German Investors Doubtful of Reforms in Ukraine

At a factory in Stryj, eastern Ukraine, workers finish cable looms for the northern German special cable manufacturer Leoni, which supplies German firms such as Opel and Porsche. Employees say the work is "okay" -- they receive their wages regularly, even if, at the equivalent of 120 euros ($140) a month, they are quite low.

But it's these excessively low wages that make Ukraine an attractive destination for foreign investors. In countries such as Poland or Hungary, the wages are double or triple the amount.

The machines at Leoni are operating in full gear, even if the initial euphoria surrounding the "Orange Revolution" that promised an end to Ukraine's shadow economy has dampened.

"From our point of view, the situation now is really frustrating," said Leoni's Ukrainian director, Werner Geillinger. "The Ukrainian government cancelled all duty-free zones, because they wanted to cut off the schemes of the oligarchs, but by doing so, they've punished investors."

Extended workbench

Auto suppliers use Ukraine like an extended workbench -- importing all the materials, having cheap labor do the work on them, and then exporting the finished products to western European carmakers. In the past, agreements were made with the Ukrainian government to guarantee exemptions from sales tax and duty. After the new government canceled such agreements, Leoni was faced with an additional 300,000 euros a month in duty fees.

The abolition of special economic zones -- which were one of the main causes of corruption inside Ukraine -- has also added to the burden borne by many employers. And the discussion about the privatization of former state-owned companies has led to large-scale uncertainty.

"After the Orange Revolution, there was a lot of demand from German industry from both suppliers to industry as well as by direct investors," said Karin Rau, who works as a German industry representative in Ukraine. "But since April of this year, there's been a stop to that, due to the passing of several laws that didn't bring about the needed trust, because companies were neither involved nor informed of the changes."

In addition, Rau said that the dismissal of 18,000 bureaucrats from civil service meant that the new Ukrainian government lost a great deal of know-how. These days, a common complaint is incompetence.

Poor management

Leoni director Geillinger also accuses the new government of bad management, either because of inactivity or resistance to advice from outsiders.

But that's starting to change, according to Lars Handrich, a consultant from the German Economic Institute in Ukraine who advises the government on economic issues.

Overall, he says, Ukraine is better off now than it was a year ago, largely due to the new open atmosphere in Ukrainian society and more intensive contact to western Europe.

"It's not all downhill," Handrich said. "The tone of the discussions here recently has been rather pessimistic in my view. If you look at the economic statistics, you see that in the past year Ukraine's gross domestic product gained 12 percent. This year, economic growth will only fall by 2 to 3 percent. It's not a recession, it's just a decrease in the growth rate."

Handrich said the decrease can partly be explained by one-off effects in the last year of rule under former President Leonid Kuchma, when the state invested in the construction of two nuclear reactors and a motorway leading from Kiev to Odessa.

More liberalization needed

The country's increased inflation rate, he said, is due to increased demand created by higher salaries -- demand that couldn't be met by industry. For that reason, there were shortages of meat and other groceries. Ukrainian lobbyists blocked imports, which led to higher prices, Handrich said.

These developments are proof that the market has to be liberalized even more, and that the government has to continue with its reforms, particularly in the areas of agriculture and health care, but also when it comes to battling corruption.

One of President Viktor Yushchenko's most important goals, however, could soon be achieved -- the granting of market economy status for Ukraine's economy from the European Commission.

Things also appear to be moving forward in the auto-supply sector. Discussions with the government about the issue of duties are ongoing and are due to finish at the end of December. For Geillinger, that's reason to be hopeful. Ukraine is an attractive country, he says, but it's wasted a whole year.

"As soon as the Ukrainian government finds a solution, many others will come here," Geillinger said. "We're already contemplating expanding our factory. In the meantime, we're planning to build a second factory in Ukraine."