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The Product Cycle Theory for Developing Countries. Ukrainian case.

Olena Gurova, PhD Student University of Rouen Abstract:
Central and Eastern European countries (CEE) had emerged as new players on the world market, opening its economies to international trade, FDI and internationalisation of products. This paper (i) refers to classical Vernon theory of Product Cycle (PCT), then analyses its evolution and following tests by other authors and by Vernon himself, (ii) studies PCTs application on Chinese case, in particular on Central office switches industrys success during last few years; and CEE countries case (CEE is seen as new global location in electronic industry), and (iii) makes an attempt to analyse Ukrainian economys case in terms of PCT, analyses which lessons Ukraine should learn on its way to internationalisation of its production. Key words: International Trade, Product Cycle Theory, FDI, MNCs, Vernon, Technological Gap, CEE.

Introduction
Central and Eastern Europe (CEE) has just recently opened its economies to international trade after the decline of Soviet Era. That means not only liberalization of trade itself and opening its market for international producers, but also its own productions internationalisation. We insist here that market integration is necessary but not sufficient condition for benefiting from global integration. It is often assumed that industrial integration would automatically follow the market integration. However, most often this is far from being a case and the failure of Washington consensus in CEE and CIS countries proved it recently. Countries could be integrated through markets but not necessarily through production and technology networks. World economy is much more integrated through finance and trade than through production and much less through technology. Similar levels of market integration do not necessarily lead to similar levels of production and technology integration.

Thus, here is a question arise what determines whether firms are able to brake into to foreign markets? Which are the steps the company and the country should take to make its product competitive at the international market? What determines the positive input of FDI? To answer these questions, we propose to use Product Cycle Theorys (PCT) approach and to analyse which are the chances for developing countries or countries with transitional economies for accomplishing the task of bringing new competitive product on foreign market or at least, to move from the developing countries status to follower or leader in terms of PCT. In aim of answering these questions for CEE countries, we find it useful to study some recent cases such as Chinese, where we already can observe some significant success of accomplishing Product Cycle. And, to move to more particular case, we take example of Ukraine, the country that follows its CEE neighbours in its economical transition; and to try to answer some important questions rising: 1) Which sectors of Ukrainian economy are developed enough to be export-intensive? Which sectors of economy should and may Ukraine develop to become a serious competitor on the international market? 2) Which foreign markets are open and which might be open in the future for Ukraine as exporter? 3) Which conditions should Ukraine meet to participate in competition on the international market? What are the obstacles at the moment for FDI hosting and developing pro-export production? 4) Could PCT be useful for programming the development economies in transition and in particular Ukrainian?

I - Theoretical approach
1. Classic Theory of Product Cycle by Vernon The Product Cycle Theory is generalization and extension of the technological gap model, sketched by M.P. POSNER in 1961, a great deal of the trade among industrialized countries is based on the introduction of new products and new production process.

These give the innovating firm and nation a temporary monopoly in the world market. Such a temporary monopoly is often based on patens and copyrights, which are granted to stimulate the flow of inventions. As the most technologically advanced countries, US exports a large number of new high-technology products. However, as foreign producers acquire the new technology, they eventually are able to conquer markets abroad, and even US market for the product, because of their lower labour cost. In the mean time, American producers may have introduced still newer product and the productions processes and may be able to export these products based on the new technological gap established. A shortcoming of this model, however, is that it does not explain the size of the technological gaps and doesnt explore the reason that technological gaps arise or exactly how they are eliminated over time. The Product Cycle Theory says that FDI starts to work only when traditional export of goods doesnt bring enough of profit any more to the company and as a solution the company chooses the organizing of production abroad. The PCT is concerned with the life-cycle of a typical new product and its impact on international trade. R. VERNON (1966) developed his theory in response to the failure of the United States the main country to do so to conform empirically to the HeckscherOhlin Model. R. VERNON emphasizes manufactured goods, and the theory begins with the developing a new product in the USA. The new product had two principal characteristics: 1) it caters to high-income demands because the US is a high-income country 2) it promises, in its production process, to be labour-saving and capital-using in nature. The reason for including the potential labour-saving nature of the production process is that the US is widely regarded as a labour-scarce country. Thus, technological change will emphasize production processes with the potential to conserve this scarce factor of production. The theory of R. VERNON divides the life cycle of this new product into three stages (Figure. 1): 1) The new product stage (innovation stage, production inside the country) the product is produced and consumed only inside the country (USA by Vernon).

2)

Maturing product stage (export of product) some general standards for the product and its characteristics begin to emerge, and mass production techniques start to be adopted.

At this stage the prices competition is increasing and the costs of products plays more and more important role. But the company continues the export of the product and avoids direct investments as long as production costs and transportation costs of this product are lower than the cost of production abroad. If this proportion changes and production abroad (investments) becomes more efficient, the company shifts production of this product to the country with the similar structure of demand and lower level of salary (as example for USA in 1960s it was Western Europe). 3) Standardized product stage (technologys export and products import) by this time in the products life cycle, the characteristics of the product itself and the production process are well known; the product is familiar to consumers and the production process to producers.

