A recent report by the Organisation for Economic Co-operation and Development (OECD) offers an interesting analysis on how Ukrainian and Russian industries evolved in terms of competitiveness and productivity between 1995-2004.
“Ukraine and Russia began the market transition with broadly similar institutions, industrial structures and levels of technology…The main difference between them is Russia’s far greater resource wealth,” the report says.
The report primarily addresses how Russia’s resource wealth and Ukraine’s relative lack thereof influence their economic competitiveness. Also, it looks at how a country with limited country resources can improve its competitiveness given the cost disadvantage it faces vis-à-vis other countries.
This is a highly topical issue among Ukrainian industrialists these days, who are under pressure to retain their external competitiveness in the face of rising gas prices. While the report confirms Russia’s obviously better performance thanks to its vast hydrocarbon wealth, it also raises the possibility that its resource-dependence may undermine its competitiveness in the future, succumbing to what is known in economics as Dutch Disease.
The term was first applied in the Netherlands, which saw the decline of its manufacturing sector following the discovery of natural gas in the 1960s. The sudden inflow of foreign currency and booming exports led to currency appreciation and had a negative impact on the country’s external competitiveness.
Similarly, a sharp increase in Russia’s foreign revenues from oil and gas sales, which puts pressure on rouble appreciation and rising cost of labour and assets prices, could yet threaten Russia’s competitiveness. The report does not go as far as to say that Russia is worse off than Ukraine because of its vast natural resources, but it does state that the country faces the risk of developing its own case of Dutch Disease.
Ukraine’s falling behind due to its limited resource base could, however, end up a blessing in disguise if lack of resources leads to energy efficiency gains and accelerating development of human-capital intensive industries, such as IT and manufacturing.
In contrast to Russia, the OECD report argues that Ukraine channelled more capital into manufacturing while the cost of labour in Russia’s manufacturing and other sectors have consistently been higher than in Ukraine throughout the transition period. According to OECD calculations, average wages in all sectors (adjusted for exchange rates) were some 20% higher in Russia than Ukraine at the end of 2004. The wage gap between the two countries is expected to widen further.
The difference in wages between Russia and Ukraine is to some extent accounted for by different exchange rate policies. While the Russian rouble has been allowed to appreciate slowly against foreign currency, backed by strong commodity-tied forex revenues, Ukrainian policymakers have opted for a narrow exchange corridor to maintain monetary stability. 
Ukraine's economy is far less reliant on energy resources than Russia's, with sectors such as agriculture also strong
Ukraine’s productivity better in most sectors
Higher Russian wages, according to the report, were accompanied by consistently higher levels of productivity. In 2004, output per employee was about 5% higher in Russia compared to Ukraine. However, since 2000 Ukraine experienced faster productivity growth than Russia, suggesting that Ukraine is catching up.
“Productivity growth in Ukraine was faster than in Russia in almost all non-energy sectors. This also holds when looking at value added per employee in volume terms.
This reinforces the sense that a large part of the gap seen in productivity stems from rouble appreciation,” the report says.
Also highlighted is that Russian output per employee was higher in value, but not in volume terms. This suggests that Russian manufacturers enjoy better market conditions for their products and are able to sell at higher prices domestically because wages and purchasing power are higher.
“Ukraine experienced a sharper contraction in domestic demand during the early-to-mid 1990s than did Russia, a fact that would seem to owe something to the role played by Russia’s resource wealth in sustaining domestic demand,” the report argues. But while Ukraine’s domestic demand was more severely affected by economic restructuring it was also quicker to recover than Russia’s, particularly since 2000.
Energy giants such as Gazprom have largely powered Russian economic growth
Ukraine slower in making reforms
In addition, Russia was much more determined in pushing through vital reforms in the early 1990s, but the momentum was squandered by 1998. One of the principle reforms Russia implemented was liberalisation of foreign trade and a massive privatisation programme, which exposed Russian companies to external competition.
Meanwhile, Ukraine got off to a slow start in terms of reforms – its privatisation programme dragged for a number of years. But eventually, it found itself pushed along an accelerated path around the turn of the century.
As Russia’s government increasingly closes off its economy to foreign investors and takes control of its energy sector, Ukraine is starting to open up. The best example is its banking sector, with Ukraine enjoying a much higher share of foreign participation than Russia. The arrival of steel giant Mittal-Arcelor also signalled that other sectors, traditionally closed off, are beginning to integrate globally.
“Competition from foreign imports or goods produced by firms with foreign investment has a positive impact on the productivity of domestic firms, which tend to restructure faster in response to the competitive threat,” the OECD’s report said.
In this regard, Ukraine could overtake Russia, benefiting from more foreign investment and know-how transfer, which will lead to productivity and efficiency gains. For the time being, however, both Russia and Ukraine suffer from weak competition and high entry barriers to many sectors.
Russia
There are lessons to be learned from this. Clearly, the key differentiating element in this competitiveness race is resources. Once again, Ukraine is going to lose some of its competitiveness when the price it pays for Russian gas rises to European levels.
However, the findings of this report show that there is a lot of room for efficiency improvements. This has already been demonstrated clearly in Ukraine’s all important metals sector, which is investing heavily to modernise the production process in order to increase efficiency. An increase in gas prices has been a major stimulus in triggering this reform process.
In the medium to long term therefore, Ukraine may benefit from relying less on natural resources for economic growth, while Russia faces the risk of succumbing to Dutch Disease due to its seemingly endless natural wealth.
faster to recover from 1990s.
