Why FTA with Israel is not benefitial for Ukraine?

Author : Oleksiy Kushch

Source : 112 Ukraine

Ukraine has almost completed the process of creating a free trade zone with Israel. On July 11, our parliament ratified the relevant agreement, previously signed by the government in January of this year. 230 MPs voted for it
22:47, 17 July 2019

112 International

Ukraine has almost completed the process of creating a free trade zone with Israel. On July 11, our parliament ratified the relevant agreement, previously signed by the government in January of this year. 230 MPs voted for it. Among the basic conditions: Israel abolishes import duties on 80% of Ukrainian goods in the industrial segment and only 9% in the agrarian segment. Ukraine operates somewhat asymmetrically: the abolition of 70% of import duties on Israeli industrial products and 6% of duties on agricultural ones. After the agreement is ratified by the Israeli Parliament - Knesset, it comes into force within 60 days from that date.

This event has remained virtually unnoticed. The previous government was concerned with the creation of a whole belt of meaningless FTA agreements around Ukraine. We are not talking about an agreement with the EU, first of all, we are referring to such “projects” as a free trade zone with Albania, joining the European Free Trade Association (EFTA), where only Iceland, Norway, Switzerland and Liechtenstein remained. No less epic was the adherence to the Pan-Euro-Med agreement. I’ll keep silent about the FTA with Canada because the main motivator of this conclusion is an opportunity for some top officials to visit their daughters and granddaughters who love Ukraine from comfortable townhouses in Toronto using a "free" budget account. The fact that after the conclusion of the FTA with Canada our trade deficit in mutual trade increased, it does not matter. Commodity volumes are still miserable, and there was no point in the agreement either before or after its conclusion.

The FTA with Israel in this series of “epic fails” was a good exception to the general rule. Any trade agreements with more developed countries should be considered through their national interest. As a rule, they are always interested in opening commodity and financial markets but never go to the opening of the labor market. Everything is natural here: their products are more competitive, their companies can benefit from the scale in the form of cost savings, their currencies are stronger, and financial markets are much more capitalized. That is, these countries will obviously win, even setting a disproportion in the level of the abolition of customs duties. The 10-20% handicap, which they give to countries such as Ukraine, canceling, for example, 80% of the duties and agreeing to a 70% cancellation, is easily recouped by them in the very first years of the free trade zone. Developing countries have an advantage in the form of cheaper labor, but there are no general rules, only temporary employment, which even in such a limited format depletes the labor market of less developed neighbors.

At one time, US President Donald Trump gave a universal recipe for increasing foreign economic efficiency for any country: to conclude agreements on the creation of an FTA with those countries with which there was a surplus in foreign trade and to break agreements with those countries where trade is scarce. Or, as a last resort, revise them.

How correctly a country builds a system of its free trade zones best describes its international subjectivity. As a rule, countries with a reduced sovereignty factor “fall” into the traps of unfavorable trade and economic zones for them, where they are squeezed out like a raw material “sponge”. But economies that value their subjectivity impose international trade conditions on weaker partners.

In the case of Israel, Ukraine had a unique chance to find a completely different format of cooperation. For this, it was necessary to apply the most basic strategic planning tools, for example, a standard SWOT analysis, identifying the strengths/weaknesses of the FTA agreement, its risks for us and potential opportunities.

Israel’s greatest strength lies in its global affiliates with the largest world economies and in the presence of a highly developed innovation component. And for us, taking into account the historical reminiscences, there are unique opportunities to use the close relations with Israel for the development of our economy and the system reset. Israel’s economic success lies on several columns: successful integration into global value chains, one of the highest rates of foreign direct investment, a significant share of domestic spending on medicine, education and science, resulting in the emergence of "living" innovations, rather than "greenhouse" ones in the form of state innovation centers.

The strong point of cooperation with such a country is the opportunity to join the chains of innovation formed there. The weak point is a small proportion of our trade.

Among the risks are the threat to get into the paradigm of the raw "younger brother" and the exporter of labor. Among the possibilities is the use of special trade relations with Israel as the development of the innovative potential of the Ukrainian economy.

Therefore, entering into any economic agreement with Israel, it is necessary to find hidden points of growth, minimize our raw material backwardness and maximize any opportunities to increase the added value and innovative potential of the domestic product.

The agreement that Ukraine concludes with Israel only partly meets the specified requirements.

At the end of 2018, Ukraine’s exports to Israel amounted to $ 580 million (95.9% of the previous year’s level, that is, a decrease), and imports – to $ 212.6 million (an increase of 26.7%). The positive balance for us reached $ 367.4 million. But this trade turnover is extremely small in the overall structure: 1.23% of our total exports and 0.37% of the total imports of Ukraine. That is, even if the conclusion of the FTA will bring a doubling of trade indicators, it will still be hundreds of millions and no more than 2% of the total international turnover of our economy. This is the weak side of SWOT analysis.