Production Consumpti on of product

Exports

imports

Innovatin g countrys consump tion

Innovating countrys production

t0 New product stage

t1 Maturing product stage

t2

Standardized product stage

Time

Figure 1. Trade pattern for innovating country. Vernon hypothesizes that production may shift to the developing countries. Labour cost again plays an important role, and the developed countries are busy introducing other products.

Exports (X)

Leaders countries

Intermediate countries (followers)

Developing countries

Time

Imports (M)

II

III

IV

Figure 2. PCT in application on 3 types of countries.

Table 1. Legend for Figure 2. USA I II III IV X X X +M M EUROPE M M X X+(M) JAPAN M M X X+(M) DEVELOPING COUNTRIES M M X

At this stage the cost plays main role. Products and processes of productions dont change a lot. Competitors gain predominant role at the market thanks to price competitions. This demand from them searching of possibilities to decrease the production costs. As a result, international companies create their production sectors in the countries with low level of remuneration of labour. Those production sectors are supplying the markets of industrial countries so they turn from exporting countries into importing countries. Example clothes of famous American brand Victoria Secrets are fabricated in 90% of cases in Philippine, Malaysia and other countries with low level of salaries, and having American label Victoria Secret, at the same time marked as imported. To drop the salaries expenses, company went even further some of its lingerie items were produced by Mexican prisoners, which caused kind of ethical discussion in press and internet magazines. Also, Mexico is ranked at the 6th place among 160 countries, - it s special case which will be discussed later in this paper. The same example is taking place in Europe. European clothes brand Etam uses a labour of Chinese, Romanian and Ukrainian workers to tailor their items. The labour cost in China is lowest one even considering that transport costs for shipping goods from China are higher than transport costs from Ukraine. But company keeps producing trousers and jackets in both countries, even thought it costs twice more paying for trousers tailoring in Ukraine than in China. Its still cheaper than tailoring in France and Ukraine has more than 15 years of experience to tailor clothes for some French brands (i.e. Kharkovs factory named after Tinjakov has 15 years experience of producing clothes for some French companies). The PCT of R. VERNON, was originally developed for explaining American investors behaviour abroad. However, the PCT, based on markets evolution concepts, has significant meaning for enterprises which make their first steps to internationalisation of their activity.

What is the evidence on the PCT? The product cycle hypothesis suggests two orderings: 1) more advanced countries are able to begin exporting earlier than developing countries; 2) less advanced products are developed and exported earlier.

In general, advanced countries are expected to begin exporting more advanced products earlier than less advanced countries. However this model cant describe sufficiently the process of division of markets by international companies in different countries, it doesnt explain their specific advantages. 2. Developing and testing Vernons Theory There is no single all-encompassing test (such as W. LEONTIEF test of HeckscherOhlin) to verify empirically the product cycle theory. Instead, researches have examined particular features of the PCT to see if they are consistent with real-world experience. For example, new product development is critical to the PCT, and it is often the result of research and development (R&D) expeditures. Therefore, economists hypothesize that, in the USA manufacturing sector, there should be a positive correlation between R&D expeditures and successful export performance by industry. A number of tests indicated this result, including those by D. KEESING (1967) and W. GRUBER, D. MEHTA, R. VERNON (1967). I. KRAVIS and R. LIPSAY (1982) found that high R&D intensity was positively associated with large shares of export by US multinational companies (MNCs). Furthermore, over the last 25 years, greater shares of US MNCs exports have come from overseas production, which is consistent with the direct-investment and exportdisplacement features of the PCT. In addition, in 1969, L. WELLS examined the income elasticity of demand of the fastest-growing US exports and found again, an occurrence consistent with the PCT. It was Wells, who summarized the product life cycle in tabular form (see table 2).

Table 2. PCT by L. Wells (1969). Early Low price elasticity for aggregate demand and for individual firm. Nature of demand not well understood by firm Short runs, rapidly changing techniques dependent on skilled labor. Low capital intensity. Small number of firms. CYCLE PHASE Growth Growing price elasticity for firm. Price competition begins. Mature Basis of competition is price or product differentiation through marketing techniques.

Demand Structure

Production

Mass production Long runs with stable methods. techniques. Labor skills unimportant. Capital intensive.

Industry Structure

Large number of Number of firms firms, but many declining. casualties and mergers. Source: Louis T. Wells, Jr., The Product Life Cycle Approach. Among the many other empirical works is G. HUFBAUERs (1966) study on trade in

synthetic materials. Hufbauer found that the US and other developed countries tended to export new products while developing countries tended to export older products. W. GRUBER, D. MEHTA, and R. VERNON (1967) also discovered that researchintensive US industries have a high propensity to invest abroad. This is consistent with the maturing product stage of theory. In 1979 R. VERNON modified his original PCT with respect to the role of multinationals. Because of the changes that occurred in production conditions in the USA mostly because of the convergence of labour costs with other technological leaders such as Japan, but also the convergence of the level income it seems likely that the actual production of new products could take place somewhere else other that in the country in which the research laboratory is. For example, while R&D activities will take place in the MNCs headquarters, usually in one of the more highly DCs, the initial production could easily tale place in one of the MNCs subsidiary companies located in a developing country. However, this modification does not bring the product-cycle and the HO trade models any closer together. In 1972, J. MORRALL found that US industries that were successful exporters also tended to have relatively high expenditures on non-payroll costs such as advertising, sales promotions, and so forth.

