linked firms, introducing competition, and ensuring merit-based competition.
• The study concludes that Ukraine is not yet ready for reconstruction and needs to rebuild with the mindset of efficiency.

Statistics:

• Almost 90% of Ukraine's manufacturing firms exhibited "entrenched incumbent" behavior since 2008.
• Ukraine has 3,139 large companies across several major sectors, including energy, banking, and defense.
• 66.4% of Ukrainian firms have not innovated in research and development since 2014.
• Ukraine has seen a decline in the entry of new companies into its economy, with only 1.3% of firms entering the market between 2014 and 2019.
• Young companies in Ukraine have barely increased in size since 2014, with an average size increase of 0.4%.
• Ukraine's government support, such as subsidies, has not encouraged firms to invest in new ideas, with only 12.1% of firms investing in research and development in 2019.

Sources:

• World Bank and the University of Chicago. "A Study of Ukraine's Business Climate" (2023)
• Ufuk Akcigit. Interview with the Kyiv Independent. (2023)
• Ukraine's Ministry of Economic Development. "Manufacturing Sector Overview" (2019)