This box uses data on almost a quarter of a million Ukrainian firms across all sectors of the economy to provide a breakdown of their productivity growth over the period 2001-09.24 Total factor productivity (TFP) increased rapidly during that period, rising by a total of 60 per cent.

That period also saw exceptional firm-level dynamics in the form of a considerable reallocation of market shares, as well as massive numbers of firms entering and exiting markets, especially in the service sectors. These dynamics were mostly caused by the liberalisation of trade and services that resulted from Ukraine’s accession to the World Trade Organization (WTO) in 2008. While in the case of goods, trade liberalisation was relatively limited, given that import duties were already low prior to 2008, services were liberalised on a large scale, significantly boosting the productivity of individual firms.25

Accession to the WTO entailed the adoption of more than 20 new laws bringing Ukrainian legislation into line with the WTO’s requirements, including laws concerning TV and broadcasting, information agencies, banks and banking activities, insurance, telecommunications and business services.

For instance, the law on telecommunications that was adopted in November 2003 allowed all legal persons in Ukraine to operate, service or own telecommunications networks. As a result, competition increased significantly, and the country now has four large and four smaller providers of wireless networks, as well as several dozen internet providers.

Likewise, financial services were gradually liberalised, allowing foreign banks to open branches in Ukraine. In addition, the circumstances under which the National Bank of Ukraine may turn down a foreign bank’s application to operate in Ukraine were defined more clearly. Insurance services also underwent considerable liberalisation, and laws on auditing and the legal profession were amended to remove nationality requirements.

The combined impact of these liberalisation measures can be seen in the breakdown of TFP growth shown in Chart 1.2.1. New, more productive entrants to the market made the largest contribution to overall TFP growth (the “entry effect”, which contributed a total of 44 percentage points). This contribution was particularly large in high-tech manufacturing sectors, such as pharmaceuticals and communications equipment.

Firms that increased their productivity also increased their market shares, and contributed 38 percentage points to the overall growth in firms’ productivity. The other components of the breakdown made negative contributions: average productivity growth within individual firms (the “within effect”) decreased, reducing overall TFP growth by 3 percentage points; the market shares of highly productive firms (the “between effect”) contracted, reducing overall TFP growth by 13 percentage points; and firms that exited markets were more productive than the average firm, so this “exit effect” reduced overall TFP growth by 8 percentage points.

The productivity of individual firms did increase in the agriculture and manufacturing sectors, and this component contributed 16 percentage points to the overall TFP growth of manufacturing firms. This largely reflects the provision of better services to manufacturing firms as a result of the liberalisation of services.26 Indeed, some of the strongest overall productivity growth was observed in the service sectors (where TFP grew by a total of 75 per cent). This was largely a result of the entry of new service providers, which contributed 67 percentage points to overall productivity growth. Knowledge-intensive services recorded the strongest growth. Interestingly, the mining, utilities and construction sectors – none of which underwent liberalisation during that period – grew at a very slow pace.

The analysis in this box shows that policy measures which allow new entrants to challenge incumbents can have a swift and significant positive impact on firms’ overall productivity. Box 1.3, on the other hand, will look at how political connections and a lack of competition owing to the abuse of entry regulations can limit productivity growth by keeping firms “stuck” in a low-productivity equilibrium.