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 BOOTSTRAPPING UKRAINE’S TECH REVOLUTION, ONE STARTUP AT A TIME

Ukraine’s IT sector is often billed as a key part of the country’s economic future. But what challenges lie ahead for the industry? What can Ukrainian society expect from tech?

When Yuri Dobronravin tried to enlist in the Ukrainian military after the annexation of Crimea in spring 2014, officers at the recruitment station told him that his expertise in anti-aircraft systems wouldn’t be needed. Dobronravin, a programmer, had been active in the protests that toppled former president Viktor Yanukovych in February 2015 — and he wanted to use his technical knowledge in Ukraine’s emerging war against separatists and Russian regulars in the east. He started working as a volunteer programmer instead, creating digital maps of the war zone at a time when, as Dobronravin, puts it, “the Ukrainian army didn’t even have paper maps.”

Over the next few months, as fighting escalated and fears of an all-out Russian invasion spread across Europe, Dobronravin and a group of volunteer programmers developed complex military maps and communications software for the Ukrainian military. They called themselves “Army SOS” and soon, they brought the technology to UaRpa, a Ukrainian startup company founded by a former deputy minister of defense. Armed with a team of engineers, coders and other IT specialists, Ihor Kabanenko, the startup’s founder, says UaRpa grew out of the understanding of “the importance of technology in the new hybrid conflict.” Like DARPA, the US Department of Defense’s research and development arm, UaRpa is trying to prepare the Ukrainian army for “next generation warfare”.

The company now employs more than 100 people, and furnishes the Ukrainian military with a variety of advanced defense technologies, including laser anti-sniper detection systems, laser rangefinders, a tablet-based intelligence system designed to improve targeting and NATO-grade armour. It is, in essence, picking up the slack for state-run behemoth defense manufacturer Ukroboronprom.

By the numbers: engine of the economy? 

Since EuroMaidan, Ukraine’s IT sector has been hailed as the next “engine” of the country’s economy. Recent success stories, such as Snapchat’s $150m purchase of Odesa startup Looksery in 2015, have been well-covered in local and international media, giving industry advocates hope for the future. The sector has grown from accounting for just.06% of Ukraine’s GDP in 2011 to 3.3% in 2015 and, according to PricewaterhouseCoopers, it is expected to double in size by 2020.

Despite Ukraine’s sluggish economy, which shrunk by 10% last year and is expected to grow by just one percent this year, the IT sector continues to flourish. In the first half of 2016 alone, it received $1.5 billion in orders. Even though Ukraine graduates more engineering students every year (130,000) than any other country in Europe, the industry is growing faster than institutions can pump out programmers. In April of this year, it was reported that there were 2,200 vacancies at Ukraine’s 25 largest companies alone.

Tech has boomed largely in major urban centres: 86% of all developers live in Kyiv, Kharkiv, Lviv, Dnipropetrovsk and Odesa. Nearly half of all Ukrainian developers live in the capital, where salaries are many times the national average. Although there are no official figures on IT salaries, executives interviewed for this story said the median salary at outsourcing companies (more than half of the economic activity in Ukraine’s IT sphere comes from outsourcing) in Kyiv is between $1,000 and $1,500 per month. According to information compiled by djinni.co, the average salary in Kyiv is much higher: $2,180 per month. In a country where the average monthly salary is $200, tech is forging a new upper class — not a new middle class, as industry leaders often contend.

There are no sprawling tech campuses in Kyiv (most companies rent out small apartments or offices), but IT’s footprint on the capital is noticeable other ways. Brooklyn-style speakeasies and other hipster oases are scattered across the city centre, and young Ukrainian programmers pack trendy Georgian restaurants on the weekends. Downtown Kyiv is no longer the playground of bureaucrats and shiny-suited businessmen. When you ask restaurant proprietors about their new clientele, the answer is always the same: aitishniki(IT workers) and foreigners.

This landscape makes many in the industry contagiously optimistic. In much the same way Silicon Valley imagines a future in which tech cures all manner of economic and societal ailments, the hopes of the Ukrainian economy are increasingly pinned on the IT sector. Agricultural inefficiencies? Smart agriculture will solve them. Corruption? Tech will make politics transparent. No middle class? Tech will create one.

Industry leaders see the transformative power of tech already taking hold in Ukraine. Andrey Kolodyuk, an entrepreneur and the chairman of the Ukrainian Venture Capital and Private Equity Association (UVCA, an industry advocacy group) supervisory board, told me: “Ukraine has been searching for a national idea for many years. Now the national idea for everyone is to build a company, how to build something out of Ukraine. It’s not like it’s happening overnight, but tech is the bridge between the old Ukraine and the new Ukraine.” 

