Localization in Public Procurement Won’t Function as Intended and Here’s Why

Supporting national producers, especially in wartime, is a logical and rational step. However, like any idea, it can be brought to life in various ways. One can promote Ukrainian producers abroad, encourage citizens to give preference to domestic goods, and help businesses develop and become more competitive.

In 2021, for some reason, Ukraine chose to support national producers through preferences in public procurement, specifically in respect to engineering goods for now. These goods must have a sufficient percentage of the Ukrainian component so that they can be purchased on Prozorro in tenders. Restrictions cover, for example, turbines, pumps, transformers, generators, trolleybuses, and buses.

Our DOZORRO project warned about the risks all this time while MPs were promoting the relevant law. First of all, this approach basically involves limiting competition, and this is bad. Competition ensures the development of the field. Producers compete for the customer by offering better prices and higher quality. Localization, according to the plan of its initiators, should gradually limit access to public procurement for foreign companies, that is, to create conditions where Ukrainian companies would compete only among each other. In the case of machine-building companies, this is literally several businesses per industry.

However, the main obstacle, due to which the approval of localization was stretched for a year and a half, was that the primary version violated Ukraine’s international obligations, in particular within the framework of the Association with the EU and the World Trade Organization.

As a result, a compromise option was approved, which in fact did not apply to procurement that was subject to international agreements. That is, public procurement remained open to the EU, the United States, Japan, and a number of other countries. Instead, localization was supposed to protect Ukrainian business from competitors from Russia, Belarus, China, and Turkey. By the way, Ukraine plans to ratify a free trade agreement with Turkey soon. Then we will have to facilitate bilateral trade between the countries.

The localization “functioned” this way for two years

Localization did not function immediately after the adoption of the law. For another six months, the Cabinet of Ministers was developing a procedure for how it should work. It turned out to be quite formal: producers of goods must fill out an electronic form with localization calculations, and the Ministry of Economy must check the mathematical correctness of these calculations. Entrepreneurs are not required to provide any other confirmation of a sufficient level of the Ukrainian component in the goods. All products in which the formula converges fall into a special list. Participation in tenders subject to localization is possible only with the goods of producers from this list.

We warned that this formula would not work. Firstly, this scheme does not provide for real verification of the reliability of the data provided by producers. Producers themselves calculate their share of localization and enter it into the system. Secondly, real information about the share of goods of Ukrainian and foreign production is production details that are generally difficult to confirm. They are hardly unchanged throughout the year. A product may be added to the list in January, for example, a tractor. Its localization was calculated in one batch, containing Ukrainian bolts, nuts, and wheels. However, who can guarantee that the August batch will consist of the same parts and that the producers will not use, say, Chinese bolts?

What do we have in practice? 100% localized production of Mercedes-Benz Sprinter (Germany, but production can be implemented jointly with other countries) and Forte and Pezal generators (China).

There are not-so-obvious but suspicious stories. For example, the degree of localization of almost all products of Ukrtranssignal LLC included in the list in 2023 was 48.45%, while that of PJSC Svessa Pump Plant had 80% in all products. What is the probability that different products from the same producer have the same percentage of Ukrainian parts?

An attempt to enhance control

In late May of this year, the government introduced changes to the localization rules. Now, producers will be required to provide additional documents, including certificates. In addition, a procedure for appealing localization is planned to be launched. While it is unclear how this will function in practice, the government has yet to develop an appropriate procedure. However, it will most likely be an opportunity for a business to complain about a competitor if the latter has potentially miscalculated the localization of its products. These complaints will be considered by the Prozorro System Activity Commission, which, by the way, I am a member of.

Even Dmytro Kysylevskyi, one of the main initiators of localization and Deputy Chair of the Parliamentary Committee on Economic Development, admitted that it had not functioned these years. He blames business representatives for not showing integrity when entering foreign goods into the list of localized ones and calls them frauds. In his opinion, control and liability will solve the problem.

However, the lack of control is only the first, most superficial problem. Underneath is the issue of who calculates the percentage of localization and how. Producers themselves provide such information once a year.

Control over localization is to be assigned to the commission, which was created primarily to consider the functioning of electronic platforms and determine what sensitive information should be hidden from Prozorro in wartime. As its member, so far, I have little idea of how I will rummage through the documents of some company to understand whether it indicated the real percentage of localization in the system. Do my colleagues and I have the competence to do this? Will we be responsible for the fairness and truthfulness of the register of localized goods? By the way, the decisions of this commission are advisory in nature.

I am still inclined to think that, first of all, it is necessary to reconsider the very idea of localization as the best way to support domestic producers. After all, the entire economic argumentation of this initiative is based on calculations of the share of imported goods in public procurement based on cross-sectoral balances made by experts of the Economic Committee of the Verkhovna Rada when adopting the law on localization. We are told that imports account for 40%, but we have not seen these calculations and do not know their methodology. We can easily calculate the share of foreign companies that win tenders on Prozorro through the BI Prozorro public analytics module. However, of course, Ukrainian business does not always sell domestic goods on Prozorro. Therefore, the issue of prompt calculation of imports in public procurement is almost an impossible task.

Now, we do not see whether localization has somehow helped Ukrainian companies. I may be mistaken, but I have not seen such statistics provided by MPs or the government. However, the business now has more paperwork. The Ministry of Economy also has more work, as well as procuring entities conducting procurement with localization. Now, even more work will be assigned to the commission on the activities of the Prozorro system. The Antimonopoly Committee and the State Audit Service are also to be engaged in monitoring and ensuring liability for compliance with localization rules.

How rational is this resource expenditure during a full-scale war? Shouldn’t we focus more on control over reconstruction and admit at some point that localization in public procurement does not function? It’s not because business representatives are frauds. Not because the Ministry of Economy is doing something wrong. But because it was basically a bad idea from the start.

This publication was prepared with the financial support of the European Union. Its content is the sole responsibility of Transparency International Ukraine and does not necessarily reflect the views of the European Union.