Back on the Ground

25 August 2015, 18:13

Over the last decade, the structure of the Ukrainian economy has changed. Its Soviet legacy manifested in energy-hungry steel industry that is disconnected from the domestic market and uncompetitive globally, as well as most machine-building and chemical plants, is in decline, its output and employment shrinking. Agriculture and related industries (primarily food industry) have taken over. The trends discussed below refer to the production industry. Like in most other countries, non-production sectors (trade, services) have been growing in Ukraine.

In the pre-crisis year of 2007, the share of agriculture in Ukraine’s GDP was a mere 6.6% while the processing industry accounted for 19.9%. In 2014, the figures changed to 10.3% and 11.4% respectively. Processing generated USD 27.4bn in gross value added, while agriculture brought only USD 9.3bn in 2007. In 2014, the figures changed to USD 13.5bn for processing and USD 15bn for agriculture.

In 2014, the food sector accounted for over 26% of the total output in the processing industry. This made it the largest sector outrunning even, for the first time ever, the steelmaking industry at slightly under 25.8%. The trend becomes even more obvious when looking at Q4 2014 (27.8%) and January-April of 2015 (25.3%), when the State Statistics Bureau stopped taking into account the occupied parts of Donbas. The branches that make food products (agriculture and food processing) already today generate at least 1.5 times more gross value added than all other processing industries taken together.

Employment dynamics in the agricultural industry is similar. In May 2015, it employed 432,100 people (without account of microbusinesses and individual entrepreneurs, the latest data on which available for 2013 state 92,300 employees, including Crimea and occupied parts of Donbas). Another 290,500 were employed in the food industry. This amounts to the total of 722,100 employees. The rest of the production industry (excluding food sector) employed 1,045,200 people (without account of microbusinesses and individual enterprises, which in 2013 employed 195,500 people, including food industry). Split by sectors, 237,700 people were employed in the steel industry, and 348,600 in machine-building. At the same time, the agricultural sector also had about 40,000 farming enterprises and over 320,000 family farms using agricultural equipment in their businesses, not to mention another 3.8 million private farms that for the most part are involved in semisubsistence farming.

Over the past decade, it was agriculture (mainly its finished goods sector) and, to a lesser extent, food industry overall that showed the most successful dynamics in terms of both output and labor productivity. From 2003 to 2014, agricultural output grew 75.6%. This was primarily due to the 5.3-times growth of labor productivity in the agricultural produce sector between 2003 and 2013. For comparison, over the same period, output  in the processing industry shrank 1.8%. The food industry saw a significant increase in output (45.1%), though modest compared with agriculture, while output in the steel industry declined 19.7%.

Such changes in the structure of the economy affected Ukraine’s position in the global division of labor, and responded to global demand for various products that the Ukrainian economy could offer based on its natural competitive advantages. While in 2008, food exports from Ukraine constituted USD 10.82bn or 16.2% of USD 66.95bn of total exports, in 2014 the share reached USD 16.67bn, or 30.9% of the total of USD 53.9bn. Exports in the steel industry – once the main export earner – shrank by about USD 11bn over the same period (from USD 26.5bn, or 39.6%, in 2008 to USD 14.6bn, or 27.1%, in 2014). Exports in machine building decreased by more than USD 3.4bn (from USD 10.9 bn, or 16.3%, to USD 7.36 bn, or 13.7%).

The trend became more pronounced in 2015, when the loss of the occupied parts of Donbas demonstrated its full effect. In Q1 2015, Ukraine exported USD 3.44 bn worth of food products, or 36.5% of total exports (USD 9.42bn). In Q1 2008, the share of food products was a mere USD 1.79, or 13% of USD 13.79. Exports of the steel industry shrank over the same period from USD 5.62bn, or 40.8% of total exports, to USD 2.46bn or 26.1%. Exports of machine-builders fell from USD 2.4 bn or 17.4% of the total to USD 1.03 bn or 10.6%.

The prospects for Ukrainian steelworks and machine-builders in their current form look dim. This gives reason to expect further reduction of their share in favor of food production in Ukraine’s economy and exports. Still, despite their losses, metallurgy and machine building remain disconnected from the needs of the domestic market and rely on exports by 60-90%. For example, in January–April 2015, 69% of Ukrainian steelwork products, including 70% of steel, cast iron and ferroalloys and 67.4% of pipes were exported. In machine building, 90.2% of parts and accessories for motorized vehicles, 68.5% of locomotives and train cars, and 73.1% of general purpose vehicles were exported. Their competitiveness on foreign markets is plummeting for obvious reasons.

