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Machine Industry Report

March 2016

Authors:

Sierz Naurodski (editor) Vladimír Benc Martin Lacny Iryna Lafiuk

Uladzimir Valetka

Commentators:

Andras Deak, Csaba Kilian, Janusz Kornecki, Vitaliy Kravchuk, Veaceslav Sutchevici

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Project partners

Sponsor: International Visegrad Fund

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Belarus,Moldova,Ukraine:MachineIndustryReport1

Abstract

There is the common view that as a result of Soviet heritage, themachine building sectorcontinuestomakeupalargesegmentoftheeconomiesofBelarus,Ukraine,andMoldova.Themain goal of this paperwas to review the current state of themachine building sectors inBelarus,Ukraine,andMoldova,andtoassesstheirvulnerabilities.Acomparativeanalysisofdevelopments, trends, and the institutional background of the machine building sectorshowedthatmachinerycanbeconsideredmorevulnerable inBelarusandUkraine,while itappears less vulnerable inMoldova. Common vulnerability factors for Belarus andUkrainearelowcapacityutilization,weakexportdiversification,therelativelylowqualityofproducts,outdated equipment and technology, labor-intensive production and the low quality ofmanagement.Specificmachinery-relatedissuesinBelarusincludeexcessiveemploymentandhighlevelsofgovernmentalinterferenceinindustrialpolicy.Ukraine-specificissuesarepoorcorporategovernanceandunderinvestment.Thekeychallenge formachinery inMoldova isthe improvementofcorporategovernancealongwiththestimulationofsmallandmedium-sizedenterprises(SMEs)inthesector.Authors:SieržNaūrodski(editor),IrynaLafiuk,VladimírBenč,UladzimirValetka,MartinLačný

1 The reportwas prepared as part of the project "Mapping out vulnerable sectors in the Eastern Partnershipcountries – structural change, Visegrad experience and relevance for EU policy" written by CASE Belarus incooperation with the Hungarian Academy of Sciences and SFPA Slovakia (http://case-belarus.eu/index.php/2015/04/mapping-out-vulnerable-sectors-in-the-eastern-partnership-countries-

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TableofContentsListoftablesandfigures 5 Listofabbreviations 7 Executivesummary 8 Introductionanddefinitionofmachineindustry 11 Comparativeanalysisofmainmachinerytrendsinthethreecountries 17

Changesinmachineryspecializationpatternsbyoutput 20 Belarus 23 Ukraine 29 Moldova 34

Export&importpatterns 39 Belarus 41 Ukraine 44 Moldova 47

Investmentsinthemachinebuildingindustry 50 Belarus 53 Ukraine 54 Moldova 57

Humancapitalinmachinery 58 Belarus 60 Ukraine 62 Moldova 63

Institutionalanalysisbasedonmicro-leveldataandcase-studies 65 Institutionalregulation/economicpolicy 67

Ownershipissuesandcorporategovernance 71

Innovation-drivenreforms 75

SWOTanalysisofmachinebuildingsectorsinthecountriesanalyzed 77 References 81 Statisticalannex 85

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Listoftablesandfigures Astheyappearinthetext.Tables:Table1.NACEcodesusedformachinerydefinitionTable2.HarmonizedSystemCodesTable3.MainindicatorsofthemachinebuildingindustryinBelarus,Ukraine,andMoldovaTable4.KeycommoditiesofthemachinebuildingsectorinBelarus,Ukraine,andMoldovaTable5.ExportdiversificationinBelarus,Moldova,andUkraine,1998and2013Table6.RiskmapofdependenceonRussiaTable7.UkrainianexportstoRussiaTable8.GovernmentsupportinstrumentsinBelarus,Moldova,andUkraineTable9.TypesofownershipinBelarus(as%ofoutput),2013 Table10SWOT-analysisformachineryinBelarusTable11SWOT-analysisformachineryinUkraineTable12SWOT-analysisformachineryinMoldovaTable13EхportsofthemachinebuildingsectorinBelarus,Ukraine,andMoldova,1994-2014,bn.USD(availableinthestatisticalannex)Table14.Exportdiversificationbysubsectors,2013(availableinthestatisticalannex) Figures:Figure1.Machineryoutput(%ofmanufacturing)andmanufacturingvalueadded(%ofGDP)inBelarus,2005-2013Figure2.Machineryoutput(%ofmanufacturing)andmanufacturingvalueadded(%ofGDP)inMoldova,2005-2013Figure3.Machineryoutput(%ofmanufacturing)andmanufacturingvalueadded(%ofGDP)inUkraine,2005-2013Figure4.ProductionofselectedcommoditiesinBelarus,1990-2014,thsd.units(LHS),units(RHS)Figure5.ProductionofselectedcommoditiesinBelarus,1990-2014,thsd.unitsFigure6.CapacityutilizationinBelarus,2005-2013,% Figure7.MachineryoutputstructureinBelarus,2005and2013,% Figure8.ManufactureofmachineryandequipmentandmanufactureoftransportvehiclesequipmentinBelarus,2010–2015,m/m,% Figure9.NetprofitofclueplantsinBelarus,2011-2014,mUSD Figure10.ReturnonsalesinthemachinebuildingsectorinBelarus,2009-2013,% Figure11.ShareofunprofitableenterprisesinthemachinebuildingsectorinBelarus,2011-2014,% Figure12.AddedvalueofthemachinebuildingsectorinBelarusbyincomes,2013,% Figure13.ProductionofselectedcommoditiesinUkraine,1990-2014,thsd.units(LHS),units(RHS) Figure14.ProductionofselectedcommoditiesinUkraine,1990-2014,thsd.units Figure15.MachineryoutputstructureinUkraine,2001and2014,% Figure16.ProfitabilityoftheUkrainianmachinebuildingindustrys,2009-2013,% Figure17.AddedvalueofthemachinebuildingsectorbyincomesinUkraine,2013,% Figure18.IndexofproductioninMoldova(1995=100),1995-2002,% Figure19.CapacityutilizationinMoldovanmachinery,1995-2002,% Figure20.ProductivitygrowthinMoldova(y/y,%),1996-2010,y/y,% Figure21.MachineryoutputstructureinMoldova,1996and2012,%Figure22.ShareofmachineryinindustrialandmanufacturingoutputinMoldova(%),2006-2013,% Figure 23. The share ofmachine building in the total exports of Belarus,Ukraine, andMoldova1994-2014,%Figure24.ExportsofthemachinebuildingsectorinBelarus,Ukraine,andMoldova1994-2014,bn.USDFigure25.ChangesinoftheexchangerateoftheBelarusianRruble,2010-2015,December/December("-"devaluation,"+"appreciation),%Figure26.ChangesintheexportoftractorsbyBelarus,2010-2015,(y/y),%Figure27.ChangesintheexportoflorriesbyBelarus,2010-2015,(y/y),%

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Figure28.AddedvalueofthemachinebuildingsectorbymethodoffinaluseinBelarus,2013,% Figure 29. The share of foreign orders as a percentage of the total volume of new orders in Ukraine, 2013-2014,% Figure30.AddedvalueofmachinebuildingsectorbymethodoffinaluseinUkraine,2013,%Figure31. Investment inandoutputof themachinebuildingsectorrelativeto totalmanufacturing industry inBelarus,2000-2013,%Figure32. Investment inandoutputof themachinebuildingsectorrelativetototalmanufacturing industry inMoldova,2000-2013,%Figure 33. Investment in and output of the machine building sector relative to the values of the entiremanufacturingindustryinUkraine,2000-2013,% Figure34.FDIsinflowsinBelarus,Ukraine,andMoldova,2000-2014,mUSDFigure35.TheshareofsubsectorsinindustrycapitalinvestmentsinUkraine,2010-2014,% Figure36.FDI(paidincapital)inUkraine,sharesintotalFDIstock,2011-2013,% Figure 37. The machine building sector's share of employment and output in the Belarusian manufacturingindustry,2005-2013,% Figure38.RealwagesandproductivitychangeinthesubsectorofmanufacturingofmachinesandequipmentinBelarusin2006-2013,y/y,%Figure 39. Real wages and productivity change in the subsector of manufacturing of transport vehiclesequipmentinBelarusin2006-2013,y/y,%Figure40.Realwages andproductivity change in the subsectorofmanufacturingof electrical, electronic, andopticalequipmentinBelarusin2006-2013,y/y,%,Figure41.ShareofemploymentandoutputofmachineryinmanufacturingindustryinUkrainein2010-2014,%Figure42.Averagemonthlynominalwagesof employees inUkraine, as a%of averagewages in thenationaleconomyaverage,2011-2013Figure43.ShareofmachinebuildinginmanufacturingindustryemploymentandoutputinMoldova,2001-2008,% Figure44.EBRDTransitionIndicatorsforBelarus,Moldova,andUkraine

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ListofabbreviationsGDP–GrossDomesticProductsNACEcodes-NomenclatureofEconomicActivitiesWTO–WorldTradeOrganizationTFP–TotalFactorProductivityFDI–ForeignDirectInvestmentSWOTtables/analysis-Strengths,Weaknesses,Opportunities,Threatstables/analysisLHS-LeftHandScaleRHS–RightHandScaleSOEs–State-ownedenterprisesUSSR(SSR)–UnionofSovietSocialistRepublicsp.p.-percentagepointsCIS–CommonwealthofIndependentStatesCEE-CentralandEasternEuropeMNF–MostFavorableNationsFEZs–FreeEconomicZonesEBRD–EuropeanBankforReconstructionandDevelopmentMOI–MinistryofindustryJSCs–JointStockCompaniesEU–EuropeanUnionFINNs–FormerPrivatizationInvestmentFundsOECD–OrganizationforEconomicCo-operationandDevelopmentR&D–ResearchanddevelopmentEEU–EurasianEconomicUnionSO–Strengths,OpportunitiesWT–Weaknesses,ThreatsST–Strengths,ThreatsWO–Weaknesses,OpportunitiesDCFTA-DeepandComprehensiveFreeTradeAreaSME–SmallandMediumEnterprisesV4–VisegradFour(VisegradCountries)

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Executivesummary Themachine building sectors in Belarus, Ukraine, and Moldova are to a significant extentshapedbytheheritageoftheSovietperiod.Inthepresentreportwetriedtofindoutwhathaschanged over the last 15-20 years in the machine building sectors of the three selectedcountries, and what positive results or missed opportunities have emerged as a result ofcountry-specific decisions.We have concluded based on our review thatmachinery can beconsideredtobeamorevulnerablesectoroftheeconomyinBelarusandUkraine,whileitislessvulnerableinMoldova.

Belarus,Moldova,andUkrainearestillintheprocessofimplementingstructuraladjustmentintheeconomytotransitionfromaSoviet-typemarketmodeltoafreemarket-basedmodel,although the pace is different in each of these countries. This transition period includes astructural move from more labor-intensive and technologically simpler products to moreadvanced industries and products, a development that gradually shifts these industriestowards becoming engineering-based industries. In 2013, industry accounted for 41.9% ofBelarusianGDP,afigurethat isreflectiveof itsrelativelyhighshareofGDPoverthelast25years.IndustryinUkraineandMoldovasubstantiallyshrankfromsharesof50.5%and33.3%ofGDP,respectively, in1991to26.2%and17.1%ofGDP,respectively, in2013.Theroleofmachineryintheeconomiesofthesecountrieshasalsobeenchanging.Asof2013,machineryhasbeenprovidingrelativelymorevalueaddedinBelarus(4.6%)comparedtoUkraine(2%)and Moldova (0.8%). The machine building sectors in Belarus and Ukraine take up asignificant share of the total employment of these countries,while inMoldova this ratio isconsiderably lower. However, the level of investment in the machine-building sector inBelarus and Ukraine is low, while in Moldova it absorbs a higher share of investments ascompared to its share in value added. In terms of its contribution to exports, themachinebuilding sector accounts for a relatively higher share of total exports in Moldova, whichindicatesthatexportedmachineryproductsofferacomparativelyhighervalueaddedthaninBelarusandUkraine.

InBelarus,industryisbasedonlargestate-ownedpost-Sovietenterprisesincludingmachinebuilding giants likeMAZ (trucks),MTZ (tractors), BELAZ (heavy-weight trucks), and a fewothers. Despite the fact that there have been some positive moments (for example, largeinvestment projects and massive investments to reduce the energy intensity of machinebuildingproduction, etc.),Belarus’machinebuilding sector currently finds itself ina ratherdifficultsituationandrequiresreforms.Largeenterpriseshaveworn-outassets,investmentsare used inefficiently, the quality of products changes slowly, and price competitivenessremains dependent on the exchange rate of the national currency. The country's criticaldependenceonRussiabecauseofthehighshareofimportedcomponentsandfossilfuels,andbecauseof thevastshareofmachineryexportsthatarepurchasedbyRussia(almostthree-quartersoftheproductsproducedbytheBelarusianmachinebuildingsectorareexportedtoRussia), reflects the depths of the structural problemsof theBelarusian economy and the

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absenceofinstitutionalreformsoverthelast25years.Asaresult,afterRussia'saccessiontotheWTO,and thesubsequentmassivedevaluationof theRussianruble in2014,Belarusianmachineryoutputdroppedby20%inthesameyear.

InUkraine,themostdevelopedsubsectorsofmachineryarerailwaymachinebuilding,heavymachine building, and machine building for agriculture. In order to reduce the distancebetween the producing company and the supplier of raw materials, these industries aremostly dependent on domestic raw materials located in Eastern Ukraine. The level ofproductivity in machine building is only two-thirds of the national average, indicating acapital and technology deficit. This suggests that there are problems with internationalcompetitiveness.Despite the fact that the exports of theUkrainianmachinebuilding sectoraremorediversifiedthanthoseoftheirBelarusiancounterparts,thelevelofUkrainianexportdiversification is nevertheless relatively low, and Russia remains an essential target forexports(morethanhalfofthegoodsproducedbytheUkrainianmachinebuildingsectorwereexported toRussia in2013).Considering thecurrentpolitical conflictbetweenUkraineandRussia,apossiblelossofaccesstotheRussianmarketwouldhitamajorityofsubsectorsveryhard.Thefiguresfor2014showthatthemachinerysectoroverallhasshrunkbyover20%,whilemostsubsectorsthatexporttoRussia,likerailwaymachinebuilding,havedroppedbyover60%.

InMoldova,machineryhasundergonesignificanttransformationsasaresultofprivatizationandchanges inoutputstructure.By2001,93%ofthemachinebuildingsector'soutputwasproducedbynon-stateenterprises,and90%ofworkersinthemachinebuildingsectorwereemployed in the private sector. Currently, Moldova can be described as a supplier of rawmaterials and components, andWestern companies have shown a growing interest in theproduction of components in Moldova. The machine building sector has become moresignificantinMoldova'sindustrialproductionsince2001,andthereisanincreasedfocusonthemachinebuildingsectorasanengineofindustrialgrowth.Today,Moldovaninvestmentsinfixedmachineryassetsaremostlydirectedtowardsthemanufacturingoffabricatedmetalproductsandequipment,aswellastheproductionofelectricalmachineryandapparatuses.At the same time,Moldovahasmade significant strides in termsofdiversifying its exports.Backin1998Moldovahadalowlevelofexportdiversification(77.2%ofitsexportswenttotheCISmarket).By2013, thedependenceon theCISmarketshadbeenreduced to27.5%,anddependenceontheRussianmarketinparticularwasrelativelylow(21.3%oftheexportsof theMoldovanmachine building sector were sold to Russia in 2013). At the same time,however, the Russian factor emerged as an issue of ownership n Moldova, as Russianbusinesses tend to control strategic enterprises in the metallurgy and machine buildingsectorsonbothsidesoftheDniesterRiver,thoughespeciallyontheleftbank.

Governmental policies on machinery differ in the three countries. In Belarus, they takevariousformsofeconomicstimuli,subsidies(hiddenandopen),softbudgetconstraints,andpreferentiallendingratesthatbenefitcompaniesinthemachinebuildingsectordirectlyandindirectly. This often results in the inefficient allocation of resources and reduces theincentives for companies to introduce new technologies and innovations. In Ukraine and

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Moldova,thelevelofgovernmentalinterferenceissignificantlylowerthaninBelarus,andiscurrentlymovingtowardsprovidingtaxincentivesindifferentforms,includingtheuseoffreeeconomic zones. There are also issues related to corporate governance. In Belarus, themajorityofenterprisesarestate-owned,whichleadstoasituationwhereinallcriticalaspectsof the operations of enterprises, including their choice of factors of production, and thetargetedlevelsofoutputanddistribution,aredirectlyorindirectlyaffectedbygovernmentalpolicies. The situation is different in Ukraine and Moldova: the leading enterprises in themachine building sector have been privatized and are often controlled by local businessgroups. The state of corporate relations in Ukraine andMoldova is characterized by a lowlevelofcorporateculture,adiscrepancybetweentheexistingcorporategovernancepractices,andgloballyacceptedprinciplesofcorporaterelations,aswellaspoorstrategicmanagement.

AsevidencedbytheexperienceoftheVisegradcountries(CzechRepublic,Hungary,Poland,and Slovakia), industrial structural changes obviously need highly coordinated efforts bycentral and local authorities. In the Visegrad Region such efforts were accompanied byeconomic policy transformations; improvements in business climate and the quality ofgovernance, i.e. price liberalization; opening the markets; increased transparency inprivatization (regardless of whether it was rapid or gradual); creating an SME-friendlybusiness environment; development of the banking sectors; as well as institutionaldevelopment,includingeffortsatgreaterprotectionofpropertyrightsandtheeliminationofcorruption.Atthecompanylevel,machinerydevelopmentintheV4countrieswasdrivenbyafocusonspecificmarketsegmentsandbyFDIsprovidedbystrategic investors.Flexibleandinnovative SMEs in the V4 succeeded thanks to either unique and specialized products ortheirflexibleresponsetotheneedsofforeigninvestors.

Even if we assume that the experiences of V4 countries on the one hand, and of Belarus,Moldova, and Ukraine on the other hand, largely do not lend themselves to a directcomparison, there are some common features in their respective developments. Firstly,improvementsincorporategovernance(alsoincludingtheeliminationofstateinterventioninthe case of Belarus) are among the key priorities. The practical application of the OECD'scorporategovernanceprinciplesmayserveasa tool forachievingbetteraccountabilityandimproved relationship with investors, spurring investments into technologically advancedassets.Secondly,investmentincentivesshouldbetargetingbothlocalbusinessesandforeigninvestors with a better tax system, a better educated workforce and a good transportinfrastructure rather than taxholidays,duty free zones,orotherpoliticalpromises.Finally,smoothcooperationwith investorsatevery level (government,municipality, company)andtherequisite institutionalcapacitiesarealsoamong thedecisive factors in thecaseofboth,the V4 as well as the CIS countries. Nevertheless, given the differing levels of sectoraldevelopmentamongtheEasternpartners,differentiationbetweentherecipientcountries isanimportantskillintermsofexperiencetransfer.Thesecountriesandenterprisesdisplayawide range of structural characteristics, and hence sometimes individual approaches mayprovideabetterbasisforexperiencetransferthannationalones.

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Introductionanddefinitionofmachineindustry Themachine building sectors2 in Belarus, Ukraine, andMoldova are to a significant extentshapedbythelegacyoftheSovietperiod.InSoviettimes,theeconomywasmanagedbasedonthecommandprinciple,andsignificantamountsofmoneyandenergywereallocatedtotheconstructionoflargeindustrialplants.Themachinebuildingsectorwasoneoftheenginesofeconomicgrowthinthesecountries[22].TheSovietUnioncollapsedover20yearsagoandfrom then on the abovementioned countries had to manage their industrial plants bythemselves.Producingqualitymachineryproductsturnedintoachallenge,whilesellingthoseproductsbecameevenmorechallenging. Inthisreportwemadeanattempttoestimatethesuccessofsucheffortsandtoassessthecurrentstateofthemachinebuildingsectorsinthesecountries.

Despite their common history, the comparative analysis of these three countries is ratherproblematicduetothedifferencesinthedefinitionsoftheconceptofmachineindustryintherelevant literature and because of numerous differences between national statistics duringthe period of transition since 1991. One of the goals of this paper was to assemblecomparativedatafromofficialstatisticalsourcessuchastheNationalBureauofStatisticsoftheRepublicofMoldova,theNationalStatisticalCommitteeoftheRepublicofBelarus,andtheStateStatisticsServiceofUkraine.TheStatisticalYearbooksofthethreecountrieswerealsoused for this work.While writing the report, the authors faced the problem of classifyingchanges in the industries of each country from the 1990s up to the present moment.Moreover, even the prevailing classification of the industries varies among the countriesinvolved,andtheyeachhavesomespecificcharacteristics.Forexample,UkraineandMoldovause a more detailed classification of their machine building sectors, while the Ukrainian"Input-Output" table is nigh impossible to use because of its poorly detailed classification.Consideringtheabove, theauthors fullyrealize that it isdifficult toprovidea fullstatisticalcomparisonofthethreecountries.

Table1.NACEcodesusedfordefinitionofmachinery CodeNo. NACEcodedescription

26 Manufactureofcomputer,electronicandopticalproducts27 Manufactureofelectricalequipment28 Manufactureofmachineryandequipmentn.e.c.29 Manufactureofmotorvehicles,trailersandsemi-trailers30 Manufactureofothertransportequipment

Source: Statistical Classification of Economic Activities in the European Community(http://ec.europa.eu/eurostat/ramon/nomenclatures/)

ThestrategicapproachofthepaperistousetheNACEcodesofthemachinebuildingsector,includingthesubsectorspresentedinTable1.However,duetothefactthatBelarus,Ukraine,

2Thereportusesdifferent,synonymousandinterchangeablenamesforthemachinebuildingsector:"machineindustry","machinebuilding"aswellas"machinery."

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andMoldovahaveonlyrecentlybegantotransitiontoNACE-likecodes,extensiveworkhadtobedonetocompletethedatabasefortheperiodofthelast9-10yearsatleast.

We used NACE codes 26-30 to define what subcategories of industry are included in themachine building industries in Belarus, Moldova, and Ukraine. Despite some nationalpractices,weexcludedsubsectors24(Manufactureofbasicmetals)and25(Manufactureoffabricatedmetalproducts,exceptmachineryandequipment)fromthebasicdefinitionduetothe facts that a) thoughUkraine’smetallurgy sector is one of the core economic sectors intermsofproductionandexports,itisneverthelessnotpartofthetopicofthecurrentreport,andb) inBelarusandMoldovasubsectors24and25werequiteoftenpresentedasasingleindustry, which effectively would have prevented us from excluding subsector 24(manufactureofbasicmetals)fromtheanalysis.

WeusedtheHarmonizedSystemCodes(Table2)classification−whichisavailableintheUNComtradeDatabase−foranalyzingexportdevelopmentsandpatternsinthemachinebuildingsector.