Taking into account all the difficulties in measuring technological advantage, the empirical evidence is as favorable toward the product-cycle theory as it could be. A number of studies have incorporated some type of technology-related variables as determinants of the pattern of trade. A comprehensive survey of the many avenues taken in empirical testing is presented by A. DEARDORFF (1984). He stresses that all the variables used to explain trade in these technology-based models are related to two things: 1) the newness of the products or process 2) the special knowledge possessed by individuals, firms, and countries that enables them to develop and exploit available technologies. This leads A. DEARDORFF to conclude that it is difficult to distinguish the evidence supporting technology from the evidence supporting human capital and skills as determinants of trade. R. FEENSTRA and A. ROSE (2000) use intuitions of Vernons Theory to produce a ranking of products and a ranking of country sophistications. The product and country ranking are based on the product cycle notion that all goods are not exported by most countries and that countries tend to export goods to the United States in a sequential order. First, the ranking of unobserved product sophistication is constructed according to the first year of exportation. A product is deemed less advanced if it begins to be exported earlier to the United States. Second, the ranking of country sophistication is constructed according to the first year in which a country exported each commodity to the United States. Empirical analysis shows that countries ranked as more advanced, in the sense that they tend to export sooner to the United States, tend to grow faster and to display higher levels of economic activity and of total factor productivity than countries ranked as less advanced. The top more sophisticated countries, according to a ranking based on the exports of manufacturing goods, are Japan, Germany, Canada, the United Kingdom, France, Italy, Switzerland, the Netherlands, and Mexico. Notice, that the ranking is affected by trade relations with the United States, which explains why Mexico is number nine among 160 countries as we stated before. One of the most important questions rising for our further analysis is what determines whether firms are able to break into foreign markets?

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A. BERNARD and J. JENSEN (2001) undertake a dynamic econometric analysis benefiting from the availability of data at the plant level. The study uses a panel of 13 550 US manufacturing plants that operated continuously during the export growth period 1984-92. the plants in the sample were a small percentage of the almost 200 000 plants surveyed in the Census of Manufactures in 1987 but accounted for 41 percent of total manufacturing employment and 70 percent of total manufacturing exports in that year. About 48 percent of the plants in the sample exported in 1984 and 54 percent in 1992. The econometric analysis tests for the effects of entry costs, exchange rates, plant characteristics, state export promotion, and other factors, on the probability of exporting. Entry costs discourage exporting, a finding that is also reported by M. ROBERTS and J. TYBOUT (1997) for Colombia. Favourable exchange rate shocks and plants characteristics indicative of past successes are found to significantly increase the probability of exporting. Export promotion by the states is found to have positive but statistically insignificant effects on exporting probabilities. However, the authors indicate that the evidence is subject to the caveat that the study focuses on the sample of large firms but state export promotion which mounted to USD 96 million in 1992 often targets small and medium enterprises.

II - Application of PCT
1. Chinas case Before we start to analyse the possibility of PCT application on Ukrainian case, we find it very useful to make some research about other economically developing countries who have already achieved some significant success in technological gap cut. Which lessons we can learn from China? What might be useful as patterns for Ukraine in its aspiration for worlds market? The research of Z. THAN (2001) is analysing application of PCT on Chinese case, in particular for Telecom Manufacturing Industry as a case. China has recently emerged as a significant player in the global telecommunication industry, in late 1980s. The wireless phone network in Chine has experienced an even higher growth rate than telephone lines. Chinas mobile telephone users reached 120,6 million persons in 2001, which made Chine the largest mobile communication market in the world, surpassing the 120,1 million users in the US. A late starter on Internet, China is trying to catch

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up, with 200-300% annual growth rate. Its enormous market size has attracted almost all the significant manufactures in the world to engage in various trade and production activities (AT&T, Motorola, CISCO, Nortel, Ericsson, Nokia, Alcatel, Siemens, NEC, Fujitsu, Samsung etc.). Direct imports from post-industrial countries continue to support most of China high-end market. Local subsidiaries and joint ventures of multinational telecom manufactures have grown to supply a large percentage of the medium-end of Chinese market. Government policy of China. China has recognized that involving MNCs is a part of the solution to national economic and social development (UNITCAD, 1999). But China apparently also realized that Development of the host countries is a fortuitous side effect at best, which will only come about if the host government maintains enough autonomy and control to guarantee that the benefits of foreign direct investments are shared between providers and recipients of foreign capital (STALLINGS, 1990). Regulations and policy have been actively formulated to promote the production localization of MNCs subsidiaries and joint ventures and to nurture indigenous manufacturers in Chinas telecom industry. Chinese government issues and updated regularly Government Guidelines for Foreign Investment in Telecommunications, dividing foreign entries into three categories: encouraged, restricted, and prohibited. Central office Switches is a good example of PCT application on Chinas case. Traditional Central Office Switch market is an instance where competition among many MNCs is fierce, technology is mature, demand is strong (more than 10 million lines annually) and Chinas government industrial policy can be effectively implemented. The technology of traditional central office switches is based on the principle of stored programming control, which originated in the 1960s and became mature in the late 1980s and 1990s. These switches have been deployed on a large-scale in Western countries since 1970s. Scale of economy limits the production of central office switches to a few large corporations. In China, switches were mostly purchased by single monopoly buyer, then China Telecom. A single monopoly buyer leads to a better organized decision-making process, which makes it more effective for China to implement its industrial policy through procurement and joint venture negotiation. These market features have determined an evolution with four distinct stages for central office switches in China (see table 3). This development is very close to a typical PC except for the last step. Theoretically, China should start to export these lower cost switches back to Western countries since the production is localized to a large extent. However, technologically advances have eliminated the export opportunities because Western markets have moved to more advanced next