With or without Bankova

The industry’s growth has come in spite of Ukraine’s government. Army SOS and UaRpa are emblematic of the emergence of the tech industry in Ukraine: with an ossified bureaucracy and a leadership that has been slow to appreciate the economic value of IT companies, the government has done little to support the sector; it has had to develop on its own. According to Kolodyuk, “Ukraine’s IT industry is the only one in the one in the world that was built without government money and government involvement and government support.”

This has been a blessing and a curse. Whereas most tech economies develop with the help of state resources, Ukrainian companies have had to bootstrap their way to profitability or secure international funding. At the same time, this has meant that the industry has largely avoided the excessive regulation that executives say plagues other tech economies.

Since 2011, between 34% and 46% of all financing has come from foreign investors. Of the $132m invested in Ukrainian IT in 2015, 46% came from foreign investors.

This international funding has largely come from “friends of Ukraine” recently. Most prominently, last year George Soros’s hedge fund invested between $20 and $50 million (the official amount remains undisclosed) in Ciklum, a software development and outsourcing company that has offices in the US, Romania, Israel, Poland and Spain. The equity fund Horizon Capital invested a similar amount in Rozetka.ua, Ukraine’s largest e-commerce company, also in 2015.

Both investors have heavily promoted Ukraine’s democratic development for years, however, making it difficult to discern their business interests from political ones. Critics cite Soros’ longstanding support for civil society initiatives in eastern Europe and Horizon Capital’s relationship with USAID as evidence that the industry’s success is not as homegrown or independent as some would like.

So far, the sector has avoided oligarchic involvement, in large part because startup companies know that oligarchic financing may “poison the well” for future rounds of funding. According to Kolodyuk, the situation is analogous to Russian state capital: “Anybody will tell you that if a Russian company has Skolkovo money [a Moscow tech centre financed from Russia’s federal budget], no one is going to invest in them because of risk mitigation, and it’s the same with the oligarchs. No one wants to be sued because the oligarchs stole money from somewhere. Not to mention that startups have a sense of patriotism.” Indeed, with the exception of the telecommunications industry, Ukraine’s IT sector is oligarch-free.

Going it alone

When entrepreneurs Andreas Flodström and Gustav Henman founded Beetroot, a Swedish-Ukrainian IT resource company, in 2012, they chose to base their operations in Kyiv in part because of the lack of regulation.

“One of the reasons that we picked Ukraine instead of Russia or Belarus is that there are fewer barriers to getting started here,” Flodström told me. What’s more, taxes on the sector are extremely low, with most companies paying a flat rate plus relatively minimal social fees. Eighty percent of Ukrainian IT specialists pay a flat four percent tax rate (now raised to five), according to Elena Minich, the head of the department of innovation and intellectual property in the ministry of economic development.

This has become a cause for concern at the national level, and there are ongoing discussions about how to raise tax rates without crippling the industry. Even tech executives like Flodström and Henman think IT companies can afford to pay more. As they wrote in an e-mail to me, “We would like to see a gradual and organized increase together with a simplification of the whole system. Unfortunately, as the situation is now, a lot of the money that could have gone to paying taxes is going to dealing with bureaucracy instead.” Although tech is thriving, low tax rates mean money is flowing into bureaucrats’ pockets and Kyiv’s bars and cafés, rather than filling holes in the national budget.

Indeed, the government hasn’t been as hands-off as Flodström and other tech executives would like: “It’s not like the authorities are so welcoming. I don’t know that things are so much better since Yanukovych left. But at that time you would try to avoid the authorities at all costs. Now it is possible to have a dialogue with authorities, at least at the central government level.”

Tech libertarianism

It is perhaps unsurprising that as the tech industry comes to the fore in Ukrainian society, so too do libertarian tendencies associated with it. In light of increasing disenchantment with the country’s leadership and institutions, this makes sense.

According to recent surveys, Ukrainians have a negative opinion of nearly every high-ranking public servant; in a recent poll, only one percent of those surveyed fully supported the cabinet of ministers. Recent revelations about state officials’ extraordinary wealth have only fueled Ukrainians’ longstanding suspicions that public servants don’t actually serve the public. Although the 2014 revolution initially gave Ukrainians hope that a new cadre of politicians would better represent their interests and strengthen their institutions, Ukrainians are now seeing that the post-Maidan cohort may just be a western-looking iteration of the Yanukovych regime.