Table2.HarmonizedSystemCodes(HSCode) HarmonizedSystemCodes

84 Nuclearreactors,boilers,machineryandmechanicalappliances,computers85 Electrical machinery and equipment and parts, telecommunications equipment, sound

recorders,televisionrecorders86 Railwayortramwaylocomotives,rollingstock,trackfixturesandfittings,signals87 Vehiclesotherthanrailwayortramwayortramwayrollingstock88 Aircraftandspacecraftandpartsthereof89 Ships,boatsandfloatingstructures

Source:UNComtradeDatabase(http://comtrade.un.org/)

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Numerous papers try to try to identify the prevailing challenges that affect machinerydevelopment in these three countries, and many suggest appropriate measures to tacklethem.Limitedcompetitiveness,worn-outcapitalassets,andthelowdiversificationofexportmarketsarethemostfrequentlymentionedcharacteristicsineconomicliteraturetodescribethemachinebuildingsectorsinthesecountries.

D.Saha(etal.,2014)showedthatamongallUkrainiansectors,themachinebuildingsectorismostexposedtotheRussianmarket,with32%ofoutputbeingexportedtoRussia[7].DuetothecurrentpoliticaltensionsbetweenUkraineandRussia,theauthorsrefertothepotentiallossesof themachinebuildingsector ifRussiandemandwere tocontract,whichwouldhitthesectorhard.Takingintoaccountthelikelihoodofsuchascenario,theauthorsidentifiedthree strategic options that the Ukrainian government might choose from: laissez-faire,conservation,andmodernization.

ArecentpaperbyV.Movchan(etal.,2014)triestoquantifythetotalexposureofUkrainetotheRussianmarket,aswellastheexposureatasectoralandregionallevel.Theauthorsfoundthat the manufacture of machinery and equipment sector features the highest level ofexposure, with 22% of its output being shipped to Russia [20]. Metallurgy and metalprocessingranksfourthintermsofexposuretoRussia,withahighbutmanageableexposurelevel of 14%. The authors also raised the problems of trade restrictions in entering theRussianmarket,andunderlinedtheimportanceoftheUkrainianauthoritiescontinuingtheireffortstonormalizetraderelationswithRussia,aswelltore-orienttheirexportsfromRussiatootherdestinations.

Box1:EU/V4classificationofthemachineindustrysectorThe Statistical Classification of Economic Activities (NACE) is the industry standard classification systemusedintheEuropeanUnion.ThecurrentversionisthesecondrevisionandwasadoptedbyRegulation(EC)No 1893/2006. It is the European implementation of the United Nations’ classification "ISIC" Rev. 4.However,intoday'sworlditisdifficulttofititexactlyintothestatisticalrecords.Acarforexamplebasicallybelongs into NACE 29 – Manufacture of motor vehicles. But a car is not just the result of mechanicalengineering. The average car ismade up of about 1,800 – 2,200 separate parts. This includes some largecomponents,suchastheengine,whichisinsertedasaunitduringtheproductionprocess,butalsocontainsthousands of individual pieces. Toyota, for example, has stated that a single car the company producesconsistsofabout30,000parts,countingeverypartdowntothesmallestscrews.Andthepartsaremadeofverydifferentmaterials,sosomecouldbecountedasproductsofthetextileindustry(seats)oroftheplasticsindustry.Furthermore,newandemergingindustriesarecombiningsometraditionalsectorsoftheeconomy.Thenewmaterialssector(suchascomposites)isonesuchexample.EvenintheEUandV4,eachcountrydefinesthemachinebuildingsector(or,asitismostcommonlyreferredto: the engineering industry) differently, using different NACE items. In Slovakia, for example, theengineeringindustrycomprisesthese4NACEsectors:NACE 25 - manufacture of metal products and fabricated metal products, except for machinery andequipment;NACE28-manufactureofmachineryandequipment,n.e.c.;NACE29-manufactureofmotorvehicles,trailers,andsemitrailers;NACE30-manufactureofothertransportequipment;

- butnotelectrotechnicalindustry:NACE26Manufacturingofcomputer,electronic,andopticproducts;NACE27Manufacturingofelectricequipment.

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Deloitteand InvestUkrainepresentanoverviewof themachinebuilding industry, includingan analysis of economic attractiveness, comparative characteristics, and undiscoveredopportunities[29].

I Fadieieva(2013) presents an analysis of the current state of corporate governance inUkrainian mechanical engineering, highlighting the main problems and features of actualcorporategovernance[30].

K. Kurilionak (et al., 2000) estimated potential gains and losses for various Belarusianindustries if the country were to join the World Trade Organization (WTO). Their resultsshowed that potential losses for the machine building sector exceed export gains fromimprovedmarketaccess[21].

J.C.Cuaresma(etal.,2012)providesanin-depthanalysisoffirmgrowthanditsdriversinthecontextofthemachinebuildingindustryinBelarus.Theirresultsindicateasignificantdegreeof inefficient resource allocation in state-run firms. The findings suggest that total factorproductivity (TFP) in non-state-owned Belarusian machine building firms exceeds thecorresponding level of productivity in state-owned enterprises. Moreover, during theobservation period 2005-2010, the difference in TFP levels between state- and non-state-owned firms has increased [4]. The authors showed that labor hoarding and soft budgetconstraints(overinvestmentorunproductiveinvestments)playaparticularlyimportantroleinexplainingdifferencesinperformancebetweenthesetwogroupsoffirms.

E. Favaro (et al., 2012) focused on state-owned enterprises in Belarus, especially in themachinebuildingsector,andhighlightedtheimportanceoftheRussianmarketforthissector[1].

M. Akulava (2011) analyzed the impact of foreign direct investment on economicperformance,usingtheBelarusianindustrialaggregatedpaneldataforthe2002-2009period.Theresults thusobtainedshowed that thedistributionof foreigncapitalacross thevarioussectorsof theeconomydetermines the impactofFDIoneconomicperformance. InBelarus,FDIhasnopositiveimpactonmachineryandisnegativeforblackmetallurgy[27].

The abovementioned papers studied the vulnerability of the machine building sectors inUkraineand/orBelarus.Nevertheless,noneofthepapersperformedacomparativeanalysisofthevulnerabilityofmachineryintheaforementionedcountries.

The overall goal of the report is to compare the respective vulnerability of the machinebuildingsectorinBelarus,Moldova,andUkraine.Avulnerabilitycheckinvolvesananalysisofthemainmacroparameters(suchasthecontributionofthemachinebuildingsectortoGDP;itsshareofexports;itsexportdiversification;aswellasemploymentandinvestmentsinthesector) as well as an analysis of country specific institutional parameters combined withmicro-levelcase-studiesfrommachinerycompaniesinthethreecountries.

Thespecificobjectivesofthereportarethusthefollowing:a) topresentacomparativeanalysisof themainmachinerytrends inBelarus,Moldova,

andUkraine;b) to identify major common opportunities and crucial common problems in the

developmentofthemachinebuildingsectorsinthethreecountries;

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c) to describe institutional features of the development of machinery based onmicro-leveldataandcase-studies;d) toassessapplicableVisegradexperiencewithrespecttomachinerydevelopment.

Followingtheabovementionedobjectives,thestructureofthestudyisasfollows.Chapter1,which is entitled "Comparative analysis of the machine industry trends in the threecountries",presentsthereviewofthegeneralperformanceofthemachinebuildingsectorsinBelarus,Ukraine,andMoldova,includingthepastandcurrentconditionsunderwhichtheseoperate. Chapter 1 is divided into four subchapters and discusses the most importantdevelopments regarding machinery, such as changes in industrial specialization patterns,export and import patterns, investments, and human capital inmachine industry. There isalsoaspecialfocusinChapter1ontheRussianFederationasthemaindestinationmarket

Box2:DevelopmentchallengesofthemachinebuildingsectorintheV4countries

Thekeyproblemsinthetransitionofthesesectorsstemfromthe"nature"ofthemachinebuildingindustry.Itischaracterizedbythesefactors:• Highmanufacturingintensityandhighinvestmentneed

o a sizeable share of value addedmust be spent onresearch and development(R&D) to be able tocompeteintheglobalmarkets;

o predominantlysmall-batchandsingle-itemproduction–adaptingproductstocustomerneeds;o highqualificationrequirementsforstaff&highlaborcosts+staffneedscontinuoustraining;o largeandrelativelycomplexcommunicationrequirementsbetweenmanufacturing,engineering,and

designdepartments.o themarketforproductsismostlyglobal,andswifttechnologicalinnovationleadstothecontinuous

renewalofproductsandtochangesinpatternsofuse.• On the other hand, the sector features high productivity and themachine industry has significant

potentialforfurthergrowthandexpansion.

CurrentchallengesintheV4:o Loss of skilled labor, especially the resulting shortage of engineers and highly-skilled personnel in

advancedtechnologies;o Diminishedaccesstocreditfromfinancialinstitutions,especiallyventurecapitale.g.forR&I;o Progressisrequiredwithrespecttotheenergysupplyinfrastructure,aswellasfortheenergyefficiency

of buildings, transport networks, and industrial production – energy demanding sector / highlyvulnerabletochangesinenergypolicy;

o Investments in research and development (R&D)are crucial and the development of smarttechnologiesisimportant,butnoneoftheV4countriesinvestmuchintoR&D;

o The V4 economies are now at a stage where they gradually lose the advantage of pricecompetitiveness,especiallyinthemanufacturingindustry.Thisrecentdevelopmentistheresultofanincreaseinthecostsoflabor,energy,andservices,andisalsoamplifiedbytheincreasingattractivenessof the conditions for locating certain types of activities in developing countries. The intensity of FDIinflow into the V4 has decreased significantly in recent years, even if there have been some majordeals(e.g.Jaguar/LandRoverrecentlyannouncedaninvestmentinSlovakia);

o Unfair global competition caused bynon-compliant goodsis affecting the competitiveness of thissector. "Theft" of know-how is also a major challenge. Access to state aid and EU funds are also achallengewithrespecttofaircompetition;

o Growing environmental costs related to increasing pressure on the environmental aspects ofproduction;

o External costs related to policy changes – the instability of the regulatory framework and theadministrative burden associated with complying with the regulatory rules, such as standardization,certification,etc.;

o Lowlevelofentrepreneurshipandinadequateperformanceoftheendogenousentrepreneurialsectorin the V4 countries is closely connected to the high dependence of the V4 countries' economicdevelopmentontheactivitiesofforeign-ownedcompaniesthatusetheV4countriesasamanufacturingbase;

o Lackofcooperationandvalueaddedchainsamonglocalbasedcompanies,especiallySMEs.

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and the source of raw materials in these the three countries. Chapter 2 is entitled"Institutional analysis based onmicro-level data and case studies", and it moves from themacrotothemicroleveltoillustratetheinstitutionalstrengthsandweaknessesofmachinerydevelopmentbasedonmicro-leveldataandcase-studiesfromthethreecountries.Chapter2isbrokendownintothreeparts:ananalysisofinstitutionalregulationsandeconomicpolicy,areview of ownership issues and corporate governance practices, and a review of past andpresent reforms and innovations. Chapter 2 is concluded by SWOT tables for each of thecountries discussed in order to structure the information obtained. The SWOT analysisincludesdraftstrategiesforthedevelopmentofthemachineindustryinBelarus,Ukraine,andMoldova. Finally, a summary and a vulnerability check conclude the previous parts of thereport and answer the question regarding the vulnerability of themachinery sector in thecountriesthusreviewed.

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Comparativeanalysisofmainmachinerytrendsinthethreecountries

Manufacturingisthecoreoftherealeconomy.Theplaneswefly,thecarswedrive,thecellphones and computers we use are all products of the manufacturing sector, specificallymachine building. Machinery is usually a capital-intensive sector of the economy thatprovidescomparativelyhighvalueaddedandknow-howthatmakeourliveseasierandmorecomfortable. Themachine building sectors of Belarus, Ukraine andMoldova are to a largeextentalegacyofSoviettimes.InthecurrentchapterweseektoanswerthequestionifthemachinebuildingsectorsinBelarus,Moldova,andUkraineareindeedamongthekeysectorsof the respective national economies today, and we also wish to ascertain how far theirpositions have changed over last 15-20 years. We are interested in both external(contributiontoGDP,contributiontoexports,exportdiversification,shareofemploymentinthissectorasapercentageoftotalemployment)andinternalindustryprocessesandpatterns(productivity,wages,efficiency,investments,assets,financialresults).

Belarus, Moldova, and Ukraine are still in the process of performing the structuraladjustmentswhicharenecessary to transformtheireconomies fromSoviet-typesystemstomarket-based economies, although the pace is different in each of these countries. Thistransition period includes a structural shift frommore labor-intensive and technologicallysimpler products tomore advanced industries and products, as well as engineering-basedindustries.In1991thesecountrieswereheavilyindustrializedasindustryproduced50%ofGDPinBelarus,50.5%inUkraine,and33.3%inMoldova.By2013,theroleofindustryintheoverall economy had fallen modestly in Belarus (to 41.9% of GDP), while it shranksubstantiallyinthecaseofUkraine(to26.2%ofGDPin2013)andMoldova(to171%ofGDPin2013).Theroleofmachineryintheeconomyofthesecountrieshasalsobeenchanging.Ascomparedto2005,Belarusianmachineryhasdeclined in termsofoutput,employment,andexports,while its contribution to the country'sGDPhas also fallenbut remains thehighestamong the three countries (Table 3). In Ukraine, the industry's declining performancebetween 2005 and 2013 has resulted in a decrease in its contribution to GDP, along withfallingoutputandemployment;nevertheless, the industry's shareofexportshas risenoverthesameperiod.TheroleofmachineryinMoldova'soverallindustryhasincreasedsincetheearly 2000s, which has manifested itself in expanding output and soaring exports, and ahigher share of GDP in 2013 when compared to 2005. As of 2013, machinery has beenproviding relativelymore value added inBelarus (4.6%) than inUkraine (2%) orMoldova(0.8%).

ThedifferentstrategiesofindustrialtransformationinBelarus,Moldova,andUkrainearealsoillustratedbythefactthatmachineryproductsoffercomparativelyhigherexportvalueaddedinMoldovathaninBelarusandUkraine.Themachinebuildingsectoraccountsforarelativelyhigher share of all exports in Moldova (14.9%) than the contribution of machinery to the

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country'sGDPoritsshareofindustry.TheroleofMoldovanmachineryexportsisverysimilartothecorrespondingfiguresofUkraineandBelarus,evenasthesector'soutputandshareofemploymentisconsiderablylowerinMoldovathanintheothertwocountries.

Table3.MainindicatorsofthemachinebuildingindustryinBelarus,Ukraine,andMoldova Belarus Ukraine Moldova 2005 2013 2005 2013 2005 2013

Industryvalueadded,%ofGDP 44.0 41.9 32.3 26.2 16.3 17.1Machinebuildingvalueadded,%ofGDP 6.7** 4.6** 3.3* 2.0* 0.6* 0.8*MachinebuildingoutputrelativetoGDP,%

18.9 16.2 13.5 9.2 1.9 2.2

Machinebuildingoutput,%ofindustry 19.0 18.1 12.7 9.7 3.4 5.6Employment inmachinebuilding sector,%ofindustryemployment

29.2 25.8 22.6 17.2 9.7 8.4

ExportofmachinebuildingsectortototalexportofallHScommodities,%

19.3 18.2 13.1 16.3 5.6 14.9

* Calculated based onWorld Bank data onmanufacturing value added,% of GDP and share ofmachinery inmanufacturingoutput**Calculated fromdataprovided in Input-Output tables:valueadded inmachinery is thesumofgrossoutputminusthevalueofintermediateinputsusedinproductionforindustries26-30,classifiedasmachinerySources:WorldBank–WorldDevelopmentIndicatorsNationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)StateStatisticsServiceofUkrainehttp://www.ukrstat.gov.ua/).NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru)Thefollowingtextanalyzesthesecountriesindetailandintendstoshowwhatthedifferencesare in theiroutput,exports,employment,and investments,andwhy thesedifferencesexist.Eachcountrywillbedivided into subsectors.Table4 showswhichmachineryproductsarecrucialineachcountryintermsofproductionandexports.3

3With respect to production, commodities are not ranked,while for export the list is ranked by diminishingexportvalueineachproductgroup.

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Table4.KeycommoditiesofthemachinebuildingsectorinBelarus,MoldovaandUkraine

Belarus Ukraine MoldovaProduction

ü Tractorsü Busesü Metalcuttingmachinesü Lorries(inc.dumptrucks)ü Trolleybusesü Feedharvestcombinesü Bicyclesü Household refrigeratorsandfreezers

ü TVsü Householdwashingmachines

ü Trailers and semi-trailers forthetransportofothergoods

ü Machine-toolsü Refrigerating or freezing

equipmentü Cranesü Tractorsü Carsü Lorries

ü ElectricalEquipment;ü Pumps(hydraulic,

electricalpumps);ü Food & beverage

equipment;ü Tractors;4ü Cuttingtools;ü Trailer and semi-trailers

(alsoforagriculturaluse);ü Bicycles;5

Export1. Vehiclesotherthanrailwayor

tramwayrolling-stock,andpartsandaccessoriesthereof(agriculturalmachinery,tractorsandtrucktractors,trucks,sparepartsandaccessoriesforautomobilesandtractors)

2. Nuclearreactors,boilers,machineryandmechanicalappliances;partsthereof

3. Electricalmachineryandequipmentandpartsthereof;soundrecordersandreproducers,televisionimageandsoundrecordersandreproducers,andpartsandaccessoriesofsucharticles



3. Railwayortramwaylocomotives,rolling-stockandpartsthereof;railwayortramwaytrackfixturesandfittingsandpartsthereof;mechanical(includingelectro-mechanical)trafficsignalingequipmentofallkinds



3. Vehiclesotherthanrailwayortramwayrolling-stock,andpartsandaccessoriesthereof

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)StateStatisticsServiceofUkrainehttp://www.ukrstat.gov.ua/).NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru)

4 CKDs(Knocked-Downkits)ofBelarustractorsfromtheBobruisktractorplant. 5 CKDs(Knocked-Downkits)ofbicyclesfortheEUmarket.

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Changesinmachineryspecializationpatternsbyoutput ChangesinthecontributionofmachinerytoGDPandtheroleofthesespecializedindustriesinthetotalindustryofthethreecountriesdiscussedhereindicatethatmachineryhasseenitsroleinindustryandmanufacturingdeclineinBelarusandUkraine,whileithasbeengainingin importance inMoldova.This happened inparallelwith theprocess of gradual change inindustrialspecializationinBelarusandUkraine:despitemassiveoutput,machineryhasbeenlosingproductivity,whichhasalsoresultedinadropofitsshareofvalueaddedandexports.6Accordingtofigures1-3,theoutputsofthemachinebuildingsectorsofBelarus,Ukraine,andMoldovahavebeenfollowingdifferenttrajectories:outputhasbeendeclininginUkraineandBelarus, while it has been on the rise in Moldova. Trends in the share of machinery as apercentageofmanufacturingoutputindicatethatstructuralchangesinthemachinebuildingindustrywent deeper inMoldova,while these changeswere rathermodest in Belarus andUkraine.

6 In thecaseofUkraine, theexportshare in2005wasat the lowest levelatany timeduring the last12years(13.1%),andremainedvirtuallythesamein2014(13.2%).SeethesectionanalyzingexportbehaviorinChapterI.

Box3:ThemachineindustrysectorintheEUTheengineeringindustryisthelargestindustrialbranchintheEU,withaturnoverofover€1,825billionin2014.TheindustryaccountsforoveraquarterofmanufacturingoutputandathirdoftheEU'smanufacturedexports.Automotive industry: The automotive industry employs approximately 12 million people. Manufacturingaccountsforthreemillionofthese12millionjobs,salesandmaintenanceaccountforanother4.3million,andtransportfor4.8million.Theautomotivesectoraccountsfor4%ofEuropeanGDP.MechanicalEngineering:3millionpeopleareemployedinthissectorintheEUandithasa9.5%shareofalltheproductioninEUmanufacturingindustries.EUistheworld’slargestproducerandexporterofmachinerywithanestimated36%shareoftheworldmarket.Aeronautics:Ca.500,000 jobs anda turnoverof close toEUR140billion.TheEU is aworld leader in theproductionofcivilaircraft,includinghelicopters,aircraftengines,partsandcomponents,buttheindustryishighly concentrated in terms of geography (United Kingdom, France, Germany, Italy, Spain, Poland, andSweden)andthesmallnumberofenterprisesitcomprises.Electrical and Electronic Engineering industries: EEI produces a wide range of products, ranging fromconsumerproductstoturbines,trains,powergrids,andpowerstations.EEI’sgrossoutputisca.EUR703.3billion, representing 9.6% of all EU manufacturing gross output. At the same time, the EU is the largestelectricalengineeringmarket,followedbytheUSAandJapan.ShipsandMaritimeEquipment Industry: Employsmore than500,000peopleandhasanaverageannualturnoverofaroundEUR72billion.Itismadeupofaround300shipyards,80%ofwhichcanbeconsideredtobe ‘smalltomedium’(buildingshipsof60-150mt).MarineEquipmentManufacturingismadeupofaround7,500companies.Defenseindustries:Directlyemploysabout400,000peopleandhasaturnoverofEUR96billionannually.Itcomprisesover1,350companies,mostlySMEs.Source: European Commission (2016). Available at http://ec.europa.eu/growth/sectors/index_en.htm(Accessedon01/25/2016)

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Figure1.Machineryoutput(%ofmanufacturing)andmanufacturing value added (% of GDP) in Belarus,2005-2013

Figure 2. Machinery output (% of manufacturing)and manufacturing value added (% of GDP) inMoldova,2005-2013

Source:WorldBank,NationalStatisticalCommitteeof theRepublicofBelarus(http://belstat.gov.by/)

Source:WorldBank,NationalBureauofStatisticsoftheRepublicofMoldova

Figure3.Machineryoutput(%ofmanufacturing)andmanufacturingvalueadded(%ofGDP)inUkraine,2005-2013

Source:WorldBank,StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)

InBelarus,machineryoutputhasbeenfluctuatingaround20%ofmanufacturingwithaslightdropafterthe2009globalcrisis.However,theGDPcontributionofmanufacturinginBelarushas been declining since 2011, which suggests that machinery value added has also beendeclining. There is an evident downward trend inmachinery output inUkraine,which hasbeen accompaniedby a rapiddecline of value added in the sector and inmanufacturing ingeneral. The only positive signal in the case of Ukraine is thatmachinery output has beenmore stable than the production of other subsectors of manufacturing. The situation iscompletelydifferentinMoldova.ThemachinebuildingsectorinMoldovahasbeengraduallyrecovering its previous output and has reclaimed its importance for the manufacturingindustry, with a slight decline during the global crisis years of 2009-2010. The mostpromising indication of growing value added in machine building in Moldova is that theoutput share of manufacturing has been growing faster than the contribution ofmanufacturingtoGDP.

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Box4:MachineindustryintheV4–importance&transformations

MachineindustryisaveryimportantsectorintheV4countries,withalongtraditionandahighshareofGDP,outputandexports.

Table:MaineconomiccharacteristicsofthemachineindustryintheV4countries CzechRepublic Hungary Poland Slovakia 2005 2013 2005 2013 2005 2013 2005 2013

Industryvalueadded,%ofGDP 28.1 27.9 22.1 22.0 22.1 22.1 26.3 22.9Machinebuildingvalueadded,%ofGDP 8.0 9.8 7.7 8.5 3.5 n/a 5.1 6.5MachinebuildingoutputrelativetoGDP,% 32.3 41.0 36.5 37.9 14.6 n/a 30.1 45.2Machine building value added, % of totalindustry

28.5 35.1 34.8 38.5 16.0 n/a 19.6 28.6

Employmentinmachinebuildingsector,%ofemploymentinindustry

27.9 32.1 29.6 34.3 19.4 17.8 23.9 29.3

Export of machine building sector of totalexportofallHScommodities,%

51.2 55.0 62.0 53.0 39.6 38.4 44.9 57.9

Source:Eurostat,2015.