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generation switches including ATM and IP capable switches. These Chinese-made traditional switches have only been exported to some less-developed countries in Asia, Latin America, and East Europe. Table 3. Market share of Central Office Switches among Three Groups. 1982 Direct import Joint Venture Indigenous Suppliers 100% 0% 0% 1987 89% 11% 0% 1992 54% 36% 10% 1997 5% 63% 32% 2000 0% 57% 43%

Source: The former MPT&MEI, the MII, suppliers annual reports. Later then, China started direct import of ATM and IP capable switches from advanced countries, and then started its own local production. In 2004 year, Chines export of office and telecom equipment reached 171782 million USD, which is 29% of whole Chinese export and leaves behind Singapore (86222 million USD), ten new members of EU all together (100552 million USD) and even US (121295 million USD). If demands keeps up, the market of ATM and IP capable switches is likely to see repeat of the four steps seen for traditional central office switches.

2. Central and East European countries as a new global production location. Very quickly after fall of the Berlin Wall Central and East European countries (CEE) has become an emerging global market location. In a matter of few years we observed jeopardizing consumer catch up in terms of consumption patterns and standards. As we always stress in our works, market integration is necessary but not only condition for benefiting from global integration. At the first few years of transformation in CEE, industry integration has been neglected aspect of CEE integration into worlds and EU economy. Empirical data allows us to assume, that for international companies of Eastern Europe and Commonwealth of Independent States (CIS) which are at their stage of forming national MNCs, its possible to define main stages of its development with the Product Cycle Theory. In general, the PCT also helps to explain the strategy of western MNCs in countries with developing or transitional economy. Basing on the PCT it is obviously an attractive factor for FDI to have a low remuneration of labor in the countries-recipients of investments. However, as numerous historical researches of internationalization of production show, the one of the problems of

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using a cheap labor by international companies is inevitability of constantly growing level of salaries. L. KLIMOVICH (1999) sees two reasons why it may happen: 1) self-appraisal of East-European workers which is slightly raised too high because of their traditionally high social guarantees ; 2) inflation expectations. Dominating factor in resource's sector is a search for cheapest resources. The benchmark of this search is investments in other countries, which will help to form trade flows. To get access to the resources in foreign country, the company invests there (FDI) and starts to export this resources from this particular country, which is acceptor of FDI. Hence, the bench-mark of this process is FDI and international trade flows are its derivative. Service's sector. Mechanism of PCT in services sector is a bit different. In this sector, it is necessary to establish companys subsidiaries in all the beginning. They will demonstrate the services offered by the company to the clients. The necessity of such presence at the foreign markets caused some fundamental shifts in the structure of FDI in favour of service sector. But there are some serious shifts going on in the service sectors itself too due to telecommunications sectors development. The speed of informations transmission has increased remarkably during last years. As a result of this process, the demand for FDI in this sector decreases. At the same time, new opportunities for international business in service industry arrive such as information processing, accounting etc. In other words, we are talking about the activities which were accomplished by each company themselves; and now are accomplishing by special companies working on transnational base. In this way company minimize its stuff of accountants and other high-paid specialists, so it minimize the salarys payments. We find not so many examples of such shifting at the Eastern European countries nowadays. It is probably because there is no necessary level of development of technical base and specially trained personnel. But we should not exclude the possibility of creation the international companies subsidiaries using the local specialists in the nearest future. CEEC's electronic industry as a case. Socialist economies of CEE were uncompetitive in computer production, relying on foreign technology for design and components. Obviously, their contribution to technology development in electronics was relatively strong only until the mid-1970s, and dependence later then on foreign technology meant that, in fact, in the early 1990s, CEECs were still using 1970s electronic technology. It was determined also by

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poor supply of components and COMECON restrictions. Production was undertaken by several large electronics companies, which by mid-1990s all but one (Hungarian Videoton) have been either broken up or slowly deteriorating. The only domestically controlled successful part of electronics during the 1990s was local PC assembly, especially in Poland. After the mid-1990s, some of CEECs, like Hungary, the Czech Republic and Poland, gradually became accepted into the supply base of large electronic companies. The dynamic of electronics export shown in the table 4. Average annual rate,% 3329 4737 6093 7802 7729 42.3 Hungary 932 989 1176 1633 1572 2224 3340 22.5 Czech 612 849 1142 1140 1290 1607 17.5 Poland 784 965 746 929 947 1138 6.4 Russia 31 58 176 510 497 54.9 Romania 36 246 309 363 382 433 17.9 Slovakia 161 284 276 228 330 350 2.7 Slovenia 298 77 85 94 220 251 28.0 Ukraine 57 123 160 164 124 152 204 8.8 Croatia 3992 7117 9150 10719 13857 155549 25.4 Total Source: Reed Electronics Research, The Yearbook of World Electronic Data. 2001/2, 1999/2000 and 2003/4, volume 4, East Europe and World Summary. In 2003, total electronics production reached 30 milliards USD, which is little above the production of Mexico (28,5 milliards USD), the bulk of this growth was achieved in the 1997-2000 period. However, this level is still low compared to East Asian economies and China. For example, Taiwanese electronics production is 5 times larger that Hungarian. In summary, among emerging markets CEE electronics has become an important second tier global location i. e. after East Asia with leader producer Hungary, which electronic production raised from 1,7 milliards USD (1996) to 8,5 milliards USD (2003) leaving behind Spain with 6,5 milliards USD (2003). Table 4. Electronics export of the CEECs, millions current USD 1996 1997 1998 1999 2000 2001

