Business Opportunities Lost . . . and Found Business Opportunities Lost

Business opportunities lost . . . and found

November 2016 Small and medium sized enterprises from Donbass responding to the conflict

Natalia Mirimanova

www.hd centre.org Credits

HD expresses its appreciation to the governments of Canada, Switzerland and the United Kingdom for their generous support for the conduct of this study.

About the author Natalia Mirimanova is a conflict resolution scholar and practitioner and has over twenty years of experience in Russia, South Caucasus, Central Asia, Moldova, Ukraine, Western Balkans and Eastern Europe advising various leading multilateral institutions and international NGOs. She received her Ph.D. from the Institute for Conflict Analysis and Resolution, George Mason University, USA and has been published widely in English and Russian.

Centre for Humanitarian Dialogue 114, Rue de Lausanne 1202 Geneva | Switzerland t : +41 22 908 11 30 f : +41 22 908 11 40 [email protected] www.hdcentre.org

The Centre for Humanitarian Dialogue (HD) is a private diplomacy organisation founded on the principles of humanity, impartiality and independence. Its mission is to help prevent, mitigate, and resolve armed conflict through dialogue and mediation.

Executive summary ...... 2

Introduction ...... 3

The research process ...... 4 Methodology 4

Results and analysis ...... 5 1. Business size and sector – and the decision to leave or stay 5 2. Markets – and the decision to leave or stay 5 3. Changes in supply chains 7 4. The business dynamic since the beginning of the conflict 9 5. Optimism 13 6. Political preferences and agency 13

Conclusions ...... 15

Endnotes ...... 16 2 Business opportunities lost . . . and found

Executive summary

This study outlines how the armed conflict in the east of explain decisions regarding the relocation and continuity of Ukraine has affected small and medium sized enterprises each business. Politics appear not to have played a major (SMEs) from Donbass. It covers those SMEs which remain role in the behaviour of this business community. The apo- in areas which aren’t controlled by the Ukrainian Government litical nature of these entrepreneurs is an asset in the highly and SMEs which left those areas because of the conflict. polarized conflict environment as it fosters pragmatic deci- The conflict in the east has severed many economic ties, to sions and favours middle ground solutions. the detriment of populations and livelihoods on both sides. However, the specific ways in which businesses have been SMEs from the NGCAs – both those that stayed and those affected and the coping strategies employed by business that left – demonstrate a high degree of resilience and a low owners need to be understood in order to broaden the scope degree of optimism. A sustainable ceasefire and the lifting of of conflict transformation approaches, including the use of some elements of the economic blockade are perceived to economic measures. The study explores the reasons why be by far the most important conditions for the further devel- SMEs chose to either remain in their areas or to leave, the opment of SME enterprises, compared to economic incen- status of their business and supply chains, as well as the state tives. This points to the habit of survival in a situation where of the markets in which they operate. The research assessed there is little or no affirmative action or empowerment of the resilience, business optimism and political agency of the entrepreneurs outside the big industries. Those in Luhansk which have re-orientated themselves towards Russian supply enterprises, particularly as SMEs are often considered an chains feel most hopeful with regard to their business devel- important constituency that naturally favours peace over con- opment, while in Donetsk, receiving supplies from Russia is flict. However, this study revealed that this is not the case in not a strong predictor for optimism about business prospects. the east of Ukraine because SMEs have not formed an organ- ised pro-peace actor by themselves, nor have the political The distance of a business’ current location from the line of leaders in Ukraine or external third parties provided them contact is a good predictor for the prospects of returning to with an enabling framework for engaging in conflict trans- and re-starting that business in its place of origin: entrepre- formation. Nonetheless, SMEs are a critical constituency in neurs currently residing in Mariupol and Donetsk demonstrate eastern Ukraine as they are non-oligarchic, independent, entre- greater willingness to re-engage with their clients, partners preneurial and a key social community which can potentially and suppliers across the current line of contact, as soon as the affect change in society. conditions permit. They are also more interested in retaining economic connections across the line of contact than their counterparts residing in Kharkiv and Luhansk. Politics appear not to have played The temporary rules for the movement of goods, people and a major role in the behaviour of vehicles across the line of contact, issued by the headquarters of the Ukrainian Government’s Anti-Terrorist Operation this business community. (ATO), favours big enterprises and the supplies necessary for their operation. In contrast, the formal and informal obstacles erected initially by the Ukrainian side and later by the The study found that SMEs from the Non-Government Con- rebel authorities makes it extremely difficult for SMEs to move trolled Areas (NGCAs) have suffered a severe reduction in small commercial cargo and this puts them in a precarious their business activities as a result of military hostilities, law- position. As a result, small businesses that were otherwise lessness and ‘the rule of the gun’ in the rebel-held territories. keen to retain supply chains and business ties with Ukrainian Their connections with the rest of Ukraine have also been enterprises have ended up in a disadvantaged position. considerably disrupted. In order to craft creative policies and mechanisms which strike The evidence suggests that physical insecurity, the inter- a sensible balance between security needs and economic ruption of critical supply chains, and the depletion of local benefits (for both sides), decision-makers should consider markets as well as the prospects for restarting businesses regular revisions of the restrictive rules for crossing the line elsewhere primarily influenced the decision-making of locally- of contact, and other ways to maintain business connections founded SMEs in Donetsk and Luhansk. Neither political between the two sides – including the banking system, logis- preferences nor prior business ties with Russia adequately tics and taxation. Business opportunities lost . . . and found 3