Duringsocialisttimes,machineindustrywaslinkedtoasignificantextenttothedefenseindustry,especiallyinCzechoslovakia.Alreadyinthemid-70’ssomecompanieshaveshiftedsomeoftheirdefenseproductiontoothersectors,mostlytotheproductionofagriculturaland/orfood-processingmachinesandvehiclessuchastractors.Generally, the first years after the collapse of socialism were the hardest for the machine industry. InSlovakia,machineindustryproductionfellby30%between1990-1993.Especiallymajorcompanieshadtoreducethenumberoftheiremployees,andinmanycasesthestateindustryreformprogramsdidnotwork.Thereisalsogroupofcompanies(especiallyintheCzechRepublic)thatsurvivedtransitionthankstotheirextensivetraditionandtheirimportance(whichmanifesteditselfinspecialattentionbythegovernmentorinfinding important global investors during the process of transition). This was the case with the CzechcompanyŠKODATransportation, for example,whichwasoriginally established in1859. It survivedand issuccessful owing to the diversification of its product range, which includes a wide variety of industrialproducts, including railway vehicles and vehicles for urbanmass transportation (subway trains, low-floortrams,trolleybuses,etc.).AnotherexampleistheSlovakiancompanyTatravagónkaPoprad,whichwasestablishedin1922andistheonlymanufacturerofrailwayfreightwagonsandbogiesinSlovakia,andisalsoamongthebiggestproducersinEuropewithrespecttotheaforementionedproducts.Thecompanystillenjoysaverystrongpositioninthemarkets of the former Soviet Republics, but it is also very successful in the EU and has acquired othercompanies,towitFabrykaWagónowGniewczyna(Poland)in2009,BratstvoSubotica(Serbia)in2011,and100%of the sharesof theGermancompanyELHEisenbahnlaufwerkeHalleGmbH&Co.KG,Landsberg in2012.

Fourgeneraltypesofsuccessfultransitionscenarioscanbeidentifiedatthelevelofcompanies:1) Abigcompanythatmaybeeithertraditionalorofrecentvintage–survivesasamajorcompanymostly

thanks tomassivegovernmentsupport in its restructuringand thediversificationof itsproduction. Itproducesawiderangeofproductsorhasseveralsubsidiaries thatspecialize inaselectedsegmentofthe market. In some cases, they are still to some extent dependent on public investments/orders(defenseindustry,publictransportvehicles,etc.);

2) Abig company that is fragmented into several smaller companies, only fewofwhich survive throughsmart specialization or by finding strong investors (mostly FDI) who invest money into themodernizationoftheirproductionandinopeningnewmarketsforthem;

3) SMEsthathaveauniqueproductinthemarket,stronglyspecializeonsomemarketniche, andareableto compete globally (one example is SPINEA Prešov in Slovakia, the only European producer of highprecisiongearboxes,whichreliesonauniqueconstructionbasedonitsownpatentedprinciple;ortheCzechcompanySORLichvaby,whichcompletelychangeditsproductionfromagriculturaltechnologies,suchasfeedingvehicles,fodderturners,silounloaders,smallmountaintractors,etc.,totheproductionofbuses,trolleys,andelectricbuses);

4) Big companies or SMEs that are able to adapt to the needs of huge automotive investors in CentralEuropeandbecametheirsuppliers.Inmanycases(especiallyinSlovakia),theyareacquiredbystrong(typically foreign) investors that modernize their production and promote the attainment ofinternationalcertificatesandbettermanagement.

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Box5:"Rebirth"ofthemachineindustrythankstotheautomotiveindustryThe Slovak economy is heavily focusedon industry, especially on industrial productionwithmedium-hightechnology. Approximately 4.5% of the labor force in the EU27 work in industrial production involvingmedium-high technology, whereas in Slovakia this share is 8.1%. With respect to this particular type ofindustry,SlovakiaisthethirdmostspecializedeconomyintheEU.Almost65%oftherelatedproductioninSlovakiastemsfrommotorvehiclesandtheirspareparts.NowhereelseintheEU27doweobservesuchahighshareofproductionbasedonmedium-hightechnologies.

Table:SelectedstatisticsdefiningsomesectorsofindustryinSlovakia–focusingonmachineindustrydevelopment Revenues(million

EUR)Shareoftotal

industrialrevenue%

Shareofexportsin%

Shareofemployment

in%

AveragewageinEUR

NACE 2004 2010 2010 2010 2010 2004 20105-35Industrytotal 48396 67484 100.0 100.0 100.0 561 79524-25 7276 8409 12.7 13.0 14.8 612 79726 1792 6816 13.6

26.15.8 532 754

27 2098 2364 4.4 7.5 492 76828 1932 2630 4.7 8.8 9.5 581 84529–30 8614 13902 28.1 23.6 17.8 632 889

Source:StatisticalOfficeoftheSlovakRepublic. The rebirth of machine building in Slovakia is closely connected to foreign direct investments in theautomotive sector. Huge investments by Volkswagen (the first factory in Slovakia, established already in1991), Peugeot-Citroen (2003), and Kia-Hyundai (2004) turned Slovakia into the "car-producing nation."Slovakiaproducesthehighestnumbersofcarsper1,000inhabitantsintheworld.In2014thisnumberwas183carsper1,000inhabitants,theCzechRepubliccamesecondwith118cars,SouthKoreawasthirdwith82cars.Hungarywasinthe11thplacewith23carsproducedper1,000inhabitants,whilePolandproduced12carsper1,000inhabitantsin2014.As for the numbers of cars produced, in 2013, 987,718 carswere produced in Slovakia, 1,132,931 in theCzechRepublic;222,400inHungary;583,258inPoland;166,428inAustria,and50,449inUkraine.Thetotalnumberofcarsproducedgloballywas87,299,993.The automotive sector in Slovakia directly employs 80,000 employees (compared to 22,000 in 1993) andindirectlycreatesanother120,000jobsinover316Tier1companiesinSlovakia(suppliers).FortypercentofthesuppliersofthesethreecarproducersarelocatedinSlovakia,60%ofcarpartsareimported.Thesectorrepresents 35%of Slovakia's total industrial exports (€17 billion) and creates€2.5 billion of added valueannually.By comparison, the automotive industry in the Czech Republic directly employs 150,000 employees andrepresents20%of thecountry'smanufacturingoutput.Thecar factories located in theCzechRepublicareŠkodaMladáBoleslav (VolkswagenGroup), TPCAKolín (Toyota, Peugeot, Citroen), andHyundaiNošovice.However,theCzechRepublicalsohasalongtraditionofproducingtrucks(TATRAKopřivnice,AVIAPraha–Čakovice)andpublictransportvehicles(KAROSA-IRISBUS,SOR,IVECO,ŠkodaPlzeň,ČKDPraha).InHungary,thecarindustryhasnotplayedadistinguishedrole,neitherearlyinthetransitionprocessnortoday(thoughitsimportancedidgrowafterthelate1990sasnewSuzuki,Audi,andMercedesfactorieswerebuilt).TheoncesuccessfulcompanyIKARUSwasestablishedalreadyin1895asacoachfactory,wentontobecome a car producer and has been producing buses since 1927. The company failed to transformeffectively in the1990s and lost its positions in the internationalmarket.By1973 Ikarushadbecome theworld's fourth largest manufacturer of buses. Irisbus, a French-Italian investing group invested in thecompanyin1999,butin2006itsoldIkarusBustoHungary'sMűszertechnikagroup,whichintroducednewbuses,forexamplethenewIkarusV187in2010.Since2014thecompanyhasalsostartedtoproduceIkarus-Skodatrolleybuses.ThebusesareproducedinSzékesfehérvár(Hungary),theenginescomefromtheCzechRepublic. However, the machine industry success stories in Hungary are typically linked to electricalequipments,electronics,anddevices–companieslikeFlextronics,Electrolux,GE-Tungsram,Orion,Nokiaandothers.

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Belarus

Machinebuildinghasbeenhistoricallyoneof thesectorsof specializationof theBelarusianeconomy and is quantitatively one of the most important industrial sectors in terms ofemployment and production. During Soviet times, administrative decisions were taken toplacethemostvitalandmostpowerfulmachinebuildingplantsintheterritoryofwhatwasthen the former Soviet SocialistRepublic ofBelarus.Among the reasonswere thequalifiedlaborforcethereandthefairlywell-developedroadinfrastructure.Butsuchdecisionshadasignificant strategic disadvantage for Belarus: Production was based on imported rawmaterials and components from other republics of the Soviet Union. Moreover, the mainscientific and research bases were located in Russia, which resulted in the fact that asubstantial share of research and innovationswere sent to Russia [22]. As a result of thissituation the country became a so-called "assembly shop" of Soviet industry. In the Soviet(command and control) economy, demandwas guaranteed regardless of the quality of theproductoffered.

After the collapse of the Soviet Union, the production of many kinds of goods declinedsignificantlyduetothefactthattheBelarusianmachinebuildingsectorhadspecializedintheproduction of unsophisticated low-price products for the captive Soviet market, andparticularlyforRussiaasthebiggestSovietandpost-Sovietmarket.In1990,themanufactureofmachineryandmetallurgicalindustrysectorsaccountedfor34.2%ofallindustrialoutput.By1995theirsharehaddroppedto23.3%[9].Duetothefactsthati)Belarus'machineplantshad tostartperforming independentmarketingandcontractualactivities, ii) theirproductswere of insufficient quality because of low-level innovation capacities, and iii) therewas arapiddepreciationof fixedcapital inkeymachinebuilding factories, theshareof thesectorcontinued to fall in the 1990s. Figures 4 and 5 depict the production dynamics of keycommoditiesproducedbythemachinebuildingsectorinBelarusbetween1990-2014.Theseshowthattheyears2011-2012werethepeakyears.Capacityutilizationofkeycommoditiesindicatesthatmachineryhaspartiallyrecoveredfromtheglobalcrisisof2009,buthasbeendiminishinginaslowandgradualtrendsince2012(Figure6).

Figure4.ProductionofselectedcommoditiesinBelarus,1990-2014,thsd.units(LHS),units(RHS)

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)

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Figure5.ProductionofselectedcommoditiesinBelarus,1990-2014,thsd.units

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/) Figure6.CapacityutilizationinBelarus,2005-2013,%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Some of Belarus machine companies were close to recovering their previous levels ofproduction in the 2000s, mostly thanks to administrative support from the Belarusiangovernment. Producing Soviet-type machines for the captive Russian market negativelyinfluencedthebusinesscultureofsuchfirmsbecausetheywerenotsufficientlyfamiliarwiththecompetition,offeredpooraftersaleservicequalityandpaidlittleattentiontoinnovationor cutting costs [1]. In most cases, administrative measures taken by the Belarusiangovernment proved most vital for the recovery of production in the 2000s, due to thefollowingreasons: i) thesectorhasalwaysbeenoneof themajoremployers inthecountry,and the privatization and restructuring of this industrywould have resulted in high socialcosts;ii)largeindustrialplantshavebeenhugeexportersandsourcesofforeigncurrencyforthe Belarusian economy, making them relatively important for macroeconomic reasons.Subsidized loans from state-owned banks and direct negotiations between the Belarusian

26

governmentandtheRussianFederationorRussianregions7madeitpossibleforBelarusianmachinerygiantstoexpandtheirpresenceintheRussianmarket[42].Asfarasadvancesareconcerned,onemightpointtosomeimprovementsinquality(forinstancetheintroductionofinternationalqualitycertificates,suchastheISO9001intheearly2000s),thedevelopmentofnew products (in passenger transportation, for example) and some energy intensityimprovements.Forexample,intheproductionofheavytrucks,by2014energyconsumptionperunithaddroppedtoalmostathirdofthe2005level;intractormanufacturing,itfellbyarateof1.6.Inthemacroeconomicmeasureoftoeperof$2,000PPP,Belarus’energyintensitylevelis15-20%belowtheaverageofthepost-Sovietstates,thoughitalmosttwiceashighastheOECDaverage[24].

Astheresultofgovernmentsupportprograms,machinerystructureinBelarushasremainedalmost unchanged. Today, the production of machinery and equipment remains the focalpointofthemachinebuildingsectorinBelarus,producingmorethanhalfofthesector'stotaloutput(Figure7).Manufactureoftransportvehicleequipmentdroppedfroma31%shareinthesectorin2005to24.2%in2013.Outputofelectricalandopticalequipmentclimbedtoa24.2%shareofmachineryoutputin2013.

Figure7.MachineryoutputstructureinBelarus,2005and2013,%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Today,Belarus’machinebuilding sector finds itself in a verydifficultpositionand requiresnew reforms. Huge investments in the sector have been used inefficiently and largeenterprisesstillhaveworn-out capitalassets, thequalityofgoodschangesslowly,andpricecompetitivenessremainshighlydependentontheexchangerateofthenationalcurrency[40,42].ThereisacriticallevelofdependenceonRussiaonaccountofthehighshareofimportedcomponentsandfossilfuels,aswellasthehighshareofexportsgoingtoRussia.Thesereflectthegeneral structuralproblemsof theBelarusianeconomyand theabsenceof institutionalreformsoverthelast25years[41].Asaresult,afterRussiajoinedtheWTOandtheRussian

7For instance, in2011-2012Russia'sbiggestbank"Sberbank" issuedover$600million insubsidized loanstoRussian regions to finance the procurement of Belarusianmachinery items after the Belarusian and Russiangovernments agreed on a corresponding deal (see http://www.belta.by/economics/view/sberbank-rf-lgotno-prokreditoval-postavki-belorusskoj-tehniki-v-rossiju-na-summu-svyshe-600-mln.-97375-2012)

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rublewasdevaluedsubstantially in2014,Belarusianmachineryoutputdroppedby20% inthesameyearandhascontinuedtoshrinkin2015(Figure8).Figure8.ManufactureofmachineryandequipmentandmanufactureoftransportvehiclesequipmentinBelarus,2010–2015,m/m,%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)ThefinancialresultsofmachineproducersconfirmthecriticalstateofmachineryinBelarus.Netprofits at the threemajormachinery companies (Belaz,MAZandMTZ -Figure9)havebeendecliningsignificantlyoverthelastyears,andtheymorphedintosteeplossesin2014.The return on sales indicator has also been following a downward trajectory since 2011,dropping near the level of 2009, the year when output droppedmost precipitously in thewakeoftheworldfinancialandeconomiccrisis(Figure10).Figure9.NetprofitofmajorplantsinBelarus,2011-2014,million$

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Figure10.ReturnonsalesinthemachinebuildingsectorinBelarus,2009-2013,%

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Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Atthesametime,theshareofunprofitablemachineryenterprises(Figure11)isalsonearthelevel of the 2008-2009 crisis. The number of unprofitable companies in the subsector oftransportvehiclesandequipmentisevenhigherthantheaveragefigureinthemanufacturingindustryoverall,whichindicatesthecriticalstateofthisparticularsubsector.Figure11.ShareofunprofitableenterprisesinthemachinebuildingsectorinBelarus,2011-2014,%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Excessive employment and the wage burden also constitute significant problems for themachinerysectorinBelarus.Mostofthemachineryoutputisproducedbylargestate-ownedenterprises (SOEs), which enjoy privileged access to low-cost financing from state subsidyprograms, often at a level of interest that is lower than inflation. Combined withadministrativewagetargetingatSOEs,thisincreasestheshareoflaborinmachineryproductsandcontributestoitslackingexportcompetitiveness.Thisisespeciallytrueinthecaseofthetransportequipmentsubsector(Figure12).

Figure12.AddedvalueofthemachinebuildingsectorinBelarusbyincomes,2013,%

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Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)To summarize, there is currently significant need for restructuring the machine buildingsector inBelarus. Sinkingoutput, bad financial results, and excessive employment result inthediminished competitiveness ofmachineryproducts in termsof quality andprices, bothdomestically and abroad. Slow demand in the Russianmarket and an overvaluation of theBelarusianrublemayyielddramaticresultsin2015andbeyond.Newreformsareneededtochangethestatusquo.

Ukraine

The Soviet Union left an impressive legacy for Ukraine, but in the 1990s machineryexperiencedasignificantslump.DuringSoviettimes,Ukrainewasoneofthekeyproducersofenergyandmetallurgyequipment,machinetools,agriculturalequipment,andrailwaycarsinthe USSR. In some of the subsectors, like specialized types of combine rotor excavators,Ukraine retained a monopoly in the market. Ukraine’s comparative advantage was thepresenceofsignificantnaturalresources(mainlyironore)formachineryproduction[5].Themoretechnologicallyadvancedmachinerysectorsatthattimeincludedrocketindustry,spaceindustry,aviationindustry,andmechanicalengineering.TheshareofmachinebuildingintheoutputoftheUkrainianSSRin1990wasbelow30%,whileitsshareofindustrialemploymentwas35%.8

In the 1990s, after the fall of the USSR, economic collapse, problems with the supply ofcomponents from other post-Soviet countries, as well as changes in ownership structurepushedUkraine’smachineryintoadecade-longslump.Large-scaleprivatizationlaunchedin1995 triggered a processwhereby private investorswere competing for the acquisition ofpreviously state-held machine production assets at significantly below market prices. By1999, the specific situation of Ukrainian privatization resulted in a push for equity

8Accordingtothe1996UkraineStatisticalYearbook.

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accumulationbyinvestmentfundsandtrusts,butthisledtopoormanagementandalackofincentives for investmentsand technological recovery [44].Also, theexistenceofenormousreserves of raw materials seems to contribute to the conservation of the status quo inmachinery structure and discourages a transition to the production of more high-techproducts.

Inthe2000smachineproducingcompanieswererecoveringquickly,buttheglobalfinancialcrisishit thesectorseverely(Figures13-14).Amongthekeyreasons for therecoverywererapidlygrowinginternaldemandcombinedwithfavorableexternalconditionsthatincreaseddemandforUkrainianexports[29].Forexample,theproductionofagriculturalmachineryinUkraineincreasedsignificantlybecauseofthefastdevelopmentoftheagriculturalsectorandbecauseforeigninvestorshadacquiredstakesinlocalproductionsites.However,thequalityofdomesticallyproducedequipmentandmachinesbarelyimproved,whiletheproductrangehadnot changedmuch [29].Asa result, therewasa significant reduction inmanufacturingandmachinery production in 2009 because of the global crisis, which led to a collapse indomestic investments in fixed assets. Since then, machinery has been following a newdownwardtrajectorywithfewsignsofrecovery.Figure13.ProductionofselectedcommoditiesinUkraine,1990-2014,units(LHS),thsd.units;(RHS)

Source:StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)

Figure14.ProductionofselectedcommoditiesinUkraine,1990-2014,thsd.units


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As a result of the transformation processes, the structure of machinery in Ukraine haschangedsignificantly,withthetransportequipmentsubsectorproducinghalfofallmachineryoutput(Figure15).Thedifferentpaceofgrowthbetween2001and2008insomesubsectorsascomparedtoothers,andapost-2009declineofthethreemachinerysubsectors,resultedinrelativelybetterdevelopmentofthetransportequipmentmanufacturingsubsectorcomparedto the subsectors ofmanufacturing of electrical and optical equipment andmachinery andequipment.Intermsofoutput,transportequipmentpresentlypredominatesinthestructureof the sector, while the subsectors manufacturing of electrical and optical equipment andmachinery and equipment saw their relative share of output diminish between 2001 and2014. Figure15.MachineryoutputstructureinUkraine,2001and2014,%


Today, the most developed sub-industries of the machine building sector in Ukraine aredependent on domestic raw materials and are located in the East of Ukraine in order toreduce the distance between production companies and the supplier of raw materials(mainly,steel) [29](seeFigure1 in thestatisticalappendix).Thesub-industriesreferredtoabove are railway machine building, heavy machine building and machine building foragriculture.

Theaveragedepreciationrateoffixedassetsiscloseto70%,butsomesub-industriesreportevenhighernumbers[29].AconsiderableshareofUkrainianenterprisesstillhaveSovieteraequipmentandtheirtechnology,too,isfromthesameera[6].Forexample,inthe"Machinebuildingforagriculture"sub-industry,between70%and90%ofthedomesticmachineparkofagriculturalmachineryisfullydepreciatedorobsolete.Asaresult,productivityinmachinebuilding is only two-thirds of the national average, which is an indication of capital andtechnology deficits, and also suggests problems with international competitiveness [7].Results for 2014 illustrate that machinery overall has shrunk by over 20%, while somesubsectors (mostly those oriented towards the Russian market, like railway machinebuilding)havedroppedbyover60%.

Thefinancialresultsofmachinerycompaniesremaininthepositivedomainandindicatethatprofits have not been reinvested into acquiring new technologies,modern equipment, andknow-how(Figure16).

Figure16.ProfitabilityintheUkrainianmachinebuilding,2010-2013,%

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Source:StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)Statistical data on value added calculated by income in Ukraine’s machinery subsectorsindicatethatcompaniesdogenerateoperationalsurpluses,buttheirlevelsdiffersubstantiallyacrosssubsectors (Figure17).Employeecompensationalsovaries,but,unlike inBelarus, itdoesnotimposeawageburdenontheindustry.Importedcomponentsprovidemajorvalueaddedinthecaseofthemanufactureofcomputers,electronicandopticalproducts,andmotorvehicles.Figure17.AddedvalueofthemachinebuildingsectorcalculatedbyincomeinUkraine,2013,%

Source:StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)Low productivity and the low level of technological progress make Ukrainian machinerysensitive to energy price increases, which undermines the competitiveness of Ukrainianmachineryproducers.Between1991-1995Ukraine’seconomyenergyintensitygrewby30%,thenstabilizedintheperiod1995-1999,whilebetween2000-2005energyintensitydroppedby40%[26].Asof2012,itisabout45%moreenergyefficientthanitwasin1990,basedonIEAopensourcedata.Theexistingimprovementsinenergyintensityhavenotresultedfromsectoral shifts in the economy but from technological improvements in individual sectors[26].Forinstance,accordingtotheenergybalanceofUkraine,in2014energyconsumptioninindustry fell by 60% as compared to 2007, while energy consumption in the machine

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buildingsectorfellbyafactorof2.1inthesameperiod.9However,thereisaneedforfurtherreductionsinenergyintensityinthevarioussectorsofindustry,includingmachinery,inordertobecompetitiveindomesticandforeignmarkets.Underinvestmentinnewtechnologiesandenergy-savingcontributetothefactthatsignificantsegmentsoftheagriculturalmachinesandmetallurgyandminingsubsectorsmainlyproducedforthedomesticmarket[29].

9Inthousandstonsofoilequivalent.