III. Ukrainian case

1. Economy of Ukraine after collapse of USSR Ukraine is an Easter European country with a considerable economic potential. Ukraine produces 5% worlds mineral raw materials and products of its processing. Explored sources of fossils in Ukraine cost approximately 7 trillions USD. Share of Ukraine in worlds production of manganese ore is 32%, production of cast iron 52 million tons, in production

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of steel 54 million tons (Ukraine remains on of the largest steel and iron producers in the world, see appendix 1), production of rolled metal 41,5 million tons. Ukraine holds fifth place in the world by these indexes. Detailed analysis of economics potential of Ukraine is done in our previous work (G. DUTHIL, O. GUROVA, 2005). Here we would mention only some most important points in aim for possible application of PCT on Ukrainian case. We should stress that at the moment of USSRs collapse Ukraine was considered by specialists of Deutsche Bank as one of the most developed its republics with the best integration indexes (see appendix 2). In general there were three groups of the country specified in this work: 1) High level of economic development (Ukraine, Baltic countries, Russia, Georgia) 2) Medium level of economic development (Byelorussia, Kazakhstan, Moldova, Armenia, Azerbaijan) 3) Low level of economic development (Uzbekistan, Turkmenistan, Kyrgyz, Tadjikistan). Ukraine also is a country which has legged in the transition stakes (see EBRD, 1997; World Bank, 1996). From the moment of its independence Ukraine started to host foreign investments. By some optimistic expectations, from the moment of USSRs collapse, Ukraine had good chances to receive foreign investments, due to some positive factors: its large market with (at that moment) 51-million population; high level of education of local working population; low level of salaries; presence of raw materials sources; presence of scientific and technical creations of worlds level; high qualification of workers; relatively developed infrastructure; good geographical position. However, these estimations didnt come true, and investment activity seriously slowed down during 1990-1996 years (investment decreased for 78.5% and the share of investments in GDP decreased from 22.7% to 13%). Then, during 2000-2004 years the situation with FDI improved (see Appendix 2). For last year investments (gross fixed) remained at the level of 20.9% of GDP, which is half less than the same index in China in the same period of time, although a bit higher than in Macedonia (with 18,3%) and even Poland (18.2%).

2. International trade evolution

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Since its independence and fall of certain export restrictions, Ukraine achieved certain progress in its international trade. The Balance of Ukrainian international trade is shown in the table 4. Table 4. Balance of Ukrainian International Trade during, 1996-2006 (million US dollars)
Years 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006* External turnover 37516,6 32563,7 32295 37638 41570 44845 56618 73590 85336 95080
*- forecast by CASE Ukraine, [12] Source: NBU, CASE Ukrainian Estimations.

trade Export 18970,3 16457,2 17058 19522 21068 23351 28953 39415 38220 51748

Import -18546,3 -16106, 5 -15237 -18116 -20502 -21494 -27665 -34175 -37180 -43332

Balance 424 350,7 1821 1406 566 1857 1288 5240 1040 8416

It should be mentioned that in spite of very optimistic forecast of some economists (CASE, 2004), influenced my Orange Revolution Inspiration, the exports level didnt achieve expected 45979 million USD in 2005 year, while import was a bit lower than expected 39357 million USD. It still left trade balance positive, but it is one of the worst balance data since 1998 for Ukraine. Instead of programmed 6622 million USD, Ukraine has achieved the balance of 1040 million USD. While the trade balance of Ukraine recently remained positive, its structure has had some negative changes. The main index of export for Ukraine was always iron and steel and its share in total volume of export constantly growing. Ukraine remains always among few leading exporters of iron and steel and its share in worlds iron and steel export was 4.2% which is 6th place among worlds leaders iron and steel exporters. Table 5 Detailed trade balance of Ukraine by industries, 2000-2005.
INDEX VALUE, MILLION USD SHARE IN ECONOMYS TOTAL MERCHANDISE EXPORT OR IMPORT, % IF NOT MENTIONED

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2000 Imports of agricultural products Import of fuels and mining products Exports of manufactures Imports of manufactures Exports of automotive products Imports of automotive products Textile exports Textile imports Clothing exports Clothing imports 9,77 5.74 145 446 127 450 417 60 1092 5997

2001 n\a 6439 10,44 7,01 167 617 n\a 493 498 82

2002 1308 6652 11,86 8,21 154 921 158 516 503 94

2003 2467 7856 15.23 11.61 126 1730 205 643 568 128

2004 2235 10160 22.68 15.19 214 2144 225 741 671 124

2000 7.8 43.0 67.1 52.4 0.1 3.2 0.9 3.2 2.9 0.4

OTHERWISE 2004 or nearest year 7.7 395.0 69.4 15.19 0,7 7,4 0.7 2.6 2,1 0,4

WTO. Statistics: International trade statistic 2005, trade by sector.