This libertarianism has manifested most strikingly in some people’s newfound appreciation of Ayn Rand, whose Atlas Shrugged was a bestseller in Ukraine in 2015. It’s easy to see why IT employees might like her: technology, Rand once argued, is “the ultimate step, the implicit purpose, of man’s quest for knowledge.” Max Ishchenko, the founder of the popular tech blog and job sitedou.ua, and other IT leaders are said to espouse Rand’s objectivist ideology.

Indeed, one of the loci of this budding individualism is technology. As a Ukrainian friend and startup founder told me, there is a feeling that “We’re going to have to do things ourselves now. The government isn’t going to do things for us.” IT provides hope for younger Ukrainians looking for a way out of poverty. As Kolodyuk argued, many in the younger generation of Ukrainians are saying: “I don’t need to go to Europe to work in construction or to clean houses. I can stay and build something.’”

Raids

Though it’s largely stayed out of tech, the Ukrainian state maintains particular kind of interest in the IT sector.
Over the past two years, tech companies have been subjected to “searches” by police and other branches of the government at a rate of about one every two weeks.

The raids often follow a similar pattern, Kolodyuk told me: officials arrive at a tech office alleging illegal activity and seize the company’s servers, essentially stopping a company’s work. And these raids have had a significant impact: “Can you imagine what the industry’s numbers would be without these raids? People put investments on hold.” Still, Kolodyuk says there’s been a “dramatic change” in the number of raids since the Yanukovych administration, allowing the “whole industry to start breathing again.”

There’s more to be done, however, and Kolodyuk and other business leaders are pushing for legislative reform to prevent the seizure of servers. The way the law stands now, investigators can search and seize companies’ servers without proof of malfeasance, often extorting the owner of the server in the process. UVCA and the IT Ukraine Association have been working with lawmakers to pass a bill amending Article 51 of Ukraine’s Criminal Code that would ban the “temporary seizure of electronic information systems or their parts, of mobile terminal communication systems.

The bill also supplements Article 223 of the code in order to make it illegal for law enforcement officers to wear masks and brandish weapons (except in extraordinary circumstances) during searches. The bill passed in its first reading, and seems likely to improve the investment climate, which, though markedly better than in other sectors of the economy, suffers from a lack of legal certitude.

As Viktor Valeev, the director of the IT Ukraine Association, told me, many of Ukraine’s political and financial heavy hitters are beginning to throw their weight behind the IT industry. For example, Anton Herashchenko, a security hardliner who heads the Verkhovna Rada’s Committee on Law Enforcement Agencies, was one of several deputies to sponsor the bill banning the seizure of servers. Dmytro Shymkiv, deputy head of the Presidential Administration on administrative, social and economic reforms, and the former CEO of Microsoft Ukraine, has been the government’s chief tech advocate.

“Hands off IT?”

As the industry grows, the government is slowly realising that it must formulate a state-level policy to support it. As Valeev says, “Poroshenko is now telling [law enforcement agencies] ‘hands off IT, get out.’ So [supporting] IT right now is becoming policy. We know about state industrial policy. We know about agricultural policy. IT right now is an exporter, and we are going to have a specific policy to develop IT, but as a player at the state level we are still too young.”

And there the government has taken some steps towards articulating an official state policy recently. On 4 November, parliament passed a bill specifically designed to help IT that reduces barriers on the export of certain services. Perhaps the most important step in this direction came in July, when IT leaders met with Poroshenko to discuss the country’s business and investment climate. In addition to the proposal to offer companies protection from raids, UVCA proposed six initiatives to support the IT industry at the meeting, including establishing a “Fund of funds” and a state office responsible for innovation policy. Poroshenko reacted positively to the meeting, noting that raids on tech companies “bring no benefit to the government, Ukraine’s image, or to the judicial system.”

Poroshenko’s acknowledgement of the importance of IT is an important step in the right direction, though the lack of state resources devoted to it may mean that the sector has a growth ceiling. Outsourcing is poised to remain the driving force in the industry, though the very things that make Ukraine attractive to foreign companies — cheap labour and living costs — mean that the success of IT in Ukraine is predicated on overall economic weakness.

If the cost of business becomes too high, companies will pack up and leave. The answer may be found in the domestic IT economy, which will require state support: the government must find ways to develop IT infrastructure, ensueconore legal protections for companies and establish a tax system that invites investment but also grows the state coffers. The IT sector’s concerns are, broadly, the same as almost every other part of Ukraine’s economy.

By Isaac Webb, Open Democracy
 
 
 
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