Box6:"SmartSpecialization"andthefutureofmachineindustryintheV4

TheEU's current approach to increasing the competitiveness of theEUeconomy is basedon the so-calledSmart Specialization or RIS3 program, which is a strategic approach to economic development throughtargetedsupportforresearchandinnovation.Itinvolvesaprocessofdevelopingavision,identifyingwherethegreateststrategicpotential lies,developingmulti-stakeholdergovernancemechanismsandusingsmartpolicies to maximize the knowledge-based development potential of a region, regardless of whether it isstrongorweak,high-techorlow-tech.Itisthenfollowedupbyfinancialinstrumentsandnationalcohesionfunds,whichsupportinnovationinthecompanies.

The following table presents decisions taken by the V4 countries about the sectors that will receive thehighest levels of support in the following years. Machine building industry is the key priority in all V4countries,whichunderlinestheimportanceofthesectorfortheeconomiesofthecountriesinvolved.

Table:AreasofEconomicSpecializationintheV4CzechRepublic Hungary SlovakRepublic

Manufactureofmeansoftransportationandequipment Healthysocietyandwell-being Automotiveandmechanical

engineeringindustries

Mechanicalengineering Advancedtechnologiesinvehicleandothermachineindustries

Consumerelectronicsandelectricalequipment

Electronicsandelectricalengineering Cleanandrenewableenergies ICTandServices

ITservicesandsoftware

Sustainableenvironment(naturalresourcemanagement,advancedenvironmentaltechnologies)

Productionandprocessingofironandsteel

Electricityproductionanddistribution

Healthylocalfood(foodprocessing)

Prospectivearea:Automation,RoboticsandDigitalTechnology

Drugsandmedicalproductsandmethods Agriculturalinnovation

Prospectivearea:Processingandincreasingthevalueoflightmetalsandtheiralloys

Prospectivearea:Naturalresources,agriculture,andfood

Horizontalarea:ICT(info-communicationtechnologies)&Services

Prospectivearea:Productionandprocessingofplastics

Horizontalarea:Inclusiveandsustainablesociety,viableenvironment

Prospectivearea:Creativeindustry

Prospectivearea:Increasingthevalueofdomesticrawmaterialbase

Source:RIS3oftheV4countriesinvolved,2014and2015.

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Summingup,machineryinUkrainecurrentlyseemstofinditselfintheprocessofstructuralandtechnologicaladjustment.Problemswithinternaldemandandinstabilityintheexternalmarkets have lead to a significant decline in machinery production over the last decades.Goodtimesinthe2000shavenotledtothemodernizationofequipmentortheintroductionof innovations. Subsectors that rely on domestic rawmaterials produce the major part ofmachinery products and seem to lack an incentive to accelerate the transition to theproduction ofmore high-tech industrial products. Further proactive steps are needed bothfrommachineryproducersandthegovernmentinordertofacilitatechangesinthestructureoftheindustry,inequipmentmodernization,andintheapplicationofnewtechnologies.

Moldova

InMoldova,machinery has undergone significant transformation throughprivatization andchangesinitsoutputstructuresincethecountrybecameindependentin1991.ThemachinebuildingsectorinMoldovahadbeenformedmainlyinthe1960-1980s,duringthetimeoftheMoldovanSovietSocialistRepublicwithintheUSSR.Atthetimeitwasprimarilyaimedatthedevelopmentof thesubsectorsofagriculturalmachinebuilding,andelectronicsandprecisemachine tools (laterasapartofSovietmilitary industry) [45].Throughout the1990s,afterthe economic reformswere launched, therewas a sharp decrease inMoldovanmachineryproduction(Figure18).Asaresultofcoupon-basedmassprivatization,by200193%ofthemachine building sector's output was produced by non-state enterprises, and 90% of thesector'sworkerswereemployedbyprivatecompanies.Thosenumberswerehigherthantheaverageindustryfiguresatthattime,indicatingtheauthorities'directorindirectwillingnesstoreformthesector.Afterprivatization,themachinebuildingsectorregisteredonlylimitedinvestment, which− with few exceptions− lead to a decline in the competitiveness of thesector. Some of the companies in the sector switched from producing parts for militaryequipmentandpartsforindustrialgiantsinRussiatomanufacturinghouseholdgoods.Manycompanies went through bankruptcy procedures, stopped producing, and rented out theirassetstootherprivatecompanies.Thecapacityutilizationofsomecommodities inMoldovabetween1995-2002reflectstherecessioninmachinebuildinginthe90s,andalsoshowsthefirstsignsofrecoveryintheearly2000s,specificallyinagriculturalmachinery(Figure19).Figure18.IndexofproductioninMoldova(1995=100),1995-2002,%

Source:NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru)

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Figure19.CapacityutilizationinMoldovanmachinery,1995-2002,%


Machine building has achieved amore significant share ofMoldovan industrial productionsince2001,and there isan increased focuson themachinebuildingsectoras theengineofindustrialgrowthinMoldova.Productivitygrowthinvariousmachinebuildingsubsectorshasexceededtheindustryaverageinthe2000s(Figure20).However,itseemsratherdifficulttopinpoint the key factor that was the main contributor of the growth of the machinerysubsectorduringthistime.Majorinvestmentsbyglobalautomotivecomponentsproducersin2006, 2007, and 2010weremajor drivers of growth. This resulted in sharp growth in theexport figures of the electrical machinery and apparatus manufacturing subsectors, whichjumped from $53.1 million in 2006 to $315.9 million in 2012. Figure 20 also depicts thenegativeimpactofthe2008-2009globalfinancialcrisisonMoldovanindustryandmachineryspecifically.Industryproductivityfellby10%in2009,whileproductivityinthemanufactureofthemedical,precision,andopticalinstrumentssubsectorfellby40%.Figure20.ProductivitygrowthinMoldova,1996-2010,(y/y)%


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Deep reforms resulted in a transformation in the structure of the machinery sector, andpushedittowardsamorebalancedandtechnology-orientedoutputstructure(Figure21).Theweightofthemachineryandequipmentsubsectordroppedfrom70%to40%oftotaloutput,while the subsectors manufacturing of medical, precision, and optical instruments andmanufactureofelectricalmachineryandapparatusexpandedtoabout30%each.Figure21.MachineryoutputstructureinMoldova,1996and2012,%

Source:NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru)Since2004,whenMoldova joined theEuropeanNeighborhoodPolicy (ENP)andsigned theMoldova-EUactionplanin2005,therehasbeenagrowinginterestbyEuropeaninvestorsinMoldovan industry.After theEU–MoldovaAssociationAgreement, including theDeepandComprehensiveFreeTradeArea(DCFTA),wassignedin2014,Moldovabecameattractivefor2ndtierand3rdtiersuppliersofautomotivecomponents,aswellasforthemachinebuildingsector[31].Westerncompaniesareincreasinglyinterestedintheproductionofcomponents,and also in outsourcing component production, assemblies, and machines. This is alsoapparentinthegrowingimportanceofmachineryinbothindustryandmanufacturing(Figure22) inMoldova.Aswewillshowlater,Moldovan investments in fixedmachineryassetsarecurrentlymostlydirectedtowardsthemanufactureofelectricalmachineryandapparatuses.There is an increased interest inMoldova in the production ofmachinery components andtoolsbasedonlicensesprovidedbyWesterncompanies(ItalianandGermancompaniesareparticularly active in these areas), which indicates that the country is turning into acomponentsupplierforbothWesternandEasternmarkets.Laborintensiveproductionsitesareattractive for foreign investment, asMoldovaoffers themost competitive labor costs inEurope,incompetitionwithUkraine[31].

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Figure22.ShareofmachineryinindustrialandmanufacturingoutputinMoldova,2006-2013,%

Source:NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru) Summingup,themachinebuildingsectorinMoldovahasbeencontributingagrowingshareof industrial production since 2001. Compared with Belarus and Ukraine, the machinebuilding sector in Moldova contributes far less to the country's GDP, but the sector hasexperienced a surge in its productivity and there is an increased focus on the machinebuildingsectorasanengineofindustrialgrowthinMoldova.Thisindicatesthatthecountry’smachinery has undergone deep structural changes and has managed to attract greenfieldinvestmentsintheareaofmachinerycomponents.Apparently,pragmaticeconomicpolicies,combined with the benefits of the country's geographical location, may attract newinvestmentsintothesector,whichwillservetoenhancemachinerydevelopmentandturnthecountryintoanimportantregionalplayer.

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Box7:V4–lessonsfromthepast20years–Casestudiesonincreasingproductivityandshiftingfocusonnewemergingsectorsoftheeconomy

CaseofZTSVVUKošice,SlovakiaEstablished in 1976, the state-owned company developed commercial vehicles, heavy hydraulicmanipulators,transportandhandlingsystems,specialtechnologies(reararmsandengineeringhardwareonautomotivecarriages),formingmachines,high-speedstampingpresslines,andstationarygearunits.ItwasincorporatedintoZTSMartin(apreviouslymentioneddefensecompany)in1981.In1990,theZTSconcernwasbrokenupandonJuly1,1990,ZTSVVUKosicewasformedasanindependentstateenterprise.Aspartofthistransformationprocess,ZTSVVUKosicewasturnedintoajoint-stockcompanyandwasprivatizedinthefirst wave of privatization in the years 1992-1993. Subsequently, the enterprise stabilized, its productionprogramwas retained and it developed specialized purpose extensions for vehicles, handling equipment,assembliesforthepaperindustry,andtransportcontainersfornuclearenergy.The year 2004marked an important milestone for the company, as it then became a supplier of roboticdevices for positioning cryo-magnets in the Large Hadron Collider at CERN in Geneva, Switzerland. ThecompanyisstillinSlovakianhands,anditssuccesshingesonitsabilitytoadaptitsproductiontocustomerneedsandtospecializeinmeetingthesespecificneeds.Thecompanycontinuestoenjoyastrongpositioninthe defense industry, but after 1993 it was able to shift its production first to robot systems for nuclearplants,andlatertotheproductionofservice&securityrobots.CurrentlythecompanyisalreadyinvolvedinEUresearchintheareaofsmartmobilityandambientassistedliving,developingthePersonalIntelligentCityAccessible Vehicle System (PICAV) and the Freight Urban Robotic Vehicle (FURBOT). These could yieldanothernewproductionprograminthenearfuture.CaseofSPINEAPrešov,SlovakiaTheSPINEAcompanyisamodernSlovakengineeringcompany,engagedinthedevelopment,manufacturing,andsaleofhigh-precisionreductiongears,whicharesoldunder the trademarkTwinSpin.The impetus fortheestablishmentofthecompanywastheinventionofaSlovakengineer in1994.TwinSpinhighprecisionreduction gears are serially manufactured based on an international patent. The company's products aresuitable formechanicalandroboticapplicationsofdifferentkind.Theyarewidelyused inautomationandindustrial robotics, in the field of machine tools manufacturing, in navigation and camera equipments,medicalsystems,andinmanyotherfields.The company is growing rapidly thanks to theunique invention. It has only twomajor competitors in theworld(one is located intheUS,andanother is in Japan). Itexports itsproductsworldwideandcooperateswith such companies as KUKA, ABB, COMAU, RR Robotica, BMW, and many others. The company is anexample of a success story, even though it is located in Eastern Slovakia, the poorest region in the SlovakRepublic.ThefoundationofthecompanywasalsobasedonthetraditionofrobotdevelopmentthatbeganattheVUKOVPrešovfactoryinthe1980s–whichwasastate-ownedR&Dandproductioncompanyatthetime.Unfortunately,VUKOVhadto layoffa lotofstaff(itemployedover1,200engineers inthe1980s) in1991,when the companywas transformed into a state-owned joint stock company. In2005 it receiveda capitalinjectionand the companywas strengthened througha restructuringof its ownership and the arrival of anewowner.SincethentheVUKOVcompanyhasbeengrowingagain.CaseofPataLtd.,HungaryEstablishedasafamily-ownedventureinasmallHungarianvillage(Fajsz)in1988,thecompanyspecializesinmanufacturingautomotivebodyparts.ThehistoryofthecompanyisthesuccessstoryofaSuzukisupplierthat has established itself as themost important domestic supplier of the Japanese automotive company'sHungariansubsidiary.Itssuccessisbasedoncontinuoustechnologicaldevelopment,learning,andupgrading.Initially the company specialized inmanufacturingparts for farmingmachinery. It signed its first suppliercontractwithSuzuki in1992.Sincethen, itsdevelopmenthasbecomeanexemplificationofthenotionthatsupplier firmscangrow jointlywith their contractors if theyadopta long-termstrategyandmake sure tokeepupwith theever-increasingrequirements. Initially,Patahadsuppliedeightcomponents,butby2015thenumberofproductcategoriesitsuppliedtoSuzukiamountedto170.Pata’sturnoverwas€8.7millionin2015:about15timeshigherthanitssalesvolumein2000.Currently,thecompanyhas99employees.Thisrapid development necessitated a continuous reinvestment of its earnings: It has invested in capacityexpansion,processupgrading,andintangibleassets(Kaizen,qualitycertificates).Theexampleofthiscompanyisespeciallyinstructivebecauseoftheroleoftechnology-basedupgrading:Inanindustrycharacterizedbyrapidtechnologicalchange,thediffusionofadvancedmanufacturingsolutions,automation, cyber-physical systems and ever-stricter regulations, a smallHungarian companymanaged tokeepupthepace,grow,andincreasequalityandproductivity,all thewhile it installedthemostup-to-dateroboticsolutions(suchasroboticwelding)andexpanded itsproduct/activitymix(includingassemblyanddesign).

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Export&importpatternsAccordingtotheUNComtradeDatabase,themachinebuildingsector'sshareoftotalexportshas risen in Moldova, lost some of its importance in Belarus, and has been fluctuating inUkraine(Figure23).Thoughthetrendsintheirmachineryexportsweredifferent,theirratiohasbeenconvergingaroundthesameshareofthetotalexportsinallthreecountries.In2014,theshareofexportsprovidedbythemachinebuildingsectorrelativetototalexportswasjustbelow15%forallthreecountries.Figure23.The share ofmachinebuilding in the total exports ofBelarus,Ukraine, andMoldova1994-2014,%


In termsofabsolutevalues, asof2014machineryexports inBelarushadgrown twoandahalf-foldsince1998,whileinUkrainethecorrespondingfigureis3.5timesthevaluein1996,and in Moldova it has grown five-fold as compared to 1994 (Figure 24, Table 14 in thestatisticalannex).Figure24.ExportsofthemachinebuildingsectorinBelarus,Ukraine,andMoldova1994-2014,bn.USD


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Belarus hasmaintained the lowest level of export diversification. Ukraine’s dependence onRussiaandtheCIShasincreasedoverthelastyears,whileMoldovahassubstantiallyreducedthe level of itsEasternmachineryexports.Table5presents changes in the levelsof exportdiversificationoverthelast15years.IthaschangedonlyslightlyinBelarus:in1998,86.4%ofcommodities produced by themachine building sector were sold in the CISmarket, while76.4%wereexportedtoRussia.By2013,export to theCISmarkethad increasedto90.6%,while during the same period the importance of the Russian market decreased by 3 p.p.(73.4%).In1998Moldovahadthelowestlevelofexportdiversification(77.2%ofitsexportswenttotheCISmarket).Nonetheless,by2013yearthisnumberhasdroppedsignificantlyto27.5%. The data indicate that Moldova's dependence on the Russian market has beenrelativelylow(from32.8%in1998to21.3%in2013).InUkraine,thelevelofdiversificationofmachineryexportstotheCIShasslightlyincreased(61.2%to62.8%),whiledependenceontheRussianmarkethasincreasedby8p.p.(43.9%to51.9%)since1998.Table5.ExportdiversificationinBelarus,Moldova,andUkraine,1998and2013

(HSCode) RussianFederation

CIS+Ukraine+Turkmenistan

World

Machinebuildingsector

1998Belarus 76.4 86.4 100Ukraine 43.9 61.2 100Moldova 32.8 77.2 100

2013Belarus 73.4 90.6 100Ukraine 51.9 62.8 100Moldova 21.3 27.5 100


According to Moody’s report, Belarus, Ukraine, and Moldova are massively dependent onRussiaasaresultofacombinationoffactors,towitexportdependence,FDIdependence,anddependence on remittances. The risk map (Table 6) shows that Belarus’ high level ofdependenceonRussiaisexplainedbythehugeshareofitsexportgoingtoRussia,whileinthecaseofMoldovathehighlevelofdependenceonRussiaismostlyexplainedbythehighvalueofremittances.ForUkraine,itisexplainedbyacombinationofthesefactors.Table6.RiskmapofdependenceonRussia

Country DegreeofdependenceonRussia

ExporttoGDP

(2013),%

FDItoGDP(2013),%

Remittances(2013)toGDP,%

Belarus 25.2 23.5 1.2 0.6Ukraine 10.6 8.4 0.3 1.9Moldova 24.5 7.9 0.5 16.0

Source:Moody’s(https://www.moodys.com/)

morethan10%GDP 5-10%GDP lessthan5%GDP

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Belarus

WeakexportdiversificationremainsthekeyproblemfortheexportofBelarusianmachineryindustryproducts. In fact, thesituationhasnotchangedmuchsinceSoviet timesduetothefact that Belarusian machine building enterprises have been able to produce and sell lowvalue added products and export them to Russia and other CIS countries [1]. Withoutinstitutionalreformsandchangeinthecountry'sgeopoliticalagenda,thisshareisexpectedtoremainhighonaccountofthefactthatBelarusianmachineryproductsarecurrentlytarifffreeinRussiaandtherestoftheEurasianEconomicUnion.

TheBelarusianmachinebuildingindustryisdeeplyintegratedwithRussiaviaasupplychainnetworkandenergysubsidies.Withrespecttothemachinebuildingsector,theeconomiesof the two countries are highly integrated asmuch as 85% of the production volume is

Box8:V4exports–value,maindestinations,andexperiencewithshiftingthedestinationmarketfromtheformerUSSRtotheEU/widerworld

All V4 countries are currently economies in which foreign trade − mainly intra-EU trade − plays a pre-eminentrole.Thiscanbeattributedtodevelopmentsinthepasttwodecadesandistheresultofthemassiveexpansionofboth, theexportsand importsofV4countries.Thevalueof theregion'sexportsofgoodsandservicesrelativetotheirGDPhasroughlydoubledsince1993.InthecaseoftheCzechRepublicandSlovakia,thissignificantincreasehasbeenachieveddespitearelativelyhighbaselinevalue;eveninthe1990s,exportsaccounted forabouthalfof theirGDP.Hungary,which, likePoland,hada lower levelofexportsrelative toGDPinthe1990s,hasbeenabletoalmostquadrupleitsexportsofgoodsandservicesrelativetoGDP.

Figure:V4Countries'Exports(PercentageofGDP)

Country/Year CzechRepublic Hungary Poland Slovakia2015 74 82 40 861993 40 23 21 55Sourceofdata:CIA,TheWorldFactbookDecline in machinery production as a result of structural changes has caused a drop in the share ofengineeringproductsintheexportsofV4countries,mainlyinthe1990s.Recently,thecommoditystructureof themerchandise trade of V4 countries has been dominated by trade inmachine industry products andotherprocessedindustrialproducts.

Exports–maincommodities(2012,CIAWorldFactbookandUNCTAD):CzechRepublic–machineryandtransportequipment:54.6%;fuelsandchemicals9%;rawmaterials5%Hungary - machinery and equipment: 53.5%; other manufacturing: 31.2%; food products: 8.7%; rawmaterials:3.4%;fuelsandelectricity:3.9%Poland - machinery and transport equipment: 37.8%; intermediate manufactured goods: 23.7%;miscellaneousmanufacturedgoods:17.1%;foodandliveanimals:7.6%Slovakia-vehiclesandrelatedparts:27%;machineryandelectricalequipment:20%;nuclearreactorsandfurnaces:12%;ironandsteel4%;mineraloilsandfuels:5%

AfterthecollapseoftheEasternbloc,thetradetiesoftheV4countriesgraduallyshiftedtowardstheWest.ThetotalexportdataforalltransitioncountrieswithouttheformerUSSRshowthatwhilein198940.4%oftheirexportswenttoothercountriesoftheEasternbloc(and24.4%totheUSSR)and41.0%totheWest,in1999 itwas just 18.8% to the former Soviet-ledblock (4.7% to the formerUSSR) and75.5% to theWest.Eurostat's calculation for2002show that thevalueofV4machine industryproductexports toRussiawasonly4.51%ofthevalueofV4machineindustryexportstotheEU15.

ThemainexportpartnersoftheV4includeGermany,Austria,UK,France, Italy,andotherEUmarkets.TheGermanmarketservesbothasaV4finalmarketandasagatewaytotheoutsideworld,assomeV4goodsareonlycompletedinGermanyandarethenrelabeledas"MadeinGermany"tobeexportedtonon-EUmarkets.OfcoursetherearesignificantmutualtradelinksbetweenthecountriesoftheV4region.EvenpriortotheiraccessiontotheEU,thetradebetweenV4countrieswassubstantial.

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related in different forms to Russian counterparts [2]. Currently, about 800 RussiancompaniesareinamanufacturingcooperationwithBelarusianpartners,whicharebasedonacommonhistoryduring Soviet times.Apart fromhistorical links stemming froma commonsupply chain with Russia, an important channel of Russian influence over the Belarusianmachine building sector is the privileged access to underpriced Russian energy supply.Energy-intensiveBelarusianmachinerygiantsreceivethelowestgaspriceintheregion,closeto Russian domestic prices.10 Calculations have shown that the average level of Russianenergysubsidiesoverthelasttwodecadesamountedtoroughly15%ofBelarus'annualGDP[32].However,ithasbeendroppingoverthelastyears.

The massive dependence of machinery exports on the Russian Federation has a negativeimpactonBelarusianmachineryoutput, sinceanyproductionorconsumptionslowdown inRussia is felt inBelarus.Onthedemandside, theRussianmarket ismarkedbyhighincomeelasticityofdemandforqualityequipment[1].ThisexplainswhyBelarusianmachineryhaslost market share in Russia, as the Belarusian machine building sector was not able tocompete in terms of quality. In the heavy truck segment, Belarus’ sales to Russia werestagnantforthesecondhalfofthe2000s,despitethefactthattheRussianmarketforheavytruckswasgrowingatanaveragerateof11%annuallybetween2000and2008[1].Demandfor more sophisticated products in Russia has increased recently, fueled by imports ofWestern-madehighqualityproducts.

On the supply side, the competitiveness of Belarusian machinery products in Russia andworldwide remains highly dependent on the exchange rate of the national currency.Inefficientuseofinvestments,excessiveemployment,andthelowqualityofgoodsmakelargemachine building enterprises in Belarus dependent on price competitiveness achievedthroughthe lowexchangerateof theirnationalcurrency.Over the lastdecade, thenominalexchange rate of the Belarusian ruble has been falling steadily, and the currency hasundergonethreesignificantdevaluationsoverthelastfiveyearsin2009,2011,and2015(seeFigure 25 as an example for BYR/RUB exchange rate). However, in 2012-2014, the realexchange rate of theBelarusian ruble (both the real effective and the real rate forRussianruble) has gone up (Figure 25). This has resulted in a reduction of the number of keymachineryproductitemsexportedinrecentyears(Figures26-27).

10AccordingtointergovernmentalagreementsbetweenBelarusandtheRussianFederation.