At the moment, there are some important structural tendencies of Ukrainian exportimport worth mentioning: export of row materials predominant (about 70%), mainly consisting of ferrous metallurgys products 32%, chemical production 12%, food industry 10%, machine-building 10%. Import, oriented on vitally important production petroleum, gas (52%), products of machine-building (13%), close burning coal, medical supplies, food products; Extreme irregular allocation of export potential of Ukraine, which means that 4 regions from 25 supply more than 50% of whole export (Dnepropetrovsk, Donetsk, Lougansk, Odessa regions); High orientation of Ukrainian trade on republics of ex-USSR (up to 70% of external trade turnover in some sectors) predominated during few first years of independence; Domination of raw material intensive equipment in export of products of machine-building. One of the most significant changes in Ukrainian international trade is change of its main trade partners or regional structure of trade.

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If we look through statistics of few first years of independence, for example 1995year (see appendix 2), we would notice that 59% of Ukrainian external trade was realized with CIS countries and only 24% with European countries, which is logical. Ten years later, the most important export partners for Ukraine are Russia 19.3%, Turkey 7%, Italy 6.1% (2005) and the most important importers are Russia 33.9%, Germany 11.3%, Poland 6.7%, China 6.5%, and Turkmenistan 5.5% (2005).

3. PCT and chances for Ukraine. Classification of economical sectors Considering internationalization of Ukrainian companies, it is probably possible (there are no exact application of the model done yet), to apply the classic Vernons model. In this case we can only hypothesize a second stage of the model initiation of exporting of selected goods. In his later works, R. VERNON (1972) moves forward with his theory and makes very important remarks about disposition of a country to develop a new product, which means to become a leader in some fields. He says that in order for substantial industrial innovation to take place in the country, a body of trained engineers and interested businessmen must exist. But this is not enough. The new products that engineers and businessmen are likely to develop are those which seem most wanted in the country, that is, those which seem to have the most ready local market. But there are no two countries in which local market conditions are quite alike. In industrial field, to be sure, all countries welcome new products or processes that will cut costs, Vernon underline (1972). But in the country where skilled labor is exceedingly scarce and dear while capital is abundant and cheap, the innovations that will cut costs tend to be labor saving and capital-using. And the countries where raw materials are scarce and dear while labor is abundant and cheap, the innovations that will capture the imagination of businessmen and engineers tend to be material-saving and labor saving. Some authors (L. KLIMOVICH and others) suppose, taking into consideration positive examples of China, Poland, Czech Republic, Hungary (as analyzed above), that it is possible for the ex-USSR countries to gain a part of European market. Of course, for the moments it is only assumption. For example, Byelorussian metallurgical plant (BMP), after applying certain innovations, started to produce high tech metal production and became a monopolist on

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internal market and at the Russian market. Geographical expansion of the sales allowed this company to occupy 14 % of world market of metal cord. Its also contributed to effective export policy of the enterprise. There are some joint ventures founded with partners of this company. They are located in Western Europe. At the moment there is creation of joint venture with US partners going on. Unfortunately, there are always some obstacles for exports growth in Byelorussia remaining which is beyond the scope of this paper to discuss. According classification of Pavitt (1984) there are two main sectors of economy exist: Traditional sectors: in developing countries and countries with transitional economy this sector hosts up to 44% of FDI in particular in Poland and Ukraine. As an example it is food production, mineral sources, raw material sectors in Ukraine which attract FDI at the moment. Innovation sectors: are not always popular among foreign investors. In whole Central and Eastern Europe it is Hungary, Czech Republic and Poland who host 82% of all FDI in innovation sectors. As competitive high-technological (or innovative) sectors of Ukrainian economy we have mentioned the aerospace technologies, and aircrafts production. Here might be the key to the question of possible leading at the international markets for Ukraine. Lets see the situation in details in those branches of the economy. As for aerospace technologies, according to E. KUZNETCOV (2005), vice-president of National Aerospace Agency of Ukraine, Ukraine just finished to prepare the project of agreement with EU considering the programme of global civil satellite system EGNOS Galileo: We just worked out the project of agreement between Ukraine and EU considering integration of Ukraine into Galileo system. Ukraine will give its on-earth stations of observation, which will treat telemetric data of European satellites. The Global European system of navigation will be expanding in 2007-2008 years. Its planned to send to the orbit up to 30 spacecrafts for telecommunication and Earths sounding. The total cost of the project is over 3 milliards euros. Thanks to Galileo System, the owners of vehicles may always have the exact information about its location E. KUZNETCOV also stressed: We would like also to participate in development, production and launching of space technical equipment for Galileo system, but we faced some refuse because European countries are interested in promoting their equipment and services, they see Ukraine as serious competitor in this sphere. The main competitor for Ukraine in this sphere is France, but French carrier rocket Arian has fewer contracts for space transporting services than Ukrainian carrier rockets Cyclone and Zenith.