Introduction

This study outlines how the armed conflict in the east of shares second place with the Kiev and Dnipro regions Ukraine has affected small and medium sized enterprises (0.3%)2. The Donetsk and Luhansk regions have an above (SMEs) from Donbass. It covers those SMEs which have average percentage of medium-sized businesses (6% remained in areas not controlled by the Ukrainian Govern- and 6.5%, respectively), while they have a smaller than ment and SMEs which have left those areas because of the average percentage of small businesses: 93.5% and conflict. The conflict in its east has severed many economic 93%3. The Donetsk and Luhansk regions are in the mid- ties, to the detriment of populations and livelihoods on both dle of the scale of the number of small businesses per sides. However, the specific ways in which businesses have 10,000 people in Ukraine4. The Donetsk region is among been affected and the coping strategies business owners the leading regions in relation to the number of medium- have employed need to be understood in order to broaden the sized businesses per 10,000 people. At the same time, scope of conflict transformation approaches, including the use the total volume of goods and services traded by the of economic measures. This study assessed the impact of the small business segment in the Donetsk region is 58 billion conflict (as well as the impact of policies adopted by the con- UAH, while in Kharkiv, where the ratio of small businesses flict parties) on the resilience, business optimism and political per 10,000 people is 86, this figure is 43.8 billion UAH agency of the SMEs. Two categories of businesses were sur- and in Zaporizhiia, where there are 76 small businesses veyed: those that stayed in Donetsk and Luhansk, and those per 10,000 people, their volume of production is 21.23 that left for Kharkiv and Mariupol. This analysis contributes to billion UAH. Therefore, the numerical data on the per- the search for peace constituencies across the line of conflict centage of businesses or people running their business and explores the niche that SMEs could occupy in conflict needs to be supplemented by their relative weight in terms termination, peacebuilding and post-conflict recovery efforts. of regional and sectoral economic turnover, the type of products they sell, the employment options they provide, The study focuses on the economic, social and political pro- etc. Consequently, the common view that the Donetsk file of SMEs originating from the current Non-Government and Luhansk regions are not entrepreneurial needs cor- Controlled Areas (NGCAs) of Donbass. Cities were selected rection. Against the background of massive job losses in as the basis of the analysis since SMEs tend to be predom- the big, labour-intensive industries of the Eastern Donbass, inantly concentrated in big cities. the SME sector’s prominence as an alternative employer becomes more significant. The operation of SMEs may The SME segment was selected as the focal point of the also be an important component in the (re-)integration study for the following reasons: of internally displaced people (IDPs). • The SME segment is comprised of economically inde- • These two regions score lowest on the ‘soft factors’ pendent agents that are self-employed and provide relating to attracting investment and the negative results employment to others. They are outside the oligarchic big of this have become increasingly visible in recent years. businesses and public service, are not employees, and, Low levels of business optimism and high levels of resil- thus, constitute a distinct social cluster of the population. ience seem to characterize the paradoxical SME segment • SMEs are natural allies in reforms that introduce fair play in the two regions. rules, curb corruption and safeguard freedom as the nec- • As in any industrial area, a sizeable proportion of SMEs essary condition for fair competition1. operate as part of the expanded infrastructure of big indus- • SMEs are usually immediately affected by the war as tries or are part of their supply chains for goods and services. they are vulnerable to the external security situation and Therefore, interdependence within the regional economy economic circumstances, and lack significant back-up is likely to be stronger than in the regions where the pro- resources. At the same time, SMEs are flexible and can duction and services sectors are relatively autonomous. adapt relatively easily to the changing context. Their Analysis of the behaviour of the SME segment vis-à-vis the coping strategies, aspirations and concerns are rarely massive disruption of industrial production and supply the centre of attention for the designers of peace pro- chains as a result of the military conflict, tests a common cesses, yet SMEs’ mode of operation – especially across assumption about the low degree of autonomy – eco- conflict divides – as well as their role in the rebuilding of nomic and political/administrative – of SMEs in the region. conflict-affected communities, offers a positive model amidst conflict. The ways SMEs from the NGCAs were affected by the con- • The Donetsk region has the highest percentage of big flict, the response options which were available to them, and enterprises in Ukraine (0.4%), while the Luhansk region the choices made by SMEs are analysed in this study. 4 Business opportunities lost . . . and found

The research process

Taking an analytical, as opposed to a legalistic, approach to vulnerable. With a large number of field researchers, ver- business activities, including illicit ones, allowed this study to ifying the accuracy of their performance becomes difficult. elicit the economic rationale of business operations in the It is next-to-impossible to create a random sample using conflict context and the areas where political obstacles lists of telephone numbers or addresses because people become economic burdens or economic opportunities. In change their place of residence, do not pick up their tele- this study, no assumptions were made about the dynamic phone when receiving a call from an unknown number, of the businesses which were studied. or the lists are not accessible at all. Surveying people by telephone or on the street is also risky. The research process involved several different elements: • Qualitative data, and qualitative methods of analysis, are • Analysis of the ways in which SMEs from the NGCAs preferred in this study because of the greater reliability and were affected by the conflict during its different phases, validity of the data. The downside of qualitative methods including by the policies and behaviour adopted by the is low levels of representativeness. However, if the pur- conflict parties. pose of the study is to infer tendencies in relation to ‘why people think/act this way’ rather than figures such as • An assessment of the relative weight of the political, busi- ‘what is the percentage of the people that think/act this ness and personal factors that determined business way in the population’, qualitative methods are an opti- choices (in relation to the type of activity undertaken, the mal choice5. location of the business, the market, the supply chain, etc.) in response to the conflict during its different phases. The sample of respondents consisted of entrepreneurs from • An assessment of social optimism, resilience and the the NGCAs who had either left for Kharkiv and Mariupol or agency of SMEs from the NGCAs vis-à-vis the conflict. stayed in Donetsk and Luhansk. A ‘Snowball’ technique was used to construct the sample (this is a non-probability sam- pling technique when a subject in the study is asked to help Methodology identify other subjects of the same type – businesspeople in this case). This technique is particularly useful where it is Field research was carried out from May to September 2015 difficult to locate people to form a sample. Using this tech- in Donetsk, Luhansk, Kharkiv and Mariupol. A triangulation nique, the sample was composed as follows: strategy (measuring parameters of the phenomenon under study by several methodologies) enabled the study to increase • 76 entrepreneurs were surveyed in Kharkiv, 68 in Mariupol, the rigour of the process and the data was collected by 57 in Donetsk and 50 in Luhansk. face-to-face and telephone surveys (that were agreed upon in advance with the interlocutors), focus group discussions, • 2 focus groups were run in Kharkiv (with 7 and 6 people, and in-depth interviews. respectively) and 1 focus group was run in Mariupol (with 8 people). The choices made with regard to the methodology used • In-depth interviews were carried out in Donetsk (8) and were defined by the specific demands of data collection in Luhansk (6). difficult contexts:

• In an environment of military hostilities, intimidation, sur- veillance and high emotions, data collection methods have to minimize risks for researchers and respondents. Therefore, presence in the field is discreet, low key, and human sources of data are kept confidential. • Surveys that require probability samples of over 1000 respondents in order to meet the standard of the com- monly accepted 5% margin of error are not useful in such contexts. This is because they unjustifiably increase risks and costs since many interviewers need to be involved, which makes the process of data collection visible, hence, Business opportunities lost . . . and found 5

