Government taking protectionist route to economic growth
y of supporting domestic automobile manufacturing. A small businessman, he makes his living importing old Opels and selling them at the Kyiv Automobile Market. His line of business isn't easy – custom agents hassle him, traffic police demand bribes, and tax inspectors dig through his books.
'But what really makes me mad,' complained the burly used car salesman as he hawked a 1989 Opel Ascona on a recent snowy weekend, 'is that our Ukrainian population is poor, but our bureaucrats think it's necessary to protect Korean multinationals.'
What is at issue here is not just the rights and wrongs of upping import taxes to force people like Yeremenko off the used car lot, thereby creating an artificial gap in the market for Daewoo and AvtoZAZ to fill.
The question is a wider one. Should Kyiv favor specific industries and projects, such as the AvtoZAZ/Daewoo joint venture that promises to pump $1.3 billion in South Korean foreign investment into Ukraine's automotive industry, or should the unfettered free market decide which economic sectors and firms succeed or fail?
Supporters of free markets advocate what Viktor Novitzky, director of Ukrainian Free Economy Foundation, calls 'the American Way.' That model limits the government's role to enforcing laws designed to promote growth. Actual investment decisions that create that growth are left to the professionals: private businessmen.
'If I am the government, it's my job to create conditions so that investment will come,' said Novitzky. 'If every minister and bureaucrat gets involved in promoting a pet project, you create good soil for corruption, but the economy will not be helped much.'
Government officials are skeptical of the hands-off approach. 'That's pretty funny,' said an Economy Ministry spokesman. 'An Economy Ministry that does not intervene in the economy.'
Ukraine also has a Ministry of Industrial Policy, as well as an industrial policy whose list of priorities reads suspiciously like the product of Soviet central planning: large-scale agriculture, metallurgy, chemicals and machine building.
Maintaining the outdated enterprises that make up the bulk of those sectors is an expensive proposition. Ukraine spent Hr 4.4 billion ($2.2 billion) last year 13.3 percent of its national budget – on subsidies to state-owned industry, according to State Statistics Committee data.
The Barents Group, a U.S. Agency for International Development contractor, estimates that state-owned enterprises swallowed even more in public funds – a total of Hr 5.5 billion. Of that, roughly Hr 242.4 million went to agriculture, Hr 535.5 million was spent on capital investment, Hr 1.1 billion was consumed by the coal industry, and Hr 2.8 billion was pumped into state-owned industrial enterprises.
'You have to be careful about these statistics as they are based on Ukrainian accounting and the categories do not correspond exactly to particular industries,' said Barents Group Kyiv Office Manager Wayne Thirsk, 'But the 'national economy' is, by and large, a code word for subsidies to state-owned enterprises.'
And that does not even include cheap credit channeled to state-owned giants from banks who depend on the government's business and are at the mercy of its regulators.
'Our job is to, with the national government, support national industrial policy,' said Privatbank spokesman Dmitry Zaichenko. 'Our goal is to develop strategic industries.'
But the government's enthusiasm for industrial planning is not matched by the resources available to it or to domestic banks, so now foreigners are welcome to aid the effort. Some are more than willing – if the terms are right. 'The Ukrainians have two choices – either to just give up on having a national automobile industry, or to do the hard work to develop a national automobile industry,' said President of Daewoo Motor Ukraine Lee Pil Choo. Lee argues that Ukraine is no America. The example for Ukraine to copy, said Lee – who is a key executive in one of the last decade's most successful companies – is that of the Asian tigers like South Korea which industrialized by protecting domestic manufacturers and intervening heavily in the economy, not least by assuring easy credit from domestic banks.
Kyiv likes the idea. 'Our approach is not precisely that of the Korean school,' said Economy Ministry spokesman Bohdan Perestiniuk. 'But the Ukrainian variant is close.' And if it works, South Korea's is a great lead to follow. South Korean government sponsorship of selected heavy industries yielded double digit growth, a rocketing standard of living, and internationally competitive goods. That meant access to even more profitable markets in West Europe and the United States for sponsored firms like Daewoo.
'[South] Korean cars today are competitive in all markets all over the world,' Lee boasted. 'They are twenty percent cheaper and just as good as similar models … This is the approach for Ukraine to take as well.'
This approach – active government involvement in economic development – was the key to the South Korean economic miracle, and if some fingers of private industry got stepped on in the process, well, that's just the price of creating high-tech industry where it didn't exist before. 'You need protection,' said Lee. 'It is very hard to start up a national motor industry without it.
The counter-argument is the current Asian economic crisis. Korean smokestack industry had financed its growth in part on easy credit from booming financial markets. Now with money suddenly tight, car manufacturers like Daewoo are retrenching and unemployment lines in Seoul are lengthening. Some economists say it makes little sense for Ukraine to repeat South Korea's mistakes.
Other market analysts say the Ukrainian government simply has no business meddling in business. The free market, with the assistance of Adam Smith's invisible but inexorable hand, is the way to efficiently allocate resources, they maintain.
'I have watched countries pursue projectionist policies for the last 30 years,' said Economic Advisor of the World Bank Resident Mission in Ukraine John Hansen. 'They never have worked.'
Hansen argues that vested interests develop which demand protection even after industries are developed enough to survive without government support. This leads to higher prices for consumers, which in turn lower sales and cut tax income. Also, the government may promote industries not best suited to competing internationally – and waste a lot of money in the process.
'The key is that protectionism wastes resources,' said Hansen. 'The consumers pay for it. And the same economic logic applies for other naturally advantaged Ukrainian industries like steel and pharmaceuticals.' How much is it costing Ukraine to follow South Korea's lead?
'Protectionism could well be costing the Ukrainian consumer $600 million a year,' said Hansen. 'That could add up to $5,000 per worker per month in a protected industry.' Lee argued that the cost is worth it.
'For the time being you have to protect the industry,' he said. 'If you want to do the hard work to build the industry, there is no other way.'
But while the foreigners still argue, as far as the Ukrainian government is concerned the issue apparently is decided.
'We believe the Daewoo project is in the country's best interest,' Kuznetsov stated. 'Of course we support it.' One small businessman is less sure.
'It's a typical situation. The government makes a deal with a big foreign company,' Yeremenko said. 'They still think like Communists. They think about big factories, not the small businessman.'