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Agreement between Ukraine and EU should lead to their collaboration in civil satellite navigation. Besides this, the agreement should become a base for following projects and programmes considering participating of Ukraine in management of Galileo project and help to approaching between Ukraine and European space agency (ESA). Galileo is the first common programme of EU and ESA. This new navigation satellite system is supposed to provide by 2008 year the same level of service as American system Global Position System (GPS). Its preview to product and launch to the orbit 38 satellites. Its supposed that participation in EGNOS Galileo would provide high-effectiveness of international transporting corridors going through Ukraine, and will access to highfrequency navigation information of very vary application, including national economy, science, national security system etc. Another product, giving an economic perspective to Ukraine is its aircrafts creation and construction. Well-known Ukrainian transporting aircraft AN-225 Mria keeps the record on shipping of large dimension cargo and even mentioned in Guinness Record book (information by press-service of named after Antonov with the reference to International Aerospace Federation - FAI). Furthermore, Antonovs company has another six international records achieved at 16, 18, and 19 of June, 2004 by the plane AN-225 Mrija after establishing of commercial flights Prague-Tashkent (transportation of big-volume goods). There are also some speed records in two classes of turbo-reactive planes C1 and C1t (with the takeoff weight more than 300 tons) on the approved by FAI routes Prague-Kiiv, Kiiv-Ulianovsk, Tashkent-Kiiv. The plane AN-225 Mrija achieved the speed of 684,67; 662; 693,2 km per hour. Thus, the plane AN-225 Mrija has 240 international records, as a plane which took off with the maximal weight 640860 kilograms and which has maximum of records, AN-225 Mrija was included in Guiness Records book at November,9 2004. Service's sector in Ukraine is one of developing at the moment. Summing up, there are some sectors of Ukrainian economy which have certain potential to become export-intensive. Unfortunately, hosting of FDI in Ukraine is still pretty chaotic, innovative and service sectors have luck of investment while traditional sectors which are better to protect, remaining the main destination of FDI. What are the obstacles which delay the braking into international market for those potentially successful products for Ukraine? Lets see in the next part of the paper.

21

4. Obstacles for PCT application on Ukrainian case. Perspectives of further industrial upgrading. Considering all said above we can assume, that the country has no chances to transform its economy into post-industrial only with trade liberalisation (complete fail of Washington consensus is studied more detailed in our paper O. GUROVA Globalization and the process of transition in Eastern-European countries. The case of Ukraine). It is impossible, stresses PAKHOMOV Y., and other Ukrainian economists, without developing science intensive technologies. But even considerably developed technologies can not guarantee success on the world market without certification and respect of common worlds standards. In process of developing this paper we arrived to conclusion, however, that there are some important determinants for becoming a trade leader at the world market for Ukrainian strong sectors of economics: 1) Developing of technological clusters 2) realization of common certification for perspective range of products 3) well-balanced governmental policy towards developing exports, hosting FDI, developing high tech production (example of China is very useful). Both, M. PORTER (1990) and S. SOKOLENKO (2003) consider that when we talk about competitiveness of the country, we should talk about competitiveness of its clusters, not simply particular firms and companies. The main idea of the cluster theory here is the ability of the cluster to use whole the range of its internal sources on its maximum. M. PORTER, within his theory of clusters, developed the system of determinants of counties competitiveness, which is called Diamond Model. According to M. PORTERs theory (1990), cluster is a group of geographically close, interconnected companies (producers, suppliers etc.) and other establishments connected to them (universities, authorities, infrastructures firms), acting in the same field and supplementing each others. It means that traditional country advantages (land, location, natural resources, labor, local population size) which are hardly influenced, should not determine completely national economys opportunity, so, to influence countrys economys development, there clusters strategy proposed. M. PORTER says clusters can influence competition in three ways: - they can increase the productivity of the companies in the cluster; - they can drive innovation in the field; - they can stimulate new business in the field.

22

Well-known

examples

of

clusters

are

USA/Silicon

Valley

(computers),

Netherlands/Rotterdam (logistics), India/Bangalore (software outsourcing), USA/Hollywood (movies), France/Paris (fashion). St. SOKOLENKO (2003) proposes to use the example of France in clusters strategy. In France, there are few important clusters exist at the moment: 1) healthcare cluster(Lyon, Rhone-Alps) 2) Aerospace technologies cluster (Bordeaux, Toulouse) 3) Transportation and navigation integrated system (le de France) 4) Telecommunications systems security (Province, Alps, Cote dAzr) 5) Nanotechnologies and microelectronics systems (near Grenoble) 6) Biotechnologies cluster (Midi Tech Sant) Ukrainian scientists already have some potential for leadership in fields as following: aerospace technologies; science of materials; electrometallurgy; electric welding; mechanics of interaction of solids with ionized medium and E-field radiation; mechanics of composition and heterogeneous medium; methods of nano-processes control; radio-physics; functions theory; cryobiology and cryological medicine; neurophysiology; marine radio- and hemoecology. From our point of view, there some of mentioned field of science may become the basis for future economic clusters in Ukraine. Detailed examination of M. PORTERs theory and its application on Ukrainian case is beyond the scope of this paper, but the aim of our next paper. Second obstacle mentioned is certification issue. During Soviet time, Ukrainian industry as well as industry of other 14 Soviet republics, worked under internal common standards and certification system. That enabled USSR economy to have commonly respected, high quality certification within the country and COMECON, but disabled to export majority of them as well as services. This lead CEE and CIS countries to another significant gap between them and their potential trade partners. Even thought some of Ukrainian goods have higher quality than Chinese, for example, we can not offer them, at European market, because of luck of ISO certificates and different standards. Obviously, there are only one way to resolve this problem to let Ukrainian goods get ISO certificates and to enable Ukrainian producers to be equal players at the world market. This is also one of the major obstacles for the trade liberalization idea: without worlds common certification,

23

Ukraine became just a good market for international companies, exporter of raw materials, but not an equal trader.