Results and analysis

1. Business size and sector – and the Figure 1. Business profile: Donetsk sample decision to leave or stay Business size (%) >250 people 9% A majority of the SMEs which moved from the current

NGCAs to Kharkiv and Mariupol were involved in the pro- 51-250 people <10 people duction and industry sector in comparison with the busi- 20% 37% nesses which stayed in Donetsk and Luhansk (Fig. 1, 2, 3, 4). These businesses are likely to have been most affected by war and interrupted supply because:

Production and industrial cycles are sensitive to the availa- bility of raw materials, spare parts and other components 10-50 people 34% which are more difficult to replace compared to goods for retail trade or services. Business sector (%) Other 7% IT Retail trade 5% 20% Equipment is vital for the production and industry sector. Education 4% Businesses have lost workshop space and lost, or suf- Transport fered damage to, equipment in some areas due to shelling 7% and interruptions in the power supply in the areas of the anti- Construction terrorist operation (ATO). 4%

Production/industry As a rule, production and industrial businesses have more 9% significant cash flow, upscale office space, equipment and Agriculture Services vehicles in comparison with small retailers and service pro- 7% 37% viders. Hence, they were likely to be primary targets for looting (including of expensive equipment) and production space Figure 2. Business profile: Luhansk sample takeover by rebels and Russian military. This may have led to Business size (%) 51-250 people >250 people the termination of business activities. 4% 2%

2. Markets – and the decision to leave 10-50 people or stay 34% As part of the study, businesses were asked to indicate <10 people which markets they operated in from a choice of several 60% different categories: local (current NGCAs); current NGCAs and other regions of Ukraine; current NGCAs, Russia and the Commonwealth of Independent States (CIS): and Rus- Other Business sector (%) IT sia and the CIS. The “Other” category was used for busi- 4% Education 4% nesses which had markets that did not fit into any of these 2% Transport categories. 8% Retail trade 38%

• SMEs from the current NGCAs tended to cater predom- Construction inantly for the local market (Fig. 5, 6). The percentages 10% of businesses who have moved from the NGCAs to Production/industry Kharkiv and Mariupol that used to orientate themselves 6% exclusively toward markets elsewhere in Ukraine has not Agriculture exceeded 10% in either case (Fig. 7, 8). This is a ten- 8% Services dency in Ukraine, in general6. 20% 6 Business opportunities lost . . . and found

Figure 3. Business profile: Kharkiv sample Figure 4. Business profile: Mariupol sample

Business size (%) >250 people Business size (%) >250 people 17% 10%

<10 people 35% 51-250 people <10 people 19% 40%

51-250 people 16%

10-50 people 10-50 people 32% 31%

Other Other Business sector (%) Business sector (%) IT Retail trade IT 6% 4% Retail trade 4% 12% 4% Education 20% Education 6% 4%

Transport Transport 8% 7%

Construction Services 8% Construction 27% 9%

Services 24%

Production/industry 19% Agriculture Agriculture Production/industry 7% 9% 24%

Figure 5. Markets for businesses (%) before the conflict, Figure 6. Markets for businesses (%) before the conflict, Donetsk and Luhansk samples Kharkiv and Mariupol samples

Donetsk Other Kharkiv Russia and the CIS 2% 5%

NGCAs and other NGCAs and other regions of Ukraine regions of Ukraine 23% 39%

NGCAs 56%

Note: the values for NGCAs, Russia and the CIS and for Russia and the CIS are NGCAs Note: the values for NGCAs, Russia and equal to zero. 75% the CIS and for Other are equal to zero.

Luhansk NGCAs, Russia and Russia and the CIS Mariupol Russia and the CIS the CIS 2% 3% 2% NGCAs and other regions of Ukraine NGCAs and other 10% regions of Ukraine 26%

NGCAs NGCAs Note: the values for NGCAs, Russia and 71% Note: the value for Other is equal to zero. 86% the CIS and for Other are equal to zero. Business opportunities lost . . . and found 7

Figure 7. Markets for businesses (%) before the conflict • Those businesses which have stayed in Luhansk are cur- and at present, Donetsk sample rently orientating themselves exclusively toward the local

Market market, while about 10% of the businesses that stayed in NGCAs regionsNGCAs other ofand Ukraine Other Donetsk and continue to operate are still serving markets

No business activity in Ukraine which are outside their area of residence, although NGCAs, Russia and the CIS NGCAs, the and Russia this figure has halved in comparison with the time before Russia and the CIS No business activity business No

Russia and theRussia and CIS the conflict (Fig. 7, 8).

Market NGCAs, Russia and the CIS • The Russian market is still only a small part of the range At present At NGCAs

NGCAs and other regionsOther of Ukraine of markets catered for by the businesses which have stayed in Donetsk and Luhansk. NGCAs

Enterprises, % Before the conflict

At present Before the conflict 3. Changes in supply chains As part of the study, businesses were asked to identify their

Enterprises, % Figure 8. Markets for businesses (%) before the conflict and at present, Luhansk sample sources of supplies from a choice of several different categories: from Ukraine directly or via a third party; from Russia Market NGCAs regionsNGCAs other ofand Ukraine No business activity directly or via a third party; from other countries directly or via a third party; multiple sources including Ukraine (“Mixed Russia and the CIS NGCAs, Russia and the CIS NGCAs, the and Russia + Ukraine”); and multiple sources not including Ukraine

NGC, activity business No Russia and the CIS (“Mixed – Ukraine”). For businesses that did not require any Russia and theRussia and CIS Market supplies, the “No supply” category was used. An “Other” NGCAs and other regions of Ukraine category was used for businesses that had a source of sup- At present At NGCAs Other NGCAs ply that did not fit into any of these categories. A “No business activity” category was used for the businesses that stopped 0 20 40 60 80 100 their business operation. Enterprises, % Before the conflict

