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Iryna Kosse, Garry Poluschkin

A strong IT sector supports Ukraine’s economic resilience

Russia’s full-scale war has been causing massive economic suffering. Ukraine’s overall economy fell by 29.1% yoy in 2022. However, the IT sector, which doubled its share of the economy between 2016 and 2022, did not follow this trend. The decline of regular employment was fully covered by additional individual entrepreneurs, leading to more flexibility in the sector. Thus, total employment remained stable. As subcontracting individual entrepreneurs is subject to tax preferences compared to regular employment, the IT sector contributed a lower level of taxes in 2022 than its economic activities would suggest.

  • Ukraine
NL 181 | November 2023
Private Sector Development

This aspect is critical as Ukraine has been facing a large budget deficit. On the other hand, this subsidy supports the sector in its development, its export capacity and as a backbone for eco-nomic resilience. Exports remained strong, contributing 7% to total exports and IT companies play a decisive role in Ukraine’s digital resilience as well as in establishing rebuilding platforms. This role highlights the importance of the sector.

Ukraine’s IT sector

In the forthcoming IT sector monitor, the German Economic Team and Institute for Economic Research and Policy Consulting define the IT sector by including IT services, IT retail and repair as well as IT manufacturing and by excluding communication. This definition allows to have a focus on IT companies and separate it from the broader ICT sector.

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The IT sector doubled its share of GVA to 3.7% between 2016 and 2022, driven by IT services as the main component.

Employment flexibility

Employment data show a slight increase in absolute numbers despite the war. As the economy’s total employment fell strongly, the sector’s share further increased to 4.5%.

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The increase in employment is driven by 12,000 additional individual entrepreneurs while the number of regular employees fell by 10,000 in 2022. This development shows a clear tendency towards flexibility. This shift usually takes place during periods of economic down-turn. However, in Ukraine, this trend dates back even before the beginning of the full scale war. The share of individual entrepreneurs in total employment increased continuously from 71% to 79% between 2018 and 2022.

Is the sector undertaxed?

This flexibility comes with an economic price. Subcontracting individual entrepreneurs saves tax and social contributions compared to regular employment. As a result, the IT sector contributed just 3.0% of all direct taxes and 1.6% of domestic VAT to total tax revenues in 2022. At the same time, its GVA share would suggest 3.7%. This made a difference of ca. UAH 9 bn (ca. USD 0.28 m) of missing tax revenues in 2022.

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On the one hand, undertaxation is critical as Ukraine facing unprecedented fiscal deficits. Tax revenues accounted for less than half of total expenditures in 2022 and after 9M2023.

Exports twice as large as imports

On the other hand, this policy subsidises a sector with a strong export focus. The sector generated USD 3.8 bn of export revenues in 2022. This is more than twice the size of import revenues, leading to a trade surplus of USD 2.1 bn in 2022. The export share has increased from 5% to 7% as total exports strongly fell during the war due to blocked seaports. When only considering services, the IT service exports accounted for 39% (!) of total service exports in 2022.

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The strong focus on services provides an important tool to generate export revenues when transport routes for goods exports are disrupted.

Value chain maturing of IT companies

Employment by different company categories reveals the sector’s advance in supply chains. Employment in companies that develop and sell their own products grew by 3 p.p. compared to the pre-war level and accounted for 40% of total employment, while the employment share of outsourcing and outstaffing companies fell. This structural change can be associated with disruptions of value chains and war-related uncertainty.
Furthermore, the increased share of IT product companies is based on the sector’s involvement in Ukraine’s economic resilience. Many IT companies fully develop new products for different ministries of Ukraine in the area of cybersecurity and other areas as part of the public technology cluster “BRAVE1”. Similarly, IT companies are decisive in recording war damages and establishing transparent reconstruction monitoring platforms. War damages are regularly recorded and updated by the Kyiv School of Economics through economic assess-ment. Data definition, collection, and verification tools are, however, developed and conducted by IT companies using AI, computer vision algorithms, geographic information systems and drones.
A further example is the Digital Restoration EcoSystem for Accountable Management (DREAM) for monitoring reconstruction projects. IT companies developed a web platform interlinking different digital public services and monitoring opportunities for the coordination between all stakeholders. Overall, these approaches are key steps towards making the reconstruction process transparent and successful.

Outlook

The development of the IT sector generates not only important employment and export opportunities but is also a key backbone of Ukraine’s economy and reconstruction. Limited tax preferences of the sector can be seen as reasonable in this context. Ukraine’s war-disrupted economy needs a strong IT sector to further improve resilience and establish the reconstruction track on a transparent path.

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This newsletter is based on the forthcoming IT sector monitor by the Institute for Economic Research and Policy Consulting and the German Economic Team.

Picture: ©AdobeStock #626775308 von pramool