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Figure25.Changes in theexchangerateof theBelarusianruble,2010-2015,December/December ("-"devaluation,"+"appreciation),%

Source:NationalBankoftheRepublicofBelarus(http://www.nbrb.by/)Thecombinedeffectofchangesinsupplyanddemandhasbeenasharpdeclineinthemarketshare of Belarusian machinery and transport in the total imports of Russia and othercountriesoverthelastyears.Forexample,withamarketshareof24%in2010,MinskTractorPlant(MTZ)wasthemarketleaderintheUkrainiantractormarket.Butafter2010MTZbegantoloseitsleadingpositiontoitscompetitorsJohnDeereandCASE[28].Exportsoflorriesandtractorshavebeenfallingsince2013,indicatingthattherehasbeenasignificantdeclineinthecompetitivenessoftheindustry(Figures26-27).Figure 26. Change in the export of tractors byBelarus,2010-2015,(y/y),%

Figure 27. Change in the export of lorries byBelarus,2010-2015,(y/y),%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)The high level of imported components is another problem for the Belarusian machinebuildingsector,renderingitevenmorevulnerable.Onaverage,roughly40%ofthesuppliesneededbythemachinebuildingsectorstemfromimports,bothfromtheWestandfromtheCIS (final and intermediate, Figure 28). Import components have the highest share in themanufactureofelectricalmachineryandapparatus.Figure28.AddedvalueofthemachinebuildingsectorbymethodoffinaluseinBelarus,2013,%

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Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Lowexportdiversification,therelativelylowqualityofproducts,andproblemswithexternaldemandcausedBelarus’machineryandequipment sector to loseexportmarket share.Thehighratioof importedcomponents increasestheexternalrisksfordomesticproducers.TheweightoftheRussiafactorhaspracticallynotchangedoverthelasttwodecades.TheRussianFederationremainsthemainimporterofBelarusianproductsandthesupplierof itsenergyneedsatarelativelylowprice.

Ukraine

InUkraine, the key exportmachineryproducts are railway cars, locomotives, turbines, andengines[29].AsignificantportionofexportsgoestotheCEE,theMiddleEast,Africa,China,andIndia.Figure29showsthat40%to50%ofnewordersare foreignorders,but in2014this sharehas slightlydecreased.At the same time the capacitiesof someenterpriseswerefullytiedupbyforeignorders.Butonlyfewplayerssellmachinesglobally[29].Figure 29. The share of foreign orders as a percentage of the total volume of new orders in Ukraine,2013-2014,%

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Source:StateStatisticsServiceofUkrainehttp://www.ukrstat.gov.ua/).The "Input-Output" table shows that in terms of supplies, the most import-dependentsubsectorsaremanufactureofcomputer,electronic,andopticalproducts(61.8%ofsuppliesare imported) and manufacture of motor vehicles, trailers, and semi-trailers (59.2% ofsuppliesareimported).Manufactureofothertransportequipment(8.3%)isleastdependentonimportsincoveringitssupplies.Morethen36%oftheoutputofthissubsectorisexported.Figure30.AddedvalueofmachinebuildingsectorbymethodoffinaluseinUkraine,2013,%

Source:StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)Following the country's WTO accession in 2008, import duties on Ukrainian products,includingmachineryproducts,werereducedbythemembercountriesoftheWTOtothelevelextended tomost favorable nations (MFN). However, the expected export boom has not

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materializedyet[46].Trade liberalizationhas ledto increasedcompetition intheUkrainianinternal market and has also laid bare the low international competitiveness of Ukrainianproducts.Apparently,theUkrainiantradebalancehasexperiencedfastgrowthoverthepastdecade.Besides,theyearofUkraine'saccessiontotheWTOcoincidedwiththeglobalcrisis,which was followed by a domestic political and economic crisis in 2014-2015. Thesedevelopmentsmake it impossible to adequately assess the consequencesofWTOaccessionformachineryandtheeconomyingeneral.

DespitethefactthattheexportsoftheUkrainianmachinebuildingsectoraremorediversifiedthan those of the corresponding Belarusian subsector, the Russian factor is still crucial inUkraine,too,speciallyifonetakesintoaccountthecurrentsituationinEasternUkraineandthe political tensions with Russia. Before the collapse of the Soviet Union, exports ofmachineryandequipment fromUkraine toRussiawere2.7 timeshigher thanexports fromBelarus.In1999,thevalueofBelarusianexportstoRussiawastwiceashighasthevalueofUkrainianexports.However,since2000thegaphasbeengraduallyshrinking[23].

ThetotalshareofmachinebuildingsectoroutputexportedtoRussiadecreasedby7p.p.from51.9% in 2013 to 44.3% in 2014 (Table 7). Ukraine mostly sent commodities from twosections to Russia: 86 (railway or tramway locomotives, rolling stock, track fixtures andfittings, signals) and 84 (nuclear reactors, boilers, machinery and mechanical appliances,computers).Table7.UkrainianexportstoRussia


World

84 2013 57.9 1002014 56.4 100

85 2013 35.1 1002014 25.1 100

86 2013 70.8 1002014 71.7 100

87 2013 51.1 1002014 44.0 100

88 2013 14.5 1002014 29.4 100

89 2013 25.2 1002014 4.6 100


2013 51.9 1002014 44.3 100

Source:UNComtradeDatabase(http://comtrade.un.org/)The significance of the Russian market largely stems from the historical economic tiesbetweenthetwocountries.Goodknowledgeoftradepartners,sharedproductionstandards,andcustomizedproductsusuallymakesuchlong-standingtraderelationsmutuallybeneficial,anditisthussensibleforbothpartiestomaintaintheseties.Atthemicro-levelofsubsectorsandenterprises,theRussianfactorissometimescrucial.Forexample,62%ofUkrainianheavy

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machine building exports go to Russia. Prior to the Ukrainian-Russian conflict, theLuganskteplovoz companyused to sell around94%of its locomotives toRussia,while lessthan1%wenttoKazakhstanandroughly5%toothercountries[29].

A possible loss of access to the Russian market would hit the sector hard, as exportdiversification andproductivity are low inmost subsectors.A relevant calculation suggeststhatacomplete lossofmachinebuildingexports toRussiawoulddirectlyreduceUkrainianGDPby1.1%comparedtothebaselineof2012[7].MostimportsfromUkrainewillbereadilyreplaceable by imports from other countries or domestic Russian production, althoughpossiblyathigherprices.

To summarize, despite the fact that some leading players have been negotiating exportdeliveries to new markets in Asia and Africa, which will increase the geographicaldiversificationof sales andboost long-termgrowth, the level of diversification inUkraine'smachineryexportscontinuestoremainrelativelylow.TakingintoaccountthehighshareofRussia in the export of machinery products, the fact that a significant part of Ukraine’smachinery is located in Eastern Ukraine, as well as the current political and economictensionsbetweenUkraineandRussia,theRussianfactorappearstohaveemergedasthemostcrucialproblemforUkraineinthecomingyears.

Moldova

Moldovanmachineryexportsstagnatedduring the firstdecadeofpost-Soviet independence(1991-2001),butoverthelasttenyearsexportsgrewfive-fold,reachingarecordhighinthecountry's history. Export data confirms that ownership changes in themachinery sector inMoldova in the 1990s paved the way for the subsequent expansion of exports. There areclearly twodifferent trends inmachineryexportdevelopment: stagnation in the1990sandearly2000s,andfastgrowthsince2003.Thenewownershipstructureandthepromotionoffreeeconomiczones [12]allowed forespeciallyrapidgrowth in2008(63%).Poorexternalconditionsinterruptedgrowthin2009,buttheslumpwasfollowedbyevenfastergrowthin2011(74%).Despitetheglobalcrisisof2008-2009,theshareofMoldovanmachineryintotalexports kept increasing over that period, indicating that machinery products enjoyed arelativelystrongpositionamongallexportitems.

WTOaccessionin2001alsocontributedtothegrowthofMoldovanexports.MoldovajoinedtheWTOonthetermsthatapplytoadevelopedcountry,withatransitionalperiodofjustfouryears. To do that, the Moldovan government almost fully opened the country's market. Inaddition,Moldova joinedmost of theoptional sectoral initiatives,with the exceptionof theinitiativesrelatingtoalcohol.JoiningtheWTOledtoanincreasingimportdependenceoftheMoldovan economy, but over the years ofWTOmembership total foreign trade has grownfive-fold[46].

Moldova has made significant improvements in machinery export diversification. Back in1998,Moldovausedtohavealowlevelofexportdiversification(77.2%ofitsexportswenttotheCISmarket).By2013,CISdependencehaddroppedto27.5%.Thecountry'sdependence

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on the Russian market, specifically, is also relatively low: 21.3% of Moldovan machinebuildingexportsweresoldtoRussiain2013(downfrom32.8%in1998).However, the role of the Russian factor inMoldovamerits a discussionwith regard to theissue of ownership. Russian or Russia-related businesses own substantial stakes inenterprisesinthemetallurgyandmachinebuildingsectorsonthebothsidesoftheDniesterRiver,withanespeciallymajorimpactontheleftbankoftheriver[11].Russiatopsthelistofcountries that have FDI stock inMoldova, and Russians are also the top investors in eachsectoroftheeconomyexceptforbanking.ThetotalstockofRussianinvestmentexceeds$200million [47].Nevertheless, theshareofCIScountries in the total stockofequitycapitalFDIdrops to 11.2%, far behind the EU countries' 52.1% share [47]. Earlier acquisitions ofprivatized Moldovan state enterprise by Russian investors resulted in limited technologytransfer and know-how for specific industrial companies. Some companies went bankruptand others are struggling to survive by investing their own capital intomodernizing theirbusinessesand looking formarketdiversification. Inrecentyears,ca.35%of theexportsofMoldova'stroubledEasternrayons–theTransnistriaregion–wereorientedtowardstheEU,while40%wenttoMoldovaand15%totheRussianFederation[55].

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Box9:ExportgrowthofthemachineindustryintheCzechRepublic

ExportspecializationoftheCzechRepublicTable:SITC2classeswiththehighestshareinCzechexportsExportitem

ShareofCzechexports(%)

Code Title 2002–2004 2011–201378 Roadvehicles 15.53 17.7577 Electricalmachinery,apparatus&appliancesn.e.s. 10.20 9.3175 Officemachines&automaticdataprocessingequip. 5.79 7.4274 Generalindustrialmachinery&equipment,andparts 6.61 6.8276 Telecommunications&soundrecordingapparatus 3.65 5.5289 Manufacturesofmetal,n.e.s. 5.58 4.8569 Miscellaneousmanufacturedarticles,n.e.s. 4.20 4.8267 Ironandsteel 4.34 3.5271 Powergeneratingmachineryandequipment 3.03 2.9262 Rubbermanufactures,n.e.s. 3.16 2.4672 Machineryspecializedforparticularindustries 2.29 2.3782 Furnitureandpartsthereof 2.51 1.6135 Electriccurrent 0.66 1.48Source:RIS3–CzechRepublic(2014).

ThemaindriversofCzechexportsarethe(i)automotive(SITC78),(ii)electricalengineeringandelectronics(SITC75, 76, and77), and (iii)mechanical engineering (SITC71, 72, and74) industries. Itemswithin themetal-working industry (SITC 69) and metallurgical industry (SITC 67) also have a significant share ofexports.Theextentandexportpowerofthelattertwoindustrialareasprovidesastrongbackgroundforthemechanical engineering, automotive, and electrical engineering industries. Especially the automotiveindustry – as a sophisticated customer – increases the transnational competitiveness of these traditionalindustrial areas, which also control a large share of employment. As a result, the dominant automotive,electricalengineeringandmechanicalengineeringindustriesrepresent–toalargeextent–thedriversoftheinternal restructuring of other traditional industrial areas. At the same time, they support exports fromrelatedareas,e.g.SITC62"Rubbermanufactures,n.e.s.",whichislargelytheresultofthehighconcentrationoftiremanufacturers(notonlyforvehicles).

Chart:NACEsectionsbytheirshareinCzechexportsandbusinessR&Dexpenditure,2010–2012

Source:RIS3–CzechRepublic(2014).

The Chart confirms the dominant role in exports of the automotive (NACE 29), electronics (NACE 26),mechanicalengineering(NACE28),andelectricalengineering(NACE27)industries.Withrespecttoitsshareof business R&D expenditure, the automotive industry dominates the domestic economy, accounting forabout one-third (30.6%) of R&D expenditure in the corporate sector. On the other hand, this position islargely attributable to Škoda Auto a.s., the biggest Czech exporter, which significantly contributes to totalR&Dspending.It isfollowedbymechanicalengineeringwitha7%shareinbusinessR&Dexpenditure,andmanufacture of other transport equipment (5.3%). The combined share of the electrical engineering andelectronicsindustriesinbusinessR&Dexpenditureamountsto6.7%.

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InvestmentsinthemachinebuildingindustryThe data illustrate different trends in total machinery investments between 2000-2013(Figures 31-33). There is the downward trend of machinery investments in Belarus, anupward trend in Moldova machinery investments, and a rather fluctuating trend in thevolumeofinvestmentsgoingintothemachinebuildingsectorinUkraine.

Comparing the respective shares of machinery in manufacturing industry output and ininvestments,thereisevidenceofunderinvestmentinthemachinebuildingsectorsofBelarusand Ukraine, while there are intense machinery investments in Moldova. In the case ofBelarus, thegapbetweeninvestmentandoutputsharehasbeenincreasing,which indicatesthat more investments are needed to maintain the high share of machinery in industrialproductionoverall.InUkraine,thegaphasvanishedin2012–2013,whichcouldberelatedtoincreased investment intensity after signing long-term contracts with the good exportmarkets of Russia and Kazakhstan [29]. Investment intensity is much higher in Moldova,which goes a long way towards explaining growth in Moldovan machinery output andexports.Figure31.InvestmentinandoutputofthemachinebuildingsectorrelativetototalmanufacturingindustryinBelarus,2000-2013,%

Figure 32. Investment in and output of the machine building sector relative to total manufacturing industry inMoldova,2000-2013,%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru)

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Figure33. Investment inandoutputof themachinebuildingsectorrelative to thevaluesof theentiremanufacturingindustryinUkraine,2000-2013,%


Foreigndirect investment (FDI) intensity evolveddifferently over time inBelarus,Ukraine,andMoldova(Figure34).Intransitioncountries,FDIisperceivedasanimportantsourceforaccumulatingassets(physical,organizational,marketaccess)andcapabilities.Inpost-Sovietcountries, the level of domestic savings and investments is rather low and insufficient forstableeconomicgrowth, that iswhy the importanceofattractingFDI increases [27].As thebiggesteconomyamongthethreecountries,Ukrainehasbeenattractingthehighestamountof FDI, especially between 2005-2013. However, an economic downturn and an unstablepolitical situation have caused FDI inflows to drop dramatically in 2014. The intensity offoreigninvestmentsinBelarusstartedtogrowin2007,spurredbymajorprivatizationdealswith Russia.11 FDI inflow in Moldova was seriously affected by the global economic andfinancialcrisisin2009,butarecoverytookplacebetween2010-2014.However,intermsofthesizeofFDIstockrelativetoGDP,in2014UkraineandMoldovaattainedratiosof48%and44%ofGDP,respectively,whileBelarus'ratioonlystoodat23%.Figure34.FDIinflowsinBelarus,Ukraine,andMoldova,2000-2014,mUSD

Source:WorldBank’sWorldDevelopmentIndicators

11Firstofall,BelarussolditsgastransmissionpipelinesystemtotheRussianGazpromcorporationfor$5billionbetween2007-2011.

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TheroleofFDIinthedevelopmentofthemachinerysectorsdiffersinthesethreecountries.Integration intomultinational value chains,which leads to higher investment intensity andimprovedmodernizationprocesses, only seems tobeprominentlypresent inMoldova, it isless frequent in Ukraine and Belarus. Previous empirical studies have shown that in themanufacturingsectorsoftheeconomy,firmswithforeigncapitalperformbetterintheregionthan domestic companies [see 51, 52, 53]. Based on national statistics and case studies,machinery remains an important destination sector for FDI in all three countries, as itgeneratessubstantialexportflows.However,onlyinMoldovaareinvestmentsinthemachinebuildingsectorassociatedwithlargeandsustainablegreenfieldsandsubstantialequityflowsfrommultinationalcompanies.

As a result, investments seem to influence innovation capacities differently in these threecountries. In Belarus and Ukraine, investment effectiveness is affected by low levels ofcapacityutilization,reducedproductivity,ahighshareofimportedmachineryaggregates,anda high degree of dependence on the Russian Federation. In Moldova, higher investmentactivity in machinery enhances the development of knowledge-based subsectors, likeelectricalmachinerymanufacture.AsMoldovaoffersoneofthelowestlaborrates,investmentinelectricalmachinerymanufactureisexpectedtogrowfurther,alsotakingintoaccountthenewprojectsthathavebeenannounced.However,eachcountryshouldbereviewedindetailtoexaminethespecificsofinvestmenteffectiveness.

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Belarus

In Belarus, a significant share of machinery investments come from state-directed lendingprograms.TheBelarusianauthoritieshaveactivelyreliedonavarietyofstateprogramsandmeasures for developing priority sectors in the economy, and this effort included themachinerysector,whichhasplentyofmajorstate-ownedenterprises.Mostoftheprogramshave been sustained by credit from state-owned commercial banks. Lending involves a

Box10:TheroleofFDIintheV4machineindustryPriortotheEUaccessionoftheV4countries,thelevelofFDIinflowandFDIstockinthesecountrieshingedon their ability to create a stable, favorable, and encouraging environment for foreign investors, on thepromptnessofeconomicreformsaswellas thespeedwithwhich individualV4countriescompliedduringthepre-accessionperiodwiththerequirementofopennesstointernationalcapitalmovements.UnderArticle56 of the Treaty on European Union, therewas a timetable for the gradual liberalization of capital flows,whichwasdraftedandappliedseparately ineachoftheV4countries.WhiletheCzechRepublichadbegunde-regulatingcapital transactionsasearlyas1995,Hungary,Poland,andSlovakiawere liberalizingcapitalflows gradually, practically until their EU accession. Another accelerating factor with regard to the de-regulationofcapitalweretheV4countries'effortstobecomemembersoftheOECD.Theapproachthatthesestatestooktoprivatizingstateassetsduringthetransitionperiodalsoplayedadecisiverole in influencingvolumesofFDI inflow.Thus,whileHungary implementedprivatizationbydirectly sellingassets to foreigninvestors,Slovakiainthe1990spreferredtoleaveformerstateenterprisesinthehandsofdomesticowners.Nevertheless,FDIinflowsreceivedamajorboostbytheinclusionoftheV4countriesinthegroupofstatesthat acceded to the EU in 2004. In the context of V4 countries overall, the highest levels of FDI inflowoccurred in the finalyearsof thepre-accessionperiod(1999-2003),mainlydue to themassive increaseofFDI in Slovakia and the CzechRepublic. After 2009 therewas a considerable drop in FDI inflow in all V4countries (1.7-fold decline on average) – Slovakia experienced the steepest drop (a factor of 3.2), whileHungarywassubjectedtothemildest(afactorof1.2).

Figure:FDIInflowinV4Countries(PercentageofGDP)

Source:FDIStatisticsDatabase,UNCTAD

Therelocationofindustries(notonly)fromoldEUmemberstothenewlyacceptedmemberstateswasmoststrikinginthecaseoftheautomotiveindustry,whichemergedasadominantindustryintheV4countries.Intheearly1990s,theexistingautomotiveindustrycapacitiesintheCzechRepublic,Slovakia,andPolandwereprivatized and acquired by Volkswagen and Fiat. Hungary became a popular greenfield investmentdestinationinthemid1990s.Duringthelate1990sandearly2000s,FDIinflowintheautomotiveindustrywasdominatedbygreenfieldinvestments,whileinvestmentincentivesplayedaneverincreasingroleastheoffersofmutuallycompetingV4stateswereusuallysimilar.Approximately75%ofV4automotiveassemblyplants and suppliers are now located within a 200km radius centered on the border between the CzechRepublic,Slovakia,andPoland.

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combinationofvarioustypesofpublicsectorsubsidies,suchasearmarkedfundingprovidedby the public sector to commercial banks, subsidized interest rates, and governmentguarantees [48]. There are also direct subsidies for particular projects or individualcompanies.

Directed lending programs hamper the efficient use of capital in the targeted sectors andnegatively influencemanagementpractices inparticipatingstate-ownedenterprises (SOEs).Large-scale lending at below-market rates promotes inefficiency and the misallocation ofresources in the economy [48]. Misallocation often leads to reduced investment efficiency.Directed lending programs with subsidized interest rates do not create incentives for themanagersofSOEstoensuretheefficientallocationofcapitaltothemostprofitableprojects,and in fact they erode the culture of investment. Directed lending programs have alsointerferedwiththedevelopmentofasoundriskmanagementculture,precludingtheproperpricingandefficientallocationofmoneyinaccordancewithrisk.

FDIflowingintoBelarus’machinerycouldpositivelyaffectthesectorduetonewtechnologies,new markets, and improvements in strategic management and operations. However, thepositive impact of FDI emerges slowly, if at all. The presence of foreign capital in theBelarusianmachinebuildingindustryisratherlimitedbecausethesectorismostlycomposedof large state-owned enterprises and holdings. Foreign investment in the industrypredominantly manifests itself in the creation of joint enterprises with Belarusiancompanies12 and only rarely in the form of greenfields.13 Privatization of state machinebuildingenterprisesisalsoarareoccurrence[39].

However,studiesfindthatFDIhasapositiveimpactonmachinebuildingindustryoutputinBelarus.Thereasonisthatthismostlyexport-orientedsectorforcesproducersandinvestorstospendsomeoftheirassetsonrenovationinordertoremaincompetitive[27].Thiscallsforlaunching a new modernization policy for the machine building sector in Belarus, whichwould combine restructuring with a partial sell-off of machine building SOEs to foreigninvestors.Inanycase,theroleofforeigndirectinvestmentsintheBelarusianeconomyisoneoftheburningissuesnowadays.

Ukraine

ThereisevidencethatinvestmentsinUkrainianindustryareprimarilyflowingintoresource-intensiveindustries,likemetallurgy(Figure35).Theamountofinvestmentsflowingintothebasicand fabricatedmetals industryexceeds the investments receivedbymachinebuildingsubsectors by several orders ofmagnitude. Inmachinery, the highest share of investmentsgoes to vehicle production companies. The subsector "production of machinery and

12Forinstance,Minskautomobileplant(MAZ)hasajointventurewiththeGermantruckproducerMAN.13The latest example is "StadtlerBelarus": Initially, therewas a joint venturebetweenStadtlerRailAG (60%share)andBekommunmashHolding (40%share) tobuildabrandnew facility forproducingrailwayvehiclesworth$50million.Twoyearslater,StadtlerRailAGperformedabuyoutofthecompanyforabout$10million.

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equipment, not related to other groups," which includes companies in heavy machinebuilding,railwaymachinebuilding,aswellasagriculturalmachinebuilding,holdsthesecondplace. Manufacture of knowledge-intensive products like electronic, optic, and electricequipmentarerelativelyinsignificantintermsofinvestmentflows.