At present Before • Before the conflict, supplies from the rest of Ukraine con- stituted 44% to 60% of direct supplies to SMEs in the Enterprises, % current NGCAs, while another 5% to 30% of enterprises • Trading with both local and national Ukrainian markets were receiving supplies from Ukraine via third parties and is a stronger predictor for the decision to leave the area: as part of mixed supply chains. Thus, Ukraine was the 39% of those who left for Kharkiv had previously had their dominant source of supplies to all the SMEs surveyed markets within the area of their residence as well as else- (Fig. 9, 10, 11, 12). where in Ukraine, while only 10% of those who stayed in Luhansk had catered for the Ukrainian market. Businesses that used to cater to a diversity of markets are likely to have Figure 9. Supply chains (%) before the conflict and at greater competitive capacity, a broader network of con- present, Donetsk sample

tacts, and be known to clients outside their area of res- Enterprises, % 10 15 20 25 30 35 40 45 50 0 5 5050 idence – hence having a greater chance of re-establishing 4545 Ukraine directly 40 From 4040 their business activities in a new location. 3535 3030 25 via third via Ukraine 2525 party • No businesses among those surveyed in Luhansk andFrom 2020 15

Enterprises, % Enterprises, 1515

Donetsk used to be orientated toward the Russian market, % Enterprises, % Enterprises, 1010

directly 5 Russia while those businesses that left for Mariupol and KharkivFrom 5 5 0 0 From From From From From From Mixed + Mixed - No Other had previously had customers in Russia. Thus,Before the conflict having prior FromFrom FromFrom FromFrom FromFrom FromFrom FromFrom MixedMixed + +MixedMixed - - NoNo OtherOther Russia via Russia UkraineUkraineUkraineUkraine RussiaRussiaRussiaRussia via viaotherother otherother UkraineUkraineUkraineUkraine supplysupply party From business ties with Russia does not explain the decisionthird directlydirectlyviavia third thirddirectlydirectly thirdthird countriescountriescountriescountries partyparty partyparty directlydirectlyviavia third third to stay or leave. A broader geography of business ties party

countries partyparty directly other is characteristic of the businesses that decided to leaveFrom SourceSource Source for Kharkiv and Mariupol Before the conflict At present countries via third via BeforeBefore the the conflict conflict At Atpresent present other party From At present At Mixed + Mixed Ukraine Ukraine Mixed - Mixed supply No Other 8 Business opportunities lost . . . and found

Figure 10. Supply chains (%) before the conflict and at their way to the NGCAs, but via third parties (including via present, Luhansk sample corruption and other intermediary schemes to pass through

Enterprises, % the Ukrainian checkpoints) and as part of mixed supply 10 15 20 25 30 35 40 45 50

0 5 70 70 sources. At the time of the field research, it was by and

Ukraine 60 directly 60 From 50 large Ukrainian checkpoints that were named by the 40

via third via respondents as posing most difficulties for the passage Ukraine party From 30 of goods, most notably by introducing “passing fees”. The Enterprises, % Enterprises, % 20

directly checkpoints of the self-styled Donetsk People’s Republic Russia From 10 0 (DPR) and Luhansk People’s Republic (LPR) republics Before the conflict From From From From From From Mixed + Mixed - No supply Other Russia via Russia From From From From From From Mixed + Mixed - No supply Other party From Ukraine Ukraine Russia Russia via other other Ukraine Ukraine were reported as being relatively unproblematic. The situ- third Ukraine Ukraine Russia Russia via other other Ukraine Ukraine directly via third directly third party countries countries party directly via third ation changed in December 2015 after the introduction party countries party directly 7 other From of a ban on Ukrainian goods by the rebel authorities ). Source Source Nearly complete reorientation of SMEs toward Russian Before the conflict At present countries via third via Before the conflict At present other party From suppliers is most apparent in Luhansk. For SMEs that At present At Figure 11. Supply chains (%) before the conflict and at resettled in Mariupol and Kharkiv, about 50% of supplies Mixed + Mixed Ukraine present, Kharkiv sample for the 70 to 80% of operational businesses come from the rest of Ukraine, both exclusively and in combination with Ukraine

Mixed - Mixed Enterprises, % 10 15 20 25 30 35 40 45 50 0 5 60 other supply chains. Virtually no supplies come from Russia. Ukraine directly 50 From 50

supply 40

No 40 • Entrepreneurs in Luhansk and Donetsk state that Ukrain- via third via Ukraine 30 party From 50 ian suppliers and supplies are still preferred over those 20 Other 20 45 Enterprises, % Enterprises,

Enterprises, % Enterprises, from Russia because of a better price-quality combination 40 10 directly Russia From 35 and the proven reliability of partners. However, economic 0 From From From 30From From From Mixed + Mixed - No supply No

Before the conflict From From From From From From Mixed + Mixed - No supply No 25 blockades (most of the respondents imply economic block- Russia via Russia Ukraine Ukraine Russia Russia via other other Ukraine Ukraine business party From third directly via third directly 20third countries countries activity ades by the Ukrainian side, but some also mentioned the

party % Enterprises, 15party directly via third party 10 party improvised ban on Ukrainian supplies in the self-proclaimed countries directly

other Source From 5 Source republics and harassment of the entrepreneurs that were

Source 0 8 Before theFrom conflict From AtFrom present From From From Mixed + Mixed - No supply No countries Before the conflict At present found selling Ukrainian brands ) increased risks associ- via third via other party From Ukraine Ukraine Russia Russia via other other Ukraine Ukraine business

At present At directly via third directly third countries countries ated withactivity smuggling supplies from Ukraine to such an party party directly via third Figure 12. Supply chains (%) before the conflict andparty at Mixed + Mixed Ukraine extent that importing Russian supplies became a better present, Mariupol sample Source alternative. High checkpoint “passing fees”, intimidation Before the conflict At present Ukraine

Mixed - Mixed Enterprises, % 10 15 20 25 30 35 40 45 50 and the unpredictable behaviour of the guards were named 0 5 50

Ukraine among the factors that affected the decision by the busi- directly 45 From 40 supply nesses in Donetsk and Luhansk to substitute Ukrainian No 35 via third via Ukraine 30 suppliers with Russian ones. For most, this is an unfor- party From 25 Other 20 tunate decision. They look forward to the restoration of Enterprises, % Enterprises, directly

Russia 15

From normal – “just like before the war” – business relations 10

Before the conflict 5 with Ukrainian partners. Russia via Russia 0 party From third From From From From From From Mixed + Mixed - No supply No • Another important factor which prohibits sustaining busi- Ukraine Ukraine Russia Russia via other other Ukraine Ukraine business

countries directly via third directly third countries countries activity

directly ness relations with Ukrainian partners is the lack of legal other From party party directly via third

