nt AvtoZAZ‑Daewoo debacle is a watershed event that makes it imperative that Ukraine takes a hard look at policy, strategy and legislation within this industry.
There are several main factors Ukraine must take into account in formulating its future policy and strategy concerning the automobile sector.
First, the low purchasing power in Ukraine, combined with an absence of consumer credit from the banking system, place inherent constraints on domestic automobile demand. Quite simply, the country lacks a domestic market sufficient to absorb the production of a national automobile industry, which means Ukraine must insert itself into the worldwide automobile industry sector in order to maintain a domestic automobile industry.
Of course, to compete on the world market Ukraine automakers must retool themselves to meet international standards of quality. That, of course, would require vast technological improvements, which in turn requires foreign direct investment, since the state of technology in the Ukrainian automotive industry does not allow for the production of vehicles for Western markets.
Thus, for Ukraine’s auto industry to survive it needs to attract enough foreign investment to be able to make cars good enough to sell in the West. Ukraine today needs to make a concerted choice about whether or not it wants to save its automotive industry, and in particular save the AvtoZAZ plant in Zaporizhya. Any decision must take into account not only the social cost of closing the plant, but also whether it is feasible to reach Western markets.
If Ukraine decides that it does indeed want to sustain domestic automobile production, appropriate institutional conditions, including legislation and transparency, must be put into place that favor investments of foreign capital into the sector. The success of Volkswagen in the Czech Republic and Renault’s nascent automobile venture with Romania’s Dacia show that the success of foreign car makers in Eastern Europe depends on a combination of market openness and a proper commercial and industrial strategy.
Daewoo has failed because it had neither of those: It had the wrong commercial strategy and approach, and it had suffered from Ukraine’s poor investment climate and poor government strategy. Looking forward, choosing an investor with a better long‑term vision is an essential component of any strategy to revitalize AvtoZAZ. It is not solely about liberalizing markets.
At this point there are three possible scenarios that are available for Ukraine, in regards to the automotive industry.
The first is to do nothing and retain the status quo. Under this scenario, the existing industry would simply collapse, and the country will be left assessing the social costs of that loss.
The second scenario envisions Ukraine’s automotive industry developing a strategy in the context of future EU enlargement. It involves linking the domestic automobile industry with West European manufacturers as an extension of their existing Central and Eastern European strategy.
Such a strategy mainly envisions the targeting of an integrated economic region; for example, the Black Sea region economic area, which includes Ukraine, Turkey, the Caucasus region, and the area southwest of Ukraine. The Renault‑Dacia strategy fits well into this model.
This second scenario envisions the absorption of existing facilities, not simply the creation of joint ventures, which at this point have little potential, if any.
The third possible scenario is integration with a Russian company or a company from another CIS country. The process of increased interaction between Ukrainian and Russian manufacturers has already begun. Under this scenario, the Ukrainian automobile industry would be just one part of the CIS‑wide market for automobiles, led by Russian manufacturers. In this case, the end product would likely improve little, as Russian investors would likely continue using the same production techniques while introducing few advances in either technology or aesthetics.
The fourth possible scenario – rescue by a white knight – is unrealistic. This scenario envisions basing the development of the sector on manufacturers that belong to neither the European economic area nor Russian or another CIS country. About 80 percent of the cars sold in the world are manufactured within the Economic and Trade area where they are produced. Ukraine does not belong to any well‑organized economic area; therefore no credible outsider can be expected to come in.
Five years ago, with a proper partner and proper investment strategy, Ukraine might have had a chance at establishing itself as a viable automobile‑manufacturing country. But through a series of poor decisions and misjudgments, Ukraine ended up choosing Daewoo – a poor investor.
To find a better investor this time around, Ukraine may consider implementing some better policies. The current law on the development of the automobile industry was designed to benefit essentially one manufacturer: Daewoo.
Ukraine must rethink its policy and offer incentives to other potential investors. One item it must take into account is the adequacy of the threshold amount above which certain advantages are triggered for investors.
Such threshold investment amounts should strive to satisfy several goals. The first is to link the capital requirement to the needs of the industrial sector. The second goal should be to foster competition rather than being prohibitively restrictive. The third goal should be to make the capital requirement subject to incentives that are sound both for the investor and for Ukraine. (Of course, one must bear in mind that incentives alone will not simply negate the many other negative factors that have so far kept foreign investments at a minimum in this country.)
Most countries located in the Eastern European region and some of the Baltic states have set threshold capital investment levels at less than $5 million, and in the case of Lithuania as low as $1 million. Such relatively low thresholds permit the capitalization of many industries. They also lead to the increase of investments over time once investors secure their positions.
In the case of the Ukrainian auto industry – and the entire machine‑building industry, for that matter – investors would benefit from lower investment requirements. That would enable many manufacturers to enter the market over time. Initial investments would act as a conduit for first the transfer of technology and know‑how, and later on the healthy development of a competitive market.
Of course legislation concerning threshold capital requirements and investment privileges will not alone be enough to rescue Ukraine’s auto industry. It must go hand in hand with the development of a core national policy for industrialization and corporate governance.
Petro Morgos is a lawyer, currently working as head of the PCA Task Force in the UEPLAC‑Tacis project in Ukraine. This article is based on a current study undertaken by UEPLAC on the automobile industry in Ukraine.
