Ukraine’s economy has sailed through stormy waters since the global crisis hit late last year. The impact of the downturn has been more severe because it followed a period of such dramatic growth.
And regardless of who wins the much-contested presidential elections early next year, they will face the major challenge of putting Ukraine on track again towards economic growth, strong and sustainable.
As the world starts to see glimmers of light at the end of the dark economic tunnel, it is critical to be prepared for the new growth environment. Today is the time to act to ensure that the country is well-placed to tackle the challenges that lie on the road ahead. This means focusing on high-growth sectors, especially those that can generate meaningful numbers of new jobs, and on boosting productivity in all sectors, especially those at risk of losing their competitive edge.
Even when the global recession fades, Ukraine’s industries will still face a series of challenges that will not simply disappear. Production in Ukraine is not competitive when compared with other countries. Raising quality and productivity is the key. For example, with 27 percent of electricity generation capacity at least 40 years old, the sector is less competitive on the whole.
External pressures are also intensifying: recent protectionist measures add to the effect from last-year’s substantial investment in capacity in many traditional export markets. Between 2004 and 2007, for example, China’s annual additional steel capacity was the equivalent of Ukraine’s total yearly output. As a result, the country that used to import steel, including Ukrainian, is now an exporter intensifying competition on this market that has been traditional for Ukraine.
Finally, the labor force is shrinking. It dropped by 3 percent between 1998 and 2007, and this trend is expected to accelerate with a further 10 percent drop by 2020. This means that to renew the gross domestic product growth rates the country enjoyed between 1998 and 2007, 29 million people would need to join the labor force if productivity remains where it is today. This is obviously impossible, and the only logical option is to raise productivity.
Unleashing potential
Ukraine has the opportunity to overcome these challenges. To do so, it must make the most of new growth sectors while boosting productivity in industries that are under pressure. Sectors such as retail, telecoms and financial services have strong prospects and productivity improvements will enhance their performance.
A second group of sectors, including logistics, tourism and construction, could create large numbers of jobs in the mid to long-term future, providing they are given the right conditions to flourish. Sectors such as steel and other metals and mining sectors will remain a core part of the country’s economy, but will struggle to increase physical output. These sectors must improve labor productivity to remain competitive.
If we look at logistics, it is clear that Ukraine has vast potential, especially in the road cargo sector. It needs to become more attractive as both an east-west transit route connecting southern Russia with the rest of Europe, as well as for north-south transit, linking Russia with Black Sea ports. However, customs procedures need to be simplified and road quality needs to be improved. Likewise, a successful tourism industry would require regional authorities to harness individuals’ entrepreneurial drive into a coordinated tourism development program to establish world-class tourist areas. Estimates suggest that tourism could create hundreds of thousands of new jobs, and a glance at how much foreign visitors spend relative to other countries hints at the hidden potential.
Construction typically benefits from a general upswing in the economy, but merely rising with the tide is not enough. The construction sector could double by 2020, increasing its workforce by 20–30 percent, driven by broader economic growth.
Laying foundations
Raising labor productivity is crucial for Ukraine’s economy. Today a worker in the United States does in a day what it takes a local worker six days to achieve.
Some companies in the country are already making huge advances down this path, suggesting that just improving basic business processes could have a major impact. Broadly, this is where the greatest potential lies for boosting productivity. Other important tools include improving labor skills, unleashing innovation, redeploying the labor force to jobs that add more value, and upgrading technology, although this last point is less important than is often perceived.
None of these improvement measures will take root, and nor will the growth sectors maximize their potential, unless the right conditions are in place.
Based on the experiences of other countries, the single most important factor is fair competition – already we see that the most competitive sectors (banking, retail) are the most productive. Ensuring a level playing field is essential for fair competition: all companies should have equal access to public services, and law enforcement must be consistent.
This – along with economic stability – will also attract investment and foreign expertise, which will bring best practices to the country and boost domestic companies’ performance. The state must also ease the administrative burden on companies, which wastes time and resources. For example, it takes 476 days to get a construction permit for a two-storey warehouse in Ukraine. In the United States, it takes just 40 days.
The general business environment also needs improving. This encompasses elements such as a robust financial system, an education program that meets the market’s needs, reliable physical infrastructure, and integrated urban planning. This may sound like a daunting list of tasks, but they are all key foundations of rebuilding the economy, laying the groundwork for high growth sectors to flourish and ensuring that slower growth sectors remain competitive.
Even with these foundations, high growth sectors need to attract a workforce, which is why promoting workforce mobility must lie at the heart of any overarching economic strategy. As growth slows in some sectors and accelerates in others, large numbers of people will be moving into jobs in the high-potential sectors. Focused labor mobility and social support programs are essential to smooth this transition. Training courses need to focus on developing skills, while a national job vacancies database can help workers find interesting opportunities in other regions.
Collaboration crucial
To maximize the opportunities that these various measures and tools create, the state and the private sector must collaborate, especially on complex issues such as labor mobility programs. The private sector can provide realistic growth assumptions, clarify the barriers to growth and suggest pragmatic ways in which they can be overcome. The state of course has all manner of ways in which it can support the economy – regulation, infrastructure development, education etc.
No one disputes that the economic upheaval we are talking about will be disruptive, but the social cost can be minimized if these two pillars of the economy pull in the same direction. A crisis is not an excuse for abstaining from developing policies that strive to boost productivity. On the contrary, it is precisely the time to act.
Georges Massoud is the managing partner of the Kyiv office for McKinsey & Company, regarded as the world’s top business consultancy. He has worked for the group since 1999 and can be reached at: [email protected].