Source party possibilities for formalizing trade in goods and services Source countries via third via between businesses registered in the self-proclaimed other party From At present At Before the conflict At present republics, where registration is imposed by the authori- Mixed + Mixed Ukraine • At present, less than 2% of supplies reach SMEs in Donetsk ties and Ukrainian enterprises. Few can afford registra- and Luhansk directly from Ukraine, while the share of tion in both places (and, hence, double taxation). Some Ukraine Mixed - Mixed supplies directly and via a third party from Russia has micro businesses continue to operate outside any legal grown from zero to 70% for Luhansk and to 35 % for field, just like in the 1990s, however more visible busi- supply

No Donetsk SMEs (Fig. 9, 10). Ukrainian supplies still find nesses cannot run the risk of being prosecuted by the Other Business opportunities lost . . . and found 9

new authorities. Cases of torture, extortion and other types 4. The business dynamic since the of arm-twisting tactics applied to the reluctant enterprise beginning of the conflict owners are too well known. • Overwhelmingly, SMEs have experienced a decline in their • Financial transactions have also become complicated as business activities since the beginning of the conflict businesspeople based in Luhansk and Donetsk can do (Fig. 13). bank transfers or card payments to their Ukrainian clients • Approximately 30% of those who have left for Kharkiv or suppliers only in the territories under Ukraine’s control. and Mariupol stopped their business activities, while nearly Frequent travel across the line of contact is an increas- all respondents in Donetsk and Luhansk have retained ingly expensive and time-consuming exercise. Some do their business, although 80% of the respondents stated not feel secure when crossing checkpoints on either side. that they had experienced a decline in their business activ- • Due to the artificially-inflated exchange rate of the Ukrain- ities. Some of the Donetsk and Luhansk businesses ian Hryvna in the NGCAs, purchasing Ukrainian supplies started to gradually regain their pre-conflict positions. has become more expensive for businesses that oper- In order to remain afloat in the hope that the economic situation would improve, all had to set higher prices (but ate in the Ruble financial space compared to purchasing had to balance that with the sharply reduced purchas- supplies from Russia. ing power of the population); go for inexpensive goods, • Importantly, no cases of Ukrainian business partners hav- spare parts and raw materials; and opt for zero profit. ing violated contracts (mostly verbal and based on trust • There is a marginally higher percentage of growing busi- exclusively) or having not fulfilled their obligations under the nesses among those who relocated to Kharkiv and Mariupol force majeure premise were reported by the respondents. compared to those who had stayed in Luhansk and • Entrepreneurs that have left for Mariupol and Kharkiv retain Donetsk. This may be explained by better conditions for their Ukrainian suppliers, while they have not acquired business outside the area of conflict and fighting, as any Russian ones. The decline in the direct supplies from well as the specifics of the businesses that were easy to other regions of Ukraine is likely to be related to the relocate or which were not heavily dependent on the market and supplies inside the conflict area. Some growth suspension of business activities by 20% to 30% of the was detected in the NGCAs, mostly due to the exodus of internally displaced entrepreneurs surveyed. competitors in certain sectors. 9090 90 90 • The80 80survey80 80 respondent commentaries, focus groups and Changes in supply chains: getting across the line interviews7070 70 70 indicate a timeline of the changing business of contact dynamics6060 60 60 in the areas where there has been armed con- • Some businesses left behind in the NGCAs continue to frontation.5050 50 50 Entrepreneurs who had decided to leave men- receive Ukrainian supplies (goods, raw materials) across tion40 40June40 40 and July 2014 as the definitive moment: looting

checkpoints. The smuggling of commercial goods dis- andEnterprises, % 30Enterprises, % 30extortionEnterprises, % 30Enterprises, % 30 were at their most intense, and businesses guised as goods for personal use or as humanitarian 2020 20 20 aid is a popular tactic that may still require paying bribes 1010 10 10 Figure 13. The business dynamic since the beginning of at checkpoints. 0 0 0 0 the conflict DonetskDonetskDonetskDonetsk LuhanskLuhanskLuhanskLuhansk KharkivKharkivKharkivKharkiv MariupolMariupolMariupolMariupol • Marked goods made in Ukraine are not welcome in the Enterprises, % DeclineDeclineDeclineDeclineGrowthGrowthGrowthGrowthStabilityStabilityStabilityStabilityBusinessBusinessBusiness Businessactivity activity activity interrupted/stopped activity interrupted/stopped interrupted/stopped interrupted/stopped 10 20 30 40 50 60 70 80 90 self-proclaimed republics and business people can0 be 90

prosecuted for spreading Ukrainian “propaganda”.Decline 80

Donetsk 70 • Heavy or bulky cargo is impossible to get across the line 60

of contact without high bribes as the movementGrowth of trans- 50 port across the line of contact is prohibited. People can 40

cross on foot or in their private cars. Enterprises, % 30 Stability Luhansk • A new class of ‘middlemen’ has emerged who help with 20 10 commercial cargo and cash transfers across the line of 0 contact. Business activity interrupted/stopped Donetsk Luhansk Kharkiv Mariupol

Decline Growth Stability Business activity interrupted/stopped Kharkiv Mariupol Business opportunities lost . . . and found | Natalia Mirimanova 10

that had competitive office space, competitive locations pects for restarting businesses elsewhere were the defining and car pools as well as businesses run by individuals with factors in the decision-making of locally-founded SMEs in clear pro-Ukrainian positions were among the first targets. Donetsk and Luhansk. It is important to note that branches The events that convinced some to leave and evacuate of Ukrainian business chains, especially of West Ukrainian their businesses included the following: origin, found themselves in an extremely hostile environment and left because of political and security considerations or • When all the delivery and post services had been were pushed out, while their businesses were expropriated looted and this virtually stopped their operations. and rebranded by the new local masters9. The turning point • When there were no more possibilities for bringing for the service and retail businesses was when pension and goods and raw materials in from the Ukrainian territory. public sector salary payments resumed in the NGCAs around 10 • When reserves had been depleted at the end of July December 2014 . 2014 and there was nothing left to be sold. Reasons for the decline in business • When customers could no longer pay for any products beyond bare necessities. • Physical insecurity featured prominently as the reason • When shelling began and people around were get- to leave among those entrepreneurs who ended up in ting killed. Mariupol and Kharkiv. For those who stayed in Donetsk and Luhansk, physical security appeared to be less of a • When they had personal experience of extortion and concern (Fig. 14). physical assault by rebels and Russian military. • Loss of clients was the major reason for the decline of • When staff were leaving as well. Some enterprises had businesses, particularly for the businesses that stayed to completely re-recruit and train new staff. in Donetsk, possibly as it had the highest outflow of Thus, physical insecurity, the interruption of critical supply people who also had the greatest pre-conflict purchas- chains, and the depletion of local markets as well as the pros- ing power.

