location in the north-west industrial district of Grodno on the borders with Poland and Lithuania and within the territory of Free Economic Zone «Grodnoinvest».

**Vertical conglomerates comprise a large final output assembly plant and include many smaller producers of intermediary goods.** Final goods assembly enterprises are employment-wise seven times larger than intermediate goods producing enterprises; they are also more export-oriented (Table 1.4); pay higher wages and employ more capital intensive technologies.  In addition, these vertically integrated enterprises are often located in towns where they are among the largest employers. For example, MMP’s subsidiary in Stolbtsi employs about 1500 people that are almost 10 percent of the total population of Stolbtsi (Table 1.5).

Table 1.4: Characteristics of vertically integrated enterprises (annual weighted averages 20052010)

||**_Size (average_**<br>**_employment)_**|**_Average wage,_**<br>**_BYR million per_**<br>**_year(2010)_**|**_Share of labor costs in_**<br>**_total costs_**|**_Share of_**<br>**_imported_**<br>**_materials_**|**_Share of_**<br>**_exports_**|
|---|---|---|---|---|---|
|**SOEs (all enterprises)**|1,428|13.80|15.6%|32.9%|58.3%|
|Vertically integrated|7,305|16.19|12.8%|33.3%|71.3%|
|final assembly<br>enterprises||||||
|Vertically integrated<br>intermediary goods<br>producingenterprises|1,033|12.38|21.9%|20.7%|21.2%|

Source: Authors estimates based on the NBRB dataset.

Table 1.5: Vertically integrated enterprises <u>of Minsk Motor Plant (key characteristics)</u>

|**_Name of the enterprise_**|**_Role_**|**_Employment_**<br>**_at the_**<br>**_enterprise_**|**_Km from_**<br>**_Minsk_**|**_Employment_**<br>**_as a share_**<br>**_of total_**<br>**_population_**|
|---|---|---|---|---|
|Minsk Motor Plant|Final Assembly line|5800|0|0.3%|
|Gomel enterprise of engine starters|Subsidiary|530|302|0.1%|
|Zhitkovichsk motor works|Subsidiary|530|122|3.3%|
|Lida mechanical enterprise|Subsidiary|480|160|0.4%|
|Radiovolna factory|Subsidiary|2000|386|0.6%|
|Subsidiary in Stolbtsi|Subsidiary|1480|79|9.6%|
|Enterprise BZA|Subsidiary|1500|100|1.0%|

Source: Authors estimates based on information provided by the Ministry of Industry.

**The economic rationale underlying vertical integration of production is to ensure governance.** How would otherwise the producer of final products guarantee that intermediate parts would be available on time and quality?<sup>9</sup> Vertical integration has contributed to improve reliability of supplies of critical components and has streamlined negotiations regarding cost and price structure of these components; and, in recent times, it has helped maintain continuity of production process and preserve production capacity.

**But vertical integration has also helped mask inefficiencies within SOEs with profit making firms cross-subsidizing loss-making firms** . A finished product of a firm within a vertically integrated conglomerate is an intermediate product for another member of the conglomerate and its price is, often, not subject to a clear market benchmark.  According to procurement law, a tender is not required

> 9 A similar solution happens in market economies when transaction costs are high.  See the study on determinants of vertical integration in the US automobile industry by Monteverde Kirk and David J. Teece , Supplier Switching Costs and Vertical Integration in the Automobile Industry, The Bell Journal of Economics, Vol. 13, No. 1 (Spring 1982), Pp. 206-213.

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