How Ukraine can upgrade its technological capabilities

Ukraine has been getting a lot of press recently, for all the wrong reasons. In actuality, during the last 25 years, Ukraine has transformed structurally and socially, and even the political changes have been largely positive. Despite its enormous potential, though, Ukraine’s economy has not done well. Per capita GDP has fallen from about $12,000 in 1990 to about $8,500 in 2018.

Over the last decade, there have been two encouraging developments. The first is that Ukrainian workers have become more productive. Labor productivity—the output per employee—has increased 22 percent since 2010, about the same as in neighboring Poland and other transition economies. The second is a rapid and sustained growth of the information and communications technology (ICT) sector since 2008 and the growing exports of machinery and equipment. In 2017, the sector generated $3.5 billion of exports—more than 3 percent of GDP—and accounted for a tenth of foreign direct investment flowing into Ukraine.

But even here, Ukraine has underperformed. The ICT sector remains decoupled from the rest of the economy, raising doubts about the sustainability of its growth as well as the potentially lost opportunity of productivity-improving digitization of the real economy. The ICT sector could help the rest of Ukraine’s economy grow faster and its workers become more productive, but only if this problem is remedied. In this recent World Bank report, we propose some solutions.

Benchmarking innovation in middle-income economies

In middle-income countries, innovation often occurs in “downstream” activities related to production capabilities: adoption of new technology and standards, cost- and quality-oriented process improvements, and improved management practices. But Ukraine has been judged more often by international benchmarks on upstream innovation and R&D. In the long run, R&D-based growth is undoubtedly essential. But it is not the primary source of growth of Ukraine.

In our recent assessment of Ukraine’s tech upgrading potential, we adopt a three-dimensional conceptual framework that goes beyond R&D in explaining the building of technological capability in Ukraine and other middle- income economies. Technology upgrading consists of three main parts: technology intensity, breadth of upgrading, and interactions with the international economy. These include subcomponents that benchmark Ukraine to its peers across 37 indicators (Figure 1). Consequently, technology upgrading is an outcome of the interaction between these three parts.

Figure 1. Measuring technology upgrading: Intensity, breadth, and interactions

Source: Radosevic, Slavo; Bruno, Randolph Luca; Hayter, Christopher Scott; Aridi, Anwar. 2019. Path for Ukraine’s Economic Growth: Technology Upgrading. Washington, D.C.: World Bank Group

Note: Data in standardized units ranked in decreasing order from left to right

Ukraine has a long way to go

With the exception of science and engineering education, the growing ICT industry, and agricultural production, Ukraine does not fare well.

• It is ranked lowest in the intensity of technology upgrading, mainly due to poor performance in production, management, and R&D capability.
• Ukraine’s shortfall relative to its peers is greatest in organizational and production capabilities. Ukraine has a relatively low rate of ISO 9001 adoption, an indicator of the quality of production, including services (Figure 2). With just 27 certificates per million residents in 2011-2016, it was lagging behind Belarus and Russia, economies that are more dependent on internal markets.
• Ukraine does relatively well in interactions with the global economy, primarily due to inflows of foreign direct investment and the emergence of the ICT industry. But many opportunities to enhance Ukraine’s increasing interconnectivity to global markets remain unexploited, especially with the EU.

Figure 2. The quality of production in Ukraine is low, even compared with Belarus and Russia
Number of ISO 9001 Certificates (per million inhabitants), average rate per period, 2001–2015.

Source: Author estimates, based on ISO database.

Ukraine’s export structure is the result of a low share of “complex industries” and the predominance of two parts of the economy: (1) Natural resource-based sectors such as agriculture and low processed commodities, which amount to the bulk of Ukrainian exports, and (2) ICT services. We focused on ICT services industry both because it is the rising star of Ukraine’s exports but also because of its potential in enabling the upgrading of Ukrainian firms. ICT—actually digitization overall—embodies the attributes of general purpose technologies that could bring economy-wide benefits.

Transforming ICT from an ‘exclave’ to a macroeconomic lever

Exports of software have already reached 10 percent of total exports of goods and services and become economically relevant. Also, the rate of growth of software has speeded up since 2010, which has put Ukraine firmly in the second tier of software exporters that includes Hungary, Poland, Russia, and South Korea. Ukraine is still well behind world leaders such as China, India, Ireland, and Israel, but there is no reason why Ukraine shouldn’t be setting its sights on them. But the lack of local demand and of backward linkages with domestic sectors will not just keep Ukraine from catching up to global leaders, it poses a serious threat to the sustainability of its current growth.

The growth of ICT was due to Ukraine’s human capital and low barriers to entry into global markets. International trends such as the search for cost savings after the 2008 financial crash, the growing “servicification” of manufacturing, and the emerging Industry 4.0 technologies have also contributed to the rapid expansion of the industry. But continued growth is not guaranteed and its effects on the domestic economy will likely remain modest unless Ukraine changes tack. Without turning inward, Ukraine must find ways to integrate its export-oriented ICT sector into the rest of the economy. Innovation policy experiences point to three imperatives:

• Adopt an appropriate approach. To upgrade the capabilities of the ICT sector and integrate it into low performance sectors, Ukraine has to devise an innovation strategy that is more relevant to its policy, production, and technological capabilities. Any policy effort to promote technology upgrading needs to recognize the government’s low institutional capacity and focus on ways to leverage the private sector, pilot and upscale initiatives, and encourage subnational initiatives.
• Go downstream. A “downstream tech upgrading” strategy could promote wider adoption of technology through the integration of its strong outward-oriented ICT services into a range of domestic activities and promising sectors. A downstream strategy consists mainly of measures to: (i) increase managerial capabilities and the adoption of productivity-enhancing technologies; (ii) attract more FDI; and (iii) sustain the supply and retention of a digitally ready workforce.
• Learn from the leaders. The ICT sector is dominated by business-to-business outsourcing to developed economies, especially the U.S. Much of this activity is generated by 1,000 or so ICT outsourcing companies located in Ukraine. Most operate in an export-focused “silo” serving foreign markets with few ties to domestic industries. Ukraine can learn more from the experience of the few firms that operate in high-value-added activities by creating the capacity to co-develop end-to-end solutions with clients or develop new products to sell directly to consumers.