Figure 14. Reasons for the decline in business

100 90 80 70 60 50 40 30 Enterprises, % 20 10 0 Loss of More Shrinking Some of the Less Physical Lack of legal Lack of Other clients expensive market business investment insecurity possibility freedom of supplies activities for movement became cooperating across the irrelevant with line of partners and contact clients on the other side Reason

Kharkiv Mariupol Donetsk Luhansk Business opportunities lost . . . and found 11

• Entrepreneurs currently residing in Mariupol and in Donetsk Figure 16. Elements of businesses left behind in the NGCAs appear most inclined to retain economic connections (%) of businesspeople who moved to Kharkiv and Mariupol across the dividing line: they see the lack of legal possi- BusinessBusiness partners partners bilities for continuing business co-operation and restricted Market/customersMarket/customers freedom of movement as detrimental to their business activities and prospects. Entrepreneurs residing in Kharkiv Office/workshopsOffice/workshops and Luhansk are less dependent on economic connec- RawRaw materials materials tions with the other side. EquipmentEquipment PersonnelPersonnel Businesspeople from the NGCAs of Donbass in Mariupol WholeWhole business business and Kharkiv: torn between the two territories 00 1010 2020 3030 4040 5050 6060 7070 Enterprises,Enterprises, % % • Businesspeople who moved to Mariupol and Kharkiv partly or fully retain their business means (equipment, storage, KharkivKharkiv MariupolMariupol office, workshops), business connections, staff and clients Figure 17. Business prospects in the NGCAs (%) for in the NGCAs. This trend is more prominent in Mariupol businesspeople who moved to Kharkiv and Mariupol than Kharkiv. • Some evacuated their equipment, documentation and OtherOther other necessary means, either fully or partly. NoNo prospects prospects • Many suffered the loss of their entire business, either BusinessBusiness in inthe the NGCAs NGCAs without without physical physical return return through extortion or due to destruction during the war. BusinessBusiness in ina newa new location location Some were tortured and harassed. BusinessBusiness in inthe the NGCAs NGCAs upon upon return return at at the the earliestearliest opportunity opportunity BusinessBusiness in inthe the NGCAs NGCAs upon upon return return under under certaincertain conditions conditions Figure 15. Current location of business (%) of business- 0 0 55 10 10 15 15 20 20 25 25 30 30 35 35 40 40 45 45 50 50 people who moved to Mariupol and Kharkiv Enterprises,Enterprises, % %

Mariupol No business KharkivKharkiv MariupolMariupol activity 3% Business prospects in a new location (%) for Other regions of Figure 18. Ukraine businesspeople who moved to Kharkiv and Mariupol 25% Business in a new location and in the NGCAs BusinessBusiness in in a a new new location location and and in in the the NGCAs NGCAs

No return NoNo return return

Business in a new location NGCAs and BusinessBusiness in in a a new new location location other regions of NGCAs Note: the value for Business currently operational in the NGAs Ukraine 65% BusinessBusiness currently currently operational operational in in the the NGAs NGAs Russia and the CIS 7% is equal to zero. Return under certain conditions ReturnReturn under under certain certain conditions conditions

Return at the earliest opportunity Kharkiv No business ReturnReturn at at the the earliest earliest opportunity opportunity Russia and the activity 0 10 20 30 40 50 60 CIS 5% 00 1010 2020 3030 4040 5050 6060 1% Enterprises, % Enterprises,Enterprises, % %

Kharkiv Mariupol KharkivKharkiv MariupolMariupol NGCAs 41% • Nearly half of the businesspeople who relocated to Mariupol and to Kharkiv do not see any prospects for resuming business in the NGCAs (Fig. 17). • IDP business communities in Mariupol and Kharkiv demon- Other regions NGCAs and of Ukraine other regions of strate sharp differences with respect to the question of 45% Ukraine 8% returning home versus starting new businesses and new 12 Business opportunities lost . . . and found

lives in a new location (Fig. 17, 18). Those residing in Figure 19. Business prospects in the NGCAs (%), Mariupol are clearly willing to go back or to resume busi- Donetsk and Luhansk samples

ness activities from a distance at the earliest opportu- DoDo not not know know

nity. Meanwhile a significant number of them are ready NoNo prospects prospects

to adopt strategies to keep their business in the NGCAs OtherOther

afloat while they are away. BusinessBusiness after after the the blockade blockade is is lifted lifted • The option of continuing their business in the NGCAs HopeHope for for growth/stability growth/stability without physical return – as a temporary solution – is LocalLocal business business development development only only popular among businesspeople residing in Mariupol BusinessBusiness with with Russia/CIS Russia/CIS (Fig. 17). This mode of operation is risky, but the pay- NoNo business business prospects prospects before before end end of of conflict conflict back is much better compared to profits made outside 00 55 1010 1515 2020 2525 3030 3535 4040 4545 5050 the NGCAs. Due to the difference in the course of the LuhanskLuhansk DonetskDonetsk Ukrainian Hryvna in the GCAs and NGCAs, and 2-3 fold increase in prices in the NGCAs, business owners in business activities is a specific set of acts and conditions Mariupol benefit from the status quo. They appear to be that is assessed pragmatically. more flexible and willing to take risks than their Kharkiv colleagues who would often only consider the resump- • In the case of Kharkiv-based businesspeople, the results tion of business activities in the NGCAs if the necessary of co-variance of the current type of supply chain and the conditions are in place. prospects for the resumption of business in the NGCAs are in line with the findings of previous studies: the option • The business climate in their host community is also an of return for those who continue to receive supplies directly important factor which shapes an individual entrepreneur’s from other regions of Ukraine is not excluded, but it is choice to stay in the new location or to return home. conditional. According to the IDP businesspeople in Mariupol, the business community is hostile toward them, the rules Businesspeople from the NGCAs of Donbass in Donetsk for doing business are of the ‘survival of the fittest’ type, and the law is not respected. On the contrary, IDP entre- and Luhansk: business prospects in the NGCAs preneurs in Kharkiv appreciate the welcoming spirit of • A sustainable ceasefire is the most important condition their fellow businesspeople, as well as the assistance for the resumption of business in Donetsk. The lack of a available to businesses in the form of advice, training or sustainable ceasefire is an overwhelming burden for the financial help. The Kharkiv business community demon- Donetsk SME segment. strated understanding of the hardship faced by the IDP • The remaining threat of the resumption of armed hostil- businesses and was supportive (with lowered rents, making ities does not appear to be a significant impediment for concessions on payment delays, etc.) SMEs in Luhansk. The economic blockade is seen as a • IDP businesspeople in Mariupol who have not yet man- more detrimental condition. aged to resume their business activities are the most likely of all not to see business prospects in the NGCAs. • Luhansk entrepreneurs are hopeful and concentrate on This result may seem not to be in line with the previous the development of local business. finding that those with no currently operational business • Those in Luhansk who have reorientated themselves are more likely to return home at the earliest opportunity. towards Russian supply chains feel most hopeful. The discrepancy may be due to differences in the time • In Donetsk, those who have suspended business activ- horizons, with the ‘earliest opportunity’ being a more ities tend not to see prospects for business development distant moment in time than prospects for doing busi- in the absence of the sustainable cessation of armed ness in the NGCAs at present. This may also be due to hostilities. the concept of return as a psychological phenomenon, a goal that may be unattainable today, but the teleology • In Donetsk, receiving supplies from Russia is not a strong is defining the choices made at present. Resumption of predictor for feeling hopeful. Business opportunities lost . . . and found 13