Figure35.TheshareofsubsectorsinindustrycapitalinvestmentsinUkraine,2010-2014,%


One possible explanation for underinvestment in machinery may be related to the weakcultureofcorporategovernanceinthecountry’sindustry,whichstemsfromcertainspecificaspectsofthetransitionprocess.LeadingmarketplayersaremainlycontrolledbylocalandRussian business groups, while only a few companies are state-owned [29]. As AndreyMovchan, Director of the Economic Policy Program of CarnegieMoscow argues,14 Russian-style corporate development relies on a strategy of "cash-flow" maximization rather than"equity"development.Even though the sharesof someUkrainianmachinerygiants suchasKryukiv Car, Stahanov Car, Luhanskteplovoz, and Motor Sich are actively traded on thenationalstockexchange,corporatedevelopmentmaytakeyearsandneedsstimulitoachievechange.

FDI statistics also show that machinery remains relatively underinvested in Ukraine, as itattractsroughly7%ofall industryinvestments.Comparedtometallurgyandmanufacturingoffabricatedmetals,machinebuildingis5.5timeslesslikelytoreceiveforeigninvestment.IntermsofthedistributionofFDIstocksamongmanufacturingsectors,machinebuildingranksonlyfourth(metallurgydominates,followedbyfood,beverages,andtobacco;oilprocessing,chemicals, rubber, and plastics). This makes Ukraine a special case with respect to thedistribution of FDI when compared to the sectoral structure in other Eastern Europeancountries,sinceUkrainehasattractedcomparativelylessFDIintoexport-orientedindustries.

Forfurtherdetailsseehttp://carnegie.ru/commentary/experts/?fa=1057

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Inparticular, themain targetsofFDI inUkrainearenotmachinebuildingand thechemicalindustry (which are the most important subsectors in both Poland and Romania) butmetallurgyandfoodprocessing.Finally,thehighshareofFDIintheUkrainianfinancialsectormeansthatshareholderloansaccountforabout14%ofthetotalreportedFDIstock[54].Asaresult,theshareofmachineryintotalFDIstockhasdiminishedfrom2.8%in2009to2.2%in2014(Figure36).

Figure36.FDI(paidincapital)inUkraine,sharesintotalFDIstock,2009-2014,%


The main sources of FDI flowing into Ukraine are Cyprus (30% of total stock), Germany(16.6%), the Netherlands (10%), the Russian Federation (6%), Austria (5.5%), and GreatBritain(4.7%). In industry, themostactive investorsare fromGermany($5billion),Cyprus($3.3billion),andtheNetherlands($1.9billion).Inmachinery,foreigninterestismanifestinboth greenfields and brownfields. For example, investments in machine building foragriculture take the formsof newplants, purchases of company shares, anddebt financing[29].However,thepre-dominantpositionofCyprusasasourceofFDIraisesdoubtsaboutthequality and actual origin of such investments. First, Cyprus-based investment inflows areoftenlinkedtoRussianorlocaloligarchsortheirbusinesses,andarequiteoftentheresultsoftaxevasionortaxavoidance.Second,asexpertsfromtheGermanAdvisoryGroupinUkrainebelieve, FDI originating from Cyprus points to the presence of "round-tripping" funds thatwerepreviouslywithdrawn fromUkraine (orperhapsotherCIS countries, e.g.Russia), andarenowchanneledtoUkraineviaCyprus.Thepresenceof"roundtripping"isalsosupportedbyaglanceatUkraine’soutwardFDIstock,whereCypruscommandsanimpressiveshareof92%15[54].

15Ofcourse,CypriotFDIinUkraineandUkrainianFDIinCyprusarenotcomparableinabsoluteterms,asthelatterismuchlowersincemostoutflowsareprobablynotofficiallyrecorded.

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Theunderinvestment inUkraine’smachineryexplains the intensedepreciationrateof fixedassets, which equals about 70%. Underinvestment also leads to the slow adoption ofcontemporary technologies and to lagging modernization in the fixed assets of machinebuilding companies. Taking into account output decline and low export diversification, themodernizationprospectsofUkraine’smachinebuildingsectorareuncertainatbest.

Moldova

Foreign investments in Moldova were directed into the financial, wholesale and retail,manufacturing industry, energy, transport, and communication sectors. FDI intensity hascontributed to changes in the structure of the Moldovan economy [33]. According to dataprovidedbytheNationalBankofMoldova,asofmid-2015manufacturingindustryaccountedfor22.3%ofFDIstockinMoldova.Thetopfiveinvestingcountries(notcountinginvestmentsinthefinancialsector)areRussia,theNetherlands,Italy,theUS,andCyprus.WTOaccessionhad a positive impact on FDI flows. Statistical data on foreign direct investment showssignificantgrowth:FDIincreasedseven-foldbetween2002and2008[46].

Freeeconomiczones(FEZs)andindustrialparkshaveemergedasmajorfactorsinattractinginvestment to Moldova. There are currently seven free economic zones and six industrialparksinMoldova.Bytheendof2013,totalinvestmentintoFEZsamountedtoroughly$200million[12].Largeindustrial investorsincludeDraexlmaier (Germany, wire harnesses), the Lear Corporation (USA, automotive seating, car seat covers), Gebauer&Griller (Austria, wires and cables), Euro Yarns (Belgium, synthetic fibers), LaTrivinetaCavi (Italy, wires and cables), Ceccato Production, and Eastsord Production (both from Italy, machinery-building components). FEZs employ about 7,000 people in total [12]. Since2010,industrial parks are being actively developed as instruments to promote export and industrial potential.Nevertheless, thus far industrial parks have registered less investment activity byinternationalcompaniesthanFEZs.

Reinvestmentshavebecomean important sourceof innovation.According to theMoldovanStatistical Office, investments in fixed assets are relatively high in the manufacture ofelectricalmachineryandapparatussubsector,whereforeigninvestorstendtobeveryactive.

FDIinMoldovaappearstoforcechangesintheownershipstructureofMoldovanindustryandmitigatestheimpactoftheRussianfactor,sinceRussianbusinessescontrolseveralstrategicenterprises in the metallurgy and machine building subsectors [11]. The share of activeRussian businesses has been decreasing, especially since the signing of the AssociationAgreement between theEU andMoldova in 2014.Apart from the electricalmachinery andapparatussubsector,machinebuildingalsoregistersincreasinginvestmentsandoutsourcingopportunities fromEUcompanies.FDI into theMoldovanmachinebuildingsectorseems tohavepavedadefinitepathforthecountry’sinclusionintoglobalvaluechains.

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Humancapitalinmachinery In Belarus, Moldova, and Ukraine there has been a trend of continuous reductions in thenumberofemployeesinthemachinebuildingsector,evenastherespectiveindustriesremainamongthelargestemployersintheseeconomies.Thissuggeststhattheperiodoftransitionfrommorelabor-intensiveandtechnologicallysimplerproductstomoreadvancedproductsisstillongoinginallthethreecountries.Suchatransitionalsorequiresintensiveinvestmentsintohumancapital,sinceaskilledlaborforceisakeyfactorinmachinerydevelopmentandinproductivity gains. Investment in human capital is one of the components of a successfultransitiontotheproductionofhighervalue-addedmachinery.

AmongthekeyassetsofBelarus,Ukraine,andMoldovaaretheskilledlaborforceandthehighleveloftechnicaleducationinthesecountries.InBelarusthereareuniversitiesandcollegesfor training the specialists needed in themachine building sector. The BelarusianNationalTechnical University is one of the largest and most famous. According to the industryoverviewpostedonthewebsiteoftheItalianIndustrialChamberofCommerceinUkraine,one of advantages of the Ukrainian machine building sector is its qualified labor force.

Box11:"TheFDIbattle"–thecaseoftheJaguarLandRoverinvestmentinSlovakia

In 2015 Jaguar LandRoverdecided to invest £1.1 billion (ca.€1.4 billion) into a new car factory inNitra,Slovakia.Thecompanywillcreate2,800 jobs–directly.The firstcarswillbeproduced in2018,and in thefirstphasetheplantisexpectedtoproduce150,000vehicles.Itwillproducelightweightluxuryvehicles;theBritishmediahave speculated that theproductmanufacturedwillbe thenextgenerationLandRover.ThecontractbetweenJaguarLandRoverandtheSlovakianGovernmentwassignedonDecember11,2015.ItisthelargestinvestmentinEuropeinthelastsevenyears.

The company had performed analyses of several possible factory sites in Europe, the United States, andMexicoin2014.Inearly2015theshortlistincludedMexico,Poland,andSlovakia.OfficialtalkswithSlovakiacommenced in February 2015. The final "battle" was between Poland and Slovakia, and in August 2015unofficialsourcesclaimedthatSlovakiahadcomeoutontop.

Poland opposed the Slovakian policy of offering massive state incentives for investment and refused tocontinuetocompetewithSlovakiainthatregard.TheSlovakiangovernmentapprovedasubsidytothetuneof€130millionfortangibleandintangibleassetsprovidedbythecarmaker.Thesubsidyamountsto9%ofthe total investment volume. This amount is also the ceiling that the Slovakian government can offerinvestorsasaninvestmentincentivefortheparticularregionandtypeofinvestment.TheActontheRulesforInvestmentIncentivesandStateAidrules,whichhasbeenapprovedbytheEuropeanCommission,specifiesthemaximumlevelofaidthatmaybeallottedtoinvestmentsineachregion.ForWesternSlovakiaandtheNitraarea,themaximumlevelofstateaidcannotexceed25%oftheinvestmentvalue.However,ifthetotalinvestmentvolumeexceeds€50million, then the levelof subsidies thatmaybeawardedmustbereducedbasedona formula setby theEuropeanCommission.Furthermore, in thecaseof theNitra site theSlovakgovernmentalsocannotgrantacontributiontothecreationofnewjobs.Itmayonlygrantataxrelieforoffertheinvestorstateormunicipalpropertyatadiscountedprice.

It must also be added, however, that the amount of public funds to support this project will exceed thecurrentlysetamount.ThusthestatewillperformroadconstructiontoconnecttheindustrialsitetotheR1expressway,whichisestimatedtocostabout€10million.

But Jaguar Land Rover's final decision was not only based on government subsidies. Tough the averagehourlywageinPolishindustryis8.50euros,whileinSlovakiaitis10euros,thelatterisstillonlyhalfoftheexpectedlaborcostsintheUK.Moreover,SlovakiaisalsoamemberoftheEuroZone,whicheliminatesrisksstemmingfromcurrencyexchange.Theofficialannouncementofthecar-companyalsoreferredtoastrongnetworkofsuppliersandgoodlogistics infrastructure.CEOMr.RalfDieterSpethsaidthat"Slovakia iswellestablishedintheautomotivemarketandhasagoodreputationgloballyforhigh-qualityproduction."

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About 10,000 students graduate each year from machine building-related departments ofUkrainianuniversitiesandcolleges[29].Therearemanyuniversitieswherestudentsreceivetheeducationtheyneedforworkinginthemachinebuildingindustry.Thefollowingoccupyleadingpositionsamongthecountry's technical institutions: theTarasShevchenkoNationalUniversity of Kyiv, the National Technical University of Ukraine, also known as the "KyivPolytechnicInstitute", theDonetskNationalTechnicalUniversityandtheNationalTechnicalUniversityofUkraine,alsoknownasthe"LvivPolytechnicInstitute"[29].Moldovamaintainsastrongindustrialemphasisinitssystemofhighereducation(e.g.theTechnicalUniversityofMoldovainChisinau,polytechnic,technicalandtechnologycollegesinChisinauandBalti,aswellasvocationalschools).In2013theBaltiStateUniversityAlecuRussolaunchedatrainingprogram in partnership with Draexlmaier, which specializes on "Engineering andmanagementinautomobileconstruction."InpartnershipwithGalatiUniversity(alsoknownas "Dunarea de Jos"), Cahul State University trains students in specialized technical fields.Technical education continuously improves by adapting the curricula and fields ofspecialization[31].

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Belarus

Despiteadownwardtrendinemployment,machineryremainsahighlylabor-intensivesectoroftheeconomy.Thenumberofemployeesinmachineryhasdroppedbyover15,000persons(9.5%) since 2010. Today, around 30% of manufacturing industry workers in Belarus areemployedinmachinebuilding,eventhoughtitsshareofmanufacturingoutputisonlyabout20%(Figure37).However,thisgaphasbeenmodestlyshrinkinginrecentyears.

Overemployment remains an important issue for the Belarusian machine building sector.According to World Bank estimates, overemployment in state-owned-companies inBelarusianindustrymayreach25%[49].AsmostofthemachineryenterprisesinBelarusarestate-owned,overemploymentinthesectorcreatesafinancialburdenformachineproducersandinfluencestheirfinancialresults.

Box12:Usingtheuniversity'sR&Dpotentialforbusiness(ideastomarket)

Casestudy:theUniversityofŽilina(UNIZA)andtheCEITGroup,Žilna,SlovakiaThehistoryoftheUniversityofŽilina(UNIZA)beganonSeptember1,1953,whentheUniversityofRailwayTransportwas foundedbyslicingoffadivision fromtheCzechTechnicalUniversity inPrague.Currently ithas approximately 9,000 students who are studying at one of seven faculties: Faculty of Operation andEconomics of Transport and Communications, Faculty of Mechanical Engineering, Faculty of ElectricalEngineering, Faculty of Civil Engineering, Faculty ofManagement Science& Informatics, Faculty of SpecialEngineering,andFacultyofHumanities.In1997theUniversityestablishedtheSlovakProductivityCenterjointlywiththeMinistryofEconomyandtheFederationofEmployers'AssociationsofSlovakia.TheCenterspecializesonresearchintheareaofleanmanufacturinganddigitalenterprise.Theyear2005sawthecreationof the firstspin-off,SLCPConsulting,Ltd.Thecompanyfocusesontheprocessesofinnovation,education,andimprovingbusinessprocesses.Thesecond spin-off, CEIT SK, Ltd. was created in 2007 and focuses on product and technological innovation.Anotherspecialspin-off,CEIT-KE,Ltd.,wascreatedin2010,withafocusonbiomedicine.In2011,theCEITGroupwascreatedwithamainfocusontheseareas:

• Process innovation - optimizing the workplace and increase its efficiency, improve processes intermsofproduction,logistics,andenterprisesystems;

• Technicalinnovations-fromdesignconcepttoproductionofthefirstseriesofproducts,workplacedesignandtechnologicalunits,includingverificationandoptimizationbasedonsimulation;

• DigitalFactory-providespacetooptimizeworkplaces,processes,andsystemsalreadyinthestageoftheirdevelopment-inthedigitalenvironmentwithouttheexistenceofarealsystemorinterventionintherealsystem;

• Industrial automation - designing andmodeling the flexible, reliable, and economic production ofcells,workplaces,andoperations.Implementationofindustrialautomationandroboticsinfactories.

• BiomedicalEngineering-researchintonewdiagnosticmethodsininvasiveimplantology.Providingdesign, production, and diagnostics implants - particularly in the head area and themaxillo-facialregion. They specialize in research on implant materials, solutions, and sophisticated computeranalysisofthedimensionalandmechanicalproperties,theproposalforanewmethodologyfortheproductionofimplantsintermsofclinicalapplications.

CEIT andUNIZA are not just using joint human capital for their joint research, but also have several jointlaboratories, combiningprivate andpublic resources for research andproduction. In2015CEITTechnicalInnovation,anotherspin-offestablishedin2013,wasestimatedtobethe261stfastestgrowingtechnologicalcompanyintheEurope,MiddleEast,andAfricaintheTechnologyFast500TMrankingorganizedbyDeloitte.

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Figure 37. The machine building sector's share of employment and output in the Belarusianmanufacturingindustry,2005-2013,%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Figures38-40 indicate that in recentyears realwages inmachinery subsectorsgrew fasterthanproductivity.Excessive laborcostshindergrowth,both in the industryspecificallyandtheeconomyingeneral.RecentresearchdonebyCASEBelarusshowsthata1%increaseinrealunitlaborcostsinBelarushasleadto0.28%fallinthecountry'sGDP[50].Figure38.Realwagesandproductivitychangeinthemanufacturing of machines and equipmentsubsectorinBelarusbetween2006-2013,(y/y),%

Figure 39. Real wages and productivity in themanufacturingoftransportvehicleequipmentinBelarusbetween2006-2013,(y/y),%,(y/y),%

Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Figure40.Realwagesandproductivitychangeinthemanufacturingofelectrical,electronic,andopticalequipmentsubsectorinBelarusbetween2006-2013,(y/y),%

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Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)

TheexistingemploymentpolicyinBelarusprovidesfewstimuliforhumancapitalinnovationin companies. Due to the fact that themajority of machine building enterprises are state-owned, the Belarusian government has a significant influence over human capitaldevelopment policy in the industry, including the wage policy, working time, as well aseducation and trainings. Under such conditions, employers and employees do not havesufficient incentive for intensive investments into human capital that lead to productivityincreases.

Ukraine

The number of employees in the Ukrainian machine building sector has fallen by roughly48,000 (11%) since 2010. But the reduction in machinery is slower than in the generalindustry or in themanufacturing industry in general, and as a result the sector hasmademodest (2 percentage points) gains in terms of its relative share of manufacturingemployment(Figure41).

MachinebuildinginUkraineremainslabor-intensiveandthisintensityhasbeengrowingoverthe last 5 years. In 2013,machine building companies employed 27%of allmanufacturingindustryworkers,evenas theyproduced less thanhalf thatratio(13.1%)ofmanufacturingoutput.Moreover,Ukraine’smachinery is still inaprocessof structural adjustment, and itsoutputand tradestructureare in theprocessofbeingdowngraded toproducemore labor-intensiveandtechnologicallysimplerproducts.Figure 41. Share of employment and output of machinery in the Ukrainian manufacturing industrybetween2010-2014,%

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Source:StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)Unlike inBelarus,wages intheUkrainianmachinerysubsectorarenotstate-subsidizedandremain lower than the average wages in the economy. Work remuneration in machinebuilding is lower than the industry and manufacturing industry average, and significantlylowerthaninmetallurgy,theleaderintermsofnominalpayrollnumbers(Figure42). Figure42.AveragemonthlynominalwagesofemployeesinUkraine,%ofeconomyaverage,2011-2013

Source:StateStatisticsServiceofUkraine(http://www.ukrstat.gov.ua/)Given the situation of significant labor intensity and below averagewages inmachinery inUkraine,investmentsintohumancapitalatthemicro-levelseemtoberatherlimited.Agoodengineering education is obviously not enough for technological advancement and betterproductivity.Thecollapseoftheeconomy,highunemployment,andsocialtensionsinEasternUkraine will contribute to the persistence of the current status quo, unless changes areinitiatedatthecentralgovernmentlevelandarethenalsoconsistentlyimplemented.

Moldova

Around 6.58% of industry employees in Moldova are currently employed in the machinebuildingsector.This indicatorhasbeencontinuouslygrowing in recentyears.Themachinebuilding sector is also labor intensive, just like in Belarus and Ukraine. Since 2006, themajorityofinvestmentsandnewjobswereaddedinthesubsectorselectricalmachineryandequipment,aswellascomponents.

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Figure 43. Share ofmachine building inmanufacturing industry employment and output inMoldova,2001-2008,%

Source:NationalBureauofStatisticsoftheRepublicofMoldova(http://www.statistica.md/index.php?l=ru)Traditional employers in Moldova include companies producing electrical machinery andequipment, as well as their components; pump design and construction companies (eventhough these remain competitive in the CIS market, they have failed to penetrate the EUmarket);agriculturalmachinesandequipment(theirshareholdersarelocalcompanieswhichare continuously investing in new equipment and product enhancement, and are alsoapplying for CE certification in order to penetrate the EU market); and most recently themachinebuildingforautomotiveindustrysubsector(forexample,themanufacturingofseatframesforVanHoolbuses,metalpartsforVolvoandCaterpillar,etc.).

There is evidence of close cooperation between Moldovan universities and industrialproducers.Theshareofemployeeswithhighereducationinindustryhasgraduallyincreasedfrom11.2%in2000to21%in2014.

OneoftheadvantagesofemploymentinMoldovaisthelowcostoflabor−sometimesclaimedtobeamongthelowestintheregion−,whichensurescost-effectiveoperations.Contrarytoother Eastern European countries, Moldova’s unit labor cost is stable and only increasesslowly[31].

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Institutionalanalysisbasedonmicro-leveldataandcase-studies

Institutional analysis is used to identify possible constraints within the machine buildingsectorinBelarus,Moldova,andUkraine,initssubsectorsandincompaniesthatsignificantlyinfluence sector performance. Chapter II also explains the differences in machine sectordevelopment across the three countries. The different pace of reforms in Belarus, Ukraine,and Moldova since independence in 1991, and the different models these countries havepursued, have contributed to different structural transformations of their economies,

The machine building sectors in Belarus, Ukraine, and Moldova are to a large extent alegacy of Soviet times, and, correspondingly, they have retained a significant role inindustry.Thethreecountriesstill findthemselvesintheprocessofstructuraladjustmentastheytransitionfromaSoviet-typeindustrytoamarket-basedone,althoughthepaceoftransformation is different in each country. During the transition period, machinery inBelarus, Moldova, and Ukraine has been evolving from labor-intensive production oftechnologically simple products to capital-intensive machinery that produces moresophisticatedproductswithrelativelyhighvalueaddedandknow-howcontent.Moldovaappears to have the fastest track record in this process of transition,while Belarus andUkraine lagbehind,as theirmachineryremainsmore labor-intensiveandunderinvested.Machinery export data show that the machine building sector accounts for a relativelyhigher share of total exports in Moldova, which also indicates that exportedmachineryproducts produced in Moldova boast a comparatively higher value added than thosemanufacturedinBelarusandUkraine.

The key vulnerability factors that apply to both Belarus and Ukraine are low capacityutilization, weak export diversification (including a high dependence on the Russianmarket), the relatively lowquality of products, outdated equipment and technology, andresource intensive production. For Belarus, machinery-related issues are the dominantpositions of state-owned large producers, excessive employment, and the high level ofimported components in high-tech subsectors. In Ukraine, machinery remains highlydependentonRussia,andischaracterizedbyhighpowerconsumptionandaratherweakcorporate culture. Unlike in Belarus andUkraine,machinery inMoldova is transformingintoasupplierofcomponentswithafocusonelectricalmachineryandapparatuses.Italsoboasts a significantly improved level of export diversification. However, the Moldovanmachinebuildingsectorishighlyconcentratedinfreeeconomiczonesandindustrialparks.TheindustryontheleftbankoftheriverNistruismoreofdependentonRussianorpro-Russianbusiness,thoughtheshareofexportsgoingtotheEUisconstantlygrowing.

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includingtheunderlyingindustrialspecifics.AstheEBRDTransitionIndicators16(Figure44)show, Belarus remains the least advanced in all six components of transition reforms.Moldova has fully opened up its economy to foreign trade, and has almost completed theprocess of small scale privatization and price liberalization. Ukraine has also advanced inprice liberalization, trade reform, as well as small scale privatization. However, all threecountries show poor performance as for governance and enterprise restructuring andcompetitionpolicyasthose indicatorsrangebetweenlowlevelsof1.7and2.2forthethreecountries.Figure44.EBRDTransitionIndicatorsforBelarus,Moldova,andUkraine

16Themeasurementscalefortheindicatorsrangesfrom1to4+,where1representslittleornochangefromarigid centrally planned economy and 4+ represents the standards of an industrialized market economy[ebrd.com].