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Global steel production has doubled from 0.85 bn tons in 2000 to 1.67 bn tons in 2014. It increased in China by nearly 700 mn tons (from 128.5 to 822.7 mn tons), in India by 60 mn tons (from 26.9 mn tons), in South Korea by 28 mn tons (from 43.1 mn tons), and in Turkey by 20 mn tons (from 14.3 mn tons). Meanwhile, in a number of the Middle East countries it grew 2.5-3 times or even tenfold (see Losing market for steel). This was due to the development, in the past 15 years, of modern steel production capacities that mostly focus on extensive domestic markets (in most of the above countries), and/or to cheap energy (in the Middle East). The “old steel” countries where production facilities had been built over 50-100 years ago and since underwent only partial overhaul at best, saw continued reduction or stagnation of production (EU countries, US, and Ukraine).

With this in mind, Ukrainian steel industry that sells 70% of its products abroad has no sufficient competitive advantage in the long run – neither over the "new industry" countries that have modern plants with much higher efficiency, no need for major upgrades in the near future, and focused on large domestic markets for 80-95% of their output; nor over the rich “old industry” states that have cash to invest in modernization and means to protect their domestic markets, to which their steel manufacturers mainly sell. Ukraine’s domestic market needs only about half of the industry currently produces (surplus products could be exported after domestic demand is met). The revival of Ukraine’s machine-building is only possible after a comprehensive reboot including shutdown of most plants that produce goods uncompetitive outside of the Eurasian Economic Union and the establishment of new facilities oriented on the extensive domestic market, as well as on foreign markets.

In this context, besides the potentially promising new sectors such as IT, it is agriculture that will most likely determine the growth of Ukraine’s economy and its place in the global division of labor in the decades to come. This will require deep changes to the Ukrainian mindset.

Stereotypes and reality

Under the influence of the long years of Soviet propaganda based on the realities of the 19th and the early 20th century, a stereotype was imprinted in the minds of Ukrainians that agro-industrial countries are doomed to be poor and backward, and that agricultural exports come from the Third World countries that are seen exclusively as raw material suppliers to the advanced and the rich that do the processing and consumption. The 21st century reality is quite the opposite. The share of agribusiness in general and of growers’ output in particular in the economy and employment of a country depends not only on its wealth or level of development, but primarily on its potential to manufacture these products. Whereas industrial goods (from clothing to steel and electronics) may be produced for imported raw materials anywhere from Korea and Turkey to Saudi Arabia, the UAE, the Philippines, Vietnam or Bangladesh, agricultural products can only be grown in the countries with suitable lands and climate.

According to the data of the Food and Agriculture Organization of the United Nations (FAO) for 2011 (the latest comparative data available on its website), among the top twenty leading exporters of wheat there is just one poor country, Pakistan, with symbolic export volumes of 2.1 mn tons. GDP (PPP) per capita of the rest (except for Ukraine) was at least not lower than that of the poorest EU member-states. A similar situation is in corn exports, which today take the first place among all grain exports from Ukraine. In global rankings, Ukraine has risen to the second and third places (with 19 mn tons in 2014/15 marketing year) from the 4th place in 2011. The list of the top ten sunflower oil exporters again is far from the concept of poor or backward countries: Ukraine, Argentina, France, Netherlands, Russia, Hungary, Turkey, Romania, and Belgium. On the list of rape exporters, Ukraine finds itself in the company of Canada (7.9 mn tons), France (1.7 mn tons), Australia (1.55 mn tons) and the UK (0.66 mn tons). Recently, Ukraine has been rapidly increasing poultry exports (175,000 tons in 2014), but there are no countries poorer than Ukraine among poultry exporters, the top ten of which include the US, the Netherlands, France, Belgium, Germany, Turkey, Poland, and Argentina.

Let's now look at the food export structure of the global leaders. The US exports soybeans (USD 17.6bn), corn (USD 14bn), wheat (USD 11.1bn), cotton (USD 8.4bn), pork (USD 4.7bn), poultry (USD 4bn), cattle (USD 4bn), and soybean meal (USD 2.7bn). Canada exports rape and rapeseed oil (USD 8bn), wheat (USD 5.7bn), pork (USD 2.3bn) and soybeans (USD 1.4bn). The structure of food exports of the major European exporters is somewhat different. For example, in the structure of French exports, wine takes the first place (USD 9.9bn), alcoholic beverages the third (USD 4.5bn), and cheese the fourth (USD 3.4bn). However, top five exported French food products also include raw wheat (20.3 mn tons, or USD 6.7bn) and corn (6.2 mn tons, or USD 2.5bn). Besides, France exported rape and rapeseed oil (USD 2bn), barley (5 mn tons, or USD 1.4bn), and poultry (0.43 mn tons, or USD 1.1bn).