In the top 4 best positions of our exports are agricultural products and processing ($ 336 million), metals (199 million), wood (17 million), that is, pure raw materials. Equipment supplies are only 12 million.

In the top of Israeli imports are chemical products (79 million), plastics (15 million), equipment (24 million), that is, goods with a high level of added value. Plus $ 31 million - goods in the ports, as evidence that for Israel it is very profitable to use the port free trade zones. Agricultural products and fuel are only $ 11 and $ 21 million, respectively.

Given the above structure, the risk of becoming a raw materials appendage for our country is large enough.

But what about the capabilities and strengths according to the SWOT analysis?

Ukraine exports services to Israel at $ 197 million, and they grow by 1.7% per year, while the supply of goods is declining. In total, the export of services to Israel is 1.7%. Imports of services from that country in 2018 made 43 million (0.8% of the total), that is, a surplus in our favor ($ 154 million).

The most profitable for our surplus is the direction of export of IT services: + 91 million and an increase of 7.2% per year. This is our strength and the most realistic opportunity to form a new point of growth in mutual economic relations. That's just for this you need a slightly different package of economic agreements.

In accordance with the agreements between Ukraine and Israel, it is planned to practically recreate the trade and economic model, which is already in operation between our country and the EU. This is a standard trade stencil, which, unfortunately, does not fully take into account innovative opportunities for further cooperation. What is it? As a rule, a country that is more economically developed opens its market more deeply than its underdeveloped partner. Currently, Israel’s GDP per capita amounts to $ 35–37 thousand per year, while in Ukraine this indicator fluctuates at a level of just over $ 3 thousand, that is, the economic potentials of the two countries can be estimated at 10: 1. It is assumed that Israel will open its market by 80%, and Ukraine - by 70%. It would seem that the advantage is on our side, but a handicap of 10% does not compensate for our economic lag.

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But if you look a few years ahead, Ukraine needs to get access not so much to the goods market as to the services and investments market of Israel, and first of all in terms of the development of the start-up system. To get into the Israeli ecosystem of innovations is like a lucky lottery ticket, because, according to Startup Genome, this country ranks second in the world in innovative development after Silicon Valley in the United States.

Thus, with a country like Israel, it is completely meaningless to conclude a standard agreement on an FTA, more precisely, it will not have any significant effect. Israel needs to propose a fundamentally different agreement on the creation of a special zone of economic cooperation in the services sector, investment, and innovation, completely freeing joint innovation projects and start-ups from taxes and any currency restrictions. Ukraine has enormous human capital and today it is also becoming a supplier of “digital raw materials”, the peak of which has already been passed, and in the next five to ten years this direction will face an inevitable decline. At the same time, we practically do not use our innovative potential to attract venture capital investments and create start-ups that are attractive to foreign buyers. In this regard, Israel will be interesting for us as a bridge to Silicon Valley (USA): American companies are the main players in the local start-up market.

In addition, the formation of the port-free zone in the Ukrainian Black Sea ports could create an additional trade bridge with the Mediterranean ports of Israel.

At the moment, there is a risk that the agreement on the creation of an FTA with Israel will be transformed into another “Canada”, that is, the only result for us will be the penetration of better Israeli consumer goods into the Ukrainian domestic market.

How to change this trading paradigm of raw materials appendage? Among the incentive tools worth highlighting фку:

1) Partial compensation of the interest rate on the loan and its body in case of non-return (up to 50% of the debt).

2) Long-term crediting of foreign companies - buyers of local exporters in the line of durable goods, investment goods and engineering services. Credit lines are opened for foreign buyers of local products for a period of 1 to 10 years with a grace period of 30 months.

3) Lending for purchases of imported equipment and technologies for the production of non-traditional export goods for a period of 6 months to 8 years with a grace period of 18 months.

4) Provision of guarantees for loans to micro, small and medium exporting enterprises for the renewal of fixed assets. The guarantee covers from 50 to 80% of the loan body and is issued for a period of 1-10 years at the expense of the funds of a special state fund.

5) Government subsidies, covering 80% of the costs for consulting services and marketing research.

In addition, exporters of non-traditional products receive substantial tax benefits. Thanks to this model, the prerequisites are created for increasing exports with a high level of added value.

Ukraine is still able to actively apply the synthesized model of development of its economic potential, when competent internal protectionism is combined with strengthening non-traditional export directions, mainly in the small and medium business segment, which does not preclude the development of large corporations. And further investments and private initiative will do their work better than any official.

The agreement on the creation of FTA with Israel can be a good step for the transition of our countries to a new format of cooperation. The main thing is not to perceive written on paper as a universal key that will launch the engine of the domestic economy. As the experience of the FTA agreement with the EU shows, not a single international framework document will save us from having to find our niche in the global value chain and work to create a high-quality economic environment within the country.

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