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Energy subsidies, macroeconomic policy, ownership issues, and the quality of corporategovernanceare someof the issues thatwill be considered in this chapter.The chapterwillconclude by presenting SWOT tables formachinery in Belarus, Moldova, and Ukraine as asummary of the institutional analysis together with conclusions from the comparativeanalysisinthepreviouschapter.Institutionalregulation/economicpolicyThegovernmentalsystemforregulatingthemachinebuilding industry inBelarus,Moldova,and Ukraine has changed significantly since the Soviet period, and today the respectivesystems in these countries eachhave their owndistinguishing features. In the 1980s therewere dedicated ministries to regulate the machine building sector. Among them were theministries of Heavy Machine Building Industry, Medium Machine Building Industry,Automobile,Tractors,andAgricultureMachineIndustry,etc.Today,machineryinUkraineisgenerally regulated by the Ukrainian Cabinet of Ministers and the Ministry of EconomicDevelopment and Trade. In Moldova it is generally regulated by the Moldovan Cabinet ofMinisters and the Ministry of the Economy. In Belarus it is regulated by the Council ofMinisters,theMinistryofIndustry(MOI),andtheMinistryoftheEconomy.InBelarustheMOIis the main governmental body that coordinates and regulates the activities of industrialenterprises inwhichthatstatehasanykindofownershipstake.Asof2011,164jointstockcompanies (JSCs) and 85 fully state-owned enterprises were subject to the Ministry'seconomicgovernance[1].

TherearenospeciallawsregulatingthemachinebuildingindustryinBelarus,Moldova,andUkraine.However,lawsaimedatstimulatingtheseindustriesareoftenusedinthelegislativepractice of these countries. For example, in Belarus there are so-called Rulings of thePresident of the Republic,which are sometimes partially classified documents that are notmade fully available to the public.17 In Ukraine, one shouldmention the laws like "On thestimulation of the development of nativemachine building for the purposes of agriculturalcomplex", "Onmeasuresof statesupport for theshipbuilding industry inUkraine",and"Onthe development of the aircraft industry", which determine the basic policies forgovernmentalsupport in thesesubsectors.Moldovahasused legalacts tosetgovernmentalactiontowardsthedevelopmentofmachinery.Thisincludestheactsonfreeeconomiczonesand on industrial parks, which set tax rates and incentives for the residents of thesezones/parks.

17TherecentRulingNo.284,whichwassignedbythePresidentonJune29,2015,isacaseinpoint.Itcontainsmeasures involving financial support for the state-ownedmachinery giants "Minsk Tractor Plant (MTZ)" and"GomSelMash."Accordingtotheruling,MTZwillbeabletoissuecorporatebondsworth$150millionandwillreceive taxexemptions to cover its losses in2014.GomSelMash in turnwill receiveapreferential loanworthroughly $425million from theMinistry of Finance in Belarus. Parts of the ruling are not available for publicreview(seehttp://news.tut.by/economics/454262.html)

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Followingbothglobalpracticeandcommonsense,machinebuildingcompaniesinthesethreecountriesdonotrequirespecial licenses forproduction.Special licensesareobligatoryonlyfor theproductionof rockets, space crafts and their spareparts, andotherweapon-relatedproducts.However,itisobligatoryandsometimesquitecostlytoobtaincertainpermitsfromtheauthoritiesrelatedtosuchissuesaslabor,fire,sanitation,andecologicalsafety,whicharerequiredinordertooperatethesebusinesses.

Table8.GovernmentsupportinstrumentsinBelarus,Moldova,andUkraineSubsidy

instrumentsBelarus Ukraine Moldova

Energysubsidies

YESAssuming that Belarus receivesRussian energy subsidies for over twodecades, and attains a comparativelyhigh level of energy intensity inmachinery, then the machine buildingsector receives substantial benefitsthrough the underlying Russiansubsidies.

NOAfter the escalation of thegeopolitical conflict between thetwocountries,Russiaincreasedtheprices of oil and gas for Ukraine.Today Ukraine receives energyresources from Russia and the EUatglobalprices.

NOMoldovareceivesoilandgas from Russia at aprice that reflects globalprices.

Exportsubsidies

YESThere are preferential conditions forexporters in Belarus. Due to the factthatmostmachinebuildingcompaniesare exporters, they have access toexport subsidies. Companies can getexportcreditfrombanksorloansfromthe budget. Enterprises also securethemselves against export risks byusing government insurancecompanies [34]. The most importantdocument regulatingexport support isPresidential Decree № 534 of August25,2006"Onthepromotionofexportsofgoods(works,services)."

NOThere is no evidence of directexport support for Ukrainianmachinebuildingcompanies.

NOThere is no evidence ofdirectexportsupportforMoldovan machinebuildingcompanies.

Policyofimport

substitution

YESPolicy of import substitution iswidelyused by the government in Belarus,including active support of localproducers in the machine buildingsector18.

YESImport substitution policy iscurrently used in the agriculturalmachinery and solar energy(panels)subsectors.Butitisrathernarrowinpractice.

NOThere is no evidence ofimport substitutionpoliciesinMoldova.

18 Starting in 2009, Russia’s biggest car producer "VAZ" has significantly reduced its imports ofcomponents from Belarus-based companies like BATE Borisov, "Avtogydrousilitel" Grodno, and"BelKart." Those state-owned companies took part in the import substitution program forcomponents,whichwas initiated by the Belarusian government using financial, organizational, and technicalmeasures.Thewholepackageofmeasuresallowedthosecompaniesto increasetheirsalesandtograduallyrecoverfromthecrisis[14].

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Protectionistpolicies

YESProtectionism is commonly used inBelarus19.

NOThere is no evidence ofprotectionistpoliciesinUkraineasitisthememberofWTO.

NOThere is no evidence ofprotectionist policies inMoldova

Preferential

accesstocredit

YESAn expansive credit policy and softmonetarypolicyhavebeenat the coreof the Belarusian macroeconomicmodel. State-owned companies havedirect access to credit underpreferential conditions. See examplesinChapter1.

YESThe Ukrainian economy used tofeature state-backed loans [35].Currently preferential creditpolicies are used to subsidize theaircraft industry. State guaranteesfor loans are also used in a fewindustrial sectors (defense,nuclear).

YESCurrently there is somepreferential access tocredits with lowerinterestrates forcertainprograms financed byinternationaldonors.

Lowinterest

rates

YESAsubstantial levelofsupporthasbeenprovided through the state-ownedbanking sector. This also includesinterest rate compensation to makeexport products and domesticconsumer electronic goods moreattainableforcustomers[14].

NOUkraine used to support localproducers of agricultural vehiclesandmachines,includingthepartialcompensation of the interest theypaid on loans [29]. But they seemtohaveabandonedthispracticeforthetimebeing.

YESLow interest rates areapplied to support bigprojects financed withfunds provided byinternationaldonors.

Taxbenefits

YESTax benefits for state-ownedmachineryproducershavebeenwidelyused by the government in Belarus.This distorts competition in the sectorfor both local and foreign machine-builders. There are also specialeconomic zones in Belarus, includingnewly created industrial parks (theBelarusian-Chinese industrial park, forinstance).

YESSomemachinebuildingenterprises(space, aircraft subsectors) areseenaspriorityareasforeconomicpolicy and are expected to receivetaxbenefits[19].Ukrainehasmadesomemodestuseofthepracticeofspecial economic zones, and hasimplementeddirect taxbenefits inthatcontext.

YESTax benefits in Moldovaare provided throughthe creation of freeeconomiczones.

SOE

YESAlmost all large enterprises in theBelarusianmachinebuildingsectorarestate-owned or controlled by thegovernment20.

YESState-ownedcompanies inUkraineremainonlyinstrategicsubsectorsofmachinery likeaircraftbuilding,defense machinery, and nucleartechnology.

NOThereareonlyfewSOEsin Moldova, and thegovernment intends toprivatize these, too, inthenearfuture.

19 The macroeconomic policy of stimulating internal demand was widely used in Belarus between2011-2015.However,toasignificantextentitwasbasedonprotectionism,whichlimitedcompetitionandfurtherdistortedthecountry'smacroeconomicbalance[41,50].20 Afinishedproductofafirmwithinaverticallyintegratedconglomerateisanintermediateproductfor another member of the conglomerate. Its price is thus often not subject to a clear marketbenchmark. According to procurement law, a tender is not required if the procurement ofintermediaryproductsisperformedwithinaverticallyintegratedchain.Similarly,accordingtocertainlaws, thepricesof internally tradedgoodsandservicesarebasedonrigidunit costs rather thanonmarket reference prices. Prices cannot be lower than a predetermined unit cost estimate, which istypicallybasedontheexistingcoststructureoftheenterprise.Assuch,enterpriseswithhigherexcesslabor are able to pass on these excess labor costs and other inefficiencies along the verticallyintegratedsupplychain.Thesesourcesofpotentialinefficiencyareverydifficulttooffset[1].

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Otherformsofgovernmentsupport

YESCurrentinstrumentsofsupportare:a) Government support for machinerysometimes takes an implicit form andis not readily apparent due to the factthat enterprises in the machinebuildingsectoraremostlyorganizedasvertical networks. Vertical integrationof machinery production serves toensure the better governance of state-ownedenterprises[9].b)Leasingmechanismshavebeenusedas a support mechanism for thedomestic machine building sectorduringthetimeofcrisis[14].21c) The Belarusian government oftendetermines marketing and exportpolicy with a view towards theinterests of the largest enterprises inthemachinebuildingsector.22

YESThefollowingareamongtherecentforms of government supportprogramsinUkraine:a) State guarantees and stateinsuranceforexporters.b)Stateacquisitionofnewrailcars.c) Partial compensation of thecosts of domestically producedagriculturalmachinery.d) The acquisition of domesticagricultural machinery andequipment under a nationalfinancialleaseprogram[29].

YESGovernmentsupportcanbeusedintheFEZsand,in limited forms, in theIndustrialParks.

Source:BasedonallavailablesourcesGovernmental regulations on machinery manifest themselves through different forms ofeconomic stimulus, subsidies (hidden and open), soft budget constraints, and provision ofpreferentiallending.Enterprisesinthemachinebuildingsectorbenefitdirectlyandindirectlyfromsuchconditions.It isratherdifficulttoidentifyallsubsidyinstrumentsalongthevaluechain, what we can do, however, is to compare the key support instruments in the threecountries.

As is apparent in Table 8, of the three selected countries Belarus uses thewidest range ofpotentialinstruments.InUkraine,therehasbeenareductioninthenumberofsubsidiesandstateprograms, although theUkrainiangovernment stillusesa relativelyhighernumberofsupport mechanisms compared to Moldova. Moldova seems to have most European-typesystemofgovernmentsupportformachinery,basedonfreeeconomiczonesandwithoutanykindofhiddenchannels.

Government support often results in the inefficient allocationof resources and reduces theincentivesforcompaniestointroducenewtechnologiesandinnovations,aswasdiscussedinthecontextofBelarusinthepreviouschapter.Moreover,anyfinancialsupport,beitimplicit

21 The state-owned leasing company "Promagroleasing"was created inBelarus to support industrialproducers operating in bothdomestic and foreignmarkets. The companyoffered a 5-year lease forbuyingcostlyequipmentatalowrateofinterest.22 Starting in 2009, Russia’s biggest car producer "VAZ" has significantly reduced its imports ofcomponentsfromBelarus-basedcompanieslikeBATEBorisov,"Avtogydrousilitel"Grodno,"BelKart."Those state-owned companies tookpart in the import substitutionprogram for components,whichwas initiated by the Belarusian government using financial, organizational, and technicalmeasures.The whole package of measures allowed those companies to increase their sales and to graduallyrecoverfromthecrisis[14].

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or explicit, results in a burden on the budget. The volume of government support alwaysdepends on what kind of fiscal policy is used in the given country, of course, and on theavailabilityofsufficientfundsinthestatebudgetforaparticularyear.

Ownershipissuesandcorporategovernance AlmostalllargeenterprisesintheBelarusianmachinebuildingsectorarestate-owned(SOE)or controlledby thegovernment.According toofficial statistics, roughly85%belong to theprivatesector(Table9),butinfactthegovernmentcontrolsamajorityofcorporatizedlargemachine building plants and interferes substantially with their operations. ThecorporatizationofBelarusianmachinebuildingplantsbytransformingSOEsintojointstock

Box13:V4Institutionalregulation/economicpolicyThere are no specific governmental regulations concerning the machine industry in the V4 countries,especiallysincetheEUaccession.SpecifictaxbenefitsandotherformsofgovernmentalsupportmainlyrelatetoFDI.Weassumethat inmostcasesinvestorsfirst lookattheV4countriesasageneralregionorcluster,andthenanalyzecountry-specificconditions,factors,features,andpolicies.

• AskilledandabundantlaborforceiscommonlyunderstoodasanimportantfactorinattractingFDIinmanufacturing.Overthelasttwodecades,thepercentageofthoseinthegeneralpopulationoftheV4whoareaged15-64andhaveatleastuppersecondaryeducationrangedbetween70%to85%.Researchby thePricewaterhouseCoopersAutomotive Institute shows that in comparisonwith theEU15,thelaborcostadvantageofV4countriesinmanufacturingwillremainsignificantforseveraldecadestocome(PricewaterhouseCoopers2007).

• Withregardtotheleveloftransportinfrastructure,themostdevelopedcountryintheregionistheCzech Republic, followed by Hungary and Slovakia. With the exception of the Southern Polishregions,whicharecompetingforstrategicmanufacturinginvestments,PolandistheleastdevelopedV4countrywhenitcomesto(motorwaysandrailways)transportinfrastructure.

• In terms of taxation, the V4 countries have occupied an interesting position in the Paying TaxesRankingaspublishedintheframeworktheWorldBankGroup’sDoingBusinessproject.Allofthesecountries derive a significant competitive advantage from their tax systems and from the changestheyhaveenactedinthesesystems.ThePayingTaxes2016reportshowsthatintermsoftaxation,asof late themost attractive V4 country has been Poland (Overall Paying Taxes 2016 Ranking: 58),followedbySlovakia(73),Hungary(95),andCzechRepublic(122).

• Investment incentives represent an important competitive tool, especially in a situation wheninvestmentsitesofferedbycandidatecountriesandotherconditionsareonparwiththoseofferedbyV4countries.TheEUsetsanupperceilingforthetotalamountofincentivesthatmaybegrantedtoaninvestorinthemotorvehicleindustry.Thismaynotexceed15%ofthetotalinvestmentvalue.The European Commission has to approve the amount of investment incentives proposed by thememberstate’sgovernmenttoastrategicinvestor.Inorderforanincentivetobeexemptfromthe15% rule as a so-called indirect incentive, it has to qualify as a public good. The nature of theinvestmentagreementitselfcanalsobepartofthebidding,sincetheEUauthorityonlyapprovesthetotalvalueofincentivesofferedratherthantheagreementitself.ApartfromEUconstraints,eachV4country also has its own rules for theprovision of investment incentives. The general reasons foradopting national rules for the provision of investment incentives include increased transparencyandcredibilitytowardsforeigninvestors–negotiationswithoutanygeneralguidelineslimitingstateaid arenot acceptablepolitically, and they are alsoproblematicwith regard to thepotential fiscaleffectsofincentives.Nevertheless,despitethedetailedincentiveschemes,V4countriesusuallyallowforthespecialtreatmentofstrategicallyimportantinvestors,whichgivesgovernmentsflexibilityinnegotiationswithsignificantinvestors.

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companiesoccurredinthelate2000sasapreliminarystepintheprocessofprivatization,butultimately it did not yield real private ownership nor did it improve the level of corporategovernance. The process of privatization in Belarus currently proceeds as follows. First, aunitarystateenterprise(ownedbythestate)istransformedintoanopenjointstockcompany(JSC). Initially, allof thesharesarestillownedby thestate.After corporatization,however,there is a possibility that a portion or all of the assets will be sold to a private investor.However, inmost cases the corporatization process (as the first step of privatization) onlyimpliesaformalchange−alleconomicdecisionsremaininthehandsofthegovernment[37].Intheory,corporatizationimpliesthatSOEsaresubjecttothesamelawsthatgovernprivatecorporations, and thus such a step substantially improves transparency by separating theaccountsoftheenterprisefromthoseoftheministry.Inpractice,however,theexperienceofBelarusandseveralothercountriesshowsthatcorporatizationisnotasufficientconditionforinsulating public enterprises from government interference or soft budget constraints [1].Undersuchconditions,allcriticalaspectsofanenterprise'soperations,includingthechoiceoffactors of production, output, and distribution, are affected directly and indirectly bygovernmentpolicies at the central,ministerial, or local levels.Numerous legislative acts bythegovernmentorbythecompetentministryspecifykeyaspectsofcorporationoperation–management of reserves, use of investment funds, and efficient use of spare parts. Forexample, theBelarusianMinistry of Industry (MOI) has a special committee to oversee theefficientuseofenergyandothermaterialsuppliesusedbyenterprisesunderitsjurisdiction.Anotherrulespecifiesinputnormsforvariousproductiontechnologies,thepurposeofwhichis to ensure the efficient use of resources in the production process. Formally, the statefollowsadecentralizedmanagementmodel,wherefirmsarecontrolledbytheministrythatisresponsibleforthepolicyareaunderwhichtheyproductsfall.Evenso,inpracticetherearesignificant overlaps between the responsibilities of variousministries, with the result thattheyfrequentlyinterferewithoneanotherintheircontrolactivities[1].Table9.TypesofownershipinBelarus(as%ofoutput),2013

Manufactureofmachineryandequipment

Manufactureoftransportequipment

Manufactureofelectrical,

electronicandopticalequipment

Total 100 100 100State 35.0 3.7 9.5

National 34.6 3.7 9.3Municipal 0.5 - 0.2

Private (includingprimarilycorporatized)

63.8 95.3 86.0

Foreign 1.2 1.0 4.5Source:NationalStatisticalCommitteeoftheRepublicofBelarus(http://belstat.gov.by/)Most machine building enterprises in Belarus are organized as vertical conglomeratescontrolled by the government (Ministry of Industry). This structure conceals the economicinefficiencythatmanifestsitselfpredominantlyintheformofcross-subsidizingunprofitablefirms(seeBoxNo.5above).Moreover,SOEs in theBelarusianmachinebuilding industry

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are less productive than private enterprises because of inefficient resource allocation. Thetotal factor productivity (TFP) of firms that do not report to a government ministrysubstantially exceeds the corresponding figures of their state-controlled counterparts [4].Moreover,managingcompaniesofverticalconglomerateswithlowercapacityutilizationtendto experience higher increases in their employee figures [3]. This results in excessemployment and requires large amountsofmoney for salaries (seeFigure17).As a result,Belarusian machine building enterprises become less competitive in both domestic andinternationalmarkets.However,therearesignsthattheBelarusiangovernmentunderstandstheexistingproblemswiththemanagementofstate-ownedmachinerycompanies.Thereisapromisethatverticalsystemswillbereformedinnearfuture,andthatownershipfunctionsexercised by the government will be separated from management functions. Also, theeliminationofoverlapping responsibilitiesbetweenvariousministries isexpected.But thusfartheseareonlypromises,andnorealplanshavebeenpubliclypresentedyet.

During the transition period that followed the collapse of the Soviet Union, Ukrainianenterpriseswereprivatizedandcorporatized.Stockcorporationshaveemergedasthemostcommonformofbusinessorganization,andcorporateownershipisthemostcommonformofownership in the machine building sector today.[30]. The specific features of Ukrainianprivatization have led to a situation inwhich the leadingmachine building enterprises aremainlycontrolledbylocalandRussian(orpro-Russian)businessgroups,whilethereareonlyfew state-ownedenterprises among the topplayers: Zorya-mashproekt, Turboatom,Artem,andAntonov[29].

The current state of corporate governance in Ukraine is characterized by a low level ofcorporate culture, a discrepancy between the existing corporate governance practices, andgenerally accepted principles of corporate relations, poor and inadequate legislation, andweakprotections forsmallshareholders [15].Asignificantdeficitwithrespect tocorporaterelationsintheengineeringsectorinUkraineisthealmostcompleteabsenceofcommitteeson thesupervisoryboards,even thoughUkrainianand internationalprinciplesofcorporategovernance imply that such structures should exist, and also recommend the existence ofcorporatesecretariesonthesupervisoryboards[30].Solvingthisproblemisveryimportantforthemachinebuildingsectorandinfactforindustryoverallbecausebetterconditionswillimprove competition, efficiency, the attractiveness of investment opportunities, thedevelopment of the stock market, and will ultimately boost national wealth. The mosteffective formof corporategovernance inUkraineprevailsatenterprisesownedby foreigninvestors,specificallythosewheretheshareofforeigncapitalisnolessthan30%.However,local corporatemanagers rarely trying to attract external financing by selling their shares[30].

Corporate governance in Ukrainian companies is regulated by a number of legal acts,includingtheActonCompanies(thecoreregulatoryinstrument),theCivilCode,theEconomicActivityCode,privatizationprograms,etc.Butstill,manyaspectsofcorporategovernancearenotcoveredby legalregulationsand,accordingto internationalsurveys,Ukrainian lawsareamong the least compliantwith international standardsof corporategovernance regulation[16].

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There is also the issue of small shareholders in Ukraine, which is similar to that of othercountrieswithtransitioneconomies. Inparticular, there isan issueofemployeeownership.Employees,asarule,arenotinvolvedincorporatecontrol.Theirsharesareeithercontrolledbymanagers,oraremitigatedandformanamorphousstructureofstockholdings.Asaresult,the activity of small shareholders-employees is traditionally low, and their interests aremainlyfocusedonvariouspayouts.

In Moldova, the structure of corporate ownership was changed by the mass privatizationprogramof themid-1990s.Massprivatizationwas followedbyawaveofconsolidationandstruggle for control at many Moldovan companies. These have resulted in control beingdistributedamongavarietyofowners, including the formerprivatization investment funds(FINNs),management,andnewlocalinvestors[45].Atthosecompanieswhereconsolidationwas associated with conflicting interests competing for strategic control, a variety ofcorporategovernanceabuseswereusedtogaintheupperhand,includingsharedilutionsandinadequatenotificationsof shareholdermeetings [38].As a result, key enterprises arenowcontrolled by local business groups,while foreign strategic investors are only present to asmaller degree. After the privatization process, the majority of former industrial giantsbecame uncompetitive and many companies resorted to renting out industrial and officepremises as their main business activity. Strategic investors prefer to invest in start-upsratherthantakingoverexistingmanufacturingplants.

EBRDandWorldBankindicatorsshowthatthedomestictranspositionoftheOECDPrinciplesofCorporateGovernance,whichlaydowntherightsofshareholdersandtherulesconcerningtheir equitable treatment, the role of stakeholders in corporate governance, the rules ondisclosure and transparency, and the responsibility of the board, remains inadequate inMoldova.AmongthekeycorporategovernanceissuesthatarestillontheagendainMoldovatoday are the adoption of legal requirements for shareholders to disclose their beneficialownershipandcontrolpositions,removingtheauthorityofboardstoincreasecapitalwithoutshareholder approval, establishing clear rules concerning the liability and duties of boardmembers,requiringannualindependentauditsforjointstockcompanies,andtheprotectionofsmallshareholders'rights[38].