5. Optimism Figure 22. Conditions for the improvement of the business environment • The Donetsk SME community is least optimistic about Enterprises, % 10 15 20 25 30 35 40 45 50

their current and future business. This may have to 0 do5 50

with the fact that the once well-off city has experienced economic Lifting 45 destruction on the greatest scale as well as a moreblockade dra- 40 matic relative decline in living and business standards 35 30 Kharkiv (Fig. 20, 21). 25

Ceasation ofCeasation 20 warfare

• SMEs which left for Mariupol are the most optimistic among Enterprises, % 15 the selected sample. This tendency may be explained by

Mariupol 10 the high share of entrepreneurs that manage to benefit 5 from their ‘dual’ status and keep doing business on both 0 incentives Economic Lifting economic Ceasation of Economic Provision of Other sides (Fig. 20, 21). blockade warfare incentives armed security • Economic incentives – in the form of favourableDonetsk tax pol- Kharkiv Mariupol Donetsk Luhansk icies, access to bank loans, etc. – do not seem to be armed securityarmed considered an important condition for improving the of Provision busi- • A ceasefire is the most urgent condition for the Donetsk

ness environment. This may be due to the longLuhansk disillu- business community, while reviving the – still preferred sionment of the business community and their habit of – commercial links with Ukraine appears to be an impor- relying on their own means. In their view, the best the state tant condition for Luhansk SMEs.

could do is not to interfere (Fig. 22). Other • The Donetsk and Luhansk regions scored lowest on business optimism11 with respect to the business environment Figure 20. Reasons for staying in business in the two regions. However, the tendency to rely exclu- Enterprises, %

10 20 30 40 50 60 70 80 90 sively on their own funds for business development is prom-

0 90 80 inent across Ukraine: only 22% were planning to get a future market Believe in theBelieve in 70 bank loan as opposed to the 82.7% of those who had growth 60 50 decided to invest their own funds to ensure their business 40 12 30 growth in the next 5 years .

Enterprises, % Enterprises, 20 Kharkiv return of stability

Believe in the Believe in 10 • IDP businesspeople in Kharkiv are least inclined to see 0 Believe in the Believe in the Other income It is an Other economic blockades as a major obstacle to the improve- future market return of stability generating adaptation Mariupol ment of the business environment. This could be explained growth options are mechanism of worse or non- sorts by the presence among this group of the greatest share worse or non- or worse Other incomeOther existent options are options generating Reason existent of those who have decided to start a new business in a Reason Donetsk new place, hence they do not associate their business Kharkiv Mariupol Donetsk Luhansk future with the NGCAs (Fig. 18). mechanism of mechanism Luhansk adaptation Figure 21. Reasons for staying in business, by location It is anIt is sorts Enterprises, %

10 20 30 40 50 60 70 80 90 6. Political preferences and agency

0 50

40 future market

Believe in theBelieve in Eliciting the general political beliefs and preferences of the

growth 30 entrepreneurs from Donbass was not part of this research. Other 20 However, their deliberations about political power and author-

Enterprises, % 10 ities vis-à-vis the hopes and concerns of the business com- Kharkiv return of stability

Believe in the Believe in 0 munity were solicited. Kharkiv Mariupol Donetsk Luhansk

Believe in the future market growth

Mariupol Overall, the SME community from the Donbass area is apo- Believe in the return of stability litical and does not claim to be a change agent. Throughout Other income generating options are worse or non-existent worse or non- or worse Other incomeOther options are options generating the phase of mounting tensions, the strategy of the business Reason existent It is an adaptation mechanism of sorts

Donetsk Other community in the areas of conflict was to wait and adjust. mechanism of mechanism Luhansk adaptation It is anIt is sorts Other 14 Business opportunities lost . . . and found

None of the respondents was an active participant in the protests or counter-protests on either side. The President of Ukraine, leaders of the self-proclaimed republics, and occa- sionally the President of Russia were named as the ones who should make peace, open borders and normalize the situation.

The specifics of the political-territorial arrangements seem to be secondary to the more immediate modus operandi preferred that implies free movement of goods and people, and the cessation of armed hostilities – “back to normal”.

Respondents in Luhansk and Donetsk demonstrate a pal- let of ideas on the current and future political course, ranging from reintegration into Ukraine to various degrees of autonomy and independence. However, business relations with Ukrainian partners are unanimously considered to be natural and preferential.