Ukrainian agribusiness potential

In the countries that are comparable to Ukraine by their agricultural potential, agriculture generates much larger shares of GDP. In Canada its share in GDP is more than USD 35bn, in Argentina USD 45bn, in France USD 50bn, and in Australia USD 60bn. In Ukraine, this figure is still below USD 17bn. Argentina is the poorest country on the list, but the share of export-oriented agroindustrial complex (the share of food exports is over 50%) in its PPP GDP per capita in 2014 was USD 22.600. This is comparable to Poland (USD 23.700) or Hungary (USD 22.900), the level that Ukraine can only dream of in the next decade.

Ukraine, despite being geographically located in Europe, is closer to Argentina, Canada and Australia in terms of its agricultural potential per capita. Today its agricultural holdings and farm businesses employ about as many people as does the highly mechanized agricultural sector of the UK (535,000), despite the fact that Ukraine has much vaster ​​agricultural lands: 2.5 times more farmlands and 5.5 more croplands. For another comparison, Ukraine has almost as much arable land as France and Germany combined, but 3.6 times less population and at least 4.5 times fewer people employed in agricultural production (without account of homesteads).

Moreover, while the share of agriculture proper in GDP and employment in most developed countries is usually 2–5%, its share in agroindustrial complex hits 20–25% or more. The latter traditionally has three main components. The first one is cultivation. The second one is gathering, storage, transportation, processing and selling agricultural produce and food goods. The third one includes industries production of capital goods for agriculture and food sectors (agricultural, livestock husbandry and food processing equipment, fertilizers, compound feed, bioindustry products, and construction of farming facilities).

Ukraine today is realizing, to some success, its potential in the first of these three components. Ukrainian growers were the first to enter the global market. The production and exports of grain, oil-yielding crops and their derivative products has placed Ukraine on the list of the top producers of some goods. In 2014, grain harvest reached the record of 63.9 mn tons compared to 41.8 mn tons in 2004. Exports in 2014/15 marketing year (lasting from July to June) amounted to 34.4 mn tons vs. 11.4 mn tons in 2004/05. The actual growth was even bigger, since the data for the year 2004/05 include the occupied parts of Donbas and Crimea statistics. It is absent from the data for 2014/15. The potential of Ukrainian crops is still very high compared with the rest of the leading global players. Land under cereal production in Ukraine (14.9 mn hectares) is comparable with that of Canada and Australia and is more than 1.5 times larger than those of Argentina and France.

However, despite the widespread stereotypes, the last decade saw a rapid growth not only in crops or oilseeds harvesting, but also in livestock breeding. In 2004-2014, according to statistics, the production of meat grew 1.5 times (from 1.6 mn to 2.4 mn tons) and the output of eggs increased more than 1.6 times (from 11.96 bn to 19.59 bn), but the actual growth rate was even higher, as the 2004 statistics include Crimea and occupied parts of Donbas. The growth was due primarily to the businesses producing finished goods.

The progress in the production and exports of poultry is especially manifest: domestic manufacturers not only replaced imports, but also made this sector of the Ukrainian economy export-oriented (almost one third of all domestically produced poultry today is exported). Egg production is also becoming increasingly export-oriented. Recently, the largest Ukrainian egg manufacturer, Avangard holding, announced the intention to increase over three to five years the share of exports in its sales to 50-60% compared to the current 20-25%. Ukraine’s prospects also look good in the dairy sector. While cheese exports are still going through a crisis after the loss of the Russian market, the exports of butter, condensed and noncondensed milk and cream have resumed growth after entering the new markets of the Mediterranean and the Middle East. For example, the main importers of Ukrainian butter today are Egypt, Morocco, and Azerbaijan.

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The first component of the agribusiness industry (cultivation), with its successful growth dynamics, is performing significantly better than the second and especially the third components. The lack of efficient storage, processing and transportation capacities results in significant annual losses for Ukrainian agriculture and hinders its growth, making it necessary to import fruits, berries and vegetables instead of exporting them in the off-season period. The situation in the third component is rather critical: Ukrainian agribusiness largely depends on the imports of most machinery and equipment used for agricultural production, cattle breeding and food processing, as well as components, seeds, crop protection agents, fertilizers, etc.

This is the evidence, on the one hand, of the problems existing in the sector, and on the other hand, of its significant potential for production and employment through import substitution in case modern jobs with high labor productivity are created. In this case, the share of agriculture and related industries in GDP and employment, despite high mechanization and labor efficiency, may be several times higher than in the European countries. The key to success here is focusing primarily on the competitiveness of Ukrainian producers that need no subsidies in global markets. Ukraine has all the prerequisites for this. Otherwise, Ukrainian agribusiness may become a burden on the country's taxpayers and other industries, only becoming heavier with the growth of production and employment, instead of being one of the locomotives of the national economy.

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