Among the positive changes in the three countries one should note the existence ofassociationsandmember-basedorganizationswhichaimtocontributetothedevelopmentofthemachinebuilding industry, to furthertheprotectionofmembers’ interests,aswellastolobby for legislativeproposalsandotheractivities.The "BelarusianScientificand IndustrialAssociation," the "Republican Association of Industrial Enterprises," and the "BelarusianChamberofCommerce"areamongsuchorganizationsinBelarus.InMoldovatheEmployersAssociationoftheManufacturingIndustryandthe"ChamberofCommerce"arekeyplayers.In Ukraine there are several important organizations, such as the "Ukrainian League ofIndustrialists and Entrepreneurs," "Ukragromash," the "International Machine BuildingUnion," the "AssociationofTechnologists andMachineBuildingSpecialistsofUkraine," andthe "League of UkrainianMachine Builders". They aim to represent and protect members’interestsinrelationswithstateandlocalauthorities,andotherinstitutionsandorganizations,aswellasduringdisputeresolutionsincourtsofanyauthorityorjurisdiction.

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Innovation-drivenreforms TheanalysisofthemachinebuildingsectorsinBelarus,Ukraine,andMoldovacarriedoutinthis report indicates the existence of a technological gap between companies in Belarus,Ukraine, Moldova, and the V4 countries. Closing the gap requires a broad restructuringprogram, up-front investments, transfer of innovation and "know how". The share ofexpenditure spent on research and development in the industrial sector is very low. InBelarus, for example, where the machinery sector has experienced the highest level ofinvestment among the three countries analyzed here, 65.5% of expenditures described asspendingontechnological innovations in2010werespentonpurchasesofnewequipment,21.4% were spent on research and development, while only 0.4% were spent on theacquisitionofnewtechnologies[2].Sometimestheprobleminthesecountriesiscomplicatedby the fact thatmanagers of large enterprises have little incentive to innovate, sometimesthey do not want to innovate at all, and at other times they believe that innovation hasactuallybeenacquiredsuccessfully.

All three countries employ government-initiated programs to promote the development ofindustry in general and of themachine building sector in particular. In Belarus, there is"TheprogramforthedevelopmentofindustryintheRepublicofBelarusuntil2020";"The

Box14:V4Ownershipissuesandcorporategovernance

Afterseveralwavesofprivatizationinthe1990s,thevastmajorityofcompaniesintheV4machineindustrysector are privately owned. Only few state-owned companies remain in the V4 countries, mainly in theenergyandresources,consumerbusiness,andtransportationsectors.SincetheV4countriesaremembersoftheOECD, theyarerequired todomestically implement theOECDPrinciplesofCorporateGovernance.Therecently publishedOECDCorporateGovernance Factbook shows several considerable differences betweenV4 countries when it comes to the rights of shareholders and key ownership functions, and institutional,legal,andregulatoryframeworks.As a matter of corporate ownership structures, most of the listed companies in any V4 country have acontrollingshareholder,whichmeanstheyaredeemedtohaveaconcentratedownershipstructure.Specificcorporate structures that differ from the previously mentioned structure can be found in Hungary andPoland. In the case of Hungary (where one finds both concentrated and dispersed ownership structuresamonglistedcompanies),theaveragesizeofthefree-floatisabout47%,andathirdofalllistedcompaniesarecontrolledbyamajorityshareholder.InPoland,30-60%ofsharesbelongtothecontrollingshareholdersand15-20%areheldbypensionfundsorinvestmentfunds.Companies with concentrated ownership structures may be more likely to engender horizontal agencyproblemsthatarisebetweencontrollingandminorityshareholders,whileverticalagencyproblems–whicharise between managers and shareholders – may be mitigated. In general, in the V4 countries there istraditionallyvery littleopposition to themanagement'spositiononresolutionsat corporatemeetings.TherelativelylowlevelofaveragedissentduringthediscussionsofresolutionsatannualgeneralmeetingisthehighestinHungary(4.51%)andPoland(4.15%),whileit ismuchlowerintheCzechRepublic(0.68%)andSlovakia(0.06%).Inaddressingissuesofcorporategovernance,allV4countrieshaveappliedcorporategovernancestandardsincompanylawandsecuritylaw.IntheCzechRepublicthekeyregulatoryframeworkconsistsoftwolaws,specifically the Business Corporations Act and the Capital Market Undertakings Act. The HungarianjurisdictionusestheCivilCodeandtheActontheCapitalMarketThemainpublicregulatorofcorporategovernanceinPolandisthePolishFinancialSupervisionAuthority.InSlovakiacorporategovernanceissupervisedbytheMinistryofFinance.IntheCzechRepublicandHungary,the role of the main public regulator is played by the respective national banks. The implementationmechanismsofdomesticcorporategovernancecodesandprinciplesvaryslightlyamongtheV4countries.

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state scientific and technical program "Development of the machine building industrybetween2011-2015"; a programbetweenRussia andBelarus that provides the frameworkfortheproductionofcategoryEuro-4dieselengines,and"TheprogramforthedevelopmentoftheRussiancarindustryuntil2030,"whichwasadoptedjointlyadoptedbytheMinistryofIndustryandTradeoftheRussianFederationandtheMinistryofIndustryoftheRepublicofBelarus, which set up a joint working group for the development of themachine buildingsector. InUkraine there is "The IndustrialDevelopmentProgramofUkraine,"but currentlytheprogramdoesnotofferanyfunding.Itsgoalistoencourageandsupporttheactivitiesofenterprises to improve the technical level ofproduction.Amongother things, theyproposevariouskindsoftaxincentivesinordertocarryoutlarge-scaleprojectsaimedatmodernizingof production facilities. They also seek to help in developing an innovative infrastructure,establishing industrialparksanddevelopingtheirnetwork.Themost importantprograminMoldova today is the "Strategy for thedevelopmentof industryuntil2015,"which is still atimelystrategy.Theseprogramsarehugelyimportantbecausemanyenterpriseseitherdonotproduceenoughprofitsforinvestments(Belarus),donotwanttoreinvestprofits(Ukraine),orhaveonlylimitedaccesstoexternalfunding(Moldova),whichleadstosuspendanyeffortsaimed at expanding and modernizing their production, and leads them to stick with theirhighly worn fixed assets. The issue needs to be addressed with properly integratedgovernmentsupportprograms.

AsaresultoftheSoviettraditionsoftechnicaleducation,Belarus,Moldova,andUkrainehavewell-educatedandwell-qualifiedemployeesinmachinery.Hugemachinebuildingcompanies(BelaAZ, MTZ, and MAZ in Belarus; Azovmash, Motor Sich, Mining Machines, Turboatom,Dniprovagonmash in Ukraine) have their own R&D departments, which are active indeveloping products and training staff. Still, the technological level of the sector requiressignificantR&Dexpendituresandinnovations.Therearestrongdomesticscientificinstitutesand organizations that work to develop new technologies and train highly skilled staff. InBelarus these are the National Academy of Sciences, the Belarusian National TechnicalUniversity, etc. In Ukraine these include, among others, the Physical-and-TechnologicalInstitute of Metals and Alloys, the G. Pysarenko Special Design and Technology BureauInstitute for the Problems of Strength of the National Academy of Science of Ukraine, thePatonElectricWelding Instituteof theNationalAcademyofScienceofUkraine. InMoldovathese are the Technical University of Moldova, the Technical College, which is part of theuniversity, and the Academy of Sciences of Moldova and its specialized institutes fortechnologytransferandresearch.Inallthreecountries,theabovementionedinstitutionsalsoseek to foster cooperation between scientists, experts, and representatives of industrialenterprisesfromvariousdifferentcountries,aswellasthearrangementofscientificseminarsandconferencesdedicatedtomachinebuilding.

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SWOTanalysisofmachinebuildingsectorsinthecountriesanalyzed We use SWOT analysis to summarize the results of our comparative analysis of the mainmachinery trends inBelarus,Moldova, andUkraine, andof our institutional analysis of thedevelopmentsinthesecountries.TheSWOTanalysiswillhelptosummarizethesecountries’weaknesses and strengths, the common problems for and opportunities of their machinebuilding sectors. We will consider each country individually in order to identify the keycountry-specific points. This approach makes it possible to define the current situation ofmachinery in Belarus, Ukraine, and Moldova, as well as to propose key directions andstrategiesformachinerydevelopment,drawingontheiropportunitiesandstrengths,andtoovercometheweaknessesandthreatsthatmachineryfacesinthesecountries.

Box15:Internationalcooperationandclustering–opportunityforSMEs,butalsoforbigcompanies(creatingvalueaddedchainsforglobalmarkets)

Case:Clusterforautomationtechnologiesandrobotics,Košice,SlovakRepublicTheClusterforAutomationTechnologiesandRobotics(ClusterAT+R)wasestablishedinKošicein2010.Theclusterfounders–sixinnovativemanufacturingcompanies,aswellastheresearchcentersattheTechnicalUniversity in Košice and the University of Žilina, supported by the Self-Governing Regions of Prešov andKošice, provide the development of research, training,manufacturing, and supply capacities in the field ofautomationandroboticstechnology.TheAT+Rclusteralreadyestablishedthreejointresearchcenters:theCenter of Mechatronics, the Center of Robotics and Modules, and the Center of Automated ProductionSystems.Allof themhaveseveral laboratories thatareavailable toclustermembersandareused for jointprojects.

Case:AviationValleyinsoutheasternPolandTheAviationValleyAssociationwaslaunchedonApril11,2003,asanon-profitorganization.ItwassetupasameansoffurtheringtherapiddevelopmentandgrowthoftheaerospaceindustryinsoutheasternPoland.Significant fundingfortheAssociationhasbeenprovidedbyPratt&Whitney,aworld leader inthedesign,manufacture, and service of aircraft engines, space propulsion systems, and industrial gas turbines. TheAviationValleyAssociationcurrentlyrepresents125companiesintheregion.Thelong-termobjectiveoftheAviation Valley Association is to transform southeastern Poland into one of Europe’s leading aerospaceregions, which would be able to provide a diverse cross-section of products and services for the mostdemandingclients.HírösSupplierClusterincentralHungaryEstablished in 2008 in the South Great Plain region (Kecskemét), the cluster specializes in machinery,electronics, and automotive industries. Its mission is to enhance the collaboration of regional companies,regionalsciencecenters,andR&Dservicesproviders,andtopromotetheinnovation-basedupgradingoftheregion’seconomy.AfurtherobjectiveistofacilitatetheintegrationofregionalSMEsintoglobalvaluechainsandmakethemcapableofbecomingsupplierstomultinationalcompanies.Asoftheendof2013,theclusterbecame an accredited innovation cluster (AIC), and is entitled to submit tender applications to supportprogramsdesignatedspecificallyforAICs.CoordinatedbytheChamberofIndustryandCommerceofBács-KiskunCounty(theclustermanager),Hírösclustercurrentlyhas25membersincludinglocalsubsidiariesofflagshipmultinationalanddomestic-owned,rapidlydevelopingcompaniescompanies,regionaleducationcenters,engineeringoffices,consultancyfirms,andR&Dservicesprovidersandbanks.

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Table10–SWOTanalysisofmachineryinBelarus InternalFactors

ExternalFactors

Strengths(S) Weaknesses(W)-Access to preferential financingmechanisms-Well-educatedstaff-Own research base and deep cooperationwithnationalresearchinstitutes-Renownedmachineryhistoryandgoodwilltowards Belarusian machinery products intheregion

-Lowcapacityutilization-Highlevelofimportedcomponents-Outdatedequipmentandtechnology-Labor-intensiveproduction-Overemployment-Relativelylowqualityofproducts-Highvolumeoffinishedproductstocks-Lowexportdiversification-High level of government interference instrategicmanagement-Lack of innovation incentives for topmanagement-Vertical organization of huge state-ownedcompaniesintoholdings

Belarus

Opportunities(O)

-Comparativelylowenergycosts-Preferableexportconditionstothelarge market of the EurasianEconomic Union (EEU) andspecificallyRussia-Zero-tariff import of ore andcomponents from the countries ofthe Eurasian Economic Union andspecificallyRussia-Strong technical education in thecountry-Strong machinery lobbying circlesinthegovernment

1.SOStrategiesa) More efficient utilization ofinvestmentsb) Increasing share of high value addedandengineeringproductsBoth strategies aim to improve thecompetitive positions of BelarusianmachineryproducersintheEEUmarketandto diversify the range of products availableforexport.Bothcouldbeusedtoutilizethesector'seducationpotential.

3.WOStrategiesa) Quality improvement and pricereductionb) ImprovingcorporategovernanceandeliminatingstateinterventionThis approach could be used to unloadexisting stocks and to ensure a betterpositionintheEEUmarketastheproducerof"cheapbutreliablemachineryproducts."Improving corporate governance in linewith the relevant OECD principles, in bothstate-ownedandprivate companies,wouldensurethesustainabilityofthisapproach.

Threats(T)

-High importance for the economyintermsofshareinGDP-Social vulnerability due to highnumberofemployees-Decreasingexportvolumes-Decreasing share in the country'sexports-HighlevelofdependenceonRussia-Increasing dependence on the CISmarket-Lackofnationalironoreresources-Excessive number of state subsidyinstruments

2.STStrategiesa) More efficient utilization ofinvestmentsb) Development of machinerycomponentsA combination of the two strategies isneeded to diversify the sector's export andimport risks. The development ofcomponents could yield improvements intrade balance and export diversification.This, in turn, could mitigate thevulnerabilityofthesectorinBelarus.

4.WTStrategiesa) Structural change in machinerythroughprivatization(partialorfull)b) ImprovingcorporategovernanceandeliminatingstateinterventionThis constitutes themost radical approachformachineryreforminBelarus.Changesinownership and in the structure of thesector, along with improvements in thequality of management, would allow forattracting foreign investors andtechnologies, increasing productivity, andcuttingcost,whichwouldinturncontributetoimprovedproductquality,launchingnewproducts,andexpandingintonewmarkets.

ItseemsthatcurrentlytheBelarusiangovernmenthasbeenimplementingthefirstsetofSOstrategiesbyusingmainlyadministrativeinstrumentsinordertoexploitsectorstrengthsandexternal opportunities. At the same time, the government appears to pay less attention tothreatsandignoresallkindsofweaknesses.Addressingthesewouldbenecessarytochangethecoresituationinthesector.ToovercomethedifficultiesthatBelarusianmachineryfacestoday, theWT strategies in Belarus appear vital. The governmentmight directly apply thescenariosetoutintheWTstrategies(theidealscenario),ormovegraduallybyusingtheSTandWOapproaches.

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Table11–SWOTanalysisofmachineryinUkraineInternalFactors

ExternalFactors

Strengths(S) Weaknesses(W)-Convenient geographic location close tooresourcesandmetallurgicalplants-Widerangeofmachinebuildingproducts-Competitive price of domestic machinebuilding products compared to worldprices-Relativelylowlaborcosts-Well-educatedstaff-Ownresearchbaseanddeepcooperationwithnationalresearchinstitutes-Longmachineryhistoryandtieswithkeyclientsintheregion

-Laborandenergyintensiveproduction-Lowexportdiversification-High level of imported components in high-techsectors-Low consumer quality and competitivenessofdomesticmachinebuildingproducts-Outdated equipment and technology, alongwithhighdepreciationrateoffixedassets-Slow application of contemporarytechnologies and slow modernization of thefixedassetsofmachinebuildingcompanies-Inefficiencyofmanagement(imperfect,complicated,hierarchicalandgenerallyineffectivemanagementstructure)-Slow application of global standards incorporategovernance

Ukraine Opportunities(O)

-Developed metallurgy industry incombinationwithsignificantreservesofrawmaterials thataresufficient tocovertheneedsofproduction-AccesstoEuropeanmarketswithintheframeworkoftheDCFTAagreement-RecentmarketingsuccessesinAfricaandAsia-Significantpotentialofnationaltechnologicalresearch-Strongtechnologicaleducation-Broadnationalmarket- Migration of EU machine buildingcompaniestoEasternEurope

1.SOStrategiesa)Increasingshareofhighvalueaddedandengineeringproductsb)ExpandingaccesstoworldmarketsSO strategies are used to optimize thestructureofUkrainianmachineryexportsin order to open up new markets andexpand existing ones. More advancedproducts will be also in demand in thewiderlocalmarket.

3.WOStrategiesa)Improvingcorporategovernanceb)AssetsmodernizationImproving corporate governance based ontherelevantOECDprinciplesseemstobethecoregoalforWOstrategies.Asapriority,bestcorporate government practices should beenforced in the public companies activelytradedatUkrainianthestockexchangeBetteraccountability and improved relationshipwith investors is expected to automaticallycontribute to the process of increasinginvestments in technologically advancedassets.

Threats(T)

-HighlysignificantfortheeconomyintermsofGDPshare-Social vulnerability due to highnumberofemployed-HighlevelofdependencyonRussia-Decreasing share in total exportsoverthelastyears-Ukrainianeconomicrecession-Labormigration-Complex system of intellectualpropertyrightsprotections-Lackofenergyresources

2.STStrategiesa)Increasingshareofhighvalueaddedandengineeringproductsb)IncreasingproductivityinthesectorIncreasingproductivityandenhancingtheoutputofhighervalueaddedproductsarethe core steps thatneed tobeperformedduring times of economic downturn anddiminishing exports. These strategiescontribute to export growth and create afoundation for sustainableoutput growthinthefuture.

4.WTStrategiesa)Improvingcorporategovernanceb)IncreasingproductivityinthesectorAs in the case of the WO approach, thestimulation by the Ukrainian government ofimprovements in corporate governanceseems to be the core of WT strategies. Incombination with government efforts topromoteincreasedproductivityinthesector,this would contribute to attracting foreigninvestorsandtechnologies,improvedproductquality, the launching of new productsexpansionintonewmarkets.

BearinginmindtheeconomicrecessioninUkraine,aswellaspoliticalandeconomictensionswithRussia,itseemsreasonabletolaunchcomprehensivebutsustainablereformsusingtheWTstrategies. Improvements in themanagementofmachinerycompanies inUkraine is theareawheretheUkrainiangovernment'sattentionismostneeded.However,thereisalsotheneed to stimulate productivity increases in the Ukrainian economy, including themachinebuilding sector. These are rather radical efforts that require a targeted approach by thegovernmentbutcouldcontributetosustainableeconomicgrowthinthefuture.

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Table12–SWOTanalysisofmachineryinMoldova

InternalFactors

ExternalFactors

Strengths(S) Weaknesses(W)

-Goodexportdiversification-Relativelylowlaborcosts-Well-educatedstaff-Cooperation with national researchinstitutes

-Labor-intensiveproduction-Low capacity utilization in local-ownedcompanies-Weakprotectionofsmallshareholders-Lowqualityoflocalmanagement-Moreinvestmentsareneeded

Moldova

Opportunities(O)

-Bettersectorperformanceafterdeepstructuralchange-Increasingshareofthecountry'stotalexports-Increasinginvestmentsinthesector-AccesstoEuropeanmarketswithintheframeworkoftheDCFTAagreement-InterestfromEUcompaniesandinvestors-Strongtechnicaleducation- Migration of EU machinebuilding companies to EasternEurope

1.SOStrategiesa) Stimulation of subsectors withhigh value added and engineeringproductsb) Expanding access to the EUmarketGreater access to the EU marketseems to provide new opportunitiesfor Moldovan machinery products.The further optimization of thestructureofmachinerybydevelopingadvanced products will boostmachinery exports and utilize agreatershareofthelocallaborforce.

3.WOStrategiesa)Improvingcorporategovernanceb)ModernizationofassetsJust as in the case of Ukraine, improvingcorporategovernancebasedontherelevantOECDprinciples seems to be the core goalforWOstrategies.Itisnecessarytoenforcethe principles of corporate governance atpublic companies in order to achievegreater accountability and better investorrelations.Thiswillcontributeto increasinginvestments in technologically advancedassets.

Threats(T)

-Concentrationofmachineryproductioninspecialeconomiczones-Russianfactorinownership-Labormigration-Lackofenergyresourcesandironore-Narrownationalmarket

2.STStrategiesa) Targeted cooperation withEuropeaninvestorsCooperationwithEU investorsseemsto be the only reliable strategy forovercoming existing threats. Thisstrategy is rather easy to implementfor the Moldovan government andwill contribute to Moldova'sexpansion into the EU market,increase productivity, and improveownership structures andmanagementquality.b) Create new state incentiveprograms and improve thebusiness environment. Attract EUcompanies to relocate production toMoldova.Subsidiesandincentivesarenecessary to manage toughcompetition from the region(subsidies offered for job creation inSerbia,Macedonia,etc.,andforcapitalinvestment (equipment, buildings,etc.) in Romania. Also, the businessenvironmentneedstobeimprovedallover the country to offer similarconditionsas theones thatprevail inFEZsforallregions.

4.WTStrategiesa) Improving corporategovernanceandproductivity and productivityimprovementb) Stimulating small and medium-sizedmachineryproducersIf we assume that principles of corporategovernance are implemented as part of astrategy pursued by the government ofMoldova, some targeted efforts atincreasing productivity in the sector areneeded to draw foreign investors andtechnologiesintotheeconomy.Atthesametimes policies should aim to stimulate thecreation of new businesses by providingopportunities for small and medium sizemachinery producers. This is the definiteway to improve the quality of products,launchnewproducts,andincreaseexports.

ThebestcourseforMoldovawouldseemtobeacontinuationofreformswithatargeteduseof corporate governance best practices, in combinationwith stimulation for SMEs that areactiveinthemachinerysector.Theseappeartoberadicalmeasuresandarethebestwaytoattract foreign capital into the economy and spur development in the sector and in theeconomyoverall.

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Statisticalannex Picture1.AllocationofkeymachineryproducersinUkraine(takenfrom:InvestUkraine,Deloitte.Machinebuildingindustry/Industryoverview/downloadedfromhttp://ccipu.org/ua/industry_analysis/machine_building/Table13.EхportsofthemachinebuildingsectorinBelarus,Ukraine,andMoldova,1994-2014,bn.USD

Belarus Ukraine Moldova1994 0.071995 0.061996 2.04 0.051997 1.91 0.101998 2,01 1.72 0.051999 1.62 1.33 0.032000 1.76 1.80 0.032001 1.86 2.26 0.042002 1.93 2.45 0.042003 2.30 3.30 0.042004 3.05 5.06 0.062005 3.09 4.49 0.062006 3.78 5.41 0.072007 5.20 8.28 0.112008 5.89 10.66 0.182009 3.15 6.61 0.152010 4.56 8.93 0.192011 7.86 11.61 0.332012 7.89 12.98 0.342013 6.79 10.31 0.362014 5.22 7.13 0.34


Table14.Exportdiversificationbysubsectors,2013


CIS+Ukraine+Turkmenistan

World

84 Belarus 73.8 100

Ukraine 57.9 100Moldova 65.2 100

85 Belarus 76.7 100Ukraine 35.1 100Moldova 2.9 100


87 Belarus 72.3 100Ukraine 51.1 100

86

Moldova 59.0 10088 Belarus - -

Ukraine 14.5 100Moldova 0.3 100



Belarus 73.4 90.6 100Ukraine 51.9 62.8 100Moldova 21.3 27.5 100


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