Economic obstacles for SME trade including limited access to banking and restricted movement introduced by the Ukrainian government are unanimously considered to be detrimental to business development within the NGCAs and to economic connectivity across the line of contact Business opportunities lost . . . and found 15

Conclusions

• SMEs from the current NGCAs have suffered a severe their great potential to become leaders (particularly in reduction in their business activities as a result of military industry-linked businesses including research and inno- hostilities, lawlessness and ‘the rule of the gun’ in the rebel- vation as well as other sectors where scientific and tech- held territories, as well as a disruption of connections nical capital could be acclaimed) on the other. with the rest of Ukraine. • SMEs from the NGCAs have been making their deci- • The temporary rules for the movement of goods, people sions regarding the location of their businesses as well and vehicles across the line of contact, issued by the as adjustments in their markets and supply chains based headquarters of the ATO, favours big enterprises and the predominantly on business calculations apart from the supplies necessary for their operation in order to keep basic physical security considerations. Politics appears large numbers of people employed on both sides of the to have not played a major role in the behaviour of this divide13. Their cargo is moved across the line of contact business community. The apolitical nature of small and by rail. However, insurmountable obstacles erected by medium sized entrepreneurs is an asset in the highly polar- the Ukrainian side, both formally and informally, on the ized conflict environment as it fosters pragmatic decisions movement of small commercial cargo puts SMEs in a and favours middle ground solutions. precarious position. As a result, small businesses that • SMEs from the NGCAs who left the area of fighting are were voluntarily, and driven by their business interests, ready to return and restart their businesses with the con- keen to retain connections with their fellow Ukrainian sup- dition that the situation is secure and under clear and pliers and clients ended up in a disadvantaged position enabling rules of commerce. Regular revisions of the since rail transport was too expensive and slow for their restrictive rules for crossing the line of contact and other types of cargo compared to big businesses. Dominant ways to maintain business connections between the two military security logic and the influence of proponents of sides – including in the banking system, logistics and cutting off the rebel-held territories seem to have overrid- taxation – are necessary in order to craft creative policies den the political logic of retaining not only humanitarian and mechanisms which foster balance between security but also pragmatic business connections with the popu- and the economic connections between SMEs. lation on the rebel-held side. • No references to the humanitarian-logistical centres which had been set up by the Ukrainian side to facilitate the movement of goods were made by any of the respondents. Instead, all complained about the arbitrariness and corruption at checkpoints. Several possible explanations for why the services of the structures established to facilitate the movement of small cargo were not in demand can be offered: information about the centres has not reached entrepreneurs; the centres were not helpful for taking perishable goods across the line of contact as the procedures for doing so may have been lengthy; the centres were set up in locations that were not easy to reach for the majority of the crossers, etc. However addi- tional research is needed to test these hypotheses. These centres need to be reconsidered in order to ensure both security and the flow of trade. • SMEs from the NGCAs – both those that stayed and those that left – demonstrate a high degree of resilience and a low degree of optimism. This is a paradox among Donbass SMEs. It is likely that it points to the persistent lack of affirmative action and empowerment of entrepreneurs outside the big industries on the one hand, and 16 Business opportunities lost . . . and found

Endnotes

1 European Bank for Reconstruction and Development (EBRD), for exam- консультаційна замовлення Державного агентства з інвестицій ple, places special emphasis on the importance of support for SMEs as та управління національними проектами України, Kiev 2014 [Kiev reform agents. See http://www.ebrd.com/what-we-do/sectors-and-topics/ International Sociology Institute and Institute of Economic Research why-small-businesses-matter.htm and Political Consultating, Investment attractiveness rating of the regions of Ukraine, (Kiev: 2014)]. 2 Enterprise size here is defined according to the following standards: micro = 0–10 employees, small = 10–50, medium = 51–250, big = over 250, 13 ТИМЧАСОВИЙ ПОРЯДОК контролю за переміщенням осіб, see Neighborhood SME Financing: Ukraine, European Investment транспортних засобів та вантажів (товарів) через лінію зіткнення Bank, February 2016. у межах Донецької та Луганської областей [Temporary rules of the control of the crossing of the line of contact within the limits of the 3 Рейтинг інвестиційної привабливості регіонів України 2014, Donetsk and Luhansk regions by persons, vehicles and cargo (goods)] Підготовлено Київським міжнародним інститутом соціології у and the Annexes 4 and 5, 12.06.2015, 24.06.2016.] available at http:// партнерстві з Інститутом економічних досліджень та політичних sfs.gov.ua/diyalnist-/zakonodavstvo-pro-diyalnis/nakazi-pro-diyal- консультаційна замовлення Державного агентства з інвестицій nist/63768.html та управління національними проектами України, Kiev 2014 [Kiev International Sociology Institute and Institute for Economic Research and Political Consulting, Investment attractiveness rating of the regions of Ukraine, Kiev, 2014].

4 Рейтинг інвестиційної привабливості регіонів України 2014, Підготовлено Київським міжнародним інститутом соціології у партнерстві з Інститутом економічних досліджень та політичних консультаційна замовлення Державного агентства з інвестицій та управління національними проектами України, Kiev 2014 [Kiev International Sociology Institute and Institute for Economic Research and Political Consulting, Investment attractiveness rating of the regions of Ukraine, Kiev, 2014].

5 There are statistical methods for small samples as well but for this exploratory study qualitative analysis methods sufficed.

6 Activity of Small Business Entities, 2012, Statistical publication, (Kiev: State Statistics Service of Ukraine, Kiev2013) available at www.ukrstat. gov.ua

7 http://sovminlnr.su/akt/06.01.2016/7.pdf

8 The formal ban on Ukrainian food stuffs and excisable goods had not been introduced in the Luhansk People’s Republic before December 2015, while there was no official ban in the Donetsk People’s Republic.

9 For example, the Lviv Chocolate Workshop chain, ATB supermarkets and others.

10 Pensioners and employees of big enterprises had to travel to the Govern- ment Controlled Areas (GCAs) to get their Ukrainian pensions. Russia transferred finances to the self-proclaimed governments for social payments, however their exact volume and periodicity is hard to verify.

11 Рейтинг інвестиційної привабливості регіонів України 2014, Підготовлено Київським міжнародним інститутом соціології у партнерстві з Інститутом економічних досліджень та політичних консультаційна замовлення Державного агентства з інвестицій та управління національними проектами України, Kiev 2014 [Kiev International Sociology Institute and Institute of Economic Research and Political Consultating, Investment attractiveness rating of the regions of Ukraine, (Kiev: 2014)].

12 Рейтинг інвестиційної привабливості регіонів України 2014, Підготовлено Київським міжнародним інститутом соціології у партнерстві з Інститутом економічних досліджень та політичних www.hd centre.org