A Closer Look at Weaknesses in Ukraine’s State-Owned Enterprises by Denys Kostrzhevskyi

Naftogaz, one of Ukraine’s most prominent state-owned enterprises, recently released a report detailing its financial successes, including significant profits in the first quarter of 2024.

At first glance, this appears to be positive news, indicating the effectiveness and success of the company. However, a more detailed analysis raises serious questions and doubts about the ethics and expediency of such a ‘victory.’

Profit is undoubtedly the lifeblood of any business. However, when it concerns a state-owned enterprise operating in a market with regulated tariffs—where gas prices for consumers, both the population and industry, are set by political decisions rather than market mechanisms—such profits are both surprising and outrageous.

You would agree that it is a dubious ‘achievement’ to sell energy to a depleted economy with huge margins. Just like to report that you are selling exorbitantly priced gas of Ukrainian origin to your people, which, according to the Constitution, is already the property of the people! On top of that, you make extra profits on it for years. Paradoxical? No, it’s the system.

State-owned enterprises operating at prices set by the state should operate with zero profit. Their main task is to provide the population with vital resources at the lowest possible prices. This is the initial essence and task of the state as a regulator and owner of these enterprises.

Only taxes and fees can and should be a source of budget filling. The state should play the role of an arbiter, and business should play the role of market players. This approach will help avoid conflicts of interest, increase the efficiency of the economy, and ensure transparency and accountability in the use of people’s resources.

The Socialist Legacy: The Root of Economic Stagnation

The answer to the question of why things are as they are, obviously is hidden in our recent past.  Despite decommunisation and other reforms, Ukraine actually is still the heir of the Soviet system in economic terms. Public ownership and governance dominate key sectors of the economy, hampering development and innovation.

The Antonov Plant, once the pride of Ukrainian aircraft construction, today looks more like the ghost of the past.

Between 1957 and 1991, the Antonov Plant was one of the largest manufacturers of military and civilian transport aircraft in the Soviet Union. In total, by 1991, more than 22 thousand aircraft of various models were produced, such as An-12, An-22, An-124, An-225 (Mriya). After Ukraine gained independence, production at the plant decreased significantly. New developments were no longer done, aircraft was assembled while using what was available, and old aircraft was modernised. As a result, in 35 years, no new aircraft has been created that could not only fly, but even go beyond the gates of the plant! 

For defence production, the beginning of Ukraine’s independence was also marked by a decline. If 3,594 enterprises were operating in Ukraine at the beginning of 1991, which were involved in the production of military products and dual-use products. By 2020, there were only 147 state-owned enterprises of the defence industry and about 250 private ones left, with a total staff of not more than 100,000 people.

In general, during the post-Soviet period (1992–2012), Ukraine only entered the group of the world’s leading arms exporters. However, this potential was mostly based on the sale of used weapons. The production of new equipment remained at a low level.

A country with a reputable aerospace past and huge potential in the defence and military industry faces a paradoxical situation today: instead of modern tanks, powerful guns, high-precision missiles, and advanced aircraft, which should have been the result of long-term investments in the military-industrial complex, we have bloated budgets of projects that have never been implemented, constant kickbacks, and aerospace salaries of officials.

The problem is not in management. The problem is in the system. It is the example of such strategic state-owned enterprises as Naftogaz, Antonov, Ukroboronprom Concern, and others that we can use to trace these same systemic problems inherent in the public sector of the economy. Only 15% of more than three thousand state-owned enterprises in Ukraine are profitable. The rest are unprofitable, but continue to function, paying salaries and bonuses at the expense of taxpayers and creating opportunities for corruption.

This situation differs significantly from that in developed countries such as the United States, the United Kingdom, or Germany, where the number of state-owned enterprises is much smaller. This indicates the inefficiency of public administration of enterprises and the urgency of reforms.

For example, in Germany, the share of state-owned enterprises is only about 11% of the economy, while in Sweden, it is 13%, and in France, it is about 7-8% of the economy. In the UK, it is even smaller and accounts for about 2% of the economy, mainly in transport and utilities.

Schrödinger’s Air Strategy

In addition, I would also like to draw attention to the aviation industry, in particular, to the document called the National Strategy for the Development of Civil Aviation of Ukraine for the Period up to 2030, which these days is being developed by the relevant agency. Based on the name, the document itself is ambitious and important, but in this case, it looks like an attempt to create an illusion of stability and development in an environment where the aviation industry is actually paralysed.

Firstly, the strategy developed in such conditions can hardly take into account the real needs and capabilities of the industry after the end of the war and the restoration of infrastructure. Secondly, strategy is a kind of plan in and of itself for a long period of time. The strategy for 5 years, especially in the current conditions, looks ridiculous. Anyway, if you look at the text of this strategy, you may think that it is written with one purpose in mind: to give reasons for and justify the establishment of yet another state-owned enterprise for the maintenance and management of airfield complexes.

Section 2.2 of the Strategy reads:

‘A management company or a state body has been established to manage airfield complexes built at the expense of the state and owned by the state, including airfield complexes of municipal airports if transferred to state ownership’.

Taking into account all the above facts, this strategy may serve to demonstrate the activity and optimism of its authors. This once again emphasises that the state apparatus is far from reality and is unable to adequately respond to the challenges of time.

There is a way out

It seems that the war, although it became a catalyst for change, did not lead to a radical transformation of the public sector. Despite decommunisation and other reforms, Ukraine is still largely a socialist state in terms of economic base and ownership of the means of production. The communist, public style of enterprise management proved ineffective back at the end of the last century, but for some reason, it still persists in the most important sectors of the economy.

The reason for the 35-year stagnation of the Ukrainian economy and the decline of key industries, such as aerospace, energy, and defence industries, is in the public sector, in public administration. But there is a way out—immediate and complete denationalisation. At the same time, the state retains control over strategic sectors of the economy through various mechanisms, such as state supervision, quotas, tariff setting, licensing, etc. But definitely not through direct ownership and receiving surplus profits from entrepreneurial activity.