Ukraine won't solve its nationwide investment deficit by creating Free Economic Zones with special investor privileges and may only make matters worse by doing so, the World Bank warned at a conference on Jan. 28.
FEZs are territories where certain tax holidays and investor privileges have been put in place as a way of attracting much-needed capital investment.
Ukraine currently has four FEZs. The first one was established near the lake of Sivash in northern Crimea in 1996. That was followed by the creation of the Donetsk FEZ in eastern Ukraine, the Slavutych FEZ near Chernobyl, and the Transcarpathian FEZ in western Ukraine.
Claiming that FEZs are the solution to economic decline in the country, the government plans to expand its network of official FEZs to 30.
But some government officials – and many analysts – feel that, rather than a solution to Ukraine's woes, FEZs are simply a way for the government to avoid facing the real problems. And there are those who say that, in reality, FEZs only make matters worse.
At a special FEZ conference held at its Kyiv offices, the World Bank warned against the creation of free economic zones without a macroeconomic analysis of their impact on the economy and without attempts to solve problems on the national level.
'Gifts to investors [like tax concessions] are of no importance if general economic problems in the country are not addressed,' John Hansen, an economic analyst at the World Bank's Kyiv office, said at the conference.
Hansen also warned that tax breaks given to FEZs often result in costly budgetary losses.
Hansen and other World Bank representatives said that FEZs generally do little good for the economy if the government refuses to supplement their creation with comprehensive reform measures.
He cited regulatory hassles, poor enforcement of basic law and order, vague tax laws and the prohibition of land ownership as being among the significant risks investors in Ukraine face.
Hansen warned that the government often gives out too many concessions in terms of tax collection, which results in budgetary losses.
Hansen also said that the legal basis for the creation of FEZs – the presidential decree – is not at all firm because what was established by a decree can be removed by another decree.
'Other countries of the world often find that [the type of] industries [that] come to the free economic zones [are those] that can easily leave if the conditions change,' he said.
Other analysts say that there is a tendency to use free economic zones as a form of patronage.
There is some evidence of that. For instance, Viktor Medvedchuk, the deputy speaker of parliament and head of the Social Democratic Party, along with the party's second-in-command, Hryhory Surkis, both actively lobbied for the creation of the Transcarpathian FEZ. Meanwhile, both men were elected to parliament in that region, and both are believed to have significant business interests there. Some allege that is no coincidence.
But other speakers praised the achievements of the zones. Serhy Kunitsyn, head of the Crimean government and a member of the supervisory board for the Sivash economic zone, said his zone alone was responsible for 2.3 percent economic growth in Crimea in 1998 – the first such growth in the last four years. On the whole, the Ukrainian economy shrank by 1.7 percent last year.
The Crimean zone has comparatively few tax and other privileges: The companies are exempted from customs duties on raw materials for production in the zone, and the company's profit tax rate is reduced by half if the free half goes toward production investment.
Those few exemptions jump-started 24 investment projects that otherwise would not be in the area, according to the Crimean government. The FEZ laws have contributed to the complete revival of three out of four large chemical plants that employ almost 20,000 people.
However, a businesswoman working in the SIVASH FEZ confirmed many of Hansen's fears. Svitlana Zahrebelna, president of Euro-Sivash leasing company, complained that while free economic zones sound good on paper, they don't always work as well in practice.
She said that businesses often must pay full duties on raw materials purchased for use in production within the zone because deals are reviewed case by case and officials often decide the exemption doesn't apply.
'The subjects of the zone must always prove that they are not guilty,' she said.
Zahrebelna added that when the national value-added tax was introduced, parliament gave no exemptions to Sivash-based companies, which she said caused them tremendous losses and discouraged 60 others from beginning operations in the zone.
'But now the most difficult issue is whether the [Sivash FEZ] experiment will be continued at all,' she said.
The president's decree that established the zone in 1996 only gave tax breaks and other privileges for five years, and no legislation has been passed to prolong that time frame.
Leonid Minin, a deputy economics minister and head of the Agency for Free Economic Zones, said the government can't afford to give the kinds of breaks it gives in FEZs on a nationwide level.
'We cannot afford to lower taxes because we have a large social sphere to support,' he said.
