TAX EXEMPTIONS FOR RUSSIAN, UKRAINIAN AUTO INDUSTRIES COME UNDER ATTACK…

The International Monetary Fund and the European Commission have attacked recent decision by the Russian and Ukrainian governments to attract direct foreign investment into their automobile industries. Although countries with large domestic markets can sometimes turn the rules of international trade to their advantage, developments in these countries show that such attempts do not always work.

Like many developing and developed economies, Russia and Ukraine restrict automobile imports. (Interfax, February 19, 21; Itar-Tass, February 17; Xinhua, February 20) These duties can then be waived for companies that form joint ventures with domestic automobile firms. In principle, foreign firms and domestic auto producers both gain from such arrangements: Foreign firms gain monopolistic positions in markets protected from imports, while domestic producers acquire the investment and working capital, as well as the modern technology and know-how, needed to produce more modern, competitive cars. Although host governments can gain privatization and tariff revenues from these arrangements, the benefits can be negated by tax exemptions used to attract the investment in the first place. The losers are domestic consumers, forced to pay higher auto prices, as well as other, potentially more competitive auto exporters. Still, the experience of countries like Poland shows that, if the domestic market is large enough and the domestic auto firms sufficiently attractive, limited tax rebates and tariff protection can be effective in attracting billions of dollars in new investment for domestic firms.

In practice, however, things do not always turn out this way. One problem is that foreign auto companies are often unwilling to invest billions in transition economies, and prefer instead to build assembly plants in the target countries, where imported components are assembled into finished cars. Ford recently began assembling cars in Belarus (which, under the Russo-Belarusan customs union, can be shipped to Russia duty-free); GM has been assembling Chevy Blazers in Tatarstan for a year; while Daewoo has been producing cars from kits in Uzbekistan for a number of years. Only Fiat, which pledged in November to invest $600 million in production facilities at the GAZ auto plant in Nizhny Novgorod, has been willing to risk actually investing in automobile production in these countries.

… but Russian Attempts Are More Likely to Succeed.