Conclusion:
It is obvious that PCT developed originally only USA and other developed countries might be applied for others, even developing economies (China as recent evidence). It is too early to correlate Ukrainian trade and PCT. Ukraine economy has range of fields where leading might be possible forced by its scientific potential and/or its relatively cheap and abundant sources. There are some valuable experience that Ukraine can learn from its CEE neighbours, especially Poland and Hungary (in electronics production sector), and China with its governmental control of FDI and production development. However, there some serious obstacles as luck of certification, lack of support on governmental level in such important issues as creation of common programme of export development and FDI hosting, battling corruption (as an important obstacle to FDI hosting) etc. In our opinion, Porters Diamond Model and clusters creation might be a solution for some perspective sectors of Ukrainian economy. There are some examples of clusters creation in Ukraine which development and efficiency are worth to observe before making conclusion.

24

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Appendixes
Appendix 1 Rating of worlds largest steels producers (by beginning of 2004) Place in the rating 1 2 3 4 5 6 7 8 9 10 13 28 Name of the company Production (million tons)

Arcelor 42,8 LNM Group 35,3 Nippon Steel 31,3 JFE 30,2 Posco 28,9 Shanghai Baosteel 19,9 Corus Group 19,1 US Steel 17,9 ThyssenKrupp 16,1 Nuccor 15,8 ISG 10,3 Kryvorozhstal 7,1 ( ) (became a part of Mital Group in 2006) 31 C names after Illich 6,5 ( ) 40 Azovstal () 5,3 55 Zaporozhstal 4,4 () 67 Alchevsk metal combinat 3,5 ( ) 73 DMP named after 3,2 Petrovsky ( .) Data by International Institute of cast iron and steel, compiled by author. Appendix 2. Direct Foreign Investments into Ukrainian economy 1999-2005yy.

Year $ mln 1999 2001 2002 2003 2004 1074.82 1319,9 1559,5

Addition (growth) Times or %

Per habitant, $ 50 80

Total, milliards $ 3.1 3,923 5,339 6,6576 8.3539

8,4% 16-17% 23%

111 140 177

Data by The State Statistics committee of Ukraine

29

Appendix 3. Deutsche Banks Estimation of basic indexes of production, infrastructural and export potential of ex-USSR republics
Indexes
Countries

High level of development

Ukr aine Baltic Countries

economic Medium level development

Georgia Byelorussia Kazakhstan Moldova

of

economic Low level development

Armeny Azerbaijan Uzbekistan Turkmenistan

of

economic
Tajikistan

Russia

Kyrgyz

Level of industrialization Ability to get the currency from export Agricultural production Ability to earn the currency from export of agriculture products Level of supply by manufactured goods Mineral sources Export potential of raw materials Psychological efficiency for private business activity Geographical closeness to Europe Level of education Homogeneity of population Infrastructure Total summary

9 6 10 6

10 5 8 3

8 6 6 3

6 3 7 6

8 4 5 3

5 4 5 4

2 2 9 7

3 1 3 1

3 2 3 2

3 2 3 3

2 1 3 3

2 1 2 3

2 1 1 1

7 8 8 3

6 0 0 10

8 10 10 2

3 4 4 9

5 1 0 3

3 9 9 1

2 0 0 5

1 4 4 8

2 7 8 2

1 6 6 2

1 5 5 1

1 4 4 1

1 3 3 1

6 6 6 8 83

10 9 6 10 77

4 5 5 5 72

6 5 2 6 61

7 7 6 6 55

5 3 2 5 55

7 5 2 8 49

6 4 6 6 47

4 4 6 5 47

1 2 1 2 32

1 2 1 2 27

1 2 1 1 24

1 2 1 1 18

Legend: 10- good potential; 5 medium potential; 0 potential doesnt exist.

Appendix 4. Regional structure of Ukrainian external trade in 1995 (mln $)

Regional markets CIS Europe : U FA Asia: SEAN NIC America : NAFTA Africa ustralia Total Goods turnover 13 942,3 5 602,3 3 028,8 1 053,0 2 146,6 378,8 210,5 1 365,8 877,9 243,6 45,6 22 946,1 Share, % 59,0 24,4 13,2 4,6 9,3 1,7 0,9 6,0 3,8 1,1 0,2 100,0 Export 6 207,9 2 644,4 1 283,4 506,2 1 760,1 329,9 178,5 742,2 557,9 186,4 25,8 11 566,8 Import 7 334,4 2 957,8 1 745,4 546,8 386,5 48,9 32,0 623,0 320,0 57,2 19,8 11 379,4 Balance -1 126,5 - 313,4 -462,0 -40,6 1 373,6 281,0 146,5 118,6 237,9 129,2 6,0 187,4

Source: WTO Statistics.